The Australian government introduces an executive termination benefits Bill that has major problems

The bill was introduced into the Australian parliament on 24 June 2009. The bill would require termination payments to company directors and senior executives which exceed one year’s salary to be subject to shareholder approval.

The bill will give effect to the Australian government’s March announcement that it would act “…to curb excessive ‘golden handshakes’ – or termination payments – paid to company executives.”

According to the government’s Explanatory Memorandum for the bill, these amendments will:

“…strengthen the existing regulatory framework applying to termination benefits by: better empowering shareholders to disallow excessive termination benefits, particularly where they are a reward for poor performance; improving the accountability of company management in setting remuneration; and promoting responsible remuneration practices.”

Parliamentary debate of the Bill, and a vote, has been deferred until parliament returns from its winter recess (i.e. from August 11).

Under the amendments to be introduced by the Corporations Amendment (Improving Accountability on Termination Payments) Bill 2009:

• Shareholder approval will be required for a termination payment more than one times average annual base pay (reduced from seven times annual remuneration in the current version of the Corporation Act), or less than this where an executive’s service is less than one year on a pro rated basis

• For listed companies, the new limit will apply to all persons who have held ‘managerial or executive office’ (i.e. who have been named in the company’s remuneration report for the prior year) during the last 3 years before their retirement (the previous limits applied only to directors and executive directors, as ‘related parties’)

• For un-listed companies, the new limits apply to all persons who have been directors of the company or of a related company during the last 3 years before their retirement (the previous limits also applied to directors)

• The new limits will apply to persons covered by new contracts that are made after the legislation receives the Royal Assent or by existing contracts that are renewed or extended after that date.  The legislation will not otherwise apply to persons covered by existing contracts

• But (confusingly) the Explanatory Memorandum accompanying the Bill indicates that minor changes to an existing contract “will not be considered a variation of a condition. However, changes which effect an essential term, including any term relating to remuneration would be considered a variation of a condition”

• The limits apply to termination benefits given by the company, an associate of the company or a prescribed superannuation fund in relation to the company

• ‘Base salary’ will have the meaning specified in yet-to-be-published regulations

• A termination payment (called a ‘benefit’ in the legislation) will include

− A payment or other valuable consideration
− Any kind of real or personal property
− Any legal or equitable estate or interest in real or personal property
− Any legal or equitable right
− A thing specified in the regulations (the Explanatory Memorandum suggests this could include superannuation payments to the extent they exceed the maximum amount required or permitted by a law of the Commonwealth, a State or a Territory (but excluding amounts financed by salary sacrifice) and an amount paid as a voluntary out of court settlement)

• A termination payment will exclude things specified in the regulations (the Explanatory Memorandum indicates this could include a deferred bonus and a payment from a defined benefits superannuation scheme that was in existence when the regulation commenced and superannuation contributions based on salary sacrifice amounts

• A benefit will be given in connection with a person’s retirement from an office or position if the benefit is given in circumstances specified in regulations (the Explanatory Memorandum indicates this could include the automatic or accelerated vesting of options and payments in lieu of notice)

• The existing requirement (under section 200E of the Corporations Act) for payment of the benefit to be approved by a resolution passed at a general meeting at any time prior to payment will continue (the earlier Exposure Draft of the legislation would have required approval to be obtained after the termination and would not have permitted a special meeting to be called to obtain approval)

• The existing requirement for details of the termination benefit to be set out in or accompany the notice of the general meeting at which approval is to be considered will be continued

• The retiree and associates of the retiree will not be able to vote on the approval

• The recipient of a termination benefit given in contravention of the shareholder approval requirements will hold the benefit on trust for the entity and will be obliged to immediately repay the benefit, which is a debt due to the company and may be recovered by the company in a court of competent jurisdiction

• Penalties for giving a benefit in contravention of the requirements for shareholder approval have been significantly increased, to $19,800 (up from $2,750) for individuals and $99,000 (up from $16,500) for companies.  Offences will remain strict liability offences.

