Legal Briefing

Team poaches and the Remuneration Code: effects on the financial services sector

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Finance | 01 December 2010

The war for talent in the financial services sector continues. Traditionally, firms have faced some obstacles in protecting their key staff, but two separate developments may give firms cause to be more optimistic in protecting their interests.

The first is the attitude of the courts in recent cases. The second is the possible effect of the Remuneration Code (the Code).

Pay and bonuses have always been an important way to incentivise staff and prevent ‘poaching’ from rivals. However, historically, these could be ‘bought out’ by the firm hiring the staff. Firms therefore fell back on the additional protections of properly drafted restrictive covenants. Such restrictions will only be enforceable where an employer can demonstrate that it has a legitimate business interest to protect. The courts have traditionally been reluctant to enforce non-compete clauses in particular, because of the infringement of the general principle that covenants in restraint of trade are unlawful.

Recently, however, there has arguably been a move towards greater enforcement of post-termination restrictions. This, combined with the provisions in the Code that defer bonuses and limit bonus buyouts, may stack the odds in favour of the employing firm.

Recent Case Law

Post-termination restrictions are commonplace in contracts for senior employees in the financial services sector and, increasingly, in the contracts of more junior staff. In recent years the High Court has upheld non-compete restrictions on the basis that they were reasonably necessary to protect the employer’s confidential information. Similarly, a non-compete clause preventing an employee from competing for 12 months was upheld. The High Court has also confirmed that it would be reasonable for a non-compete restriction to restrain an employee from working for a competitor, albeit in a different capacity, if there were a real risk that the employee could reveal confidential information of the employer.

Recent case law also demonstrates that the courts may not take the level of seniority into consideration as strictly as previously thought when determining whether to enforce post-termination restrictions. Instead, the level of access that a particular employee has to confidential information, client details and strategy information will be more relevant than seniority. This can be useful where a move involves both senior and junior employees: previously there may have been a greater risk that junior employees would be free to compete, forging or maintaining links with the former employer’s clients until more senior employees were freed from restrictions.

It seems, therefore, that employers can increasingly hope to rely on well-drafted non-compete clauses to prevent employees who have defected from competing with them.

In addition, even if employees’ contracts do not contain post-termination restrictions, employers may still have a right of redress. Of late, the courts have shown that the co-ordination of team moves, in particular, can be difficult without falling foul of the duties of fidelity and good faith implied in employees’ contracts of employment.

For example, the High Court has granted a wealth management business an interim ‘springboard injunction’ after a competitor poached a large number of the business’s staff in quick succession (a springboard injunction is used to prevent a person from making use of an earlier wrongdoing to gain a ‘head start’ in competition with a former employer). Here, the injunction prohibited the ex-employees from servicing clients of the wealth management business who had moved to the competitor, and from soliciting any further employees or clients of the business for a period of time.

In this case, the judge considered there was evidence that the former employee, who had left the business to set up in competition, had been conspiring with existing employees of the business to encourage them to leave to join the new business. Although the employee’s post-termination non-solicitation covenants had expired, the judge found that there was evidence that the poached employees had acted in breach of their duties in conspiring with the first employee and that this employee may have induced such breaches. The judge also dismissed evidence brought by the ex-employee of the voluntary nature of the defections, and their submissions that they were related to employee vulnerability due to the economic climate.

Similarly, in another case, the High Court held that three employees who deliberately misled their employer about their intentions to work for a competitor on their departure were in breach of their implied duties of fidelity. In addition, the Court held that one director and one senior employee were in breach of their fiduciary duties for hiding the fact they had been approached by a competitor and had a genuine intention to join it, and, in the case of the director, failing to disclose that they were aware that a colleague had been approached by a competitor.

Perhaps the most well-known recent case is the long-running and hotly fought saga between Tullett Prebon plc (Tullett) and BGC Brokers LP (BGC) in the so-called ‘Broker Wars’ (Tullett Prebon plc & ors v BGC Brokers LP & ors [2010]). The appeal is set to be heard by the Court of Appeal in December, and it is worth summarising the details of the case and the findings of the High Court, which were largely in favour of Tullett and generally reinforced the trend towards protecting the interests of the employing firm.

The principal parties in Tullett are competitors in the inter-dealer broker market. The former chief operating officer (COO) of Tullett commenced work with BGC on 5 January 2009. On joining, the former COO planned to recruit brokers to join BGC from Tullett. Thirteen Tullett brokers signed contracts to join BGC when their contracts permitted. Three Tullett brokers (the ‘Tullett Three’) later changed their minds. All the contracts with Tullett contained 6-12 months’ notice, garden leave provisions and post-termination restrictions, preventing the employees from working for a competitor for, typically, six months. In March 2009 Tullett commenced proceedings against BGC, the former COO and several named employees (the ‘employee defendants’), alleging conspiracy, inducing breach of contract and misuse of confidential information in connection with the recruiting from Tullett. An application for interim relief was heard in April 2009 and undertakings were given. Trial of the action commenced on 14 October 2009 and concluded on 5 February 2010. Tullett also sought to continue, by way of injunction, the undertakings, and to establish its right to damages. It claimed for the recovery of signing payments and bonuses. BGC denied any wrongdoing and counterclaimed against Tullett for inducing the Tullett Three to breach the contracts they had already entered into with BGC.

The High Court largely found in Tullett’s favour, upholding its claims for conspiracy, and inducing breach of contract against BGC and certain of the employee defendants, providing some injunctive relief. As is not unusual in these types of proceedings, it was alleged that the employee defendants had been constructively dismissed. This claim did not succeed. Tullett’s claim for conspiracy against the remainder of the employee defendants failed, but its claims against them for recovery of signing payments and bonuses succeeded. BGC’s claim against Tullett for inducing the Tullett Three to breach their contracts with BGC failed.

