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Parachute with strings: restrictions on variable and severance pay in the banking sector

Written by
Toffoletto de Luca Tamajo, working in employment law since 1925.
Authors
Emanuela Nespoli
Partner - Italy
Toffoletto De Luca Tamajo
Italy
03.02.21
15
When employers in the banking sector negotiate agreements with key employees regarding variable or post-termination pay, they may be legally required to include explicit ‘malus’ and ‘claw back’ provisions. This article discusses such requirements in Italy and beyond.

In recent years, and especially in the wake of the 2008 financial crisis, governments and bank regulators have issued a number of important rules aimed at improving the risk management and governance of banks and strengthening the transparency of the banking system.

The European Union first intervened in this arena with a directive in 2010, followed by further directives in 2013 and 2019. One of the primary aims of these directives was for banks to adopt remuneration policies and practices that reflect and promote sound and effective credit risk management.

These EU directives were expressly implemented by the Bank of Italy in December 2013 in Circular 285 (since amended on several occasions) which, along with local provisions (i.e. the so-called Banking Law Code, Testo Unico Bancario), sets limits and rules on variable remuneration. Specifically, Circular 285 and its amendments govern the amounts that can be paid to managers (i.e. directors and executives with strategic responsibilities) upon the termination of the employment relationship (the so-called ‘golden parachute’).

Under these regulations, variable remuneration in general, as well as any amounts payable upon early termination of an employment relationship or office, must always be subject to contractual ‘malus’ and ‘claw back’ mechanisms. A malus provision allows the bank or credit institution to reduce or eliminate the amount that it has yet to pay as variable remuneration or severance to its manager. A claw back provision allows the bank to request the return (in whole or in part) of amounts already paid in the event of a post-termination negative assessment of the company’s or the individual’s performance, or where the employee has engaged in fraudulent behavior or gross negligence. A bank must have remuneration policies in place that identify the criteria to apply to malus and claw back mechanisms in compliance with the rules set out in Circular 285 and its subsequent amendments.

These mechanisms must be in place in order for any agreement concerning key employees’ variable remuneration and/or severance within the banking sector to be considered valid. The Banking Law Code stipulates that any agreement or clause that does not comply with the provisions on remuneration and incentive systems is null, and that the invalid provision will (if possible) be replaced by law with a provision in line with the required mechanisms. Therefore, any agreement reached between a bank and a key employee that does not include these post-termination malus and claw back mechanisms could be invalidated.

The Court of Appeal of Milan has recently ruled on this issue in a November 2020 decision. A former bank manager filed a lawsuit aimed at obtaining from his former employer the payment of a severance that was agreed to in a full settlement agreement between the parties. The settlement agreement did not include any malus and claw back clauses, but the former manager asserted that those mechanisms were effectively included in the agreement since the language of the agreement included a generic reference to Circular 285 and to the bank’s remuneration policy. 

However, the Court considered this reference insufficient to constitute valid malus and claw back clauses, and it held that the settlement agreement was therefore invalid. The Court reasoned that the Bank of Italy Circular and the bank’s remuneration policy only identify general principles and criteria to apply to post-termination malus and claw back clauses. The parties must then determine and detail the specific terms of the clauses within the settlement agreement in compliance with those principles and criteria.   

As this ruling demonstrates, banks and credit institutions run significant risks if they do not carefully draft their internal remuneration policies and any settlement agreements with key employees. Those institutions are therefore strongly advised to seek expert assistance in drafting any such policies and agreements.

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