Reda & Anor v Flag Ltd (Bermuda) [2002] UKPC 38 (11 July 2002)

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The Judicial Committee of the Privy Council Decisions

You are here: BAILII >> Databases >> The Judicial Committee of the Privy Council Decisions >> Reda & Anor v Flag Ltd (Bermuda) [2002] UKPC 38 (11 July 2002)
URL: http://www.bailii.org/uk/cases/UKPC/2002/38.html
Cite as: [2002] IRLR 747, [2002] UKPC 38

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Reda & Anor v Flag Ltd (Bermuda) [2002] UKPC 38 (11 July 2002)

Privy Council Appeal No. 63 of 2001

(1) Nicholas Reda and

(2) Jamal Abdul-Jalil Appellants

v.

Flag Limited Respondent

FROM

THE COURT OF APPEAL OF BERMUDA

---------------

JUDGMENT OF THE LORDS OF THE JUDICIAL

COMMITTEE OF THE PRIVY COUNCIL,

Delivered the 11th July 2002

------------------

Present at the hearing:-

Lord Nicholls of Birkenhead

Lord Mackay of Clashfern

Lord Hope of Craighead

Lord Hutton

Lord Millett

[Delivered by Lord Millett]

------------------

This appeal arises out of a dispute about the payments and other benefits due to two senior executives of Flag Limited (“Flag”) on the termination of their contracts of employment. The main issue is concerned with their claim to be entitled to stock options under a stock option plan which was introduced shortly after their employment came to an end. The matter is governed by their contracts of employment. No statutory rights are involved.

The Parties

Flag was incorporated in 1993 in Bermuda as the corporate vehicle for a joint venture between its principal shareholders Nynex Networks Systems Company (“Nynex”), a Delaware company and a subsidiary of the American Nynex Corporation, and the Dallah Albaraka Group of companies of Saudi Arabia (“Albaraka”), though there were some outside shareholdings. The company was formed for the purpose of developing and constructing an undersea fibre optic cable system as part of a global cable telecommunication network. Construction of a cable system linking Europe, the Middle East and Asia was completed by Flag on budget and in time in October 1997.

The first appellant (“Mr Reda”) is a qualified electrical engineer. He was a senior executive of Nynex who was seconded to Flag. In 1989 he undertook a feasibility study for the global cable system which Flag eventually constructed. The study was completed in 1990. Thereafter he was responsible for the preparatory work needed to bring the project to the construction stage. He remained an employee of Nynex until 1st July 1995 after which he was employed by Flag full time.

The second appellant (“Mr Abdul-Jalil”) is a qualified engineer with experience of the management of large scale construction projects. He was a senior employee of Albaraka until he joined Flag at Mr Reda's invitation on a full time basis on the 1st April 1993. He was responsible for obtaining substantial equity participation for the project.

The Executive Committee

The appellants were both directors of Flag. In 1995 Mr Reda was appointed as President and Chief Operating Officer; Mr Abdul-Jalil as Executive Vice-President. They reported to the Chairman and Chief Executive Officer, a Mr Timpanaro, who like Mr Reda had been seconded from Nynex. The three men constituted an Executive Committee which represented the two major shareholders. They operated as a triumvirate and together exercised the highest executive powers in the company.

The appellants were each employed by Flag under a contract of employment for a term of three years from 1st July 1995. The terms of their employment, as well as those of other senior employees, were negotiated by a Compensation Committee which was established for the purpose. Because the Executive Committee was discharging functions normally discharged by a single chief executive officer, the contracts of its members were negotiated as a group rather than individually and were in identical terms except for the base salary each was to receive and the position he was to occupy.

The members of the Executive Committee were each to receive a base salary, a performance-related annual incentive bonus, a performance-related completion bonus payable at the end of the contractual term and a number of specified benefits in kind. Their Lordships will refer to the terms of the appellants’ contracts of employment in more detail later, but for the moment they can be sufficiently summarised as follows:

(1) The contracts were for a term of three years expiring on the 30th June 1998, but could be terminated by Flag at any time without cause on payment of compensation.

(2) The appellants’ base salary was initially fixed at $180,000 per annum, but Flag undertook to maintain it at a level equal to 90% of the base salary paid to the Chief Executive Officer for the time being. It is this provision which has given rise to much of the difficulty and to most of the issues at first instance. It is referred to in the judgments below as “the linkage clause”. Similar linkage clauses by reference to the appellants’ base salaries were included in the contracts of other senior managers below them.

(3) The appellants’ annual incentive bonus was related to their individual performance and was awarded by the Compensation Committee each year. The maximum bonus was 150% of base salary in each of the first two years and 50% of base salary in the third year. Since the amount of the bonus was related to the base salary, it was also affected by the linkage clause.

(4) The completion bonus was also awarded by the Compensation Committee and was payable at the end of the contractual term. The amount of the bonus was discretionary and was dependent on the completion of the project and its profitability.

(5) The appellants also had a contractual right to participate in any employee benefit plans which Flag might establish for senior officers in future. It is this provision which has given rise to the principal issue in the Court of Appeal and before the Board.

The Compensation Committee regarded the members of the Executive Committee as a group rather than separate individuals, and the appellants’ contracts of employment reflected this. They contained references to the principles of consistency and uniformity of treatment, as well as an express provision that no senior manager brought in from outside should be offered more favourable treatment than they received themselves.

In September 1995 a Mr Dan Petri was appointed a Director of Flag and a member of the Compensation Committee. Mr Petri was a President of Bell Atlantic International Communications Corporation (“Bell Atlantic”), a subsidiary of Nynex which later merged with its parent company. By 1997 he had become dissatisfied with Flag’s management structure, and proposed that the Executive Committee should be disbanded and a single Chief Executive Officer be appointed in its place. This called for the appointment of an outside candidate of greater experience and stature in the industry than Mr Timpanaro, whose employment was terminated on 31st May 1997. Pending the appointment of a new Chief Executive Officer, Mr Petri served as acting Chairman of Flag from June 1997 to January 1998. He regarded it as his immediate responsibility to find a new Chief Executive Officer to replace the Executive Committee as quickly as possible.

