TUPE Tuesday: share incentive plans

Hello and welcome back to our TUPE Club podcast series.

We're now on our third podcast in this mini series of "TUPE Tuesday". Each week, we're looking at a key appeal level TUPE case, and next week, in the final podcast, we'll look forward to what TUPE developments might see in 2023.

I'm Siobhan Bishop, a principle associate in the Employment, Labour & Equalities team at Gowling WLG, and this week's "TUPE Tuesday" podcast, we look at a case about whether rights to participate in a share incentive plan (SIP), which were under a separate collateral contract, transferred under TUPE.

And this is the Employment Appeal Tribunal case, called Ponticelli UK Ltd v Gallagher.

So as always the background facts are very relevant. And here Mr Gallagher's employment transferred to Ponticelli under a TUPE transfer, which occurred on 1 May 2020.

He had previously been employed by Total Exploration (the transferor) and Mr Gallagher had been a member of a share incentive plan. Under that SIP, for each share Mr Gallager was allowed to buy, Total Exploration, his employer, contributed funds for him to buy two further matching shares.

The SIP operated in accordance with a separate Trust Deed and Plan Rules, which stated that the SIP was not part of any employment contract. The explanatory booklet about the SIP specifically dealt with this and said that:

"If the relevant part of the business, in which an individual was employed was sold, then their shares must be sold or transferred to the individual or into Total Exploration's vested share account within 90 days from the date of cessation of the individual's employment."

Now, Mr Gallagher's participation in the Total Exploration SIP ended when his employment was transferred to Ponticelli, which was on 1 May 2020. The shares then held on his behalf were then transferred to him.

So Ponticelli, his new employer, told Mr Gallager that, as compensation for the fact that it was not going to provide a SIP post-transfer, Mr Gallagher would receive a one-off payment of £1855 (which was a sum equivalent to twice his average contributions to the SIP over the preceding two years).

Mr Gallagher was not happy about this and applied to the tribunal for a determination under section 12 Employment Rights Act 2006 that he was entitled, as a Ponticelli employee, to be a member of a SIP equivalent to the Total Exploration plan.

Mr Gallager argued that his right to participate in an equivalent SIP transferred to Ponticelli under regulation 4(2)(a) of TUPE, and that happened on 1 May 2020.

So, let's remind ourselves about the relevant background law.

As we know, under TUPE, the relevant employees transfer under TUPE with their employment rights, which are essentially protected. The specific wording in the TUPE regulations is that all of the transferor's "rights, power, duties and liabilities under or in connection with a transferring employee's contract pass to the transferee. And it is this wording which I want to highlight – the wording about rights "in connection with" the employment contract which are central to this case.

It is this specific wording which Mr Gallager said meant he had the right to participate in an equivalent SIP following the transfer.

Now a SIP is a type of tax-advantaged employee share scheme, where shares are held in a special employee benefit trust. There are tax benefits, assuming that there is compliance with the legal requirements, where there is no income tax or National Insurance contributions (NICs) on those shares.

Even where an individual who participates in a SIP ceases to be a group employee because his employment has transferred to a new employer under TUPE, the individual's shares won't be subject to the plan, but there is still a tax exemption meaning there is no liability to income tax.

Of course, if the individual's rights to participate in a share scheme are contractual, they will clearly transfer under TUPE to the transferee. And then any practical difficulties in replicating a scheme provided by the old employer, but that's what the case law requires, it is for the transferee to provide an equivalent scheme in those circumstances, although it is not always clear how to measure equivalence, and that is set out in a case from 2002, called Mitie Managed Services Ltd v French.

The other issue was slightly more complicated for Mr Gallagher because the Total Exploration SIP was entirely separate from the contract of employment.

So, what did the Employment Tribunal decide?

Well, the tribunal found in favour of Mr Gallagher and said that his right to participate in the SIP was part of his overall financial "package" and was "caught by" the wording under regulation 4(2)(a) of TUPE 2006.

Mr Gallagher was only entitled to participate in the SIP because he was an employee of the company. It was a benefit for employees it was Revenue approved.

It the SIP wasn't regarded as part of the financial package, it would undermine the purpose of TUPE and possibly encourage attempts to try to avoid the transfer of financially significant benefits under TUPE. Essentially, the Tribunal did not accept that the terms of the SIP were capable of isolating it from effect of TUPE in this case.

So, after the transfer to Pontecilli, Mr Gallagher was entitled to participate in a SIP of substantive equivalence, or comparable value, to the SIP operated by Total Exploration.

The tribunal also made a declaration that Mr Gallagher's terms and conditions of employment should reflect the obligation to provide him with a SIP of substantial equivalence to the Total Exploration plan on the same terms as set out in the Total Exploration explanatory booklet.

