New Danish Supreme Court ruling on buy-back provisions in incentive programme

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Issues on enforceability for incentive programmes in Denmark

Many multinational companies operate with various types of incentive programmes, often in the form of bonus, share options or similar, with the aim to recruit, motivate and retain employees.

When a foreign company is considering whether and how to extend such plans to employees in Denmark, a number of issues must be considered, primarily in the areas of tax and employment law. This article will not cover the tax perspective.

Danish Mandatory Law

As for the employment law perspective, the Danish Act on Stock Options significantly affects the enforceability in Denmark of customary provisions in share option plans purporting to restrict employees’ right to exercise share options following termination of their employment. Thus, according to the Danish Act on Stock Options, an employee who is terminated by his employer for any reason but misconduct will retain all rights to share options already granted, whether vested or unvested. Further, the employee will be entitled to a proportionate share of any future share options that the employee could have expected had he continued his employment in the full financial year or until the time of grant.

The employee’s rights are mandatory and cannot be deviated from to the detriment of an employee – not even with his or her specific consent.

Further to the Act on Stock Options, the employer must be aware of Section 17(a) of the Danish Salaried Employees Act, which states that “A salaried employee who - by agreement or practice - is partly remunerated in the form of commission on profit, bonus, or similar payments, and who terminates his or her employment during a financial year, shall be entitled to a pro rata share, having regard to the length of service during the financial year, of the payment he or she would have received if employed in the enterprise at the end of the financial year or at the time when the payments are made.”

Further to this, Section 36 of the Danish Contracts Act (unreasonableness of contracts) may be relevant as well. This was the case in a recent ruling from the Danish Supreme Court in which the court set aside buy-back provision in an incentive programme:

Ruling from Danish Supreme Court on unreasonable buy-back provision

As part of the employment, a Danish employee of a multinational company (MACH group) was offered to participate in an incentive programme, whereby he would acquire a shareholding.

The incentive programme contained various terms, including terms on termination of the employment. In this respect it was agreed that in the event of termination of the employment, the employee would - regardless of the cause thereof – be bound to waive his rights to the shares as the seller of the shares had the right (but not the duty) to claim the shares back. The price of the shares in case of such buy-back would partly depend on the cause of the termination, partly the duration of the employee's shareholding.

After about a year, the employee was terminated, and the employer, subsequently, asserted the buy-back provision against the employee which was rejected by the employee.

Initially, the Supreme Court established that neither Section 17(a) of the Salaried Employees Act nor the Act on Stock Options was applicable to the share investment concerned. The question remained whether the buy-back provision could be set aside under Section 36 of the Contracts Act (unreasonableness of contracts).

The Supreme Court majority (3-2) stated that

“Assessment of whether these provisions on a buy-back duty should be set aside in whole or in part under Section 36 of the Contracts Act must be based on the fact that the opportunity to invest in the shares and the rights pertaining to the investment have been obtained by virtue of the employment with MACH ApS (the MACH group).

It must further be emphasised that the employee at the presentation of the share investment programme was promised that it would be possible to obtain a very considerable gain within a reasonable time frame, and that the MACH group stated that the programme first of all was motivated by the wish to retain the employee in question.

On this basis, we find that it must basically be considered unreasonable to assert the buy-back duty in cases where the employment is terminated by MACH ApS, without such termination being due to breach on the part of the employee, see the principles of and the considerations underlying Section 5 of the Act on Stock Options.

In the present case, the Danish High Court has taken into account that the termination [of the employee] was unfair and ungrounded, and that he therefore has a claim for compensation pursuant to Section 2(b) of the Salaried Employees Act. The judgment was not appealed in this respect, and it must therefore be taken into account that [the employee] was terminated without any breach on his part.

Consequently, and due to there being no basis for derogation from the stated basis, we find that a buy-back duty, which according to the contractual basis lies with [the employee], must be set aside under Section 36 of the Contracts Act. It applies even though it may be taken into consideration that the market value of the shares also at the time of termination was equivalent to a purchase price of EUR 10 per share.”

On this basis, the Supreme Court found that the employee maintained the right to the shareholding.

On the basis of the judgment delivered by the Supreme Court, provisions for a buy-back duty in shareholders’ agreements may be declared void pursuant to Section 36 of the Contracts Act at least if the following conditions are fulfilled:

1. The employee participates in a joint option programme (approx. 400 employees in the actual case);
2. The employee is terminated by the company without it being due to breach;
3. The employee’s share investment has been obtained by virtue of the employment for purposes of retaining the employee;
4. The employee was promised a considerable gain within a reasonable time frame.

The Supreme Court’s decision is particularly reasoned. The scope of the decision is, therefore, uncertain, if one or more of the above conditions are not fulfilled.

Considering the reasoning, it is doubtful in DELACOUR DANIA's opinion whether the Supreme Court would have reached the same result if the employee had terminated the employment himself without a breach on the part of the employer, or if the employee had been terminated by the company giving just cause hereof.

Furthermore, we find it uncertain which effect it will have on the validity of a buy-back provision if the programme is not a joint option programme (for a plurality of employees), but only for one employee / the manager, who invests in a small shareholding in an unlisted company. In this case, the employee would typically have a considerable interest in selling the shareholding as part of the resignation. It cannot be rejected, however, that a buy-back provision in a shareholders’ agreement may be set aside as void if the other conditions for such invalidity are fulfilled.

If you have questions to the above, please contact: Tina Svanberg, attorney-at-law, tsv"@"delacourdania.dk