The Negotiations with Mr. Bande

In September 1997 Mr Petri informed his colleagues on the Compensation Committee that he and another officer of Bell Atlantic were negotiating with a Mr Andres Bande, who had favourably impressed them as a prospective Chairman and Chief Executive Officer of Flag. Mr Bande was the Chief Executive Officer of a substantial company Sprint International (“Sprint”) and a major figure in the international telecommunications industry. Because of his standing and reputation he was in a position to demand a much more generous remuneration package than Mr Timpanaro had enjoyed. Mr Petri reported to the Compensation Committee that Mr Bande was seeking an annual salary and bonus amounting to $975,000 in total, as well as a sum by way of compensation for the value of the bonus he would have received from Sprint for 1997, together with stock options to replace those he held in Sprint.

Mr Petri recommended offering Mr. Bande an annual salary of $500,000 and short-term bonus of $250,000, and a sign-on bonus of $150,000, together with participation in a phantom stock option plan which would generate $5 million in value over five years if Mr Bande achieved his business plan, and up to $10 million over the same period on a sliding scale if he exceeded it. He told the Compensation Committee that he had hoped to get away from cash bonuses, but Flag could not meet Mr. Bande's demands without a bonus unless it paid the whole of his annual remuneration by way of base salary, and he did not want to do that. He added that, while Flag did not normally pay sign-on bonuses, he looked at this as a mechanism to give Mr Bande the amount he was seeking for 1998, which would then be replaced by the phantom stock option plan in subsequent years. He commented:

“These are big numbers, but I am convinced he is worth it. In fact, our potential lenders tell us a CEO of his status and reputation in the industry is worth 25-50 basis points on the base yield, which would save us $1 million to $2 million per year.”

By 15th October 1997 the negotiations with Mr Bande had yielded significantly different terms. He was now to be paid a base salary of $625,000 and an annual bonus of $275,000, making $900,000 in all, together with a sign-on bonus of $300,000 and a further $350,000 by way of compensation for the bonus he would forfeit by leaving Sprint. He was also to receive stock options, and more generous compensation in the event of dismissal without cause than that to which the appellants were entitled. These terms were incorporated in a draft contract prepared by Bell Atlantic’s lawyers.

The draft contract was, however, not approved by the Board of Flag. According to the Board minutes Mr Bande’s earnings and in particular his potential earnings under the proposed stock option plan were unacceptable to Bell Atlantic. The Board approved Mr Petri’s proposal to renegotiate Mr Bande’s contract to ensure that his earning potential under the stock option plan would be lower than previously agreed.

Mr Bande was eventually appointed Chief Executive Officer of Flag under a contract dated 11th December 1997, and took up his position on 12th January 1998. He also became a Director and Chairman of the Board. Under the terms of his contract he was entitled to an annual base salary of $450,000 and a performance-related annual incentive bonus of up to $900,000, with a minimum of $350,000 for the first two years. He was also entitled to a sign-on bonus of $300,000 after tax and a sum of $350,000 before tax as compensation for the loss of the bonus for 1997 which he would have received from Sprint. In addition, Flag undertook within three months (that is to say by the 11th March 1998) to establish a stock option plan in typical form under which he would become entitled to rights which were potentially extremely valuable.

In his evidence Mr Petri explained how the reduction in Mr Bande's base salary from $625,000 to $450,000 came about. He said that, as Flag was an affiliate of Bell International, the remuneration of its Chairman and Chief Executive Officer needed the approval of Bell Atlantic's executive committee. In the course of discussing the matter with the Chairman of Bell Atlantic, who was the person who would be responsible for obtaining the approval of its executive committee, he was given to understand that he could not offer Mr Bande a base salary of $625,000. He went back to Mr Bande and offered him a lower base salary and a higher annual bonus, which proved acceptable both to him and to Bell Atlantic.

The waivers

The reorganisation of Flag's management structure involved the dissolution of the Executive Committee and its replacement by a single Chief Executive Officer at a greatly increased salary. But therein lay a difficulty. Unless the appellants and other senior managers waived the linkage clauses in their contracts, they would become entitled to very substantial increases in their base salaries in return for undertaking reduced responsibilities. This obviously could not be justified. Flag accordingly sought to obtain appropriate waivers, while at the same time reminding the individuals concerned that if need be their contracts of employment could be terminated at any time without cause.

Before the terms of Mr Bande’s contract were agreed, Flag obtained from the appellants what it believed to be written waivers of the linkage terms in their contracts. By mistake, however, they had been sent the wrong documents to sign (being the documents intended for other senior managers whose base salaries were linked with those of the appellants), and the waivers which these contained were inappropriate. Flag did not discover the mistake until 29th January 1998, when the appellants wrote to Mr Bande (with copies to the Compensation Committee) insisting on the linkage clauses in their contracts and demanding an increase in their base salaries to 90% of that paid to Mr Bande.

Termination of the Appellants’ contracts

This might be thought to be tactically unwise, for the appellants’ contracts were terminable at any time without cause and in any case had only five months to run. If they wanted their contracts to be extended, it was hardly prudent to demand a substantial and commercially unjustifiable increase in salary, even if they were contractually entitled to one. Moreover their long term future with Flag was none too secure. In the previous year Mr Petri had agreed with the Board that, following the dissolution of the Executive Committee, the appellants’ future roles in Flag should be left to the new management to decide. Mr Petri had sought their removal as Directors in the meantime, but the Board did not agree to this, and this too was left for future consideration.

Mr Bande’s contract gave him full authority to hire and terminate the employment of all employees with the exception of those in senior management (which included the appellants), whose hiring or dismissal required the approval of the Board. Such approval, however, was not to be unreasonably withheld. In December 1997 Mr Bande had informed the Board that he had yet to decide who would be Chief Operating Officer (the office held by Mr Reda) in the new structure. As the Court of Appeal observed, Mr Reda’s position was clearly precarious.

Mr Bande responded to the appellants’ demands by a letter indicating that, while Flag would greatly benefit from their experience and support during the transitional period, the restructured organisation did not contain suitable positions for them, and that Flag would not require their services “on a forward going basis”. After assuring the appellants that Flag would fulfil its contractual obligations to them and would make every effort to treat them with the utmost fairness, Mr Bande’s letter stated that the Compensation Committee believed that it would be in the best interests of Flag if they were to tender their resignations as Directors of Flag immediately.

