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Cite as: [2002] EWCA Civ 126, [2003] BCC 113, [2002] Emp LR 919, [2002] ICR 1045, [2002] IRLR 452

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Mallone v BPB Industries Plc [2002] EWCA Civ 126 (19th February, 2002)

		Neutral Citation Number: [2002] EWCA Civ 126
		Case No: A2/2001/0665

IN THE SUPREME COURT OF JUDICATURE
COURT OF APPEAL (CIVIL DIVISION)
ON APPEAL FROM QUEEN’S BENCH DIVISION
(Mr C Symons QC, sitting as
a Deputy High Court Judge)

Royal Courts of Justice
Strand,
London, WC2A 2LL

19th February 2002

B e f o r e :

LORD JUSTICE WALLER
LORD JUSTICE RIX
and
MR JUSTICE WILSON
____________________

	Giovanni MALLONE	Claimant/ Respondent
	and –
	BPB Industries plc	Defendant/Appellant

____________________

(Transcript of the Handed Down Judgment of
Smith Bernal Reporting Limited, 190 Fleet Street
London EC4A 2AG
Tel No: 020 7421 4040, Fax No: 020 7831 8838
Official Shorthand Writers to the Court)

____________________

Nigel Inglis-Jones QC and Andrew Colvin (instructed by Messrs Lloyd & Co) for the Claimant/Respondent
Nicholas Randall (instructed by Messrs Clifford Chance) for the Defendant/Appellant
____________________

HTML VERSION OF JUDGMENT
AS APPROVED BY THE COURT
____________________

Lord Justice Rix :

This appeal arises out of the cancellation of Mr Mallone’s share options in BPB Industries plc (“BPB”) as a consequence of his dismissal from his executive position as managing director of BPB’s Italian subsidiary, BPB Italia Spa (“BPB Italia”). The question is whether that cancellation was lawful and effective under the terms of BPB’s Senior Executive Share Option Scheme (the “Scheme”).

Mr Christopher Symons QC, sitting as a deputy high court judge, held that the discretion vested in BPB’s directors had been wrongfully exercised in three respects. First, it did not entitle the directors to cancel options which had been held for a period of three years and thus could be said to have matured. He therefore distinguished between those of Mr Mallone’s options which had matured and those which had not: as a matter of construction of the relevant rule the directors had power to cancel the immature options but not those which had been held for three years. Secondly, if that was wrong as a matter of construction, the directors had nevertheless acted irrationally in cancelling the mature options. Thirdly, the directors had acted prematurely because at the time of cancelling the options Mr Mallone was still a director of various group companies.

Mr Mallone’s employment as managing director of BPB Italia ceased on 2 (or possibly 3) November 1995. At a meeting of the directors said to have been held on 3 November 1995, his options were cancelled. Formally he remained a director of various group companies until his resignation from those offices on 4 January 1996. On 18 September 1997 he wrote to BPB to exercise his options, and it became common ground that the relevant date on which that exercise, if valid, would have been effective and the respective shares acquired and sold would have been 27 September 1997. In the event the judge held that Mr Mallone’s exercise of the options which had already matured at the time of their cancellation ought to have been recognised, and awarded damages of Ł100,636 plus interest.

BPB’s appeal from that judgment and order raises two issues, the first an issue of construction as to the relevant rule, ie rule 5(b)(iii) of the Scheme, and the second as to whether the directors’ discretion was in any event exercised in a way that any reasonable employer could have done, or, as Mr Nicholas Randall, BPB’s counsel, would prefer to say, in good faith. There is no respondent’s notice or cross-appeal with respect to the immature options. There is no question on appeal as to quantum.

A third issue was raised, it is fair to say by the court itself, with reference to the judge’s finding that the directors’ discretion was exercised prematurely. That issue was dealt with in the main in written submissions following the hearing.

The Scheme

BPB’s Scheme was open to any “executive”, defined as any full-time employee or full-time director employed by any one or more companies within the Group: “full-time” was non-exclusively defined as normally requiring 35 or more hours to be devoted to the duties of the executive’s employment or office. BPB is an English company with an international spread. The Scheme was operated by BPB’s directors or a duly authorised committee of such directors. An “option” is defined for relevant purposes as a “right to subscribe” for BPB’s shares “which has been granted…and is still subsisting”. Grant of options is effected by resolution of the directors and evidenced by the issue to an executive of a written notice stating the number of shares subject to the option, the subscription price and the date of grant. An executive to whom an option has been granted becomes a “participant”. The options granted cannot be exercised until the third anniversary of the date of grant and lapse on the expiry of ten years from date of grant. It is in that sense that an option held for three years can be said to be a “mature” option and an option held for less than three years can be said to be an “immature” option, but those expressions are not found in the Scheme’s rules and are adopted merely for the sake of convenience.

The judge made the following findings about the Scheme:

“3. The…Scheme was formed in 1984 to provide long term incentives to selected key executives. It enabled those executives to share in the long-term success of the Group. By 1995 there were some 60 participants in the scheme. Membership of the Scheme was kept under review each year and final decisions as to which executives should participate in each year’s round of options, and at what level, was taken by the board on the recommendation of the Chief Executive. A senior executive was not entitled to participate as of right and might be included one year and omitted the next. The Board delegated the task of formally granting options to the Options Scheme Committee who normally granted options in July of each year.”

