Executive pay deals not all they want

In recent years the public has been regaled by stories of executives, often after spectacular corporate failings, receiving large severance payments. But, as John Colvin* points out, the payments are not always due to an over-generous board but to the peculiarities of the NSW Industrial Relations Commission.

You are a non-executive director on a board's remuneration committee. Along with other directors you have entered into lengthy negotiations with senior executives for their employment and directorship responsibilities (for executive directors). You have taken outside advice and believe you have fulfilled your legal obligations in coming to a fair arrangement. You are wrong! It will come as a surprise to directors and many remuneration committees that having acted on the existing arrangements, this may be considered "unfair" in the view of third parties in the NSW industrial relations system. The result is that the NSW Industrial Relations Commission can set a remuneration committee's arrangements aside. This includes arrangements for all employees including the CEO. While the media feeds salaciously on the news of massive executive termination payments and sheets the blame on to the board it is the interventionist role adopted by the NSW Industrial Relations Commission (IRC) under section 106 of the Industrial Relations Act 1996 (NSW) that should also face public scrutiny.

Section 106 of the Act permits the IRC to hear evidence as to whether a contract negotiated between senior executives and the company is in some way "harsh or unfair" during the contract or in its application. This situation usually arises as a result of a termination of a senior executives employment. From the executive's point of view every termination is often unfair. From an employer/shareholder point of view, contracts entered into with executives who are capable of understanding contracts for themselves and on behalf of the employer should generally not be interfered with. In other words, they are consenting and intelligent adults and once an agreement is reached it should be honoured. If not, a case for breach of contract can be commenced in the civil courts.

This is the situation with employment contracts in most of the other states of Australia. However, NSW has now become the "home" of executive unfair contracts/dismissal litigation. Section 106 and its predecessors were originally inserted in the State's Industrial Laws for the protection of awards. In essence they were safeguards to prevent unscrupulous employers paying employees below award rates by setting up independent contractor arrangements for, say, cleaners or clothing workers. This is unexceptional and to be commended. However, because of the structure of the section it has over time been given a very wide interpretation on various appeals and now covers areas (including executives) that are arguably well beyond anything originally contemplated.

Contract law is generally about allocating and assessing risks and liabilities. Employers need to know with some precision the cost of employing employees including the costs associated with bonuses, share schemes and notice on termination of employment (for example, if downturn in business occurs). Changing the rules after the event should therefore only occur in exceptional circumstances if a smooth running economy and viable individual businesses are desired. In Moray Vincent v Merrill Lynch Australia Pty Limited, Merrill Lynch terminated Vincent's employment on the grounds of redundancy as part of a global downsizing of the Merrill Lynch organisation in October 1998. Vincent was on a salary package of $115,000 and had received a bonus in January 1998 of $US120,000 in respect of the 1997 year, the same bonus he had received the previous year. On termination of his employment Vincent was offered a redundancy package comprising one month's pay in lieu of notice and five months pay as a redundancy payment calculated on his salary package of $115,000. He was also offered outplacement assistance to help him in finding a new job and a sum of $US36,000 in respect of a 1998 bonus. This was offered on the basis that Vincent provided a signed Deed of Release. Instead, Vincent brought an action under s106 claiming that his contract and the offer was "unfair", even though it was well in excess of any contractual entitlements. The IRC held the discretionary bonus was unfair because an employee who was terminated part way through a year could miss out on a bonus and he was awarded one half of the bonus based on US$100,000 for a six month notice period and a proportion of the bonus for the balance of the 1998 year.

In Adams v Westfield Holdings Limited, Adams commenced employment as an executive with Westfield in June 1995. Part of the offer of employment included an allocation of 30,000 options over shares in Westfield. In 1997 there was a five-for-one share split so Adams became entitled to 150,000 options. On termination for redundancy the directors, exercising their discretion as to allocation of options prior to the vesting period, allowed him to exercise 45,000 share options. This was done on the basis of completed service as a proportion of the option qualifying period. The directors were required to give evidence in this case as to the exercise of their discretion. The IRC held it was "unfair" that Adams was only granted a proportionate amount and ordered that the contract be varied to permit Adams (in addition to receiving other termination payments) to exercise all options. There are numerous other cases which have shown the IRC's willingness to alter a contract and arrangements entered into between employers and executives and impose the commission's view of what it regards as "fair" in relation to notice, bonuses, shares, options, termination payments and so forth. It can be readily seen why the latest figures from the IRC for claims under section 106 show that the number of claims has increased by 76 percent in the 2000 calendar year. The cases and the operation of the jurisdiction generally however raise a number of important issues, some of which are:

• The notion of "fairness" under section 106 is a very loose and subjective concept and is in many ways similar to "beauty" in that it is "in the eye of the beholder". This subjective approach is quite opposite to the whole idea of the "rule of law" where citizens are protect from subjective views and are subject to courts applying rules of law in a judicial manner.

• It would also appear from the cases that the "fairness" concept is looked at nearly entirely from the perspective of the employee and not, for example, the employer, shareholders and investors (including superannuation funds).

• The cost of employing executives in NSW is higher than elsewhere in Australia, because in addition to any cost of living factors, an increased cost of termination of employment has to be factored into employing executives. This includes not only the direct cost of any litigation but the costs of dealing with each termination in a different and more costly and uncertain way.

• The protracted nature of many terminations and the management time involved in senior executive terminations is far in excess of anything contemplated by the original purpose of section 106 (protection of awards). Grappling with an amorphous concept such as "fairness" throughout the employment contract exacerbates this problem.

• In the medium to long term this must have an effect on Sydney becoming a global business centre because of the disincentive to invest, or for businesses to locate their head offices, in NSW.

The question must be now asked as to whether this interventionist role should continue, be abolished or limited along the lines of the federal unfair dismissal legislation (eg time limits, maximum payments, and thresholds for applications) which had to be curtailed because of similar considerations. This would leave NSW in the same position as other states. It is difficult to justify why an executive earning more than a package of several hundred thousand dollars including bonuses, superannuation and share options negotiated at arms length should not be held to the bargain (contract) entered into. Why should they be allowed to argue at the termination of the contract that the contract is in some way "unfair", particularly when a remedy before the civil courts is still available. Perhaps scarce judicial resources could be more productively spent in other areas.

* John H.C. Colvin is a senior employee relations partner of Freehills, Sydney and has lectured in employee relations at Sydney University. He was previously an adjunct professor at the Australian Graduate School of Management.

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