A meeting of the Board took place on 1st March 1998. It was held by telephone conference call. The single item for consideration was a resolution authorising the Compensation Committee in conjunction with Mr Bande to negotiate and agree the terms and conditions of the appellants’ severance and failing agreement to terminate their employment with immediate effect.

The appellants and Mr Bande were present in their capacity as Directors. Mr Abdul-Jalil addressed the meeting on behalf of Mr Reda as well as on his own behalf. He argued that it was not in Flag's interest to terminate the appellants' employment and asserted that those who proposed the resolution were motivated by a desire to deprive them of their right to stock options by dismissing them before the stock option plan was established. This was not denied. The resolution was passed, all the Directors other than the appellants voting in favour and the appellants voting against.

Immediately after the Board meeting a special meeting of the shareholders was held, also by telephone conference call. The appellants and Mr Bande were allowed to attend this meeting also, and Mr Abdul-Jalil addressed the shareholders. He invited them to reconsider the decision made by the Board in the light of Flag’s interests and their own interests as shareholders. He repeated the substance of what he had said at the Board meeting. After he concluded his remarks resolutions for the removal of the appellants as Directors of Flag with immediate effect were passed unanimously.

If there were any negotiations between the parties they were evidently unsuccessful. On 8th March 1998 the appellants each received a letter informing him that his employment had been terminated by the Compensation Committee without cause pursuant to Clause 5(c) of his contract and by the authority of the resolution of the Board of 1st March. The appellants were informed that they would be paid all remaining sums due to them under their contracts of employment.

This was some sixteen weeks before the appellants’ contracts would have expired in any event. The present proceedings were instituted by Flag on 19th March 1998. Their object was to obtain declarations as to the amounts payable to the appellants following the termination of their employment.

The Compensation Committee subsequently considered their entitlement to a completion bonus and awarded each of them a sum of $300,000.

The establishment of a stock option plan

The establishment of a stock option plan for senior executives had been under consideration since November 1997. It was initially designed as a phantom stock option plan, because Flag was not a quoted company. Later, however, it was recast as a normal plan but with special provisions to cater for the possibility that the shares might still be unquoted when the options were exercised. The final draft was not ready until 1st March 1998, and was considered by the Board on 10th March, when it was approved but only (at that stage) for the purpose of awarding stock options to Mr Bande in accordance with his contract of employment. The Board agreed that another meeting should be held shortly to discuss the adoption of a plan for general use. On the following day options were purportedly issued to Mr Bande to buy shares in Flag in accordance with the provisions of his contract.

The further Board meeting took place on 22nd March, when the Board adopted a modified version of the plan, called a “Long Term Incentive Plan”, (“the Plan”). This was followed by a special meeting of the shareholders on the same day to approve the Plan and to ratify the issue of options to Mr Bande which had already taken place.

On 8th July 1998, by which time the appellants’ employment would have come to an end (unless extended) if their contracts had not previously been terminated, the Board approved the grant of stock options to fourteen members of senior management.

Clause 1 of the Plan described the purpose of the Plan as:

“to advance the interests of the Company and its stockholders by providing a means to attract, retain and reward officers and employees of ... the Company and its subsidiaries and to enable such persons to acquire or increase a proprietary interest in the Company, thereby promoting a closer identity of interests between such persons and the Company’s stockholders.”

The Plan was to be administered by a Committee appointed by the Board and, if no Committee was appointed, by the Board. All persons who were officers or employees of Flag or its subsidiaries or who had been offered employment by Flag or any of its subsidiaries were eligible to be granted awards under the Plan, though in the latter case any award was to be cancelled if the person in question failed to commence such employment. The Committee was given complete discretion to select the persons to whom stock options should be awarded and the amount of any award. Clause 3(vii) of the Plan expressly provided that the form of any award was to be prescribed by the Committee and need not be identical for each participant.

Under Clause 6(b)(ii) of the Plan the Committee was to determine the time or times at which an option might be exercised in whole or in part; and under Clause 6(b)(iii) it was to determine the period, if any, during which options should be exercisable following a participant’s termination of employment with Flag and its subsidiaries. Clause 8(c) of the Plan provided that:

“Neither the Plan nor any action taken hereunder shall be construed as giving any employee or other person the right to be retained in the employ or service of the Company or any of its subsidiaries, nor shall it interfere in any way with the right of the Company or any of its subsidiaries to terminate any employee’s employment or other person’s service at any time;”

“there is no obligation for uniformity of treatment of Participants and employees.”

Under the terms of the options which were granted to Mr Bande and the other senior managers, the option-holder obtained deferred options, that is to say options which were not immediately exercisable. They were to “vest” (that is to say become exercisable) as to 50% three years and as to the remaining 50% four years after they were granted. Earlier vesting was to occur only if there was a public offering of Flag’s stock. Subject to certain exceptions none of which is material all unvested options were to be cancelled upon the termination of the option-holder’s employment.

The proceedings

The trial at first instance was largely taken up with the question whether the waivers which Flag had obtained in November 1997 were effective to exclude the operation of the linkage clauses in the appellants’ contracts of employment or could be rectified to make them effective to do so. The trial judge held that the waivers were void and of no legal effect as (i) unsupported by consideration (ii) obtained by economic duress and (iii) obtained in breach of the implied obligation of trust and confidence. This made it strictly unnecessary for her to decide whether Flag’s claim for rectification had been made out, but she held that it had not. This last finding was clearly supported by the evidence, and accordingly Flag did not appeal the Judge’s conclusion that the waivers were invalid. Even if they were valid, they were plainly ineffective.

The Judge’s findings of economic duress and breach of the implied term of trust and confidence, however, coloured her approach to the remaining issues. She found that every decision which was taken by Flag or the Board was designed to prevent the appellants from obtaining stock options, and that the termination of the appellants’ contracts of employment was “tainted with a collateral purpose” and “engineered” in order to prevent them from obtaining stock options under the Plan which was about to be introduced. It followed, she held, that the termination was “ultra vires” the Board and incapable of being ratified by the shareholders. For good measure she further held that, while the appellants’ contracts could be terminated at any time without cause, they could not be terminated without reasonable notice. Accordingly (though this was a non sequitur) she ruled that the appellants’ employment ran its full course and did not come to an end until 30th June 1998, by which time the Plan had been established.

