Managing a Workforce in a Regulated Environment

In this follow-up to episode three’s discussion about growth-stage fintechs navigating workforces in a regulated environment, host Joseph Kamyar is joined by Skadden colleagues Helena Derbyshire and Sebastian Barling for a conversation about how fintechs can manage the exits of senior employees and managers.

Helena and Sebastian cover topics including processes for dismissing employees, requirements for dismissals at regulated firms, and legal considerations regarding post-employment restrictions, such as non-competes.

Key Points

• Fair Reasons, Fair Process: After an employee has two years of service, their employer must have a fair reason to dismiss the employee and must follow a fair process.
• Managing a Dismissal: Should a dismissal be imminent, the employment contract is the most important place to start when looking at how to manage an exit. Another important consideration is the extent to which the departing employee is key to the business and whether the employer wants to keep the individual out of the market for a period of time.
• Post-Employment Restrictions: An employer must carefully tailor any restrictions to the individual employee, and such restrictions must not be longer in duration or wider in scope than is necessary to protect the employer’s legitimate business interest.

Voiceover (00:01):
Welcome to Fintech Focus, Skadden’s podcast for fintech industry professionals. The global regulatory and legal updates you need start now.

Joseph Kamyar (00:15):
Hi, there, and welcome back to another episode of Fintech Focus with me, Joe Kamyar, as well as Seb Barling, who heads our financial regulatory practice here in London.

Sebastian Barling (00:24):
Hi, Joe, good to be back.

Joseph Kamyar (00:26):
Today, Helena Derbyshire is also joining us. Helena heads our London employment practice.

Helena Derbyshire (00:31):
Hi, it’s great to be joining you both.

Joseph Kamyar (00:33):
Okay, so plan of action for today, we’re picking up from where we left things in our last podcast, and so quick reminder on what we covered last time. At a high level, we’re looking at points to consider when fintechs are onboarding senior hires, and in particular, looking at the requirements under the senior managers and certification regime, as well as some of the more general employment law and HR considerations that sits alongside those requirements. We also touched on some of the ongoing requirements including the annual certification regime, the rights that employees, employers, and regulators have in the context of disciplinary processes.

(01:07):
Today, we plan to focus on how fintechs can manage exits of senior employees and other senior managers, so non-execs, partners, consultants, and so on. Helena, when we were touching on disciplinary processes in the last episode, we discussed the need to navigate unfair dismissal protections, which for now at least kick in after a two-year service and what that actually meant for the employer. Primarily ensuring that A, the employer has fair reasons to dismiss, and B, a fair process is actually followed. Could you perhaps break down in a bit more detail what we mean by fair reasons and fair process?

Helena Derbyshire (01:41):
Yeah, absolutely, Joe. I think firstly, I want to just emphasize that the right to claim unfair dismissal at the moment applies to employees only. Although your non-executive directors, contractors, partners, members of an LLP are likely to have other entitlements and protections on the termination of their appointment that need to be considered to. Employee status is a different topic, but employers do need to have an eye on whether or not their different managers are categorized correctly. For example, depending on their situations, certain members of an LLP for example, and some contractors might have worker rights and the new government in the UK has proposals to extend unfair dismissal rights as well as some of the other employment rights to workers as well. We just need to have that in the back of our mind.

(02:27):
Now, employees have two basic rights on termination of their employment. One is the right under their contract of employment, and these contractual rights are likely to apply to all workers, whatever their status is. That typically boils down to their entitlement to notice and whatever their contract provides in relation to pay and benefits on termination of employment. Now, typically, in an employment contract, an employer can choose between requiring the employee to work their notice, paying the employee in lieu of notice or placing them on garden leave. Garden leave is where they remain an employee for their notice period. They still owe their obligations to their employer, but they’re kept out of the market. The contract will also govern their entitlement to bonus and other entitlements, which will come on to later. Joe, going back to your actual question, which was about unfair dismissal. As you said, at the moment, after a two-year service, the employer has to have both a fair reason to dismiss the employee as well as to follow a fair process.

(03:29):
Now, potential fair reasons are quite limited, but they do include most things that an employer might encounter. First one is misconduct, so someone’s behaving badly. If the conduct is particularly bad, what would the UK call gross misconduct, then the employee might not be entitled to notice in that situation. The next is capability, so that can just be poor performance or an inability to perform your duties, for example, as a result of ill health. The third main category is redundancy, so that’s where there’s no longer a requirement for someone to do the work that you are doing or there’s a reduced requirement overall in the organization. Bearing in mind those fair reasons, the employer also has to follow a fair process and the process will be determined partly by the reason, but there are some general rules of thumb that employers need to follow.

