The truth about Levett v Biotrace

Sandy Henderson acted for Biotrace International PLC in the Court of Appeal hearing.

In Levett -v- Biotrace International plc, the Court of Appeal upheld His Honour Judge Jack’s decision that Mr Levett’s share options had not lapsed when his employment ended. The decision was widely reported in the press and has been the subject of comment in many legal publications. Much of what has been written is inaccurate.

Background
Most share option schemes contain rules stating whether options lapse or become capable of exercise when an option holder ceases employment. The general rule is usually that an option will lapse unless the option holder’s departure is for a reason specified as entitling him to retain his option or, if it is not one of the specified reasons, unless the board of directors exercises a discretion to allow him to retain his option. The scheme under which Mr Levett’s option was granted contains an unusual version of these rules. Further, the way in which the board agreed to exercise its discretion in Mr Levett’s case was set out in a side letter.

There were three parts to Biotrace’s option scheme rules dealing with departure from employment: Rules 5.2 to 5.6 provide for option rights to be retained for 3 months (subject to extension at the board’s discretion) in cases of death, ill health, injury, disability, voluntary redundancy, retirement and take-over; Rule 5.7.1 provided for options to lapse if the option holder became subject to the company’s disciplinary procedures and his employment was “consequently terminated”; and Rule 5.7.2 provided for the board to have a discretion in all other cases to decide when and for how long to allow option rights to be retained and exercised.

The side letter was to be read in conjunction with the option scheme rules and was not intended to amend the rules of the scheme. Paragraph 2 of the side letter allowed Mr Levett to retain and exercise his option until the seventh anniversary of its grant if his employment were terminated by “notice of termination given by the company” (among other circumstances). Paragraph 3 of the side letter stated that his option would lapse if his employment were terminated “through breach of contract, gross misconduct or voluntary resignation”.

The facts
Mr Levett was suspended pending a disciplinary hearing fixed for 21st November 1995. He attended the place where the disciplinary hearing was to be held but left before the hearing could begin. The hearing was adjourned so that Mr Levett would have another chance to give his version of events, which he did by speaking to the Chairman the following day. By letter dated 24th November 1995, the board notified him that the outcome of the disciplinary proceedings was his dismissal with immediate effect for conduct which it considered to be a breach of contract. In the same letter, the board notified him that his share options had lapsed. Although Biotrace had the right under Mr Levett’s contract to make a payment of salary in lieu of notice, it did not do so.

Having initially sought to argue that Mr Levett’s conduct justified summary dismissal, Biotrace conceded before the original High Court hearing that its dismissal of Mr Levett was unlawful. However, it sought to justify the board’s decision that Mr Levett’s options had lapsed on the following grounds:

·that, under Rule 5.7.1, Mr Levett had become subject to the company’s disciplinary procedure and his employment had been “consequently terminated”, failing which
·that Mr Levett’s option lapsed under paragraph 3 of the side letter, because his employment had been terminated “through breach of contract”, failing which
·that Mr Levett’s option was not preserved by paragraph 2 of the side letter, because he had not been given “notice of termination by the company”.

In the Bristol Mercantile Court, His Honour Judge Jack QC decided:

• that Rule 5.7.1 could only apply where there were disciplinary proceedings as a result of which Mr Levett’s employment was lawfully terminated
• that paragraph 3 of the side letter could only apply where Mr Levett’s employment was lawfully terminated through his breach of contract, and
• that Mr Levett’s option was preserved by paragraph 2 of the side letter because his employment was terminated by notice of termination given by the company.

The Court of Appeal’s judgment

This reasoning was upheld by the Court of Appeal. In doing so, it rejected Biotrace’s arguments:

• that it was not necessary to imply into Rule 5.7.1 of the scheme and paragraph 3 of the side letter that termination must be lawful. Necessity, and not mere reasonableness, is the touchstone of implication. If all references to termination in the side letter and the option scheme were to be construed as meaning only lawful termination, they would in many circumstances have had the effect of depriving Mr Levett of his option rights (e.g. lawful termination by reason of redundancy). Because the options related to shares in a listed company, it was important to be able to ascertain with certainty whether or not the option was valid. This would be impossible if the issue whether or not the termination was lawful had first to be determined through the courts.
• that, if Biotrace had lawfully dismissed Mr Levett (in other words, if it had paid him salary in lieu of notice in November 1995 instead of August 1998), his option would have lapsed. For this reason, it was not relying on an unlawful means of termination to deprive Mr Levett of his option since it would have lapsed whether termination was lawful or not.
• that Biotrace had not acted in breach of the option scheme rules or the side letter. The principle of law that no man can take advantage of his own wrong could not apply where Biotrace had breached a different contract (Mr Levett’s service contract) to the ones being construed by the court (the option scheme rules and the side letter).
• that, even if Mr Levett’s case did not fall within Rule 5.7.1 of the scheme or paragraph 3 of the side letter, he still needed to show that paragraph 2 of the side letter applied. Mr Levett had not been given lawful notice of termination by the company (i.e. 12 months’ notice) or any notice. The concept of notice meant more than mere notification. Without giving detailed reasons, the Court of Appeal rejected Biotrace’s submissions that no distinction needed to be made between lawful and unlawful termination. It rejected the argument that this created uncertainty on the ground that share options were, by their very nature, uncertain (as to whether or not they would be exercised). It also decided that, because all three contracts (the service contract, the option scheme rules and the side letter) were made between Biotrace and Mr Levett and because the share option was part of Mr Levett’s remuneration package under his service contract, there was no reason why the rule (that a party cannot take advantage of its own wrong) could not be applied to prevent Biotrace from depriving Mr Levett of his option rights under the option scheme rules and the side letter by dismissing him in breach of his service contract. Comments The distinction between lawful and unlawful dismissal is unconvincing, as are the remarks that option rights do not need to be certain. There is a factual error on the first page of the judgment, where it is suggested that Mr Levett was dismissed one day short of the third anniversary of the grant of his option (the date when it would ordinarily have become exercisable for the first time). In fact, Mr Levett’s dismissal took place a year earlier. It may be that the Court inferred bad faith in Biotrace’s actions from the supposed timing of Mr Levett’s dismissal and sought to act against it. There is a wider ramification for the Court of Appeal’s judgment that, because Biotrace had breached Mr Levett’s service contract, it could not rely on rules intended for its benefit in the share option scheme. This arises in relation to the exclusion clauses contained in most share option schemes. Typically, this clause will exclude any claim by an option holder for loss of option rights in the event of the (unlawful or unfair) termination of his employment. The scheme rules under which Mr Levett’s option was granted contained such a rule. His contract of employment also included an identical exclusion clause and a clause giving him a right to be granted the option as a term of his employment. However, Mr Levett did not claim damages for loss of option rights, he claimed that his option rights were still alive. Accordingly, the validity or otherwise of these exclusion clauses was not tested in court. Before Levett -v- Biotrace, exclusion clauses in share option schemes were held to be effective in a case called Micklefield v SAC Technology. There were two bases for the decision:-
  • the first was that, in England and Wales if not in Scotland, the Unfair Contract Terms Act 1977 (which would have made the exclusion clause subject to a reasonableness test) did not apply to share option schemes because they were contracts for securities and therefore exempted under Schedule 1 of that Act. The question whether or not the Unfair Contract Terms Act 1977 would apply the reasonableness test to an exclusion clause in an employment contract - particularly one in a standard form contract - is one which the courts have consistently declined to rule on.
  • the second was that Mr Micklefield’s option was not a term of his employment contract but a collateral right. For this reason, the rule of construction preventing a party from taking advantage of his own wrong (by relying on the exclusion clause) did not apply because, although SAC Technology breached his employment contract, they had not breached the rules of the option scheme which contained the exclusion clause. In Levett -v- Biotrace, the same rule of construction was held to apply notwithstanding that the breach occurred in the service contract and not in the option scheme itself. The difference between the facts of the two cases is that Mr Levett’s option could not be said to be a right granted collateral to his service contract because the right was expressly set out in the service contract. For this reason, it was thought advisable for an employer not to make any reference to share options in its contracts of employment. By doing so, it was hoped that the employer would not lose the right to rely on the exclusion clause in the (collateral) share option scheme if it dismissed the option holder in breach of his employment contract. The decision in Levett -v- Biotrace may now mean that an employer who wrongfully dismisses an option holder will not be able to rely on the exclusion clause in its share option scheme to prevent him from claiming damages for lost option rights whether the option rights are given as a term of his employment or collateral to his employment. Typically, such loss would occur if the option lapsed on termination of employment when, if the option holder had been given due notice under his employment contract, the option would have become exercisable during the notice period. The decision in Levett will not help employees of subsidiary companies who are granted options (collateral to and not as a term of employment) by the parent company. In this situation, the decision in Micklefield should still enable the exclusion clause in the option scheme to be relied on because the parties to the employment contract and the parties to the share option scheme are not the same.