The Judge found that Mr Bande’s base salary should be taken to be $900,000 for the purpose of the linkage provisions in the appellants’ contracts because “it was more likely than not that the appropriate base salary of [US$900,000] was lowered to $450,000 to protect [Flag] against any claim to linkage”. In this respect she said that she found Mr Petri’s evidence “far from convincing”. This had the effect of requiring the appellants’ annual incentive bonus to be recalculated. She found that the appellants’ completion bonus had been calculated incorrectly and ordered that it be recalculated on a basis which was more favourable to them. She granted a declaration that the appellants were each entitled to be granted stock options to acquire a number of shares in Flag corresponding to 90% of the number of such shares in respect of which Mr Bande had been granted such options and on the same terms and conditions (mutatis mutandis) as he was entitled to acquire such shares.

The Court of Appeal allowed Flag’s appeal. It rejected the Judge’s finding that the resolution of the Board was “ultra vires”, which it interpreted as meaning in breach of fiduciary duty, observing (i) that the Board’s fiduciary obligations were owed to the company and not to the appellants and (ii) that in terminating the appellants’ employment as senior executives of Flag the Board was exercising a contractual right of the company under a contract to which the appellants were parties. It rejected the Judge’s finding that reasonable notice was required to terminate the appellants’ employment and held that no such requirement could be implied. It gave detailed consideration to the appellants’ claim that they were entitled to damages for breach of the implied term of mutual trust and confidence (albeit without the benefit of the examination of the term by the House of Lords in Johnson v Unisys [2001] 2 All ER 801), but observed that a breach of the implied term would not avail them unless they could prove damage, which they could not do if, as Flag contended, they had received all that they were entitled to under their contracts of employment.

The Court of Appeal accepted the Judge’s finding that Flag terminated the appellants’ contracts of employment when it did in order to prevent them from participating in the Plan which it was about to introduce. But it held that this did not invalidate Flag’s decision to bring their employment to an end. The question was whether the appellants were contractually entitled to participate in a stock option plan which was not established until after they had ceased to be employees, and the Court of Appeal held that they were not. This made it unnecessary to deal with Flag’s alternative submission, which the Court of Appeal described as “formidable”, that even if the appellants had been eligible to participate in the Plan any options which might have been granted to them would have been valueless as they would never have become exercisable.

The Court of Appeal rejected the Judge’s finding that the true amount of Mr Bande’s base salary was $900,000, and that it had been manipulated downwards in order to prevent the appellants from profiting from the linkage clauses in their contracts. It found that the sums of compensation eventually agreed with Mr Bande were so different from those offered by Flag in the course of the negotiations that it would be unsafe to regard any of the latter as the “true” base salary. But it found by a process of construction that Mr Bande’s base salary during the relevant period should be taken to include the $350,000 minimum annual incentive bonus which was neither performance-related nor discretionary, thus making a total of $800,000. It rejected the Judge’s finding that the appellants’ completion bonus had been wrongly calculated.

In the event, therefore, the Court of Appeal rejected all the appellants’ claims except to the extent that their base salary and annual completion bonus should be calculated on the footing that Mr Bande’s base salary during the relevant period was $800,000 and not $450,000 as Flag contended. The appellants now appeal from that decision and ask that the Judge’s orders should be restored; while Flag cross-appeals for a declaration that the appellants’ contractual entitlements should be calculated on the footing that Mr Bande’s base salary during the relevant period was limited to the $450,000 described as such in his contract.

Was the appellants’ employment lawfully terminated?

Clause 5 of the appellants’ contracts of employment entitled Flag to terminate their employment at any time during the contract period (a) for cause (meaning misconduct) (b) for unsatisfactory performance or (c) without cause. The consequences of termination were different in each case. Where the employment was terminated for cause, the employee was entitled to receive his base salary up to the date of termination but nothing more. Where it was terminated for unsatisfactory performance, he was entitled to payment of his base salary for a further three months or (if less) the balance of the contractual term and at the discretion of the Compensation Committee and the Board a proportion of his annual incentive bonus and completion bonus. Where it was terminated without cause or by death or disability the employee or his estate was entitled to continue to receive his base salary for a period of twelve months or (if less) until the expiry of the contractual term and at the discretion of the Board and the Compensation Committee a proportion of the annual incentive bonus and completion bonus.

Under the terms of the appellants’ contracts, therefore, Flag had an express contractual right, which it exercised, to bring the appellants’ contracts of employment to an end at any time during the contract period without cause. Their Lordships agree with Flag that that is an end of the matter. As the Court of Appeal observed, “the very nature of such a power is that its exercise does not have to be justified”.

The principal ground on which this was disputed by the appellants at trial was that the decision of Flag's Directors to bring their contracts to an end was vitiated by their “collateral purpose” in seeking to avoid having to grant the appellants stock options. But in the present context there is no such thing as a “collateral” or improper purpose; a power to dismiss without cause is a power to dismiss for any cause or none. The Directors of Flag were, of course, obliged to exercise their powers as directors in good faith and for the benefit of the company. As the Court of Appeal pointed out, however, this was a duty owed to the company and not to its employees. There is no reason to doubt that, in resolving to exercise Flag’s contractual right to terminate the appellants’ contracts without cause and before a stock option plan had been established, the Directors were loyally seeking to further the interests of Flag as they saw them, and Flag’s shareholders implicitly approved the action that they took on its behalf. They could properly form the view, as they undoubtedly did, that it would not be appropriate to grant the appellants stock options or, to put the matter another way, that it would be commercially inappropriate to grant such options to employees whose contracts of employment had only a few more weeks to run.

The appellants have presented a superficially more plausible argument to their Lordships, though one resting on the same factual foundation, that the decision to terminate their contracts in order to avoid having to grant them stock options was in breach of Flag’s implied obligation of trust and confidence. Flag was duty bound to preserve the relationship of trust and confidence which ought to subsist between an employer and his employees and not to destroy that relationship by discriminating arbitrarily between its employees by granting some of them valuable financial entitlements and dismissing others in order to avoid having to do so.

