AICD says draft termination payments legislation is unworkable

The Federal Government’s draft legislation on executive termination payments will have unintended consequences and practical difficulties that render it unworkable in its current form, the Australian Institute of Company Directors (AICD) says.

In its submission to the Federal Treasury on the Exposure Draft: Corporations Amendment (Improving Accountability on Termination Payments) 2009, AICD says that it remains opposed to further heavy-handed regulation in this area.

“We are concerned that the draft bill is a knee-jerk reaction, driven by market conditions which will change over time, and does not allow enough time to pass to see how the market for executive remuneration is actually impacted,” it says.

The legislation has a number of practical problems which need to be addressed.

“The proposed shareholder approval threshold should be changed from one year’s base pay to two year’s total remuneration,” said AICD chief executive, John Colvin.

“If it is not prepared to accept this, the Government should at least consider allowing a ‘stepping down’ of potential termination payments with a threshold of two year’s total remuneration within the first two years of a contract, reducing to one year’s salary over time.”

“Companies should have the ability to seek shareholder approval of executive termination payments in advance, and if they choose to seek approval after contract termination, this should not have to wait until the next AGM.

“The proposed changes – including the reduced approval threshold which could apply to all companies big or small, for-profit or not-for-profits and charities – should also apply only to publicly listed companies,” he said.

The submission argues that the changes should be referred to the Productivity Commission as part of its broader examination of executive remuneration. There should also be a sunset clause on the legislation.

The submission outlines a number of problems with the Bill and likely adverse consequences flowing from it.

• While there is scope to reduce the current seven times remuneration package threshold, the proposed 12-month "base pay" threshold is at the other extreme. There is no other comparable jurisdiction that has a legally prescribed shareholder approval threshold as low as one year’s base pay. Termination payments for North American executives are typically about three times base salary plus bonus, whereas the European Corporate Governance Forum’s recently announced guidelines state that up to two times annual remuneration is acceptable for director severance payments without shareholder approval. The United Kingdom has a 12-month notice period standard, but this is voluntary under an "if not, why not" disclosure regime.
• Not allowing shareholder meetings to be specially called to approve termination payouts means it could be up to 12 months before a company is able to seek shareholder approval of a termination payment above the prescribed threshold. This does not assist companies or shareholders. By this time market conditions or the circumstances of the company may have significantly changed, with the result that approval of the termination payment may be unreasonably and unfairly withheld by shareholders. Alternatively, there may have been a change in shareholdings in the time since the employment contract was terminated, such as a takeover, and the new shareholders feel no compulsion to make additional payments to a former executive.
• The inability to obtain prior shareholder approval will introduce further contractual uncertainty, which is likely in turn to result in the inability to secure some candidates. The uncertainty will increase the risk to the executive, which is likely to require a "price" to be negotiated for this additional uncertainty.
• The proposed changes could lead to a greater incidence of disputes over termination benefits going to court, rather than being settled through private negotiation. Court orders for termination benefits in excess of the prescribed approval threshold will be exempted, whereas negotiated settlements, which could be more favourable for the company and its shareholders, will run the additional risk of being voted down by shareholders.
• Previous overseas attempts at trying to artificially limit particular elements of executive remuneration packages have been ill advised, largely ineffectual and have put further upward pressure on other elements of remuneration packages.
• The more demanding the provisions, the greater the competitive disadvantage Australian companies will be placed in the market for executive talent, relative to overseas companies, with flow on consequences for the economy. The available evidence is that searches for CEOs and direct reports for most of our top companies are international in scope.

AICD has suggested changes to the legislation, including:

• Replacing the proposed shareholder approval threshold from one year’s base pay to two year’s total remuneration.
• Companies should be permitted to seek prior shareholder approval for the payment of termination benefits.
• Companies should retain the ability to call a special shareholders' meeting to approve termination payments as they are now, rather than waiting until the next AGM which could be up to 12 months away.
• The current definition of ‘base salary’ as having "the meaning generally accepted within the accounting profession" is inappropriate and introduces further uncertainty. If the Government persists with a ‘base salary’ threshold a more appropriate definition is required, which should be the subject of further consultation. Alternatively, the current definition of ‘remuneration’ in the Corporations Act should be adopted.
• Voluntary superannuation contributions within relevant taxation limits should count towards the shareholder approval threshold.
• Clarification that statutory benefits would not be counted for threshold purposes.
• The strict liability regime for directors should be removed. A strict liability regime is inappropriate in connection with the payment of termination benefits, particularly where there remain so many existing difficulties and uncertainties in connection with the current law and further uncertainties in the draft Bill as to the definitions of "base salary", "key management personnel", and what should be included in the threshold for determining whether shareholder approval is needed.
• The proposed increase in penalties should not proceed. If penalties are to be adopted for the failure to comply with a legislative requirement, the obligation must be clear and unambiguous. There is no evidence of failure to comply with existing laws to justify that approach.
• A sunset clause should be included in the legislation. Two to three years from the date of the new provisions coming into effect is an appropriate term for such a sunset, particularly if there is an upturn in economic activity at that time.

AICD believes that the opportunity should also be now taken to address some of the problems and complexities inherent in the existing law on termination payments.

To download and print the PDF, click here
To view the full submission, click here

Media Contacts:
Steve Burrell, General Manager Communications and Public Affairs
(02) 8248 6627 or 0407 708 485
Juliet Chandler, Communications Advisor
(02) 8248 6624 or 0412 580 402

Australian Institute of Company Directors (AICD) provides education, information and advocacy for company directors Australia-wide, with offices in each state to cater for over 24,000 members. AICD members work in diverse corporations such as small-to-medium enterprises, the ASX Top 200 corporations, public sector organisations, not-for-profit companies, large private companies and smaller private family concerns