The critical rule which fell to be construed was rule 5(b)(iii). Rule 5, of which it formed a part, is headed “Time of Exercise and Lapse of Options” and contains four sub-rules, (a) to (d). Rule 5(a) states the general rule already mentioned above that save as otherwise provided options can only be exercised between the third and tenth anniversaries of their date of grant. Rule 5(c) states the default rule that save as otherwise provided

“(c) Options will lapse forthwith on the Executive ceasing to be employed by the Group”.

Rule 5(d) contains a partial definition of the concept of “ceasing to be employed by the Group” by providing that –

“(d) No Participant shall be treated as ceasing to be employed by the Group until he ceases to hold an office or employment in the Company or any company of which the Company has Control.”

Rule 5(b) contains the important provisions within which any participant has to bring himself in order to avoid the default rule that his options would lapse on his ceasing employment.

Rule 5(b) falls into three parts, (i), (ii) and (iii). Rule 5(b)(i) is concerned solely with participants who die: their personal representatives may exercise any option capable of being exercised within twelve months of death. Rule 5(b)(ii) is concerned with participants who cease to be employed by the Group “by reason of injury, disability, redundancy, retirement…or the company by which he is employed ceasing to be a member of the Group”. In such a case, there is no discretion in the directors to cancel any part of the participant’s options. Moreover, save in the case of retirement, a participant can exercise options even within three years of their grant. It can be said that rule 5(b)(ii) is dealing with participants who cease employment for reasons which are in no sense their fault. There was a dispute below as to whether Mr Mallone ceased his employment because he was made redundant, a reason within rule 5(b)(ii). Indeed, the formal letter written to him on 2 November 1995 terminating his employment at BPB Italia stated that he had been made redundant – if indeed (BPB Italia’s primary contention at that time) he had ever had a contract of employment with BPB Italia at all! Nevertheless, the judge found that the real “reason for Mr Mallone’s dismissal was not related to redundancy but rather related to his performance” and there is no appeal from that decision. Therefore rule 5(b)(ii) did not apply in his case.

Rule 5(b)(iii) is the critical rule and I will set it out in full:

“…an Option may be exercised…

(b)…(iii) in the event of the Participant ceasing to be employed by the Group for any other reason (other than on the grounds of his misconduct or as provided for in Rule 6) either:

(1) during the six months after such cessation: or

(2) during the period expiring six months after the later of the third anniversary of the Date of Grant of the last Option he was granted under this Scheme and the third anniversary of the date (prior to such cessation) on which the participant last exercised an Option (in whole or in part)…

provided that exercise under this Rule 5(b)(iii) shall not be permitted in respect of more than an appropriate proportion of the number of Ordinary Shares comprised in (and remaining subject to) the Option, such proportion being determined by the application to such Option of a fraction of which the denominator is thirty-six and of which the numerator is either the number (not exceeding thirty-six) of complete calendar months during which the Participant has been an Executive since the date of Grant or such other number (not exceeding thirty-six) as the Directors in their absolute discretion determine.”

It follows that rule 5(b)(iii) operates to prevent the default rule applying on the cessation of employment in all cases save for those dealt with by rules 5(b)(i) and 5(b)(ii), “misconduct” and rule 6 (which deals with changes in control and winding-up of BPB). It is common ground that it is the operative rule in the case of Mr Mallone. It therefore covers a sort of middle ground between cases where the participating executive ceases employment with BPB without any fault on his part and cases of misconduct. It is common ground that “misconduct” covers only such conduct as would entitle BPB to dismiss an executive summarily. There is no specific rule covering misconduct: therefore in such a case the default rule under rule 5(c) applies. BPB submits that the discretion vested in the directors by rule 5(b)(iii) is necessary to cover a wide ground where the executive may be ceasing employment for a variety of reasons and in a host of different circumstances.

Mr Mallone’s employment and options

Mr Mallone’s employment with the company which in 1987 was acquired by the BPB group went back to May 1983. In 1988 that company re-emerged as Italgips SpA (“Italgips”) and Mr Mallone was its general manager and managing director. Italgips manufactured plasterboard and held roughly half of the Italian market. The judge found that “Mr Mallone did a good job in that company and this was not the cause of the problems”. Mr Mallone became entitled to participate in the Scheme in 1989. Each July the options scheme committee (the “committee”) awarded options on the basis of the previous year’s performance. On 17 July 1990 Mr Mallone was granted his first options, 38,700 in number (increased to 39,777 following a rights issue). In the following year he was granted a further 25,800 options on 23 July 1991. On 15 July 1992 he was granted a further 8,100 options. Those are the options which had matured by the date of his ceasing employment on 2 November 1995 and in respect of which the judge awarded Mr Mallone damages. Indeed by that time the 1990 options were already over five years old and the 1991 options over four years old.

On 19 July 1993 Mr Mallone was granted a further 40,700 options. A few months earlier, on 24 March 1993, Mr Cuny, a main board director and either then or subsequently BPB’s chief executive, had written to Mr Mallone to inform him of a salary increase from 1 April 1993. His letter contained the following:

“I believe you have put in a superior performance during the year. We are happy with the plant and you have done a good job in a very difficult market.”

On 11 July 1994 Mr Mallone was granted the last of his options, 29,300 in number. Two weeks earlier, on 30 June 1994, Mr Cuny had written to him to inform him of his bonus for the 1993/4 year and to give him “my personal thanks for all your efforts during the year”.

