Reducing directors' notice periods: The Granada experience

Compensating directors for shortening their notice periods in accordance with corporate governance recommendations can receive objections from shareholders.
Anna McCrum, PLC

The final Hampel Report on corporate governance which was published in January endorses the Greenbury Report of 1995, recommending that boards set one year service contracts as their objective. Although both reports envisage circumstances when this may not be appropriate, the reiteration of this goal may encourage some companies to revisit the matter of directors' notice periods.

Prior to publication of the Hampel report but some two years after Greenbury, Granada Group PLC reduced five of its executives directors' notice periods. The provision for the notice period to increase, on change of control of Granada, to three years, was cancelled in consideration for a payment by Granada of an amount equivalent to two months' salary. Accordingly each executive director of Granada now has an employment contract with a notice period of two years.

The reduction in notice periods and the compensatory payments were revealed when the group's annual report for 1997 was published in January. Institutional shareholders criticised the payments. The degree of dissatisfaction with Granada was evidenced in a protest vote against the re-election as director of a member of the remuneration committee. Of those voting at the AGM in February, 19% opposed the re-election and 12% registered abstentions.

Rationale for notice periods

Notice periods essentially give an employee financial protection against breach of contract by the company. An employee whose contract is broken is entitled to calculate damages for breach, having regard to his loss, that is, the amounts which would have been paid to him had the employer complied with the terms of the contract. Therefore, an employer that terminates a contract which includes a two year notice period but requires the employee to leave employment immediately, will potentially be liable to pay the employee a sum equal to two years salary. The employee will be under a duty to mitigate his loss, that is, make attempts to find another job. This may reduce the liability of the employer.

Alteration of contract terms

A change in notice periods will clearly amount to an alteration of contractual terms. The main requirement for a valid variation of a contract of employment is that the employee has consented to it (either orally or in writing). The imposition of a unilateral change by the employer will constitute a repudiatory breach of contract, giving the employee the right to resign and claim breach of contract or constructive dismissal giving rise to liability on the part of the employer for unfair dismissal or a redundancy payment.

It may be that an employee will require consideration in return for consent to any reduction of a contractual notice period. However, given that a contractual notice period only provides a contingent benefit to a director (if the company terminates the contract in breach) it will generally be difficult to justify the payment of any significant inducement to a director to amend his contract. Granada may not have considered that the equivalent of two months salary was significant (amounting to £138,000 in the case of Gerry Robinson, Chairman). Clearly shareholders considered it to be substantial.

Possible solution

The Cadbury Committee, which was the first committee to make recommendations on notice periods, did not intend that its recommendations should apply to existing contracts before they become due for renewal. Hampel confirms that remuneration committees should be sensitive and flexible, especially over timing of reductions in notice periods. A more appropriate method than paying an inducement may be to give the director on a rolling contract twelve months' notice of a change in the notice period from, say three years to two. If a director will not consent to such a proposal, the employer could give the director notice as specified under his existing contract and then re-employ him under a new contract with a reduced notice period. AM

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