Their Lordships accept that the appellants' contracts of employment contained an implied term that Flag would not without reasonable and proper cause destroy the relationship of trust and confidence which should exist between employer and employee. The existence of such a term is now well established on the authorities: see Imperial Group Pensions Trust Limited v Imperial Tobacco Ltd. [1991] 1 WLR 589 at pp. 597-9; Malik v Bank of Credit and Commerce International S.A. [1998] AC 20; Johnson v Unisys [2001] 2 All ER 801. But in common with other implied terms, it must yield to the express provisions of the contract. As Lord Millett observed in Johnson v Unisys it cannot sensibly be used to extend the relationship beyond its agreed duration; and, their Lordships would add, it cannot sensibly be used to circumscribe an express power of dismissal without cause. This would run counter to the general principle that an express and unrestricted power cannot in the ordinary way be circumscribed by an implied qualification: see Nelson v British Broadcasting Corporation [1977] IRLR 148 (where it was sought to imply a restriction of location into a contract which contained an unqualified mobility clause). Roskill LJ said at p. 151:

“... it is a basic principle of contract law that if a contract makes express provision ... in almost unrestricted language, it is impossible in the same breath to imply into that contract a restriction of the kind that the Industrial Tribunal sought to do.”

The appellants rely strongly on the decisions of the Employment Appeal Tribunal in BG plc v O’Brien [2001] IRLR 496 and Sedley J in Aspden v Webbs Poultry & Meat Group (Holding) Ltd [1996] IRLR 521, but in their Lordships’ view neither of those cases supports the proposition for which they were cited.

In BG plc v O'Brien the employee complained that he had not been offered a revised contract of employment with enhanced redundancy terms, with the result that he did not receive the enhanced payment when he was eventually made redundant. It appeared that he was the only permanent employee to be excluded from the revised terms of employment. The Employment Appeal Tribunal found that the employer was in breach of the implied term of trust and confidence. The only reason for excluding the complainant from the opportunity of entering into the revised contract of employment was the fact that the employer did not realise that he was a permanent employee. If this had been appreciated, he would have been offered the same enhanced terms as his colleagues. The employer’s mistake was not a reasonable and proper cause for singling the complainant out for different and less favourable treatment.

In Aspden v Webbs Poultry & Meat Group (Holding) Ltd the employer introduced a generous permanent health insurance scheme for directors and senior managers, including the complainant. After its introduction the complainant, who up to that point had no written contract of employment, entered into a written contract. Unfortunately the form used was one which had previously been used before the scheme was introduced, and it was mistakenly adopted without modification. The contract contained a specific power enabling the employer in the event of prolonged illness to dismiss an employee who was unfit for work and a general provision entitling either party to bring the contract to an end on three months’ notice. Sedley J was satisfied on the evidence that it was not the employer’s intention to exercise its contractual right of dismissal in circumstances where to do so would frustrate the employee’s entitlement to income replacement insurance. The question was whether it was an implied term of the contract that it should not do so.

The problem was that the implication of the necessary term would contradict the express terms of the contract. Sedley J was able to overcome this difficulty because the contract as written was internally inconsistent in its provisions for sick pay and termination. Furthermore, the situation in which the contract was entered into was known to both parties to include an income insurance scheme which could only work if the employee whom it covered remained in employment for the duration of his incapacity or until some other determining event specified in the policy took place. The inconsistent terms of the contract were the result of using an inappropriate form without appreciating the consequences of doing so. These factors persuaded the judge to imply into the contract the term for which the complainant contended.

Their Lordships consider that neither case, properly understood, supports the proposition that Flag’s express power of dismissal without cause was circumscribed in the manner for which the appellants contend. In BG plc v O’Brien the employee did not complain of his dismissal but of his treatment while he was still employed. He complained that by not being offered a revised contract he had been victimised or discriminated against in a manner which was calculated to destroy the relationship of trust and confidence between himself and his employer. The remedy was to award him damages by reference to the amount of the enhanced redundancy terms to which he would have become entitled if he had been offered the revised contract like his fellow permanent employees. These were not damages for wrongful dismissal (since his dismissal was not wrongful) but damages for breach of an implied term in his contract that he would not during the period of his employment and without reasonable and proper cause be treated less favourably than his fellow employees.

Aspden v Webbs Poultry & Meat Group (Holding) Ltd was not concerned with the implied term of trust and confidence at all. The question was whether the employer’s express right of dismissal could be limited by implication arising from the unusual circumstances in which the contract had been entered into and the inherently contradictory terms which resulted. The better course might have been to rectify the contract to include the term contended for as an express term, an unusual course but one which would appear to have been justified by the evidence. But even if the case is taken as a rare example of a term being implied into a contract to qualify an express right, the justification for this course lay in the need to reconcile express terms of the contract which were mutually inconsistent. No such problem arises in the present case.

Their Lordships accordingly agree with the Court of Appeal that Flag's express and unrestricted power to terminate the appellants' contracts of employment without cause was not qualified in any way, whether by reference to the implied term of trust and confidence or otherwise. Not surprisingly, the Appellants have some difficulty in expressing the content of their contractual right which they allege has been broken. It was not a right to be offered participation in the Plan before being dismissed, for Flag was under no obligation to establish the Plan at all; nor was it a right not to be dismissed until after the Plan had been introduced, for Flag was entitled to dismiss them without cause at any time.

In the end the appellants have been constrained to accept that they cannot complain of their dismissal. They complain instead that they were “led up the garden path” by being encouraged to stay on in order to help Flag during the transitional period. This is unsustainable on the facts, since the only period when this might have been the case lasted for less than a month and there was no resultant loss. More plausibly the appellants submit that they were victimised by being capriciously or arbitrarily singled out for dismissal in order to deprive them of their entitlement to participate in the stock option plan which was about to be introduced. Their Lordships will examine this contention later. For the moment it is sufficient to say that that they are willing to assume without deciding that such conduct might well constitute a breach of the implied term and that an employee would not necessarily be without a remedy merely because the mechanism of victimisation took the form of dismissal. Where this was the case, the employee would be entitled to compensation for the rights of which he had been wrongly deprived without having to challenge the validity of the decision to dismiss him.