Concerns with the proposals include:

1. The Bill precedes the Productivity Commission review of executive and director remuneration.  This review is taking all aspects of remuneration into account, and presumably will examine the unintended consequences of regulating one aspect of remuneration without consideration of other aspects.  Given the very few instances of poor practice over prior years, there does not seem to be an urgent requirement for this legislation to be introduced prior to the Commission report.

2. There has been no apparent consideration of current Australian governance frameworks, and how amended Corporations Act law and regulation can make use of this.  In particular, a reasonably flexible approach that would still keep a lid on excessive termination pay could incorporate both an ASX Governance Principle “if not, why not?” soft law and Corporations Act section 200 hard law to work together.

3. Given that 17% of ASX 200 executives are recruited from overseas (according to the ACSI Productivity Commission submission), where termination provisions are more generous, the new maximum of “one times” is too low.

4. The low maximum in place may result in pay distortions, such as an increase in base salary or recruitment sign ons (i.e. dowry versus divorce settlement) that are higher than otherwise may have been the case

5. The pro-rating of the 1 times cap for executives with less than one year’s service will be unfair in situations whereby the executive is made redundant as a result of merger or acquisition, or some other sudden change outside the control of the executive

6. The Bill provides that “base salary” for the purposes of the Bill will be specified in the Regulations. Unless the Regulations define “base salary” broadly, the cap could be potentially quite low for executive employees whose remuneration comprises significant “at risk” or variable components rather than fixed remuneration.

7. In practice, a large number of companies will have to obtain shareholder approval for termination payments, especially as any reward paid at termination under a current short-term incentive plan will be counted against the limit, even if the reward is performance tested and pro-rated according to the proportion of the performance period completed to the date of termination. An exemption is to be provided for ‘deferred bonus’ – in principle, this is no different from the pro-rated and performance tested bonus payment referred to here

8. Company superannuation contributions will be counted against the limit even where employers only contribute at the 9% SG rate on executive remuneration above the 2009-10 SG maximum earnings base of $160,680 per annum (the exemption for superannuation benefits funded by salary sacrifice assists where salary packaging arrangements are applied)

9. The Bill continues to provide a look back period to include persons who held an “executive and managerial office” within 3 years of their retirement whether or not they hold such office at the time of their retirement

10. The Bill applies to directors of private companies, including directors of subsidiaries of a listed company, whether or not the employee is named in the listed company’s remuneration report. For large listed companies with many subsidiaries this is an undesirable outcome. While the current laws also operate in this way the reduction in the benefits cap makes the requirement to obtain approval more likely

11.  The new laws apply where there is a “variation to a condition of a contract”.  This will have implications for companies looking to implement changes to executive terms or remuneration packages in the future – for instance, an increase in remuneration may result in an executive being covered by the laws unless their contract is drafted so that a remuneration increase does not constitute a variation to their contract

12. Listed companies will need to take care with resolutions proposed at an AGM or EGM for approval of share/option schemes to ensure that the approval is effective to cover all benefits which may require shareholder approval under these laws

13. Many companies will need to consider adding to the annual resolution “load” by seeking shareholder approval “up front” for benefits that might be caught by the new laws

14. The aggregate effect of a series of “not quite right” changes to executive remuneration is almost certain to be increased total pay, not less pay; a sort of risk premium that will become payable to executives subject to seemingly-arbitrary risks to pay

On 25 June 2009, the Senate referred the bill to the Senate Economics Legislation Committee for inquiry and report. The Committee is due to report to the Senate by 7 August 2009.  Guerdon Associates has been requested by the Committee to submit a response to the enquiry.  We will.  And we will also be keen to hear your views for incorporation into our submission.  But please be quick, as submissions are required by 17 July 2009.

The Explanatory Memorandum and the draft bill are available HERE

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