(04:19):
In the case of conduct or capability, probably the key thing is the investigation and Seb will talk in a bit more detail later about why that’s particularly important in the regulated context. The employer really needs to understand before it starts the process, it needs to understand the facts, it needs to understand what it’s dealing with rather than making assumptions and jumping straight in. Unless the conduct is particularly serious, then the process really entails giving the employee a series of warnings, what it is they need to improve and an opportunity to do that. Before each warning in the process is given and before any final dismissal, the employers in the UK expect to follow what we call the ACAS Code of Practice, which requires employers to hold a meeting with the employee about the conduct concerns and poor performance issues are explained to the employee.

(05:10):
The employee should normally be provided in advance with a note of what the concerns are and the evidence that supports them so that they can come to the meeting prepared and defend themselves, and then they have an opportunity to escape their case. They’re given a warning period, they’re given an opportunity to improve during that period. Now, employees also have the right to be accompanied by a colleague of their choice in that meeting if it’s a disciplinary meeting or could result in a sanction against the employee. That normally is a colleague of their choice, they can ask for a certified trade union representative, but that’s not always as relevant in that particular context.

Joseph Kamyar (05:46):
Understood. I guess let’s take a scenario where we actually get to the point of dismissal. Seb, when we discussed this last time, you pointed out the FCA can also bring action directly against senior managers under the senior managers and certification regime, which could ultimately result in fines, public censure, even prohibition from holding senior roles. Is there anything else that firms should be mindful of from a financial regulatory perspective?

Sebastian Barling (06:11):
Thanks, Joe. There are a couple of key points to consider here, namely understanding circumstances of an employee’s departure and any notifications that need to be made to the regulator, and that could be the FCA or PRA in this instance. Firstly, in respect of departure, this is a broad point. It is very important for regulated firms to understand the circumstances around a senior departure much more so than in the unregulated sector. This is on the basis that regulated firms need to understand whether someone is broadly a good or bad leaver, and we’re on this later, as well as ensuring that the firm complies with its obligations to operate with integrity and due skill, care and diligence. In addition, senior managers also need to ensure that the business for which they’re responsible for is being controlled effectively. If a firm doesn’t take time to conduct, for example, exit interviews or otherwise, engage with departing managers, it runs the risk of miscategorizing a departure as well as potentially missing broader issues that may exist in an organization which could be driving departures.

(07:06):
For example, bullying or individuals having otherwise undisclosed knowledge of problems in the business. Should problems with the underlying business emerge which firms should have been alive to had they better understood the reasons for employee departures. This could potentially be viewed as a firm acting without the appropriate level of due skill, care and diligence, and a breach of this principle would be actionable by regulators against the firm. Secondly, there is also an additional requirement on FSA authorized firms to notify their regulator when a senior manager departs. When someone is broadly a good leaver, this can be made within 10 business days of the departure. This is a relatively straightforward notification made on something called a form C, but firms should be ready for questions from their regulator around succession planning if these have not been preempted.

(07:46):
However, where a firm has information that suggests they will need to submit a qualified form C for a senior manager, the notification needs to be submitted as soon as practicable and ideally, within one business day. A qualified form C is triggered broadly when someone is a bad leaver. I.e., there is information that can impact the firm’s assessment that individual is being fit and property to do their job or where the firm is sought to dismiss or suspend the individual or if the individual resigns whilst under investigation. Such a filing will likely invite further questions from the regulator as to the reasons for the qualified nature for the filing and what a firm is doing to manage any issues that are coming out as a result of that or anything that they’ve uncovered as part of that investigation. Careful regulatory engagement will be required here.

Joseph Kamyar (08:28):
Thanks, Seb. I guess, Helena, if we actually get to the point where we have gone through with the dismissal as the employer, what are the options, tools, leavers that you would expect any employee to have at their disposal to help them manage that exit?

Helena Derbyshire (08:40):
Yeah, absolutely. I think we’ve already talked about the notice and the choice that the employer has with regard to garden leave and giving notice, but it’s also important to understand that the employer has to comply with the contract themselves, so they have to comply with those provisions in the contract. If they don’t and they’re in breach of contract, then the employee might be able to say that you can’t rely on the contract anymore, and that has the impact of potentially any post-termination obligations like confidentiality or restrictive covenants falling away. It’s really important the employer also follows the contract. Another important consideration is the extent to which the departing employee is key to the business and whether the employee wants to keep that individual out of the market. We’re going to talk a little bit about post-termination restrictions in a moment, but garden leave can be a really useful tool in preventing an employee for working for a competitor while they remain employed during their garden leave period and they’ll owe all their obligations to the employer during that period.