Remuneration Code

In addition to the apparent recent change in the attitude of the courts towards post-termination restrictions, employers should also be aware of relevant provisions of the Code. The Code, which requires firms to adopt remuneration policies that are consistent with and promote effective risk management, came into force at the beginning of 2010 for a limited number of large banks, building societies and broker dealers. From the beginning of January 2011 it will apply to a much wider range of firms. Essentially, the Code will apply to all ‘BIPRU firms’, although there will be a short transitional period (likely to be until July 2011), during which the Financial Services Authority (FSA) acknowledges that some firms may not be able to fully implement all of the provisions of the Code.

In July 2010 the FSA published a draft of the revised Code as part of its consultation process, although there will probably be some changes or clarifications when the final rules are published as a result of responses to the FSA’s consultation paper. However, the changes are not likely to be extensive because – as the FSA points out – the revised Code is based on the latest amendments to the EU’s Capital Requirements Directive, which leaves the FSA with little scope for flexibility in drafting the Code. Instead, the FSA has pointed to provisions within the Directive which envisage that the remuneration provisions will be applied proportionately and states that it recognises that applying the full Code may be inappropriate or unduly burdensome for some firms.

The FSA has given some guidance on how it intends to approach the question of proportionality, but a request for additional guidance and clarity on how firms can take advantage of the proportionality provisions was a common theme in several responses to the FSA’s consultation paper. It is to be hoped that the FSA will issue additional guidance on this when it publishes its policy statement along with the final rules. What is clear though is that the FSA does not consider that proportionality can be used as a complete exemption from the Code for any firm.

Key provisions of the Code (subject to the question of whether particular firms might be able to successfully argue that it would not be proportionate for them to comply with them) include a requirement that a significant proportion of bonus (at least 50%) should be paid in shares or share-linked instruments rather than cash, and that a proportion of the bonus (ranging from 40% to 60%) is deferred over a period of at least three years. While this may have the effect of dissuading employees to leave their employer if any deferred payments will be forfeited, deferral of an element of the bonus and payment in shares is not an uncommon practice, so it might not be expected to result in any significant change going forwards.

The position is different, though, in relation to the question of guaranteed bonuses. This is one of several areas dealt with in Principle 12 of the Code, which is concerned with the structure of remuneration awards. Principle 12 states that firms must not offer their employees, to whom the Code applies, guaranteed bonuses of more than one year and, even then, guaranteed bonuses may only be offered in exceptional circumstances. In addition, a guaranteed bonus can only be paid in the context of hiring new staff and can only apply for the first year of an employee’s service. That rule is supported by an evidential provision that a firm should not award or pay a guaranteed bonus unless it has taken all reasonable steps to ensure that any bonus is not more generous (in either amount or terms, including any deferral or retention period) than the bonus awarded or offered by the employee’s previous employer. This evidential provision also says that any guaranteed bonus must be subject to appropriate performance adjustment provision and, while only an evidential provision rather than a rule, inability to demonstrate compliance with the evidential provision will tend to establish a breach of the rule relating to guaranteed bonuses. FSA guidance in the draft Code also stipulates that any guaranteed bonus should be subject to the same deferral criteria as bonuses generally, and there are general anti-avoidance provisions that would prevent guaranteed bonuses from being paid by other methods in an attempt to circumvent the Code.

As previously mentioned, one of the key concerns for firms will be the extent to which they might be able to rely on the proportionality test to justify not complying with the rules on guaranteed bonuses on the basis of the firm’s nature, scale, scope and complexity. The extent to which firms will be able to do this is not entirely clear and firms will be interested to see whether any additional guidance on this is given by the FSA in its policy statement. While the FSA indicated in its consultation paper that this was a rule which firms could ‘explain’, rather than comply with, the guidance in the draft Code points out that it is best practice to extend the rules on guaranteed bonuses to all employees, rather than just the ‘Code Staff’, who are strictly caught by the rules.

It will be interesting to see whether any firm that is subject to the Code and takes the view that the rules on guaranteed bonuses applies to it will be hindered in its ability to attract high-quality staff from rival organisations. It is clear that if different firms in the same line of business take different views on the applicability of the Code, with the result that one firm feels able to pay guaranteed bonuses to attract staff and the other firm does not, there will not be a level playing field between firms in the war for talent. It is possible that, in practice, if one firm in a particular sector feels able to justify non-compliance with the rules on guaranteed bonuses for proportionality reasons, then other firms in the same sector would adopt a similar view. In that case, even if the carrots that can be used to attract new staff from rivals are less juicy than they were, there would still be a level playing field and there may simply be a change in the market overall. There may be large firms, though, who operate in several areas and apply all the provisions of the Code across their business as a whole, which may put monoline businesses that do not apply the Code in the same way at a competitive advantage in attracting the best people.

Until the final rules are published, and probably until a common approach is taken towards the Code by all firms, it is difficult to predict how much of an effect the Code will have on the ability of firms to poach teams from rivals. It will be interesting to review the position after the dust has settled to see whether there is, in fact, no change from the status quo or whether a by-product of the Code and recent court decisions is that team moves become less common and that there is less mobility of employees between rival firms.

Summary

Both the recent case law trends and the developments of the Code may give some comfort to those financial services firms who wish to prevent staff joining a competitor, but may equally pose challenges for those firms in attracting staff from a competitor. Firms will no doubt track with interest both the effects and implementation of the Code, and the developing case law in the area of post-termination restrictions.

By Fiona Bolton, partner, human resources practice group, and Jonathan Master, partner, financial services, Eversheds LLP.

E-mail: fionabolton@eversheds.com;

jonathanmaster@eversheds.com.