(In due course when in September 1997 Mr Mallone sought to exercise all his options, he was relying on the right (subject to the proviso) to exercise his options within “six months after the…third anniversary of Date of Grant of the last Option he was granted under this Scheme” within the wording of rule 5(b)(iii)(2), viz within six months of 11 July 1997.)

But the pendulum was swinging. BPB had another group company in Italy which made plaster, called Vic Italiana SpA (“Vic”), of which Mr Mallone had been a director since November 1989. This had nearly 60% of the Italian market but its share, and turnover, were falling. Indeed, Vic’s 1992/93 profit of Lire 8.5 billion had turned into a loss of Lire 5.5 billion by 1994/95. Either in the autumn of 1993 or the spring of 1994 its managing director was fired and Mr Mallone was installed as his successor. Then in July 1994 Mr Robert Sternick joined BPB as managing director for Southern Europe: he was responsible for “hiring, development and firing” of senior management at the relevant subsidiaries, was a member of BPB’s executive committee and reported to its chief executive. It was clear that Mr Sternick and Mr Mallone did not see eye to eye. BPB’s pleaded case was that Mr Mallone had failed to perform in his role as managing director (of Vic) from “at least August 1994”. Mr Sternick thought that Mr Mallone was devoting his energies to Italgips and was failing to concentrate more resources on turning Vic around. Mr Mallone thought that Mr Sternick was unrealistic and failed to recognise the improvement in Vic’s fortunes which he was in the course of engineering: in 1995/96 turnover grew for the first time in years and profits recovered to break-even. The judge found as follows:

“…[Mr Sternick] did not feel that Mr Mallone was up to the job of improving the position of the Italian companies. He told me that Mr Mallone was happy with the way things were whereas he, Mr Sternick, wanted a consistent improvement. In general I accept the evidence of Mr Sternick. He did not seek to denigrate Mr Mallone beyond giving the facts as he saw them. He was looking for a more dynamic performance at a time when things were clearly difficult. He offered Mr Mallone various other employment opportunities, which did not appeal to Mr Mallone, and Mr Sternick did not behave as though he was trying to get rid of Mr Mallone for no reason…

“In my judgment the main difference between the witnesses was that the Italians felt that they should be left to sort out the problems with Vic Italia while Mr Sternick was of the opinion that he was employed to make immediate improvements. Had it not been for what was perceived by [BPB] as the crisis in Vic Italia Mr Mallone might well have been satisfactory to them…However [BPB] wanted someone in charge whom they believed was capable of turning that company round.”

On or about 18 July 1995 the committee considered option grants in respect of the previous year. Mr Mallone’s name had been noted among “Other Possibilities” with the comment “(performance issue)”. It was decided not to grant him further options. In late July matters came to a head with a meeting in Italy which Mr Sternick described as a complete fiasco. It was decided to replace Mr Mallone as managing director of BPB Italia (into which Vic had been merged in 1994). He ceased to be managing director on 13 October 1995 and his employment was terminated on 2 or 3 November by the letter to which I have referred. It is not clear to me what happened to his office and employment at Italgips, which as far as I can tell was not merged into BPB Italia until 1996 and to which the letter of 2 November written by Mr Sternick as chairman of BPB Italia made no reference, but no specific point seems at any time to have turned on that.

The cancellation of Mr Mallone’s options

A manuscript note made by Mr Heard, a main board director and secretary of BPB, of a telephone conversation he had with Mr Sternick on 3 November 1995 reads as follows:

“Mallone ceases employment today and has been told BPB have already decided to cancel all options not exercised as at today

“Back date Op Com MTG…”

The meeting of the committee referred to in the last line of that note is recorded by the minutes as having taken place, in London, at 10 am on 3 November 1995. The minutes read as follows:

“MR G MALLONE – CANCELLATION OF OPTION ENTITLEMENT

In exercise of the authority and discretion provided under rule 5(b)(iii) of the executive scheme the Committee…RESOLVED –

“THAT Mr G Mallone’s options…subsisting as at 3^rd November 1995 be cancelled in full with effect from that date (the date on which he ceases to be employed by the Group) that is to say that it is hereby determined that the numerator of the fraction to determine the appropriate proportion referred to in such rule 5(b)(iii) shall, in this case be zero...””

and the document thereafter listed the five grants of options to Mr Mallone, of which the first three (those granted in July 1990, 1991 and 1992) had matured and the last two had not.

Mr Mallone was not informed formally of the committee’s decision. No letter was sent to him informing him of the cancellation of his options.

No reason was given for the committee’s determination that “the appropriate proportion” was zero. The committee was made up of Mr Cuny and Mr Heard. BPB’s original defence merely referred to the meeting and stated that such exercise of discretion was “in accordance with the Rules”. An amended defence added “and was exercised in good faith” and gave the following particulars:

“The Defendant contends that a central purpose of the Scheme is to reward performance of the senior management of the Defendant. In exercising its discretion under the Scheme the Defendant took into account the Claimant’s performance. In the circumstances the discretion was exercised in good faith and on a rational and legitimate basis.”

That pleading was signed with a statement of truth by Mr Heard.