(09:38):
A couple of other considerations for employers at this stage, one is the potential that an employee might have a protected characteristic. For example, sex, race, disability, or age. Disability can include poor mental health when that’s a significant issue in a lot of organizations in this space. Employers shouldn’t be too hidebound by the worry about an employee having a protected characteristic because as long as you’ve got a genuine reason to be doing what you are doing, you’ve got a defense or a discrimination claim, you need to keep that at the front of your mind. If there’s a good reason, it’s fine, of course you can do it. The one area that’s a little bit extra consideration is in the context of disability discrimination. If you have an employee with a disability, then an employer has an obligation to make reasonable adjustments.

(10:27):
A reasonable adjustment might include the way in which you conduct your process, and it might include giving the employee a bit more support if they’re a poor performer, for example, to enable them to get to where they need to be. The key word though is reasonable, so employers shouldn’t freeze and assume that you can’t do anything just because you think someone has a disability. You don’t have to carry someone who isn’t working to the standard required, but you just need to make sure you’ve considered all the options and done what you can to assist the employee before you make the decision that you can’t turn this around. Now, it’s often the case that an employer will want to negotiate a settlement exit agreement with the employee.

(11:05):
In that agreement, the employee would waive any claims against the company or against the firm. This can be a really useful tool. It’s beneficial both to the company and to the employee. It smooths the process, means that everything can be consensual, can include additional provisions in the agreement, for example, regarding derogatory statements or confidentiality provisions. Sometimes you just need to be extra careful, particularly if you have somebody who’s in a regulated role or who’s a senior, otherwise a senior manager. You need to be considerate of the timing of this and when you enter into a settlement when you confirm that they are leaving because they might need to be replaced or you might have to report the changing guard. I’m going to hand over to Seb now to explain that in a bit more detail.

Sebastian Barling (11:50):
Thanks, Helena. We’ve already touched upon the notification requirements. When someone’s senior is leaving, regulators will need to know about this. This means firms should be prepared to manage questions on succession planning. This is easy to do in respect of planned departures where replacement candidates can be presented to the regulators for approval in orderly fashion and a handover process undertaken. However, this is much more challenging in the case of bad leavers whereas Helena has said, they may be required to leave with no notice. Firms therefore need to think carefully about how they manage potential unexpected senior absences and should be prepared to articulate their approach alongside any qualified form C they have to file.

(12:24):
There is however, some flexibility in the regulatory rules that allow a person to undertake a senior management role up to 12 weeks without requiring approval, but only where such an absence is genuinely temporary or unforeseen. Another key consideration will be the impact on the departing manager’s remuneration, and in particular, any adjustments to entitlements to variable compensation, i.e., unpaid bonuses. Firm’s existing remuneration arrangements should align with any applicable remuneration code and there’ll be a need for a remuneration committee or other relevant body to review the output of any investigations departing employee conduct to determine whether malice or clawback should apply, and if so, at what amount?

(13:00):
Finally, the SMCR introduced a regulatory reference regime to ensure there’s more accountability in respect to individuals moving between firms and preventing rolling bad apples, being able to bounce around different financial institutions. This means that all UK authorized firms will need to do their best to obtain standardized references as set by the regulators from previous employers going back six years. Conversely, UK firms are also obliged to give these references when requested and to keep them updated. The questions required under these are fulsome, including asking whether an individual has ever been under investigation or subject to any disciplinary action. Whilst there are some issues with the regime, it is very UK centric. This does mean it’s now much harder for individuals to avoid scrutiny of their actions.

Joseph Kamyar (13:41):
Let’s say we get to the point of termination, employee has left the firm, clearly lots of employers will want some control over how particularly members of their senior management team are conducting themselves post-employment, the type of work they’re undertaking, and they’ll seek to do that through restrictive covenants, non-competes and similar provisions, and they’re not uncommon asks in this context, but have traditionally raised questions around enforceability. Especially, where the signs of overreach on the past of the employer. More recently, we’ve seen the government contemplate reforms in the space. Helena, could you perhaps briefly walk us through the current state of play and where we anticipate changes in law and whether the new labor government is in fact supporting the existing proposals, which obviously, a creation of the last conservative government.

Helena Derbyshire (14:26):
Absolutely. I think the starting point is that as a matter of public policy, it’s always been the case that any action that prevents someone earning a living is potentially in restraint of trade. Post-employment restrictions need to be very carefully tailored to the individual employee. They need to be no longer in duration or wider in scope than is absolutely necessary to protect a legitimate interest that the employer has, and these are legitimate business interests. They’re actually quite narrow. It’s protecting confidentiality, trade secrets, goodwill in the business, custom connections and workforce stability. Employers, when they’re preparing their restrictions, therefore really need to be honest with themselves about how long they really need to protect that interest in the business. For example, what’s the real shelf life of your price list or a current business plan, contract negotiations, how frequently are you negotiating those? How long do you really need to keep someone out of the market? It’s often less than you would like.

