New termination payment laws first announced in March moved a step closer with the release by the Government of an exposure draft of the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009 on 5 May.

We had previously expressed our concerns regarding the details in the initial announcement and subsequently reported on the clarification by the Minister for Superannuation and Corporate Law in his letter to the Australian Financial Review in late March. (See our April article HERE.)

While supportive of the need to reduce the threshold payment level requiring shareholder approval from the current seven times annual remuneration, we retain reservations concerning the practical and commercial implications of the measures outlined in the exposure draft. 

Guerdon Associates has made a submission to Treasury in relation to the Bill (see our submission HERE).

Our submission to Treasury in response to the draft focuses on a number of key issues outlined below.

1. Persons covered by the new law

The proposed law extends coverage of the shareholder approval requirements from company directors to persons holding a “managerial or executive office”, which includes:

• Those named in the remuneration report for listed companies (being key management personnel and the five most highly remunerated officers, if different); and
• Persons who are directors of non-listed companies

An individual who has at any time in the previous three years held a “managerial or executive office” in a company or a related body corporate would also be captured by the approval requirement.  As many large companies have numerous subsidiaries, this could substantially expand the number of employees falling within the operation of the proposed legislation.

While shareholders have traditionally exercised some level of control over benefits paid to directors, it is difficult to reconcile the need for them to intrude into what are effectively operational matters associated with the actual running of the company, responsibility for which they delegate to their elected directors (and which is reported back to shareholders through the extensive disclosures provided in remuneration reports.)

2. Threshold payment level for shareholder approval

The current legislation sets the threshold above which payments must be approved by shareholders at seven times a director’s total remuneration, which we consider too high.  However, reduction to the proposed level of one times base salary is too severe and risks promoting an increase in base salaries and a commensurate reduction in the amount of variable remuneration.  This is contrary to good remuneration governance and shareholders’ interests.

The draft Bill sets out methods for calculating one year’s base salary where the individual has held office for less than three years.  Although the formulae generally establish an average salary for the employment period, there is a particularly harsh treatment for those who have worked for less than one year.  In those circumstances, the termination payment is restricted to the pro rata amount of the estimated annual base salary.  This is an extremely punitive and unfair approach that does not recognise the varied circumstances that might lead to a termination event or the potential financial impact on a senior executive of the loss of employment, possibly in circumstances unrelated to performance.

The proposed limit also creates concern regarding Australia’s international competitiveness in attracting executive talent.  Termination payments for North American executives are typically about three times base salary plus bonus, while the Europeans, in their new governance guidelines released recently, are content to set the level at twice base salary.  Although the UK has a 12-month contractual period requirement, the UK practice is voluntary (on a comply or explain basis) under the Combined Code, and no shareholder approval is required for variation. 

Australian companies frequently search internationally for senior executives.  It is sometimes argued that the combination of geographic isolation, onerous taxation structures and the dislocation of moving families extensive distances to Australia militate against Australian companies’ success in attracting executives.  This problem will be exacerbated if those potential recruits, required to relinquish existing financial and employment security to accept a role in Australia, cannot have reasonable certainty of adequate compensation in the event of early termination.

3. Definition of “termination benefit”

The draft Bill extends the definition of termination benefits to eliminate perceived loopholes in the existing legislation.  In general we can understand the reasons for inclusion of the various items in the definition.  However, we express concern in regard to the following issues:

Payment of superannuation in excess of the statutory amount:

We assume that the intention is to include any employer contributions (other than, presumably, employee salary sacrifice contributions), in excess of the statutory SG requirements, that have been paid during the relevant period of employment over which the base salary amount is calculated.  However, the description as it stands could be interpreted in a number of ways.  We believe that this issue needs to be clarified in the legislation.

We do not see a justification for the inclusion of bona fide superannuation savings accumulated during the total period of employment, and which have been set aside for and are restricted to the purpose of funding lifestyle in retirement and are quite distinct from termination benefits.  In many, if not most, cases these superannuation savings will not be immediately accessible at the time of termination.  However, we agree that any additional payments made into superannuation at the time of termination should be included in the definition to avoid opportunity for the specified termination benefit limit to be circumvented.

Automatic or accelerated vesting of short and long term incentive arrangements:

We understand the Government’s motivation to remove the possibility of additional reward being made available to terminating executives via the waiving of time or performance vesting requirements on outstanding incentives.  We would not have a concern with this if the termination payment limit is calculated by reference to both base salary and short-term incentives.

The draft legislation excludes from the benefit calculation any incentives that continue past the date of termination and remain subject to time or performance vesting requirements.  This is appropriate and will facilitate implementation of governance initiatives that have gained support internationally to extend the life of incentives beyond the termination date of the relevant executives to better ensure focus on sustainable long term performance.  Similarly, the draft regulations appropriately stipulate that a termination benefit does not include deferred bonuses that have been earned and not yet paid.

4. Timing of shareholder vote

The timing and restriction on purpose of the vote are not practical and are unfair.

The draft Bill requires any shareholder vote on the termination payment to be held after the director or executive has departed from the office or position.  Additionally, it stipulates that a general meeting must not be called specifically for the purpose of holding the vote.

The practical implication of this is that if the termination event occurs shortly after an annual General Meeting of the company, the vote on the termination payment might need to await the next AGM almost one year later, unless a Special General Meeting is required for other purposes in the interim.  The problems with this scenario are threefold:

• Shareholders will possibly have little inclination to pay a termination benefit to an executive or director who has long ago departed the company and whose achievements and performance may have been obscured by the effluxion of time and subsequent events, including possible changes in the economic environment;
• The termination payment is compensation for the loss of anticipated continuing employment and income for the specified time period.  Delaying approval, and hence payment, is unfair in those circumstances;
• As mentioned previously, companies compete globally for executive talent and the lack of certainty and potentially protracted approval procedure will disadvantage Australian companies in that competitive market. 

An argument for a termination payment in excess of the legislated threshold figure would need to be presented by the directors who are entrusted by the shareholders to make decisions on their behalf on a range of other, arguably far more significant and higher dollar value, operational matters.  In our view, that case can be presented to and decided upon by shareholders just as validly at any time during the tenure of the executive or director.

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