Home Listing rules Don’t offer executive equity incentives with no employment barriers (unless you really want to)

Don’t offer executive equity incentives with no employment barriers (unless you really want to)


When granting equity incentives to directors and senior management, you should use express provisions requiring them to remain in their position or be employed until the relevant performance hurdle or milestone is met.

Performance guarantees are sometimes issued to directors, senior managers, employees or contractors, either as part of their total compensation or as part of an employee incentive program, in order to induce them to reach a particular performance.

One of their underrated aspects (as well as other forms of equity incentives) is that, without careful drafting, they could extend beyond the employment period. And without an express provision, it may be difficult to convince a court that the implied construction of the terms of an equity incentive with a performance hurdle or stage held by a director or senior officer (or their associated entity) requires them to hold their particular function or job at the time the obstacle or performance milestone is reached.

This was the position in the recent Recce Pharmaceuticals Ltd v Ian David Brown case. [2022] WASCA 66. Although the case is factual, disputes over these arrangements rarely come to court, and so it is instructive.

Performance shares and ASX Guidance

ASX Listing Rules Guidance Note 19 (GN19) refers to performance securities as securities which convert or may convert into a given number of ordinary shares with all the usual rights attached if and when a step designated performance is reached, but otherwise have limited rights until then. The number of ordinary shares into which the Performance Bond may be converted may be a fixed number or may be determined by reference to a particular formula.

In order that the number of Performance Securities into which the Performance Security will convert if the relevant milestone is reached is, in the opinion of ASX, appropriate and fair for the purposes of ASX Listing Rule 6.1, such number must be :

  • fixed or calculated by reference to a formula that provides a fixed outcome so that investors and analysts can easily understand, and have reasonable certainty about, the impact on the entity’s capital structure if the milestone is achieved; and
  • reasonably proportional to the additional value the entity will obtain if the milestone is reached, compared to if the milestone is not reached.

For a performance step attached to a performance security to be, in the opinion of ASX, appropriate and fair for the purposes of ASX Listing Rule 6.1:

  • there must be an appropriate and demonstrable link between the performance stage and the transaction or purpose for which the performance bond is issued;
  • the performance stage must be clearly articulated by reference to objective criteria so that investors and analysts can easily understand and have reasonable certainty as to the circumstances in which the performance stage will be considered to have been reached; and
  • the performance bond must have an expiry date by which the relevant milestone must be reached and, if the milestone is not reached by that date, either the performance bond must be canceled or redeemed free of charge or only for consideration, i.e. the total number of performance securities issued must be converted into a nominal number of ordinary shares.

The ASX recommends that a price hurdle for a security attached to a performance security be based on the average market price by volume over a reasonable period of time (e.g., more than 20 consecutive trading days in which the entity’s securities actually traded) rather than the market price. on a given date or for a shorter period.

Milestone is reached, but directors and senior management are gone

In Recce Pharmaceuticals Ltd v Ian David Brown [2022] WASCA 66, the company had issued various classes of performance shares to certain directors and key management personnel. Performance shares were convertible into ordinary shares upon achievement of performance milestones such that the company’s share price was not less than a specified price with a specified time after the date the shares were issued performance.

The company claimed that performance shares that had reached the performance milestone were not eligible for conversion because it required that the relevant director or key management personnel continue to be employed by the company at the time the milestone was reached. The terms of the performance shares did not expressly require this.

The company unsuccessfully tried to argue before the Court of Appeal (WA) that:

  • correctly interpreted, performance shares required “performance” by the holders up to or around the time the performance milestone was reached; Where
  • alternatively, that the conditions governing the performance shares included an implicit clause to this effect.

What the court found

In accordance with usual contractual principles, the court determined that the correct approach to interpreting the terms and conditions attached to the performance shares was what is the objective meaning to be attributed to the words that the parties or the party used to express what was agreed or intended .

Applying this test, the court held that:

  • performance milestones (i.e. the performance of the company’s share price) referred to the performance of the company rather than that of the directors or key management personnel;
  • Since matters unrelated to an entity’s performance (such as macroeconomic factors and market sentiment) can affect the share price (as recognized by GN19), the word “performance” in the expression “performance shares” did not imply that there was a link between the incentive and the milestone in terms of the performance of the tasks by the directors or key management personnel;
  • there was no identifiable textual basis for the imposition of the condition suggested by the company in the terms and conditions of the performance shares; and
  • there were conceptual difficulties with the implicit construct suggested by the company, including uncertainty as to whether a person had ceased to qualify as a key leader when the person’s role changed before the milestone was completed performance, and because some of the incumbents were entities associated with the relevant director or key management personnel.

It was not to the point that the implicit construction suggested by the company could be thought to better meet the purpose of the performance shares discerned by the court. To have preferred the implicit construction suggested by the company would have been to disregard the clear terms of the terms and conditions of the performance shares and amounted to a judicial rewriting of these terms and conditions.

Findings of the Court

Applying normal contractual principles, the court held that the suggested implied term was:

  • not reasonable and fair – the suggested implied term would likely expose the parties to the possibility of litigation to test satisfaction of the term; and
  • was not necessary to make the instrument commercially effective – the terms and conditions were commercially feasible without the addition of the suggested implied term. The express terms, properly construed, were not inconsistent with and gave effect to the purpose of the performance shares as revealed by the instrument and surrounding circumstances.