Were the appellants’ contracts terminable without notice?

Clause 5(b) of the appellants' contracts expressly required notice to be given of dismissal for unsatisfactory performance. Clause 5(c) was silent on the question whether notice was required for dismissal without cause.

The appellants submit that it would be surprising if they could not be dismissed without notice where their performance was unsatisfactory, but could be dismissed without notice where there was no good reason for their dismissal. If the financial consequences in the two cases were the same, this argument would carry great weight, for Flag could always avoid the need to give notice even where the appellants’ performance was unsatisfactory by exercising the power to dismiss without cause. But the financial consequences are very different, and their Lordships see no incongruity in Flag having to choose between dismissing for unsatisfactory performance on notice and dismissing without cause and without notice on payment of more generous compensation.

The appellants observe that dismissal without cause is not the same as dismissal without notice, and submit that the implication of a requirement of reasonable notice would accordingly not be inconsistent with the express terms of the contract. So far their Lordships agree with them. But they part company from them at the next stage of their argument viz. that all contracts of employment are, as a matter of law, subject to an implied term that they are terminable on reasonable notice, and that such a term can be displaced only by clear words: see Lefebvre v HOJ Industries Ltd [1992] 1 SCR 831.

In their Lordships’ view there is no such rule. The true rule, which is not confined to contracts of employment but applies to contracts generally, is that a contract which contains no express provision for its determination is generally (though not invariably) subject to an implied term that it is determinable by reasonable notice: see Chitty on Contracts (28th Ed.) at para. 13-025. The implication is made as a matter of law as a necessary incident of a class of contract which would otherwise be incapable of being determined at all. Most contracts of employment are of indefinite duration and are accordingly terminable by reasonable notice in the absence of express provision to the contrary. Lefebvre v HOJ Industries Ltd was such a contract. But there is no need for the law to imply such a requirement in a case where the contract is for a fixed term.

The appellants were each employed for a fixed term of three years. Save insofar as their contracts permitted it, they could not be dismissed at all during the contractual term. Clause 5 permitted earlier dismissal in specified circumstances and on prescribed grounds. In the case of dismissal without cause the contract did not expressly require notice to be given, and their Lordships can see no basis on which it would be right to imply a requirement for reasonable notice. Their Lordships agree with the Court of Appeal on this point also.

The appellants' entitlement to stock options

The terms of the appellants' remuneration were contained in Clause 3 of their contracts of employment. Clause 3(a) dealt with the base salary and contained the linkage clause to which their Lordships have referred. This was prefaced by the words:

“In order to assure its executives that compensation opportunities are made available to Flag executives on a consistent basis ... ”

“to provide a uniform approach to incentive compensation for all members of the Senior Management Group.”

“shall be eligible to participate in any employee benefit plans which may be established or maintained by Flag from time to time and which are offered to other senior officers of Flag, in accordance with the terms of the plans, as those plans may be amended from time to time.”

It is common ground that the Plan which it established for senior management on 22nd March 1998 was “an employee benefit plan” within the meaning of this Clause. The trial Judge, having held that the appellants’ employment did not determine until 30th June 1998, that is to say, until after the introduction of the Plan, held that Clause 3(c), coupled with the contractual requirements of consistent and uniform treatment, gave the appellants a contractual right to be granted stock options by reference to those granted to Mr Bande, and granted a declaration to this effect. The Court of Appeal set the declaration aside.

The declaration made by the Judge cannot be supported. The appellants had no contractual entitlement to be awarded stock options by reference to those granted to Mr Bande. Their only contractual entitlement to stock options arose under Clause 3(c) of their contracts and this contained no linkage provision similar to the linkage clause in Clause 3(a) relating to the base salary. The reference to making compensation opportunities available “on a consistent basis” was likewise contained in Clause 3(a) and related to the base salary; and while the expression “incentive bonus” is clearly apt to include the performance-related award of stock options the reference to “uniform approach” in relation to them was contained in Clause 3(b) and related to the annual incentive bonus. The appellants’ various contractual entitlements were clearly differentiated and too closely articulated to allow a linkage with Mr Bande’s contractual rights to stock options to be derived from general principles of “consistency” and “uniformity”. Such principles can be given effect only insofar as the contract provided, and this made specific and different provisions in relation to basic salary, annual incentive bonus, completion bonus, and stock options. Any contractual claim to stock options must be based on the express words of Clause 3(c) alone; though in fairness to Flag their Lordships would add that, for reasons which they will amplify, Flag’s treatment of the members of the senior management group including the appellants in relation to stock options was both consistent and uniform.

Clause 3(c) merely made the appellants eligible to participate in any employee benefit plan which was established and was offered to other senior officers of Flag. But this clearly contemplated a plan which was offered to senior managers generally and not a benefit offered to a single individual only. Mr Bande’s entitlement to stock options did not arise under the Plan which Flag established on 22nd March 1998. It arose under his contract of employment and the terms of the draft plan which was approved by the Board on the 10^th. March 1998 but only in relation to him. It was not offered to other senior officers of Flag and was not therefore an employee benefit plan within the meaning of Clause 3(c) of the appellants’ contracts. If that Clause gave the appellants any right in relation to stock options, it was only a right to be considered for a grant under the Plan.

Given that, as the Court of Appeal and their Lordships have held, the appellants’ contracts were validly terminated on 1st March 1998, however, the appellants did not become eligible to participate in the Plan which was not introduced until after their employment had come to an end. And given that, as the Court of Appeal and their Lordships have also held, the termination of the appellants’ employment was not in itself a breach of contract, the appellants are not entitled to compensation for their exclusion from participation in the Plan by way of damages for wrongful dismissal.

There remains for consideration the appellants’ contention that in terminating their employment in order to avoid the obligation to admit them to participation in the Plan Flag was in breach of its implied obligation of trust and confidence. In their Lordships’ opinion there are two answers to this contention. The first is that Flag was not in breach of the implied term; the second that in any event the appellants cannot establish any loss.

