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The tricky process of negotiating executive severance pay

Siobhan Fitzgerald, partner at UK law firm TLT, discusses the potential pitfalls of new rules on executives’ final pay

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Siobhan Fitzgerald, partner at TLT
Siobhan Fitzgerald, partner at TLT

Negotiating the exit of a member of your executive team can be a delicate process, whether it’s due to redundancy, misconduct or poor performance. With new rules coming into force in 2018 that affect how organisations calculate severance pay, now is an ideal time for HR teams to review their current practices.

 

In particular, it is always beneficial to know what your payment liabilities would be if a member of the executive team was to leave. There are also a number of steps that housing associations can take to make the process as smooth as possible and manage financial and reputational risks.

 

Contractual entitlements

The first port of call in negotiations is always the employment contract, so it pays to know what contractual entitlements are already in place and to consider potential exit costs when drafting new agreements.

 

Depending on the contract’s wording, an executive may be entitled to a number of payments when their employment ends. Things to look out for include notice pay, redundancy pay, bonuses and exceptional payments (due on a merger, for example). On top of contractual entitlements, there may also be the offer of an ‘ex gratia’ settlement payment.


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HR teams should consider the different circumstances under which an executive might leave and what payments would be due to them under their existing contract. The reputational risk associated with executive severance pay can be extremely high, and we have seen a lot of negative news stories about organisations paying poorly performing executives large bonuses – in both the public and private sector. While this continues to come under increasing scrutiny, by understanding their existing liabilities, housing associations can put themselves in a much stronger position to avoid or manage these situations.

 

If an issue is identified with an existing contract, and if the working relationship is amicable with no immediate threat to the executive’s position, it may be possible to discuss this and agree an amendment to the contract to reduce the total amount they are entitled to when they leave. This situation is not dissimilar to the recent high-profile reports of senior executives leading by example in relation to the gender pay gap, with the new boss of Easyjet taking a voluntary pay cut to support the organisation in dealing with this, meaning executives may be more open to having this sort of discussion.

 

Governance and regulatory considerations

When agreeing an exit package, the housing association’s board must be satisfied that it is in the best interests of the organisation. This will involve regulatory considerations, including in particular the power of the Regulator for Social Housing (RSH) to downgrade social housing providers if they do not comply with its standards. As part of this, housing associations are required to safeguard taxpayers’ interests and the sector’s reputation through their governance arrangements.

 

Downgrading is a real risk, and we have seen this happen where housing associations have failed to meet the RSH’s requirements regarding pay and severance packages. In one case, the RSH noted the failure of a board to exercise adequate control or fully assess the risks associated with agreeing executive contracts and severance packages. It also highlighted a lack of clarity and transparency in the roles of the remuneration committee and board in scrutinising and agreeing matters of executive pay, meaning proposals were not diligently scrutinised and challenged.

 

The government is also planning to put in place a public sector exit cap of £95,000. While this is not yet in force, the cap is due to include redundancy payments, settlement payments and payments in lieu of notice. While housing associations will not be bound by the cap when it comes into force, it is worth considering voluntary compliance to keep in step with the public sector. This is particularly relevant given the government’s rationale behind imposing a cap (fairness and value for money for the taxpayer) and the link between that and the RSH’s standards.

 

New tax rules regarding termination payments

On 6 April the distinction between contractual and non-contractual payments in lieu of notice (PILONs), under which genuine non-contractual PILONs form part of the £30,000 tax exemption, was removed. This means that all PILONs are treated as general earnings for tax purposes, and are be subject to tax and national insurance contributions (NICs) – as if the employee had worked their notice period.

 

Secondly, from April 2019, employer NICs will be due on termination payments exceeding £30,000. Employers are not permitted to pass this cost on to the employee, so it must instead be borne by the housing association. This will create additional costs for housing associations when agreeing exit payments and should be considered as part of the overall policy.

 

The decision-making process

In order to mitigate the risks set out above, the remuneration committee or board should take into account the following key considerations when determining the level of exit package for a departing senior executive. In order to evidence transparency, somebody should be appointed to take minutes detailing the factors that have been taken into account.

 

Key considerations include:

  • What are the executive’s contractual and statutory entitlements?
  • What is the total cost of the proposed exit package?
  • What is the tax treatment of the proposed exit package?
  • What is the housing association’s financial situation?
  • Is there a risk of legal claims, RSH scrutiny or adverse publicity resulting from the exit package?
  • Will the proposed package cause any reputational impact?
  • To what extent may the payment set a precedent for other departing executives?
  • Are there any other internal governance policies that should be complied with?

 

Siobhan Fitzgerald is a partner at UK law firm TLT

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