(15:23):
In the UK, the courts won’t rewrite restrictions, so you need to be quite mindful when you’re drafting them, what it is you actually may need to protect. For example, in the UK, we don’t rewrite restrictions, but we do have what’s called the blue pencil test, which is where the court will strike a part of the restriction if it doesn’t like it. Now, that restriction is going to fall away altogether if the part that struck means the rest of it doesn’t stand on its own. For example, if you have a 12-month-long compete that prevents somebody working for a competitor or having an interest in a competitor, the court might say 12 months is too long, we’ll strike 12 months and it won’t stand on its own. If the court says 12 months is fine, but we think that any interest in a competitor is far too broad because this individual should be able to have a, for example, a de minimis financial investment happens to be in a competitor, but they don’t actually have an active involvement. They might not be able to protect that.

(16:19):
Then you can strike out that part of the covenant and the provision that says that you won’t work for the competitor would still stand. Consideration is required for all restrictions. Consideration basically means that the employee is given something in return for the restriction. At the start of the employment relationship, the offer of employment is sufficient. That’s your consideration. If you’re going to make any changes to restrictive covenants during the course of the employment, then you need to offer some form of consideration whether that’s an additional payment, additional incentive in return for the change. When it comes to enforcement, the courts will look at the balance of convenience, who’s going to be more put out if the restriction is upheld. It’s really important that employers act swiftly before an employee and their new employer have got up and running and started trading to make sure that they’ve enforced those restrictions before that has come to pass.

(17:11):
Now in line with attempts to reform non-competes globally, and this is something that’s been under scrutiny for a little while. The last government did make a proposal to limit non-compete provisions in employment agreements to three months. Now it’s currently unclear whether or not the new government is supportive of it. It’s difficult to know. It’s not their priority at the moment. It’s not part of their first 100 days of legislation, but it could well be something that’s going to come in. It’s also unclear whether if this does come in, the limitation would apply to all existing restrictions and employment agreements. If it does, whether that would curtail those restrictions to three months or whether it just say it’s more than three months, it’s not enforceable altogether and you’ve got to start from scratch. The other factor as well, just in terms of the sentiment behind this is that in the US, similar provisions have been brought in that the courts in the states have already started to successfully challenge those. It may be that the tide is already turning back.

Joseph Kamyar (18:12):
Got it. I guess, what’s the practical advice for employers at the moment?

Helena Derbyshire (18:18):
The practical advice for employers at the moment really is just to sit tight pending confirmation from the new government, whether it’s going to follow this policy through. In any event, it’s always a good idea to be reviewing your restrictive covenants on a regular basis. People get promoted restrictions that applied to them three years ago, it might not be so relevant now. You need to keep a constant eye on the restrictions that you have. The other thing that we’re looking at with a lot of our clients is the provisions that they have in other agreements. Are there any outstanding restrictions in transaction documents where you’ve bought the company, for example, might those still be enforced? Also, whether you’ve got a shareholders’ arrangement, someone’s got management incentive, there could be restrictions attached to those.

(19:02):
Now this is quite a tricky area because the government’s proposals were in relation to employment agreements, and a big question for us is what actually comprises an employment agreement. You might have a distinction between someone who’s a genuine founder and shareholder in a business who has quite a chunky stake in the business, genuinely will be selling goodwill when they leave, and another employee who might just have a small grant of equity under a management incentive plan, which is really just incidental to their employment relationship, which I would say is probably more like an employment arrangement and might not be enforceable. Some practical things to think about in any event to help you future-proof contracts if you’re entering into them no, would be to really consider your garden leave provisions.

(19:47):
It may be extending notice periods, if that’s going to be what’s really the most effective way to keep someone out of the market, looking at the extent of your other restrictive covenants and whether they in fact give you enough protection. What I mean by that is your non-solicits, your non-hiring, your non-poaching, your non-dealing provisions, are they going to be able to protect the business in a way that is really what you need? Also, a greater willingness to focus on confidential information, and what we’ve seen in the states, and particularly in California where for some time non-competes have been banned, is there’s a real focus and the litigation tends to be about how you’re protecting your confidential information. I think employers need to bear these in mind to future-proof agreements they’re entering into at the moment.

Joseph Kamyar (20:29):
That all makes sense. I mean, clearly, there’s tons to consider there as we all navigate any potential reforms to the extent they actually come through. On that note, Seb, Helena, thanks very much for joining us today. We’ve covered a lot of ground on the HR front over the past couple of episodes, so thank you again for guiding us through the topic and thanks to everyone for listening. See you next time.

Sebastian Barling (20:47):
Thanks.

Helena Derbyshire (20:50):
Thank you.

Voiceover (20:51):
Thank you for joining us on Fintech Focus. If you enjoyed this conversation, be sure to subscribe in your favorite podcast app so you don’t miss any future conversations. Additional information about Skadden can be found at skadden.com.