By excluding the appellants from participation in a Plan which was offered to other senior employees, it is alleged, Flag unfairly discriminated against them. Such discrimination or, to use a stronger term, victimisation is calculated to destroy the trust and confidence which should exist between employer and employee and amounts to a breach of the implied term.

If the appellants were in the same position as their fellow employees who were admitted to the Plan, there would be much force in this contention. But they were not. Unlike that of their colleagues, the appellants’ employment had only a few weeks to run and was not to be renewed. As appeared from Clause 1 of the Plan, its object was to advance the interests of Flag by promoting a closer identity of interest between senior managers and its stockholders. To that end the options which were in fact granted were not exercisable for a considerable period of time and would not be exercisable if the option holder left Flag’s employ of his own accord or the fixed term of his contract expired before they became exercisable.

The appellants rely on the fact that the options granted to two other senior executives in July 1998, that is to say after the appellants’ employment would have determined in any event, provided for a 50% vesting on termination without cause. But at the date when the grants were made, which is the relevant date for this purpose, the executives in question had not already been dismissed, their contracts still had a considerable time to run, and there was no reason to suppose that they would not be renewed. In their case, therefore, the grants constituted an incentive not to leave Flag’s employ voluntarily or refuse an extension of their contracts. No similar incentive for the appellants could be justified.

In these circumstances their Lordships are satisfied that that there was no breach of the implied term. Flag treated the appellants differently from and less favourably than other senior employees, but it was justified in doing so on commercially legitimate and objectively defensible grounds. For the same reason, Flag cannot be said to have adopted an inconsistent or non-uniform approach to the award of stock options under the Plan to members of the senior management group.

Their Lordships are also satisfied that the appellants can prove no damage. Their claim, properly analysed, is to the loss of a chance; but they had no realistic chance of being granted any stock options, and no chance at all of being granted any options which were capable of being exercised. If the appellants’ employment had not been brought to an end before 22nd March 1998 when the Plan was introduced so that they became contractually eligible for consideration for the grant of stock options, which is the relevant hypothesis, it is in the highest degree unlikely that those administering the Plan would have contemplated exercising their discretion in their favour, and they would plainly have been justified if they had declined to do so. The grant of stock options to an employee on the eve of his departure would make no commercial sense, and would not achieve the purpose for which the Plan was established. Indeed, it would achieve nothing, for if granted on the terms on which they were granted to other senior employees, then such options, which would not have been exercisable when the three year term of appellants’ contracts expired, would have been incapable of ever becoming exercisable. The only hypothesis on which the appellants could have been awarded stock options which were capable of being exercised is that they were dismissed without cause after 22nd March 1998 when the Plan was introduced and before their contracts expired on 30th June 1998. That is not a sensible hypothesis; given Flag’s motive in dismissing them they must have been dismissed before the Plan was introduced or not at all.

The base salary

The appellants’ primary case is that the trial Judge was correct in taking Mr Bande’s base salary to be $900,000. Their Lordships agree with the Court of Appeal that her finding in this regard cannot be supported. The figure of $900,000 has no basis in fact at all. It cannot be derived either from the terms of Mr Bande’s contract or from the course of the negotiations with him. Mr Bande did not ask for a base salary of $900,000; he asked for a combined base salary and annual bonus of $975,000. Flag did not offer a base salary of $900,000; its initial offer was $900,000, but this too included both base salary and annual bonus. The highest base salary alone that was mentioned in the course of negotiations was $625,000, and this was subsequently reduced to $450,000.

The trial Judge evidently thought that this reduction was a sham device to minimise the effect of the linkage clauses in the appellants’ contracts. This was never put to Mr Petri, and while the Judge rejected his explanation for the change, which was plausible and consistent with the known facts, she gave no reason for doing so. In fact the Judge’s view cannot be right. Flag cannot have reduced the amount of Mr Bande’s base salary in order to limit the cost of complying with the linkage clauses in the appellants’ contracts, since at the time Flag thought that the linkage clauses had been waived.

Under the express terms of his contract Mr Bande was entitled to a base salary of $450,000. The question, however, is not what was the amount of that part of Mr Bande’s remuneration which was so described in his contract, but what was the amount of his base salary within the meaning of that expression in the linkage clauses in the appellants’ contracts. The two are not necessarily the same. While it was in the nature of the linkage clauses that the amount of the appellants’ base salaries would depend on what Flag chose, for whatever reasons, to agree with a third party, the appellants should not be taken to have agreed that their remuneration should depend on the language chosen, however inappropriately, to describe the various component elements of that party’s remuneration.

The question, therefore, is not concluded by the fact that only $450,000 was attributed by Mr Bande’s contract to his base salary. The Court of Appeal held that for the purpose of the linkage clauses in the appellants’ contracts “base salary” included any payments which have the characteristics of a base salary, whether so described in Mr Bande’s contract or not; and that it included all recurring annual sums payable by way of remuneration which were neither discretionary nor performance-related. During the relevant period the amount of Mr Bande’s “base salary” thus included his minimum annual incentive bonus of $350,000.

Flag submits that, in the context of these contracts, the expression “base salary” was a term of art used to describe that part of the employee’s remuneration which is payable monthly as his basic entitlement rather than annually by way of bonus following a review by the Compensation Committee, and that the fact that for the first two years of his employment Mr Bande could not be awarded less than $350,000 by way of annual bonus did not make it part of his base salary.

Their Lordships consider that the Court of Appeal was entitled to conclude, as it must have done, that a review by the Compensation Committee was not a prerequisite of the payment of the minimum bonus of $350,000, and that the difference between monthly and annual payments was not of the essence of the distinction between the base salary and the annual incentive bonus.

More pertinently, perhaps, Flag points out that the approach of the Court of Appeal means that for the purposes of determining the base salaries of other senior employees with similar linkage clauses in their contracts Mr Bande's base salary must be taken to have been $800,000 for the first two years of his employment and $450,000 thereafter, with the result that such employees would have their base salaries increased on Mr Bande's appointment only to be almost halved two years later (unless they were to be paid more by way of base salary after the first two years than their Chief Executive, which was clearly not intended). Such a consequence, Flag submits, would be commercially unacceptable (at least to the employees) and is most unlikely to have been intended. Accordingly, so the argument runs, the expression “base salary” must mean that part of the remuneration which is fixed and (unless later varied by mutual consent) payable throughout the term of the contract.