Mr Heard gave evidence, Mr Cuny did not. Mr Heard’s witness statement contained the following material. On 6 October 1995, when a decision in principle had already been taken to dismiss Mr Mallone, Mr Heard prepared a note to advise Mr Sternick, for the purposes of negotiations with Mr Mallone, that the directors had authority under the Scheme “to reduce proportionate entitlement to 0/36 on all options”. The reference to negotiations with Mr Mallone was to negotiations with regard to a “possible leaving package”. Those negotiations took place during October. BPB’s lawyers advised that Mr Mallone would be entitled to a settlement under Italian law in the region of Lire 1 billion. Mr Heard agreed with Mr Cuny that, if no settlement had been reached by the time of Mr Mallone’s formal departure, they would cancel all his options “given the large sums of money that we knew were going to be payable to the Claimant in respect of compensation for termination”. It appears to have been his evidence at that stage, therefore, that Mr Mallone’s options were cancelled primarily in the face of BPB’s potential liability to Mr Mallone under Italian law.

Mr Heard’s evidence in court appears to have developed somewhat for the judge said this:

“Mr Heard told me that he and Mr Cuny took into account Mr Mallone’s performance, the circumstances of his dismissal and the fact that he was going to receive a substantial sum in compensation from the Italian Court. While [Mr Mallone’s counsel] argued that this last matter was an improper consideration to have regard to I do not accept that. As pointed out in argument it could work the other way. If an employee received very little money for loss of office that might be a good reason to allow him or her to exercise their options in full.”

Ultimately, Mr Mallone had to sue BPB Italia by a petition dated 2 January 1996. A compromise in the form of Conciliation Minutes signed as a record of the Italian court and dated 4 January 1996 (the “Milan Agreement”) was made soon thereafter. The effect of the Milan Agreement was to supersede BPB Italia’s letter of 2 November 1995 retrospectively as the formal record of Mr Mallone’s departure, which was now defined to have taken place on 3 November 1995 “by mutual consent”. BPB agreed, without any acknowledgment of liability, to pay Mr Mallone the sum of Lire 744 million (which this court was told was equivalent to about Ł300,000) as compensation for the cancellation by mutual consent of the “labour relation” between them. It was specifically agreed, albeit not on the face of the Milan Agreement, that any rights that Mr Mallone might have had under his options lay outside the Agreement, since that was only dealing with his rights under Italian employment law. Indeed, the Scheme itself had a rule, rule 9(d), which stated in effect that terms of employment and participation in the Scheme were separate and that such participation did not entitle a participant “to take into account such participation in calculating any compensation or damages on the termination of his employment for any reason”. Mr Randall submitted that such a term would operate to protect the employing company within the group and would do so even if it were in breach of its own contract of employment, and in this respect he referred to a decision of Mr John Mowbray QC in Micklefield v. SAC Technology Ltd [1990] 1 WLR 1002. It is unnecessary for the purpose of this appeal for this court to consider whether that submission was correct. This court was told that the agreed payment of Lire 744 million was equivalent to about Ł300,000.

The judgment below

On the issue of construction of rule 5(b)(iii) the judge held that it did not cover options of more than three years’ standing. He said:

“Much clearer words are needed than appear in that proviso to remove the vested right which a participant has once an option has been held for 3 years. This interpretation of the rule also appears to me to accord with the purpose behind the rules. Once an employee has remained with his employers for 3 years after the grant of the option he is then entitled to the benefit of this long-term incentive scheme. The purpose of rule 5(b)(iii) is in my judgment to limit the exercise of options granted within 3 years of termination to a proportion of those options, depending on the fraction of the 3 years worked. There is a discretion for that fraction to be varied…”

The judge went on to consider the committee’s exercise of its discretion. In respect of the 1993 and 1994 options which had not yet matured he held that the committee was entitled to have regard to the three matters of which Mr Heard had spoken in his evidence (see para 25 above). He said that although BPB’s decision was somewhat harsh, it was not sufficient for that conduct to be described as irrational or perverse. However, in respect of the options which had matured, he said this:

“…had I reached the conclusion that the discretion applied to the mature options as well I would have found that the decision to deprive Mr Mallone of the benefit of those share options was a decision that no reasonable employer could have reached. It seems to me to take away or reduce the options that have matured, and have therefore been fully earned, would have been an irrational and perverse decision in this case. As I have said the nature of the scheme was such that employees were rewarded for their loyalty in staying with the defendant in the long-term. Once the right to exercise the options have been “earned” by a further 3 years employment in my view it requires some reason of the sort that does not exist in this case to deprive an employee of the fruits of those options…”

The first issue: the construction of rule 5(b)(iii)

On behalf of BPB Mr Randall submitted that the judge was in error in construing rule 5(b)(iii) as dealing only with options which had not yet matured. He pointed out that if that were the case, then in a situation outside rules 5(b)(i) and (ii) a mature option would lapse under rule 5(c) on a participant ceasing employment when it ought to be capable of being preserved, subject to the directors’ discretion, under rule 5(b)(iii). Moreover, rule 5(b)(iii) was framed, like every other part of rule 5(b) in terms of any “Option”, a term which was defined in a way which covered mature and immature options alike. The very possibility envisaged by the proviso that the appropriate fraction might be 36/36 (but not more than 36/36) indicated that mature options, ie options that had been held for at least 36 months, were within the contemplation of the rule. And it would have been very easy to have distinguished within the rule and to say that mature options were exercisable in full but that otherwise the proviso applied.