Ponticelli appealed to the Employment Appeal Tribunal.

So, what do you think the EAT said about the case?

Well, it is not surprising that the EAT dismissed the appeal. The appeal centred on a key point of whether regulation 4(2)(a) of TUPE applied. However, the EAT said that the SIP rights and obligations clearly arose "in connection with" employment contract, and that is the wording that I highlighted at the start of this podcast.

When Mr Gallagher originally joined the Total Exploration SIP, there was a contract - with mutual rights and obligations - between Mr Gallagher and Total Exploration. These obligations included, in particular, Mr Gallagher agreeing to certain deductions from his monthly salary and Total Exploration agreeing to use that deduction amounts to buy shares for him.

Total Exploration also agreed to give Mr Gallagher additional matching shares at no further cost to him. Well of course, Mr Gallagher was only eligible to join the SIP because he was employed by Total Exploration. But, even if the obligations by the Partnership Share Agreement did not arise "under" the employment contract, they did plainly arise "in connection with" that contract and so were covered by regulation 4(2)(a) of TUPE 2006 and transferred to the Transferee, Ponticelli.

Total Exploration had tried to rely on the judgement in the Court of Appeal case of Chapman and Elkin v CPS Computer Group plc from 1987, which separated the share options from the claimant's employment.

In the Chapman case, the claimants were given options to buy shares, which were only exercisable after a fixed period, except in limited circumstances, which included them being made redundant.

Following a transfer in that case, the transferee in Chapman refused to let the claimants exercise their options, arguing that their employment had not ceased. The Court of Appeal agreed that the claimant's employment had not ceased under TUPE but the share option contracts were separate from their employment contracts. And it was possible in that case for the claimants to have "ceased employment" by reason of redundancy, as required by the share option agreement and they were entitled to exercise their options.

However, the Employment Appeal Tribunal said that the decision in Chapman only considered if it was "under" the contract and did not consider whether it was "in connection with" the contract and the Chapman case has been subject to much academic criticism and doubt as to whether it would be followed today. In any case, the Chapman case was distinguishable, as the share option scheme was different to the SIP being offered in this case and it did not create the same kind of rights and obligations as was being created.

In Mr Gallagher's case, the SIP was directly connected to the financial package of benefits he received as remuneration for his services as an employee, and it involved matching shares paid for entirely by the employer.

There is secondary point to watch out for as well, regarding the employee's Particulars of Employment, and Ponticelli should have notified Mr Gallagher of the changes.

So, at the time of the transfer, on 1 May 2020, the identity of Mr Gallagher's employer changed, and he also couldn't continue his membership of the Total Exploration plan, but he was entitled to membership of a Ponticelli plan, which was to be of substantive equivalence. And he should have notified both of these changes as required under section 4 of the Employment Rights Act 1996.

So, what does this case mean for employers?

Well, it's easy to see why employers have generally tried to keep share schemes separate from the employees' contracts of employment.

Scheme rules often say that they are not contractual and participation in a share scheme will be specifically excluded from the employment contract.

Employers do try to exclude a claim for damages for loss of entitlement under the scheme if the employee is dismissed, but they also try to avoid the right for employees to participate passing to a buyer under TUPE.

However, in the Mitie case I mentioned earlier, there was a profit-sharing scheme, and now in this case, the EAT has found that the right to participate in a SIP was a right "in connection with" a transferring employee's contract. And this means that the new employer, the transferee, had to provide a substantially equivalent share incentive plan.

Of course, in reality, providing this benefit may be a significant cost burden for the new employer and there may be practical difficulties in providing a share scheme of substantial equivalence.

It is especially difficult for the transferee that does not operate a similar schemes to its existing employees, or where the transferee is not a listed company or cannot offer shares at all.

However, the Ponticelli case does leave open some difficult questions, including what the obligation is to establish a "substantially equivalent" scheme and what it means in practice. It is also not clear what happens if participation in the scheme is a discretionary benefit that could be terminated at any time. Could the transferee set up a new substantially similar scheme, and then terminate the scheme, relying on the unilateral termination right?

Whilst there is uncertainty on some issues, in all cases it is clear that the transferee should asses the costs associated with implementing the transferring rights and benefits, not just those that are obviously contractual, but also those that are in connection with the employment of the transferring employees.

Once the transferee fully understands the total package that the employees are on, through due diligence, the exact action the transferee wants to take having considered that will often depend on the commercial deal between the parties.

Thank you for joining us for this week's TUPE Tuesday podcast and please join us again next week for the final instalment on the changes to EU law, which may be coming next year.

In the meantime, if you want catch up with previous TUPE Tuesday podcasts, they are available on our website and, as always, if you have any questions, please do contact one of the team. Thank you and I hope you join us next week.