Their Lordships feel the force of this argument, though it may be somewhat weakened by the fact that it is the employees who argue for the result which is said to be unacceptable to them. A pre-agreed reduction in basic salary is certainly unusual, but it is an exaggeration to describe it as commercially unacceptable: any employee would be happy to accept a substantial increase in his basic salary even if it was to be only temporary.

Their Lordships consider that the arguments are finely balanced. They are not satisfied that they would necessarily have reached the same conclusion as the Court of Appeal, but they are not persuaded that the Court of Appeal was wrong. Accordingly, they would uphold its decision on this point also.

The annual incentive bonus

The appellants complain that their annual incentive bonuses were not calculated on the same basis as those paid to other members of the senior management group in accordance with Clause 3(b)(I)(D) of their contracts. This required that:

“The calculation of the amount of the Annual Incentive Bonus shall be uniformly applied to all members of the Senior Management Group, based upon the base salary of each member of the Senior Management Group.”

The amount of the annual incentive bonus depended on achieving or exceeding performance objectives which were set each year by the Board upon the recommendation of the Compensation Committee in consultation with the senior management group. The objectives were set separately for the two six-month periods which made up the year in question, and the bonus was awarded and paid in two separate amounts, the amount of the award at the end of the first period being a preliminary figure subject to recalculation at the end of the second.

The problem arose because the employment years of other senior executives roughly corresponded with the calendar year, whereas the appellants' employment years ran from 1st July to 30th June, with the result that at the end of any given period of six months the award to one set of employees would be a provisional award and the award to the other would be final. The question was: how was the provision for uniformity of treatment to be applied in that situation?

The Court of Appeal held that the proper way to comply with the uniformity requirement was by a direct comparison of concurrent six-month periods, and that the appellants were entitled to an increase in the bonuses which had been awarded to them. Flag does not challenge that conclusion.

The appellants, however, challenge the Court of Appeal’s approach to the ascertainment of the appellants’ base salary by reference to which their entitlement to the annual incentive bonus was calculated. Because of the linkage clauses in their contracts the appellants enjoyed a substantial increase in their base salaries on 12th January 1998, that is to say roughly halfway through their employment year, when Mr Bande was appointed. The appellants claimed that, for the purpose of calculating the maximum amount of the annual incentive bonus, which was finally determined at the end of the year, their base salary should be taken to be the amount of their annual salary at the end of the year. The Court of Appeal held that it should be calculated by reference to the base salary payable during the year treated as accruing day by day.

The contracts merely stated that:

“the maximum annual incentive bonus for which Executive shall be eligible in respect of such period shall be 50% of the Base Salary.”

In fact Flag did use the end of the year calculation in other cases where the simpler calculation was advantageous to the employee and the difference was modest. It is unclear whether this approach was adopted for administrative convenience or because Flag thought that the contracts required it. But whatever the explanation their Lordships do not consider that the requirement for uniformity of treatment obliges Flag to extend the practice to other employees once the true meaning of the contracts has been judicially determined.

The appellants also complain that they were treated less favourably than two other members of the senior management group who were awarded bonuses equivalent to 100% of their base salary in respect of 1998 when the appellants were awarded only 50%. In fact, however, there was no disparity of treatment. In each case the contractual ceiling was 150% of base salary in each of the first two years of employment and 50% in the third year. The other executives were still in their second year when the appellants were in their third. In their Lordships’ view, the appellants and the others received uniformity of treatment.

Their Lordships understand that by an oversight the Court of Appeal may have omitted to make an adjustment in respect of the appellants’ vacation entitlements. The matter was raised in the appellants’ written submissions in Reply and Flag had no opportunity to address it. Their Lordships understand that since the hearing this has been resolved by agreement between the parties.

The Completion Bonus

Under Clause 3(b)(ii) of their contracts, the appellants were eligible for a completion bonus

“in recognition of the successful completion of the Flag cable system project (“the Project”) on time and on budget, as well as meeting sales targets in a manner that is consistent with the base profitability projections of the Project.”

pro rata

When the appellants were dismissed, the Project had been completed on time and on budget, but the base profitability projections had not been met because sales had fallen short of target. The Compensation Committee, after due consideration, awarded the appellants a completion bonus of $300,000 each.

The appellants observe that this must have been arrived at by taking account of the shortfall on sales, and submit that this was wrong because sales had been subcontracted to a subsidiary of Nynex and were beyond the appellants’ control. This contention succeeded at trial but failed in the Court of Appeal.

Their Lordships agree with the Court of Appeal that the appellants have no grounds for complaint in relation to the amount of the compensation bonuses awarded to them. This was in the sole discretion of the Compensation Committee, and it was for the Committee, not the Court, to decide whether any and if so what weight should be ascribed to a sales shortfall. The fact that sales had been subcontracted did not necessarily make it irrelevant to take account of the shortfall. The volume of sales may well have reflected not only the skill and effort of the sales force, but the quality of the product for which Flag was itself responsible. Bonuses of the present kind usually reflect not only the contributions of those to whom they are paid but the overall success of the venture. A failure to meet targets, for whatever reason, is a potentially relevant consideration. Moreover, as the Court of Appeal pointed out, to the knowledge of the appellants sales had already been subcontracted at the date when their contracts were entered into, and the terms on which completion bonuses were payable, with their express reference to sales targets, were agreed against that background.

Conclusion

In the result, their Lordships agree with the Court of Appeal on all points. They will humbly advise Her Majesty to dismiss the appeal and cross-appeal. Their Lordships consider that Flag's failure in respect of its cross-appeal would be sufficiently recognised by an order that the appellants do pay 80% of Flag's costs of both appeal and cross-appeal to the Board.

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	The Judicial Committee of the Privy Council Decisions
You are here: BAILII >> Databases >> The Judicial Committee of the Privy Council Decisions >> Reda & Anor v Flag Ltd (Bermuda) [2002] UKPC 38 (11 July 2002) URL: http://www.bailii.org/uk/cases/UKPC/2002/38.html Cite as: [2002] IRLR 747, [2002] UKPC 38