On behalf of Mr Mallone, on the other hand, Mr Inglis-Jones QC submitted that the judge had been right to say that mature options did not fall within the ambit of rule 5(b)(iii)’s proviso. He accepted that mature options came within the earlier part of rule 5(b)(iii), but submitted that the proviso dealt only with immature options. Just as the end of rule 5(b)(i) contained a specific provision indicating whether immature options could be exercised (they could not: “at any time when an Option held by him is capable of being exercised”); and just as the end of rule 5 (b)(ii) indicated that in the specific case of retirement immature options could not be exercised (“in the case of retirement no Option may be exercised earlier than three years after the date of Grant”); so rule 5(b)(iii) ended with the proviso which dealt only with immature options. In this connection he emphasised the language of “the appropriate proportion”, which he submitted could apply only to an option held for less than 36 months and gave colour to the whole proviso; while the language “not exceeding thirty-six” also underlined the fact that mature options were not the subject-matter of the clause even if the directors were permitted in their discretion to maintain in full the options of a participant who ceased employment on the verge of the third anniversary of a date of grant. Above all, he submitted, it would take clear words, which were lacking, to permit the cancellation of an option which had already vested.

In my judgment, the submissions of Mr Randall are to be preferred. It is common ground that the body of rule 5(b)(iii) is dealing with mature as well as immature options. That must be the case, for otherwise a participant who came within neither rule 5(b)(i) nor rule 5(b)(ii) would lose his mature options. Moreover, the whole structure of rule 5(b) makes it clear that it is dealing with options of any kind, mature or immature: thus rule 5(b) begins “…an Option may be exercised…in the circumstances set out below…”; and rule 5(b)(iii)(2) in terms refers to options which have matured. In such circumstances the proposition that the proviso is dealing only with immature options should be reasonably capable of demonstration, even if the possibility that mature options might be taken away by a matter of discretion itself requires clear words. The fact is that if, having just specifically mentioned mature options in rule 5(b)(iii)(2), the draftsman intended immediately thereafter in the proviso to deal only with immature options, he could so easily have said something along the lines of “provided that in the case of the exercise of options granted less than 3 years prior to the cessation of employment…” So it is necessary to look carefully at the words of the proviso to see if they can reasonably be construed as applying only to immature options. Plainly they do apply to such options, for provision is made for an appropriate proportion dependent on a fraction whose numerator is set by the number of months (up to thirty-six) during which the participant has remained an executive since the date of grant. But equally clearly, to my mind, the words of the proviso embrace the case of the mature option, first because they expressly allow a proportion or “fraction” of 36/36 and secondly because they expressly disallow a numerator of more than thirty-six. The case of an appropriate proportion of 36/36 is plainly contemplating a mature option: subject to an exercise of discretion by the directors, the proviso provides that the appropriate proportion of a participant who has remained an executive for thirty-six “complete calendar months…since the Date of Grant” will be 36/36. That has nothing to do with an exercise of discretion to give a participant with almost but not quite three years’ further employment a 36/36 proportion. Moreover, since in the normal case an option matures on the third anniversary of its date of grant, the proviso’s requirement for “complete calendar months” may well require somewhat more than merely reaching that third anniversary (for it was common ground that the reference to calendar months was to whole months). Finally, the limitation on a numerator of thirty-six is only necessary because, in the case of a long-serving executive who continues in employment with fully mature options, the general language “the number…of complete calendar months…since the Date of Grant” requires a limitation of such a kind, otherwise it might be argued that the language permitted the exercise of more than the number of options granted. Therefore not only does the language of the proviso fail to indicate that it is dealing only with immature options, but it expressly contemplates options which have matured.

It follows that on this first issue I would acknowledge, in respectful disagreement with the judge, that the proviso could in theory embrace an exercise of the directors’ discretion in relation to mature as well as immature options.

The second issue: the exercise of discretion

In the light of my decision on the first issue, it becomes critical, subject to the third issue, to review the judge’s opinion that in any event the committee’s exercise of its discretion to cancel Mr Mallone’s mature options was irrational.

Mr Randall submitted that the committee’s decision could not be so stigmatised. It had an “absolute discretion”. The judge had accepted Mr Heard’s evidence that the committee had taken into account Mr Mallone’s performance, the circumstances of his dismissal (which Mr Randall pointed out included the fact that Mr Mallone had been offered alternative employment within the group, in England), and their understanding that Mr Mallone would receive Lire 1 billion in compensation. That was, he stated (albeit this was not a matter in evidence), greatly more than an executive in his position would have received by way of compensation under English law. He pointed out that in an international group such as BPB the Scheme had to be capable of working fairly across a wide range of multi-national executives: he came close to submitting that if in such a case the directors could not take into account the very generous provisions of Italian employment law, then it would not be possible to include Italian executives as participants within such a scheme. If that might be thought to be discriminatory, it was a discrimination which could be justified. In any event, there was no finding that the committee had acted otherwise than in good faith, or for any improper motive, or capriciously, arbitrarily or dishonestly. Therefore, it could not be said to have acted irrationally. An option, although a species of property, was not like a contractual bonus (cf Clark v. Nomura International plc [2000] IRLR 766), nor was it like a pension, to which an employee might have contributed: it was a speculative right for which under the Scheme the executive paid a merely nominal Ł1 (for each grant) and which might turn out to be worth nothing at all.

