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This article appeared in the Australian Industrial Relations Tracker
 
Employee keeps shares in contract interpretation case
 

In a battle between an employee and employer over a valuable parcel of shares, the Supreme Court has ruled in favour of the employee based on the terms of the loan agreement.

The shares and their value

The employee, Mr Scanlon, was an investment banking executive working for Sigiriya Capital Pty Ltd (Sigiriya). He reported to Mr Fraser, who was the Executive Chairman and Managing Director.

In November 2010, the employee entered a loan agreement with Sigiriya for $47,500, so that he could purchase 2,500 shares in York Potash Ltd (York Potash). Mr Fraser was the sole member of York Potash. The loan agreement also served the purpose of compensating the employee for his salary which was arguably below market value.

Before the loan agreement was entered into, the Fraser Family Trust entered a memorandum of understanding with Sirius Minerals plc (Sirius — a UK company with an Australian subsidiary). This granted Sirius an option to acquire all the shares in York Potash in exchange for 150 million Sirius shares. The loan agreement therefore contemplated that the employee’s 2,500 York Potash shares would be exchanged for the relevant number of Sirius shares.

Sirius did exercise that option on 17 January 2011, and the employee received 7,499,850 shares in Sirius. Because of “an extraordinarily good find of potash” in Yorkshire, the shares had a value of about $1.6m by August 2012. If the employee was entitled to pay out the loan agreement in cash, he would only need to pay about $58,575.

Breakdown of relationship

On 17 January 2011, Mr Fraser became the Chief Executive Officer and Managing Director of Sirius. The board did not allow him to continue with Sigiriya. As a result, he let the employee know that he was “shutting it down”.

In mid-February, Mr Fraser told the employee that his employment with Sigiriya would terminate at the end of February 2011. In March, the employee entered into an employment contract with Sirius which was expressed to commence on 17 January 2011.

The relationship soured, and in November 2011, the employee was suspended pending an investigation of his performance and conduct. On 23 December 2011, Mr Fraser sent the employee a letter on Sirius letterhead purporting to terminate his employment with both Sirius and Sigiriya because of breaches of his employment contract.

This wording was important, because by it, Mr Fraser purported the “Early Termination” of the loan agreement, under which the employee would be obliged to repay the loan by transferring his lucrative shares in Sirius to Sigiriya. (Such Early Termination only occurred under the terms of the loan if Sigiriya terminated the employment due to an employee breach or if the employee terminated the employment.)

Through an exchange of solicitors’ letters in December 2011, the employee disputed that his employment with Sigiriya continued beyond 28 February 2011.

Submissions

The employee commenced proceedings in the Supreme Court of New South Wales.

He argued that he was not required to repay the shares since the employment ended on 28 February 2011 by consent. That is, it was not an “Early Termination” under the loan agreement.

He also argued that even if it were an Early Termination, it was contrary to the implied terms of good faith and reasonableness to exercise discretion to apply the repayment by transfer.

Sigiriya conceded that the employment terminated by consent. However, it argued that this was within the definition of Early Termination, as it was by the employee.

Alternatively, Sigiriya argued that the employee had defaulted on the loan agreement, principally through transactions involving a brokerage account with JP Morgan. This was a “disposal” of shares which was a default of the loan agreement. Further, he entered a transaction which was subject to a lien, so that the shares were no longer “unencumbered” as required by the loan agreement. This entitled the company to delivery up of the shares. (The employee argued this wasn’t relevant because he was still the beneficial owner of the shares).

Early Termination repayment not triggered

Justice Young noted that he had hinted during the proceedings that this was a case where an application for forfeiture might be included — where relinquishing the shares would amount to a windfall to the lender which was unjustifiable in comparison with the actual prejudice suffered because of the alleged breach. However, this was not a pleading taken up by the employee.

In relation to the construction of the loan agreement, his Honour rejected the argument that the termination of employment by consent fell within the definition of Early Termination. It was not the employee terminating the employment. Further, when the termination of employment with Sigiriya occurred in February 2011, it was well before any contemplation of breach alleged in November 2011, so that breach was not the reason for the termination.

This meant that the employee was successful on the ultimate issue — the shares were his and repayment was required by cash payment of the loan rather than transfer of shares.

Remaining matters

For completeness, his Honour considered the alternative argument that the employee had defaulted on the loan agreement requiring delivery up of the shares. He found that the transactions with JP Morgan were a disposal of and an encumbrance on the shares — default according to the terms of the document. His Honour expressed some interest that for someone with the level of qualifications as the employee understood quite little of the legal effect of those transactions.

However, Sigiriya had not used the processes required under the loan agreement to notify the employee of the default, so that relying on these breaches in the December 2011 letter did not allow the employee to remedy them. This is necessary before relying on the default clause of the loan agreement. In any event, this was not relevant because Sigiriya did not exercise any of the options open to it under the loan agreement in relation to default. It rather relied on the Early Termination clause in the December 2011 letter.

In relation to the implied terms of good faith and reasonableness, this was not a case where they applied because of the express terms of the loan agreement which excluded them and the fundamental agreement that the shares be left intact.

Importance of truthful defences

Justice Young drew attention to inconsistencies between the sworn defence and amended defence of Mr Fraser. He said that he usually referred such matters to the police after counsel had the opportunity to cross-examine on the inconsistent pleadings. Since Mr Fraser was not called as a witness, his Honour ordered that he provide reasons for the inconsistency within 30 days and explain why the papers should not be delivered to the police.

Application

The case highlights the following matters:

  • • When drafting arrangements such as loan documents between employers and employees, always bear in mind that the relationship may end acrimoniously. Seek legal advice to help protect your interests.
  • • In this case, the employee thought that using a brokerage firm was allowed under the agreement when it was a default. Consider drafting clearer language concerning the employee’s obligations under the agreement — the prohibition should be expressed broadly enough to protect against any transaction involving the shares which could affect transfer back to the lender.
  • • Consider a requirement for written approval from the lender for any transaction involving the shares. In the present case, the lender didn’t know about the default until the proceedings had commenced and well after it had exercised the Early Termination clause.
  • • If ending an employment relationship and concerned about the impact on share arrangements, seek legal advice. Here, purporting to terminate the employment relationship because of breaches of employment was simply untrue. The relevant employment contract had ended about 10 months earlier.
  • • Consider accessing alternative dispute resolution specialists to help resolve matters which the legal position may not adequately redress. Eg LEADR Association of Dispute Resolvers has accredited members.
  • • Never swear or affirm a pleading which you are not sure about. Outcomes for falsely swearing or affirming include contempt of court and criminal sanctions, not to mention negative publicity.
  • • Lawyers must gather the evidence required to prove all aspects of a pleading in the interests of their clients and as officers of the court. They should advise their clients about the importance of swearing and affirming court documents.

Scanlon v Sigiriya Capital Pty Ltd [2013] NSWSC 227

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