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Cutting Executive Pay During Coronavirus

Responding to the extraordinary Covid-19 pandemic, major banking and insurance companies recently took the difficult decision to suspend the payment of shareholder dividends to preserve vital funds for businesses battling the anticipated sharp recession. Profit warnings are at record rates and companies are struggling to prepare financial forecasts, while revenues are plummeting and reserves are depleted – preservation of cash is paramount.

Against this backdrop, managing directors are considering whether senior executives’ pay should be cut, a decision necessitating rigorous consideration of legal and commercial implications.

From a legal perspective, two points are vital: consultation and consent. An executive’s pay is a condition of their employment contract and can only be varied by consent. Even in these unprecedented circumstances, a unilateral variation is unlawful and could give rise to claims for breach of contract and/or unlawful deduction from wages. Such breaches can nullify any restrictive covenants within the contract – a clear exposure risk.

To obtain consent, consultation is required. In clear language, executives should be informed of the proposed salary reductions, the timing of implementation, potential review stages and what will happen if none, or only some, agree. The aim is to get the necessary consent.

Managers must, therefore, consider the impact on pay-based statutory benefits and contractual-based benefits, such as enhanced pension contributions; if/when previous pay conditions will be reinstated; whether there will be a pay freeze once restrictions are lifted; whether bonuses will be paid; whether part-time hours will be implemented; and any effect on annual leave. The more reasonably and honestly these proposed changes are articulated, the more likely that executives’ consent will be secured. Any agreed variations to the contract must be documented.

From a commercial perspective, managing directors should be frank about their income and profit forecasts and the effects of the agreed cuts, without depleting faith in the company’s prospects. Falling share prices may impact on long-term incentive schemes designed for these most senior managers and, therefore, it is crucial to think carefully and formulate plans for the long term (without over-promising), as well as for the immediate cash-preservation crisis.

Demotivation can erode commitment and alienate talented key players. For some managers, the current crisis represents an opportunity and jobs are being rapidly created in some sectors for those with skills such as logistics.

Despite agreed pay cuts, some businesses will simply be unable to sustain current levels of employment, necessitating redundancies. Adherence to legal process is equally essential – a valid redundancy procedure follows clear steps.

First, a legitimate and clear business need must be established (ie, downturn in business). An ‘inform and consult’ stage must then occur: staff must be told why redundancies are necessary, the number affected, the objective criteria for selection of those at risk (such as previous performance and skillsets), plus financial information on the notice/redundancy payments they will receive. Depending on the numbers being made redundant, certain minimum consultation periods may apply but, regardless, a reasonable timescale must be allowed.

Suitable alternative roles within the business should also be explored and offered to affected staff. Care must be taken with special categories of employee, such as those approaching retirement or who are on leave for maternity or parental reasons, as a discriminatory selection will give rise to uncapped claims for unfair dismissal tainted by discrimination.

Clearly, in these precarious and indeterminable times, managing directors must think dynamically to formulate urgent continuity plans. These may include cuts to senior executives’ pay and/or wide scale redundancies, both of which require proactive analysis of these legal and commercial implications to minimise otherwise catastrophic risk to the businesses managing directors are aiming to protect.

This article was written by partner Merrill April and Associate Sophie Rothwell, and was first published by People Management on 20 April 2020.