Mr Inglis-Jones supported the reasoning of the judge. The options had been fully earned by Mr Mallone’s service to the group and could not, either rationally or in good faith, be taken away on the grounds which had motivated the committee in the present case. There was no finding of poor performance, merely that Mr Sternick and the directors had come to perceive Mr Mallone’s current performance as falling short of what was now required. But his options had been earned by good performance in the past, and by further good performance over the three years and more during which his options had matured. In that respect there was no difference between a mature option and a contractual bonus or a pension: Mr Mallone had contributed with his service over the years. The offer of another position in England, of lesser rank, was constructive dismissal. His compensation under the Milan Agreement, in any event substantially less than the figure which Mr Heard had had in mind, merely represented his rights under Italian law.

There was some, but little, discussion of authority. In Clark v. Nomura Burton J awarded substantial damages in respect of the defendant’s failure to pay Mr Clark, a senior equities trader, an “individual performance” based bonus which was part of his contract of employment. Burton J regarded the need to take “individual performance” into account as a fetter on the employer’s discretion. But he went on to consider the position of an employer’s discretion at large in this passage (at para 40):

“Quite apart from the additional contractual straitjacket for the discretion in this case, the employer’s discretion is in any event, as a result of the authorities, not unfettered, as both sides have accepted to be the law in this case. Even a simple discretion whether to award a bonus must not be exercised capriciously (United Bank Ltd v Akhtar [1989] IRLR 507 EAT, Clark v BET plc [1997] IRLR 348 and Midland Bank plc v McCann 5/6/1998 unreported EAT) or without reasonable or sufficient grounds (White v Reflecting Roadstuds Ltd [1991] IRLR 331 EAT, and McClory v Post Office [1993] IRLR 159). I do not consider that either of these definitions of the obligation are entirely apt, when considering whether an employer was in breach of contract in having exercised a discretion which on the face of the contract is unfettered or absolute, or indeed even one which is contractually fettered such as the one here considered. Capriciousness, it seems to me, is not very easy to define; and I have been referred to Harper v National Coal Board [1980] IRLR 260 and Cheall v APEX [1982] IRLR 362. It can carry with it aspects of arbitrariness or domineeringness, or whimsicality or abstractedness. On the other hand the concept of ‘without reasonable or sufficient grounds’ seems to me to be too low a test. I do not consider it is right that there be simply a contractual obligation on an employer to act reasonably in the exercise of his discretion, which would suggest that the court can simply substitute its own view for that of the employer. My conclusion is that the right test is one of irrationality or perversity (of which caprice or capriciousness would be a good example) ie that no reasonable employer would have exercised his discretion in this way. I canvassed this provisional view in the course of argument with both counsel, and neither appeared to dissent, and indeed Mr Temple QC in his closing submissions expressly adopted and used a test of irrationality. Such test of perversity or irrationality is not only one which is simple, or at any rate simpler, to understand and apply, but it is a familiar one, being that regularly applied in the Crown Office or, as it is soon to be, the Administrative Court. In reaching its conclusion, what the court does is thus not to substitute its own view, but to ask the question whether any reasonable employer could have come to such a conclusion. Of course, if and when the court concludes that the employer was in breach of contract, then it will be necessary to reach a conclusion, on the balance of probabilities, as to what would have occurred had the employer complied with its contractual obligations…”

Mr Randall accepted and indeed said he adopted that reasoning, but in a case such as the present sought to argue that irrationality could best be judged by the standard of good faith, viz. not to act dishonestly, for an improper purpose, capriciously or arbitrarily, and that none of these things could be said or had been found of the committee. In this connection he cited Nash v. Paragon Finance [2001] EWCA 1466. That was concerned with a mortgage with a variable interest rate clause. It was alleged that the mortgagee’s discretion to vary the interest rate could not be exercised unreasonably. This court rejected the implication of such a term. Having considered Abu Dhabi National Tanker Co v. Product Star Shipping Ltd (The Product Star)(No 2) [1993] 1 Lloyd’s Rep 397 and Gan Insurance Co Ltd v. Tai Ping Insurance Co Ltd (No 2) [2001] 2 All ER (Comm) 299, this court adopted the solution of those two earlier decisions which was to apply a less restricted limitation analogous to unreasonableness in the Wednesbury sense: Associated Provincial Picture Houses Ltd v. Wednesbury Corporation [1948] 1 KB 223; or what Mance LJ in the latter case called “unreasonableness in the sense of conduct or a decision to which no reasonable person having the relevant discretion could have subscribed” (at para 64). In Nash Dyson LJ then said (at para 41):

“So here too, we find a somewhat reluctant extension of the implied term to include unreasonableness that is analogous to Wednesbury unreasonableness. I entirely accept that the scope of an implied term will depend on the circumstances of the particular contract. But I find the analogy of Gan Insurance and the cases considered in the judgment of Mance LJ helpful. It is one thing to imply that a lender will not exercise his discretion in a way that no reasonable lender, acting reasonably, would do. It is unlikely that a lender who was acting in that way would not also be acting either dishonestly, for an improper purpose, capriciously or arbitrarily. It is quite another matter to imply a term that the lender would not impose unreasonable rates.”

Mr Randall submitted that because there was no finding of dishonesty, improper motive, capriciousness or arbitrariness against BPB in this case, therefore the judge must have been mistaken to have found that the committee’s decision had been one that “no reasonable employer could have reached” (see at para 28 above).

