One of the principal factors used to determine directors' bonus payments and benefits is the performance of the company for which they work. When a company's statutory accounts show that it is performing well, this often triggers bonus payments and benefits to directors. Where a company discovers however, after bonuses and benefits have been paid to directors, that its statutory accounts are incorrect due to erroneous, negligent or fraudulent internal practices, it would not be surprising to find shareholders calling for directors to repay their bonuses/benefits. While a director may decide to comply of his or her own volition, the legal recourses through which a company may effectively impose repayment are limited.
A company can dismiss a director, however this will not recoup bonuses already paid. A company may also attempt to sue a director for breach of fiduciary duty, however this is a complex and often very costly approach where success is by no means guaranteed. The US approach enshrined in the Sarbanes-Oxley Act 2002 may indicate a further avenue of recourse, this time in contract law.
Under the Sarbanes-Oxley Act, chief executive officers and chief financial officers are automatically obliged to repay any bonuses or benefits received from the company where the company has had to restate its accounts due to misconduct which caused the company to be in breach of US legislation. This obligation applies to all bonuses and benefits paid in the 12-month period following the publication of the faulty document.
In the UK, it would be possible for companies to encourage their directors to enter into a contractual arrangement mimicking the terms of the US Act. Under this contract, directors could agree to repay bonuses under certain circumstances. However, it must be carefully constructed so as not to be unenforceable. There are two possible approaches to its structure.
The first makes repayment conditional upon directors having breached a duty outlined in the contract. This approach suffers from the difficulty that the breach of duty must be substantiated. Clauses must also be worded so that they do not fall foul of the doctrine whereby a clause will not be enforceable if it amounts to a penalty. In order to avoid being regarded as a penalty, the amount repayable must be a genuine pre-estimate of the possible cost of breach to the company.
The most significant difficulty, however, is in ensuring that the clause compensates rather than acts as a deterrent. Where the amount of a director's bonus is determined by reference to achievement against pre-set group wide financial targets (such as turnover or earnings per share), it should be relatively straightforward to determine the amount of the loss simply by re-calculating the bonus on the basis of the re-stated figures; any amount by which the original award exceeded the re-calculated bonus could then be recovered from the director.
The second approach is to make repayment conditional upon factors not linked to a director's breach of duty. This approach may allow the company to extend the conditions under which repayment might be due. However, careful drafting would be necessary to ensure that this does not falter at the hurdles of the first approach. In contracts of this kind care should also be taken to ensure that the directors are advised to take independent financial advice.
At present, a company must also accept that having such a clause may dissuade prospective directors from accepting office. However, with at least one public company currently considering the introduction of such a clause into its directors' service contracts, it may be that provisions allowing companies to recoup directors' bonuses and benefits will soon become a matter of course.