Recent amendments to the Corporations Act 2001 (Cth) (Act) tighten restrictions on termination payments which can be made to executives without shareholder approval.
This article discusses the key changes and looks at the implications for employers.
Background to amendments
The changes to the Act to restrict termination payments to executives were first announced in March 2009 by the Federal Government amidst negative media surrounding what were perceived as excessive retirement payments to executives.
The Federal Government's response on executive termination pay came into operation on 24 November 2009, in the form of the Corporations Amendment (Improving Accountability on Termination Payments) Act 2009 (Amending Act). The Amending Act applies to any new employment contracts entered into on or after 24 November 2009, and any existing employment contracts varied on or after 24 November 2009.
Significantly lower threshold
Previously, termination benefits to directors and certain executives could reach up to seven times a recipient's total annual remuneration before shareholder approval was required. The key change brought about by the Amending Act is that termination benefits paid to directors or certain executives are limited to one year's base salary, unless shareholder approval is obtained.
There is a formula in the Amending Act to calculate a person's "annual base salary". This formula is based on the average amount of base salary received by the person in the last three years of service.
Extension of scope to executives – who is covered?
The category of individuals captured by the Amending Act is broader. Under the Act (pre-24 November 2009 contracts), the requirement to obtain shareholder approval for termination benefits applies only to company directors (and certain executives who act as "de facto" directors). Now, the Amending Act (24 November 2009 contracts onwards) applies to senior executives or key management personnel. The effect is that for a disclosing entity, the category includes directors, and employees whose details were included in the directors' report for the previous financial year. For all other entities, the category includes directors in the company and any individuals who hold a position connected with managing the company who are also directors of a related body corporate.
What type of benefits are captured?
Under the old regime, there was legal ambiguity as to whether certain types of payments met the definition of a termination payment, and therefore, whether the payments required shareholder approval. The Amending Act has clarified and expanded the categories of payments taken into account. For instance, the definition includes any payment or other valuable consideration, any kind of real or personal property, any legal or equitable estate or interest in real or personal property and any legal or equitable right. Further, the Amending Act specifies that a broad interpretation should be given to the definition of "benefits" and that the economic and commercial substance of the conduct is to prevail over its form or description. This is said to be designed to allow Courts to respond flexibly to changes in executive remuneration conditions. The effect is likely to be that almost any type of conceivable benefit is captured.
Who votes on approving the payment?
Under the new regime, there are restrictions on who can vote in the shareholder approval process. The individual who the payment relates to, or an associate of the individual, is prohibited from participating in the shareholder vote about whether to approve their termination payment.
What are the penalties involved?
The penalties for a company paying a termination benefit in breach of the shareholder approval provisions have been strengthened to $19,800 for natural persons or imprisonment of up to 6 months, or up to $99,000 for a body corporate.
Implications for employers
The Amending Act introduces a significant tightening on the restrictions surrounding executive termination payments. Employers must be cautious about how benefits connected with termination are provided. As a first step, employers should audit termination clauses of all executive contracts or any other enforceable terms giving rise to benefits (such as salary increase letters) to ensure any termination benefits do not have unintended consequences arising from the operation of the Amending Act. Remuneration should also be reviewed with a view to ensuring termination benefit compliance.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