I cannot accept that submission. One could debate whether an employer could act irrationally (using that term for acting as no reasonable employer would act) without it also being said that he was acting in one of the other ways described. In many cases that might be so: but I am unwilling to say that it is necessarily so. Perhaps irrationality and arbitrariness are very close to the same thing. But I think that someone may act irrationally while being honest; and as Burton J suggested in Clark v. Nomura, capriciousness is something else (eg deciding on the basis of the colour of someone’s hair or eyes). I would be reluctant to contemplate, on the facts found by the judge, that some epithet for the committee’s decision other than that chosen by the judge himself should be used. I can see no ground for doing so.

The question remains whether the judge was justified to make the finding of irrationality that he did. In my judgment he was. The directors had what is called an absolute discretion: but their discretion still remained one to find “the appropriate proportion”. The proviso indicates that, at any rate prima facie and subject to the director’s discretion, the appropriate proportion is to be found by taking the length of the participant’s service following the grant of an option: after 36 months the option becomes mature and the appropriate proportion is expressed as 36/36. In his witness statement Mr Heard himself expressed the philosophy of the Scheme in the following way (at para 4):

“As the (then) Deputy Group Secretary I was responsible for drafting the rules of the…Scheme…It was my aim, and the Defendant’s intention that the rules of this scheme should provide a means of rewarding and motivating certain selected executives through the grant of share options should the performance of participants merit it. The scheme was structured in such a way that the options would not vest, in normal circumstances, until the third anniversary of the date of grant, thereby encouraging the executive’s loyalty to the Defendant.”

That is in my judgment an accurate statement, even if expressed as a matter of subjective intent, of the objectively ascertainable purposes of the Scheme. The points to note, of course, are that options are granted in reward for past performance, and in anticipation of future loyalty, and, if you like, future performance, but that after three years they “vest”. In such circumstances any committee of directors which is contemplating applying its discretion under the proviso of rule 5(b)(iii) to the mature options of a participant needs to bear in mind that it is dealing with vested property rights. Compared with the grant of an option, or of a bonus, this case seems to me to be a fortiori. It may be that poor performance during or even after the vesting of such options will justify to some extent the application of a fraction less than 36/36. But it is hard to see why someone who is not being dismissed for misconduct should on the ground of his performance after the vesting of his options be treated just the same as one who is being dismissed summarily for misconduct.

What then is the position in this case? The committee’s minutes are silent as to its reasoning. The selection of the appropriate proportion is glossed in terms of “cancellation”. No distinction is drawn between mature and immature options. The evidence indicates that a decision to cancel Mr Mallone’s options had already been taken in advance of the meeting of 3 November 1995. There is no sign that any regard was had to the fact that the options were granted at a time when Mr Mallone’s performance was clearly regarded as excellent, and at a time when his real responsibility was with regard to Italgips, not Vic Italia: as the judge found (see para 14 above) “Mr Mallone did a good job in [Italgips] and this was not the cause of the problems”. Mr Mallone was offered another position in the group, but there is no finding that he ought to have accepted it, and, as the judge remarked, “[h]is performance was not so bad that he was not offered an alternative job”. As for the compensation that was coming his way, that was no more than his legal rights. I am not impressed, even if the judge was, by the argument that the conduct of an employer which gives rise to such rights in an employee is a valid reason for cancelling the employee’s other vested rights or for treating Mr Mallone under the Scheme in the same way as if he could have been summarily dismissed. I have no difficulty in saying that the judge was entitled to find that the committee’s decision was one which no reasonable employer could have reached. I would come to the same decision myself.

I recognise that such share option schemes can lead to controversy. A poorly performing executive may be represented as leaving in failure but with valuable options. Alternatively the options may not be worth anything or very much at the time of departure, but may subsequently become valuable because of improvements in the performance of his company after his leaving, or because of the re-rating of the market. Thus the scheme can operate in a way which might seem arbitrary.

But such possibilities are always present. An executive might be able to exercise his options before his departure, perhaps in anticipation of his employer’s displeasure. Considerations such as these, however, are not, it seems to me, a valid reason for treating the whole scheme as a sort of mirage: whereby the executive is welcomed as a participant, encouraged to perform well in return for reward, granted options in recognition of his good performance, led on to further acts of good performance and loyalty, only to learn at the end of his possibly many years of employment, when perhaps the tide has turned and his powers are waning, that his options, matured and vested as they may have become, are removed from him without explanation.

There has been no appeal on the basis that, if the discretion existed but was exercised irrationally, the true damages are not what the judge awarded below but are yet to be determined by asking what would have occurred if the discretion had been exercised contractually. It follows that BPB’s appeal against the award of damages below must fail.

The third issue: a premature exercise of discretion?

It will be recalled that the judge found that BPB was in breach of contract in acting prematurely and treating Mr Mallone as having ceased employment on 2 or 3 November 1995 when he in fact remained a director of certain group subsidiaries until January 1996. The cancellation of his options was therefore invalid: as the judge said, “that could not validly have been done until at the earliest January 1996”. However, the judge appears to have considered that the consequence of this invalidity and breach was simply to assume that the committee would have come to the same decision to cancel Mr Mallone’s options in January 1996, and that since it could not then have rationally cancelled the mature options but could still have successfully cancelled the immature options, for they would still have been immature in January 1996, “the breach had no causative effect”.

There was no appeal by either party on this aspect of the judge’s decision.

