The High Court takes a steely look at bonus clawback provisions

This article was first published by ELA Briefing.

The case of Steel provides a helpful reminder of the law relating to the interaction of restraint of trade and bonus clawback provisions, highlighting the difference between an unenforceable restraint of trade and protective provisions within a contractual remuneration package that disincentivises certain behaviour.

The facts

Mr Steel worked for The Omerta Group (Omerta), a global head-hunter company, looking for talent for investment banks, private market investing, investment managers, private equity and hedge funds. As part of his terms of employment, Mr Steel received a basic salary and an annual discretionary bonus. In January 2022, Mr Steel received a discretionary bonus of £187,500 (an amount considerably larger than his basic salary, which at the time was £65,000 a year). A few weeks later, Mr Steel resigned in order to join a competitor of Omerta.

Mr Steel's employment contract contained a clawback provision that required him o repay his discretionary bonus if he left or was given or gave notice within three months of it being paid. Accordingly, when Mr Steel resigned in February 2022, Omerta asked him to repay the bonus he had received in January 2022. Mr Steel refused to do so.

The ICC decision

As he continued to refuse to repay the bonus, Omerta served Mr Steel with a statutory demand for repayment. Mr Steel applied to the Insolvency and Companies Court (ICC) for relief, which can set aside a statutory demand if the debt is disputed ‘on grounds which appear to the court to be substantial’. Mr Steel argued that this test was satisfied because the clawback provision in his contract amounted to an unreasonable restraint of trade and/or a penalty clause and, consequently, was unenforceable.

The restraint of trade principle is based on the idea that an individual should be free to work without undue interference. Contractual terms purporting to restrict this freedom to work or carry out a trade or business will be deemed to be void unless they go no further than is necessary to protect a company's legitimate business interests. Assessment of whether a clause falls foul of the restraint of trade doctrine therefore requires a two-stage analysis: (i) whether the clause is in fact a restraint of trade; and (ii) if it is, whether it is reasonable with reference to the interests of the parties and the public.

The ICC dismissed Mr Steel's application on the basis that the clawback provision was not a restraint of trade as it did not restrict him from working elsewhere. The ICC judge relied on the judgment of Jack J in Tullett in support of this proposition. The ICC judge commented that there might be circumstances where the severity of the consequences of a clawback clause were clearly out of all proportion to the benefit received but, in the present case, he considered that this was not arguable. Indeed, the judge described the clawback provisions in this particular case as ‘very moderate’. The ICC judge also dismissed the argument that the clawback provision amounted to a penalty clause.

The High Court decision

After losing in the ICC, Mr Steel repaid the bonus to Omerta, but also appealed the ICC's decision on the question of restraint of trade to the Chancery Division of the High Court. He did not appeal the question of the clawback provision being a penalty clause.

Bacon J dismissed Mr Steel's appeal and held that<

• the ICC was correct to find that the contractual bonus clawback provision was not a restraint of trade. Although there was no doubt that an employee bonus or commission scheme which was conditional on the employee remaining in employment for a specified period of time operates as a disincentive to that employee resigning, that does not, in and of itself, make it a restraint of trade;
• that analysis was not affected by the fact that there were other contractual provisions which imposed different restrictions on Mr Steel, such as post-termination restrictive covenants (PTRs). In the context where no challenge had been brought in relation to those other provisions and itwas not suggested that the PTRs had a bearing on the interpretation of the bonus clawback provision, it was not necessary to consider the combined effect of the bonus clawback provision and the PTRs when assessing whether the clawback provision itself was in restraint of trade;
• the ICC had not conflated the two stages of the relevant test by considering whether the severity of the consequences of the clawback clause were in proportion to the benefit received. While similar considerations would arise in assessing the reasonableness of the clause, it had been quite proper for the judge to consider them in relation to the first limb of the test, particularly as Mr Steel had specifically argued the severity and disproportionate effect of the clause in his case meant it constituted a restraint of trade; and
• In so far as there was an inconsistency between Tullet and the subsequent case of 20:20 London, Tullet was to be preferred. In 20:20 London, the defendant argued that a clause requiring him to repay consideration paid to him for the sale of a business in the event that he left the business within three years of the sale was a restraint of trade. Mr Donaldson QC allowed that argument to proceed to trial, distinguishing it from Tullet on the basis that Jack J had not properly considered the disincentive effect such clauses have. Bacon J noted that 20:20 London concerned a wholly different type of contractual provision from the instant case meaning it had limited value in terms of read across. She also deprecated Mr Donaldson QC’s analysis of Tullet, holding that Jack J had the question of disincentive effect firmly before him, but had rejected the proposition that this amounted to a restraint of trade.

Bacon J also rejected the suggestion that this was a novel or developing area of law. In issuing her judgment she has perhaps made that the case, since it is now clear, at least from the perspective of the High Court, that Tullet established the precedent that bonus clawback provisions in contracts of employment will not, without something unusual or additional, be in restraint of trade even if they require the employee to remain in employment for a specified period to avoid their effect. The potential door that the decision in 20:20 London seemed to have opened to arguing to the contrary has now been closed.

Lessons from the case: advising individuals

• If an employee's contract contains a bonus clawback provision, thought should be given as to the timing of their resignation in order to try and avoid triggering repayment of a bonus.
• If this is not possible because of pressure to join a new employer, the employee should consider negotiating a sign-on bonus to compensate for bonuses lost by resigning at the new employer’s preferred time.
• As always, you should advise the employee to consider their position before litigating; the litigation costs might be more than the bonus they are potentially losing.

Lessons from the case: advising employers

If employers wish to prevent their employees leaving without much warning, clawback provisions are worth considering. This case shows that clawback provisions can serve as a strong disincentive to leaving and are less likely to be vulnerable to challenge via the courts than post termination restrictions (which are far easier to challenge, at least on an interim basis, even if, ultimately, they are found to be enforceable).

Kerenza Davis and Katie Mahoney, Mishcon de Reya LLP

KEY:

Steel Steel v Spencer Road LLP (t/a The Omerta Group) [2023] EWHC 2492 (Ch)

ICC Insolvency and Companies Court

PTRs Post-termination restrictive covenants

Tullett Tullett Prebon v BGC Brokers [2010] EWHC 484 (QB)