Good news for good and bad leaver clauses

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Good and bad leaver provisions – a mainstay of private equity deals – don’t often find themselves in court. A very recent High Court decision has considered their effectiveness.

In Moxon v Litchfield [1] a former director, Mr Moxon, sought redress in respect of his removal as a director and the provision in the company’s articles of association and shareholders’ agreement which compelled the transfer of his shares at par value where he was characterised as a “Bad Leaver” (as defined in the articles).

The essence of the case was whether or not Mr Moxon had been correctly characterised as a Bad Leaver. The court found that he had been. What is of more general interest is the approach the court then took to the operation of the Bad Leaver provision.

The court said that there was no basis for it to intervene in what was a contractual arrangement between the parties. This was the case even though this might create a “harsh, even draconian, result” (the court’s words) for the leaver. The Bad Leaver provision represented a readily understandable balance between the reasonable expectations of management and the investors. The court added that: “the provisions for removal of a director and the deemed transfer of his shares at a price depending on the circumstances of his removal, do not seem to me to be offensive to the nature of the Company as a small body corporate based on personal relationships”. This was particularly the case where, as here, provision had been made for the distributions of profit each year and was therefore not a situation where the deemed transferor lost all benefit from his participation.

Accordingly, Good and Bad Leaver provisions have received a firm measure of judicial support. The only caveat is that they be strictly interpreted, exercised in good faith and not used for (in the words of the court) “base and unworthy purposes”.

Walker Morris comment
The court’s robust commercial approach to Good and Bad Leaver provisions is to be welcomed. They form an important element of the relationship between management and investors and it is right that this be left to the parties themselves to determine, free, so far as possible, from judicial interpretation.

[1] [2013] EWHC 3957 (Ch)