In the course of the hearing, this court was nevertheless concerned to know from the parties what they had to say about the judge’s finding of invalidity. Since there was no appeal in respect of the cancelled immature options, their answer could not increase Mr Mallone’s damages. But it might possibly raise a separate route by which Mr Mallone could submit that the cancellation of his mature options was without effect, thus validating the award of damages below.

It might be said that without a respondent’s notice to this effect from Mr Mallone, the point was not open to him. However, it might equally be said that without an appeal from BPB against the judge’s finding that BPB’s exercise of discretion was premature and invalid, BPB had no answer to the award of damages against it in any event.

In these circumstances the court asked the parties to address the point in written submissions following the hearing, which they have done. I am grateful for those submissions.

It has emerged that the point is more controversial than the material previously before the court might have led me to believe it was. Mr Inglis-Jones submits that since the directors’ discretion under rule 5(b)(iii) only arose on Mr Mallone ceasing to be employed by the group (“in the event of the Participant ceasing to be employed by the Group”), that discretion had to be exercised at that time or within a reasonable time thereafter, and that such an exercise could not be anticipated prematurely (or in the Latin phrase nunc pro tunc) because to do so would or might involve a failure to take into account the circumstances properly arising at the proper time for decision: see Weller v. Ker (1866) 1 L R Sc & Div 11 at 15, Re Vestey’s Settlement [1950] 2 All ER 891 at 895F (not fully reported in [1951] Ch 209), Lewin on Trusts, 17^th ed, at para 29-83, and Breadner v. Granville-Grossman [2001] 2 WLR 593 at paras 50/55. In any event, in the absence of any valid exercise of the directors’ discretion, the primary rule under the proviso to rule 5(b)(iii) took effect, so that Mr Mallone became entitled to exercise his mature options in full, which is what he did, in September 1997, before any attempt by the directors to exercise their discretion anew, even if it had still been open to them to do so. Therefore, the judge’s award in damages could be supported on this ground as well.

In response, however, Mr Randall submitted (i) that despite the directorships which Mr Mallone continued to hold until 4 January 1996, he ceased employment for the purposes of the rules on 3 November 1995; and (ii) that the invalidity of the committee’s exercise of discretion on 3 November would be in any event irrelevant unless Mr Mallone could satisfy the court that the committee would have reached a different decision in January 1996. For his first submission he relies on the definition of “Executive” as a “full-time employee” (viz one required to devote 35 hours or more per week to his employment or office) and rule 5(d), which provides –

“(d) No Participant shall be treated as ceasing to be employed by the Group until he ceases to hold an office or employment in the Company or any company of which the Company has Control.”

He then says that already on 3 November Mr Mallone had ceased to be an executive, for he did no further work and certainly held no “full-time” employment or office; and that he was to be treated as ceasing to be employed by the group when he ceased to be employed at BPB Italia, for there was no need for him to cease to hold any or all offices or employments as long as he had ceased to hold “an” office or employment. For his second submission, he referred to In re Hastings-Bass [1975] 1 Ch 25 at 40/41 and Mettoy Pension Trustees Ltd v. Evans [1990] 1 WLR 1587 at 1624/5.

Mr Randall’s first submission shows no sign of having been advanced before the judge below. Nor does there appear to have been any dispute with the proposition that the discretion could not validly be exercised prematurely. On the contrary, the judge found that both Mr Heard and Mr Sternick were unaware that Mr Mallone retained certain offices past 3 November; and Mr Heard’s evidence appears to have been premised on the understanding that the directors’ discretion

“arises only in the event of “the participant ceasing to be employed by the group”. I therefore was careful to ensure that the meeting to cancel the Share Options was held after my telephone call with Sternick having determined that there was no need to back-date the effective time of the Committee’s decision to 2^nd November or any other date.”

In any event, I am inclined to think that this first submission is not correct: a participant, ie an option holder, does not have to be an “executive”, rather only an “executive” is eligible to become a participant (rule 2(a)). I would also be inclined to construe rule 5(d) as referring to a participant who ceases to hold any or all office or employment in the group: otherwise a person who ceased to hold a single office in any group company could be treated as ceasing to be employed by the group, with consequent dangers to his status and his options.

As for Mr Randall’s second submission, I do not believe that the cases cited assist him; nor is this case like Clark v. Nomura, where Mr Clark’s bonus depended upon an active exercise of discretion in his favour. Here, the proviso has its own default mechanism for arriving at the appropriate proportion even in the absence of any exercise of discretion by the directors.

I would be inclined to say, therefore, that this third issue does provide an alternative basis for the judge’s award of damages in Mr Mallone’s favour: but as the point has become a highly controversial one substantively, and as the court has not had the opportunity of hearing counsel develop their written submissions (helpful as they are), and as the point also has its procedural complications in terms of the absence of any formal appeal from either side in respect of it, I would in the end prefer to rest my judgment upholding the judge’s award on the second issue discussed above.

Conclusion

In my judgment BPB’s appeal on the point of construction addressed in the first issue above succeeds; but since it fails on the second issue to dislodge the judge’s alternative finding that BPB’s exercise of discretion failed for irrationality, the judge’s award of damages to Mr Mallone in the sum of Ł100,636 plus interest is upheld.

Mr Justice Wilson:

I agree.

Lord Justice Waller:

I also agree.

Order: Appeal dismissed with costs, to be subject to detailed assessment if not agreed. (Order does not form part of approved judgment).