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Is it safe to change the rules of incentive schemes?

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In the recent case of Daniels and Tate v Lloyds Bank, the High Court considered whether Lloyds had wrongfully changed its Long Term Incentive Plan (LTIP). This case involved two senior directors who participated in the Bank’s LTIP. The awards under the LTIP vested at the end of a three year period subject to the remuneration committee concluding that the LTIP performance conditions had been satisfied.

In 2011, the UK Corporate Governance Code (the Code) made it mandatory for a number of financial organisations including Lloyds Bank to include provisions in LTIPs so that unvested awards could be reduced or withheld in certain circumstances. These are known as malus clauses.

Shareholder approval was not required for minor amendments to Lloyds’s LTIP rules if the purpose of the amendments was to comply with legislation. In February 2012, following the changes introduced by the Code, Lloyds amended its existing LTIP plan to include a malus clause without shareholder approval. The malus clause allowed the shares under the LTIP to be reduced or withdrawn at the discretion of the remuneration committee.

In March 2012, Lloyds applied the malus clause and decided that the LTIP shares would not be transferred to the claimant employees. Daniels was owed £1.35M in shares, Tate £0.9M. Importantly, the Board of Directors decided that the malus clause applied after the remuneration committee had already determined that the awards under the same LTIP would vest in full.

The High Court held that the purpose of the amendment provisions in the LTIP rules was to allow for “tidying up” and there was no express power for Lloyds to amend the fundamental terms of the existing LTIP award. The High Court made it clear that the clause containing the power to amend the rules should be narrowly construed since Lloyds had unilaterally amended the LTIP to the detriment of its participants.

In addition, the High Court ruled that even if the malus clause had been capable of being lawfully applied, it should have been applied on or before the remuneration committee had determined the vesting of the LTIP awards. Further, the decision should have been made by the remuneration committee in this case and not the Board of Directors.

Finally, the LTIP rules also included a clause which stated that the employees could not claim any loss in respect of Lloyds’s exercise of its discretion (known as a “Micklefield clause”), therefore, Lloyds argued that the Claimant employees could not bring a claim for their loss under the LTIP. However, the Court decided that the Micklefield clause rule was limited to employment law claims and did not protect Lloyds from general liability arising from its breach of the LTIP.

This case is a reminder for employers to keep any award plan rules under careful review and to seek legal advice in respect of the drafting and application of any amendments to existing rules.

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