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Jurisdictional and other practical issues arising on the enforcement of US Long Term Incentive Award Agreements and restrictive covenants in the UK

07 March 2019

It is not uncommon for senior executives employed in the UK by US corporations or their UK subsidiaries to be incentivised by way of Long Term Incentive Award Agreements (LTIP Agreements). As with one such agreement we had to consider in a case, LTIPs are designed typically “for, among other things, the purpose of providing certain key executives of the company and its associated companies a proprietary interest in pursuing the long-term growth, profitability and financial success of the company”. The employer agrees to pay an “award” to one or more executives at the end of an incentive period of, say, 3 years and tend to be structured in a way to induce the executive to stay with the employer: if the executives voluntarily leaves before the end of the “award term” they forfeit any benefits under the LTIP Agreement. The amount of the awards, which are often substantial running into hundreds of thousands of US Dollars tend to be based on calculations that take into account length of service and the extent to which the company met its target for earnings before interest, taxes, depreciation and amortization. One often sees restrictive covenants in LTIP Agreements that purport to prohibit unfair competition: non-competes.

Often such LTIP Agreements are governed by the law of the particular US state in which the corporation is based and contain exclusive jurisdiction clauses.

If the company does not make an award, perhaps because it claims to have missed its sales target, the executives will have to decide whether to sue, or at least threaten to sue, and if so in which jurisdiction should they proceed. The UK executive may have participated in the scheme along with other executives who reside in the relevant US state or, indeed, other countries. But the question that arises is whether he will have to proceed with his claim in the US, where it is likely that affected participating American executives will proceed, or in the UK. Indeed, if the LTIP Agreement is governed by US State law and if there is an exclusive jurisdiction clause, will the UK executive have any choice?

Conversely, if in an attempt to mitigate his loss the UK executive seeks employment with a competitor and the US corporation wishes to enforce the restrictive covenants can it do so in the UK? Or can the UK executive prevent that by obtaining a declaration that the restrictions are unenforceable?

As the law currently stands, under Rome I (an EU Regulation on the law applicable to contractual obligations - previously called the EU Rome Convention) an “individual employment contract”, where the employee has less bargaining power of this sort a choice of law made by the parties shall not have the result of depriving the employee of the protection afforded to him by the mandatory rules of law that would have applied if no choice of law had been made and, in that case, the “rules of the country in which the employee habitually carries out his work in the performance of the contract shall apply”. Furthermore, Rome I provides that if the laws of a country are manifestly incompatible with the public policy of the jurisdiction in which a party is litigating the court can refuse to enforce the offending law. So far as the enforcement of an employment contract such as the LTIP Agreement is concerned, another EU Regulation (the Brussels Regulation) applies and provides that the “weaker party” (the employee) is entitled to receive extra protection with regard to jurisdiction. The employee can sue the employer, in our example, a US corporation employing a UK resident in the courts of the EU member state where the employer is domiciled (the UK subsidiary in the UK) or in another EU member state where the employee habitually works. An employer may only bring proceedings against an employee in the courts of the state in which the employee is domiciled but can bring a counter-claim in the court where the employee’s claim is originally brought.

Thus, in the leading case (Duarte –v-Black & Decker), it was held that, although English laws relating to restrictive covenants imposing a restraint of trade do not amount to mandatory laws under Rome I. That was because such restrictions are contractual and do not stem from employment protection statutes, the doctrine of restraint of trade is a matter of public policy and the English courts, will not enforce covenants governed, in that case, by the law of Maryland if they are not enforceable under English law. (It should be noted that in some European jurisdictions restraints of trade are mandatory laws). Mr Duarte had sought and succeeded in obtaining a declaration that the restrictive covenants in the State of Maryland law governed LTIP were unenforceable. The court had no difficulty finding that the LTIP was a contract of employment for the purposes of the Rome Convention, or Rome I as it is now, because it was obviously intended to operate as part of an overall package of Mr Duarte’s employment terms”.

In another UK (English) case, Samengo Turner & ors –v- J&H Marsh & McLennan (Services) Ltd & ors the Court of Appeal applied the Brussels Regulation to injunct Marsh & McLennan from suing three former UK based employees in New York on the basis that the US bonus agreements they benefited from, again containing restrictive covenants, were part of UK contracts of employment. The legal action had to be taken in the jurisdiction in which the employees were domiciled.

The moral of those case reports is that US corporations must consider all of the incentive agreements that operate alongside or are ancillary to the main contract of employment and when preparing them establish whether they will be able to sue EU based employees in the US.

The UK executive is, therefore, afforded considerable choice over jurisdiction. But he may, nevertheless, have hard commercial decisions to take. Does he proceed with an action for damages in the UK civil courts (almost certainly the High Court) with the attendant risk of an adverse costs order if he loses: the normal rule is that the ‘loser’ pays the ‘winner’s’ costs. Or does he proceed in the UK Employment Tribunal under the unlawful deduction of wages jurisdiction in which costs are not normally awarded. A UK Employment Tribunal will have jurisdiction where, amongst other things, the respondent employer, or one of the respondent employers, resides or carries on business, or the claim relates to a contract under which the work is or has been performed partly in England, Wales or Scotland. One further advantage of the Employment Tribunal is that it is a relatively summary process which, at least in terms of immediate funding, is significantly cheaper. On the other hand, if he proceeds in the UK High Court and wins he will probably recover a substantial proportion of his legal costs from his former employer.

If he joins with any fellow executives who are deprived of an LTIP award in an action in the US they will probably be able to achieve an economy of scale through a joint action and, as there is no cost shifting, he will be running less of a risk on costs. Furthermore, depending on the precise nature and extent of the employer’s default, i.e. the cause of action, he may be able to recover heightened, exemplary damages, which would not be the case in the UK. On the other hand, in the US he may be exposed and vulnerable to a counter-claim action for the enforcement of the restrictive covenants. There is also, of course, the sheer logistical challenge and inconvenience that the UK employee will face in proceeding in the US.

What about Brexit I hear you ask. This area of law may be affected by a hard no- deal Brexit but the extent of the impact will depend whether any agreement is reached between the UK and the EU before 29th March 2019 when, as things stand, the UK is due to leave the EU. The UK Government has, however, published draft regulations which although they will revoke the Brussels Regulation will continue the protections offered to employees domiciled in the UK. The indications are that the English courts will continue to apply the governing law rules contained in Rome I.

By David Ludlow

Partner & Head of Labour Law Barlow Robbins LLP (Ecovis Legal UK)