How we agreed a settlement sum where equity was promised in a company but the shares were never received

Background

We recently assisted a client with reaching a settlement sum where the client had been promised equity in a company that they had been working for but the shares were never issued.

The client met the founder of the company whilst working at a previous role. Initially the client, the founder and another individual had agreed to become co-founding shareholders of a new company that would be used to launch a new product developed by the founder. This never materialised and the product was later incorporated into the founder’s existing company. After the plan to incorporate a new company fell through, the client agreed to join the existing company on the agreement that he would be issued shares in the existing company in exchange for his continued involvement and contribution to the success of the business and the product.

No shares were ever issued and after 3 years the client’s position at the company was terminated.

The client contacted us shortly after receiving an initial settlement offer from the company. The company refuted that any offer of shares had been made and were instead seeking to agree a small settlement sum more relating to a payment in lieu of reasonable notice for terminating our client’s services contract.

Our client felt the settlement amount was considerably less than what the shares (had they been issued) would be worth and rather than just accepting a settlement sum, was also seeking to enforce his right to be issued shares in the capital of the company.

How we were able to help

Our instructions were to review the background information and documents provided by the client then assist with negotiating and formalising an acceptable settlement package on behalf on his.

We started by preparing a detailed written response and counteroffer for our client. This was followed by a few more letters between the parties before a formal basis of settlement and compromise was agreed. In the end there was no need for any negotiations in person or by video/tele conference. In doing so we were able to advise on and clearly set out the factual basis of our response and counteroffer. We were also able to provide advice on issues which were likely to exacerbate or unnecessarily escalate tensions between the parties.

Aside from drafting the response and offer letters, we were able to advise on the various recourse options (and the merits of each as they were relevant to the facts) and we were able to draw on our experience of managing disputes to advise on different settlement options, the pros and cons of litigation (should it reach that point), the relevant protections we would expect to see in the settlement agreement and what the other party would likely expect in terms of waiver and release of future claims against the company.

In our initial arguments, we relied on the evidence provided (including emails and other supporting documents, including a document which contained a valuation of the company) as well as technical legal analysis around contract formation to establish our client’s contractual right to be issued the shares. We also sought to rely on the client’s contribution during his 3 years working for the company as giving rise to a beneficial interest in the shares.

The counterparty initially argued that no offer had been made by the company, but later claimed that the emails failed to show unconditional acceptance of an offer. Whilst this was a positive shift, the parties eventually reached a stalemate on this point and after advising our client on the various possible outcomes (and associated costs) it was decided to pursue a cash settlement (and waive any legal and beneficial entitlement to the shares) rather than enforce the right to be issued the shares.

The client’s initial concern about accepting a settlement sum in lieu of being issued the shares was the risk that if the company was later sold for more than what the value of the shares were when the settlement sum was agreed, the client would not benefit from or be entitled to any of the increase in value. We therefore recommended seeking an anti-embarrassment provision in the settlement agreement that would protect the client so that in the event of a future sale of the company at a higher valuation (than the valuation on which the settlement sum was based), the client would be entitled to receive a proportion of the difference.

The final settlement package did not include an anti-embarrassment provision because the client was happy to accept a higher settlement sum in exchange for withdrawing the request to include it. However, if the cash sum offered had been unacceptable, this option would have offered protection and comfort to the client that if the company was sold, they could still benefit from any uplift in its value at a later date while helping the parties reach a compromise on the settlement sum..

At the latter stages of the negotiation, the key point of negotiation was reaching a settlement sum that our client was satisfied reflected a fair value for what the shares would have been worth had they been issued at the present time.

The company had rejected our initial valuation offer for the shares, but later submitted a valuation of the relevant shareholding percentage prepared by a third party accountant which related to setting up an EMI share option scheme (an HMRC approved scheme under which employees of a company are granted options to purchase shares for a price agreed with HMRC when the options are granted). Typically, share valuations for the purpose of setting up an EMI share option are much lower than what the shares could otherwise be valued at. Consequently, we rejected the valuation by the accountants and proposed an amount that we felt sat between the valuation we had originally submitted (based on the company valuation in the documentary evidence) and the valuation prepared for the purpose of the EMI share option. This approach was successful and was reflected in the final offer.

Although inevitably some matters do end up being litigated (and the language used throughout these negotiations demonstrated each party’s willingness to bring / defend any claim should it be necessary), we were able to provide advice on the risks associated with commencing litigation (namely the likelihood of significant legal costs to both parties and a risk that a lesser amount is awarded by the court, or worse, that no amount is awarded by the court) and we were ultimately able to avoid issuing a claim in respect of this matter.

Outcome

After three rounds of negotiation, the company made a final settlement offer which was accepted by our client. Whilst the company was unwilling to agree to issue shares in the company, it eventually offered a settlement sum which our client believed represented a fair and sensible offer in the circumstances, also taking into account the old adage that “a bird in the hand is worth two in the bush”.

Although the client set out with the intention to enforce their entitlement to receive the shares, we still consider this to be a successful outcome. Not only because the client received a greatly increased cash settlement that they were happy with, but also because we were able to avoid the need to pursue litigation, thus saving our client from the time, cost and uncertainty involved with that process.