The duty of good faith and the penalty doctrine

In Imam-Sadeque v BlueBay Asset Management, the High Court considered two important issues: whether the duty of good faith is reduced during garden leave and whether the penalty doctrine applied to a clause in a compromise agreement.

When Mr Imam-Sadeque, an asset manager at BlueBay, resigned he was not entitled to unvested awards under the terms of the incentive plan because he was not a "good leaver". However, he negotiated a compromise agreement which included a provision that he would be considered a "good leaver" and therefore entitled to fund units for 2012 if he did not breach the terms of his contract during his notice period (which included non-competition, confidentiality and non-solicitation clauses). BlueBay subsequently discovered that, while still employed, Mr Imam-Sadeque agreed to join and helped a competitor start up, disclosed confidential business information and was heavily involved in the recruitment of a colleague. He argued that he was not in breach as an employee's duty of good faith lessened during garden leave and that the terms of the compromise agreement, forfeiting the 2012 awards, were unenforceable as a penalty.

The duty of good faith is not reduced during garden leave

The High Court held that the duty of good faith did not lessen during garden leave. The purpose of garden leave is to secure an employee's loyalty to his current employer (while still being paid but not required to work) and to delay the transfer of that loyalty to the new employer until the notice period expires.

Conditional benefits not subject to penalty doctrine

The Court also held that the clause in the compromise agreement did not forfeit a benefit. This happened because he was a "bad leaver" under the terms of the incentive plan. The compromise agreement had merely given a conditional benefit in relation to units that, in fact, never accrued because he failed to fulfil the condition. A contingent right which had not accrued could not come within the penalty doctrine.

The judge went on to give his view that a clause could not be a penalty if, as in this case, it was commercially justified. He considered that, even if the doctrine did apply, it was not a penalty as it was freely negotiated as part of a bundle of obligations and benefits and it would be contrary to the commercial objectives of the incentive plan if an employee could act in breach of contractual duties and still receive the 2012 fund units. In addition, he acknowledged that the provisions in the incentive plan providing variable remuneration on a deferred basis also complied with FSA Remuneration Code requirements.

Key Points to take away

  • This confirms the duty of good faith is not reduced during garden leave where it relates to competitive activity or non-poaching of employees. Employers should also consider making this duty express rather than seeking to rely on the implied duty.
  • Although the judgment confirms that the penalty doctrine does not apply to conditional benefits it does leave open the possibility of a challenge as to how this might apply to accrued benefits, although generally the courts are reluctant to expand this doctrine.

When does a contract of employment end?

The answer to this question is not straightforward and was considered by the Supreme Court in Geys v Societe Generale. It held that where an employer is in repudiatory breach the contract does not end automatically, it ends when the employee elects to accept the repudiation as having that effect. The rationale behind this is to protect the innocent party. This is in recognition that there are circumstances where it is in the employee's interests to affirm the contract e.g. to ensure entitlement to bonuses or share options. Equally, if the employee is in repudiatory breach, there may be times where an employer may wish to affirm the contract, e.g. in order to enforce restrictive covenants. The Court also confirmed that clear notification of termination is required.

Key Points to take away

  • In order to avoid being in a situation which will enable employees to claim their employment is continuing, employers should ensure their PILON clauses are worded so that termination of employment takes effect once the employee has been notified that their employment is being terminated and that the PILON will follow.

As a matter of good practice the employer should also ensure it notifies the employee in writing that it is exercising its right to make the PILON.

Disciplinary procedures and injunctions

In West London Mental Health NHS Trust v Chhabra the Court of Appeal confirmed that it will only intervene in disciplinary proceedings in the form of an injunction or declaration where the employer is in breach of contract. Although the availability of this remedy only applies to those with contractual disciplinary procedures, it is likely that employees who stand to gain from prolonging their employment (e.g. where a bonus entitlement is at stake) will be looking for ways to claim that an ostensibly non-contractual procedure is contractual, for example, by arguing a policy has been incorporated into the contract as a result of an implied term.

Key Points to take away

  • Ensure that any disciplinary procedure (whether contractual or not) is followed carefully to avoid arguments that the employer is in breach.
  • Ensure that the disciplinary procedure is clearly expressed to be non-contractual. Although there is the risk that this may not be sufficient to establish that this is the case, it will certainly make it more difficult for the employee to argue otherwise.

Cases on appeal

  • Mattu concerning disciplinary proceedings and legal representation has not been granted permission to appeal to the Supreme Court and neither has Ranson , which concerned the extent of fiduciary duties and the duty of fidelity. We have covered both of these decisions in our previous updates.
  • Permission to appeal to the Supreme Court has been granted in Clyde & Co LLP v Bates van Winkelhof which we covered in our last update. This case concerns whether former LLP member is a "worker" and can bring a whistleblowing claim.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.