Articles of Association: good leaver/bad leaver

When do I use this document?

• for inclusion in the company’s existing Articles of Association
• for a private limited company incorporated in England and Wales
• in conjunction with a shareholder resolution to amend the Articles of Association – see
  • Shareholder resolution – amend Articles of Association

What are the key features?

• good leaver and bad leaver definitions
• provision for a founder’s shares to vest over a period of time
• mechanism for leaver’s shares to be offered to the company, to new employees and to the remaining shareholders
• determination of fair value by an independent accountant

What else do I need to know?

Good and bad leaver clauses are a mechanism under which the company can require a departed employee to sell and transfer shares back to the company or to other shareholders.

Under general company law, there is no default requirement for an employee shareholder who leaves the business to sell their shares.  This may be unattractive both for investors and for remaining employee shareholders.  Founders and other employee shareholders often hold significant stakes in the company.  If they retain these shares when their employment ends, this can diminish value for both existing shareholders and potential new investors.  Moreover, it can also demotivate both the remaining and new management team, whose future efforts could enhance the shareholding value of someone no longer contributing to the company’s growth and success.

How do good and bad leaver clauses operate?

Good and bad leaver clauses are included in the company’s Articles of Association.  An employee shareholder is required to offer their shares for sale upon termination of employment.

The circumstances of leaving determine whether the employee is classified as either:

• good leaver: typically, circumstances such as death, illness or termination of employment by the company that amounts to wrongful or constructive dismissal
• bad leaver: usually, events such as voluntary resignation by the employee or dismissal by the company for misconduct

The price received for the shares depends on the good leaver or bad leaver classification.

• good leaver: usually receives “fair value” for their shares.
• bad leaver: usually receives a reduced value for their shares, often only the nominal value or the amount originally paid of the shares were acquired on exercise of an employee share option.

Do good and bad leaver clauses apply to founders?

For founder shareholders, good and bad leaver clauses might be modified depending on the circumstances of the business and the terms negotiated between the founder and investors.

In an established business, flounders resist provisions which allow for all of their shares to be bought back or which prevent them receiving fair value.

From the investor’s perspective, the investor may require that a founder who leaves, even as a good leaver, in the early years of the business operations should not receive fair value for all of their shares.