Treatment of bankers’ remuneration in divorce and financial proceedings

Financial proceedings following divorce which involve bankers’ remuneration are increasingly featuring complex structures. When grappling with such remuneration structures many issues can arise, including:

• whether assets are classified as marital or non-marital; and
• how to assess these in the context of spousal maintenance payments.

This article considers the key elements of these complex remuneration structures and how they should be treated to ensure the smooth resolution of financial proceedings for the parties involved.

Classification of bankers’ remuneration

Banks regulated by the Prudential Regulation Authority and the Financial Conduct Authority divide senior bankers’ remuneration into two parts. The first part is fixed remuneration, which historically consisted of a base salary and an additional payment known as a ‘fixed pay allowance’ or ‘role based allowance’. The second part is variable remuneration, which includes annual bonuses and longer-term awards such as restricted stock units (RSUs) and long-term incentive plans (LTIPs).

Fixed pay allowances were introduced after the European bonus cap was brought into effect in 2014. The bonus cap limited the amount of variable pay a bank could award relative to fixed pay, which had the unintended effect of pushing fixed pay upwards. Regulators have confirmed that firms responded to the cap by increasing fixed pay because it was the only way to offer competitive total remuneration to senior staff. Fixed pay allowances therefore became a common mechanism for banks to remain internationally competitive by increasing the fixed portion of remuneration so that they could pay higher bonuses within the regulatory limits. These allowances were guaranteed and paid regularly, in the same way as base salary.

Removal of the bonus cap and the recent phasing out of fixed pay allowances

Following Brexit, the UK regulators abolished the bonus cap with effect from 31 October 2023. The regulators have published joint policy confirming the removal of the fixed to variable pay ratio and related rules, which gives firms greater flexibility to choose the appropriate mix between fixed and variable pay for senior roles.

As a result, many banks are phasing out fixed pay allowances and returning to remuneration structures that place greater emphasis on variable pay. Therefore, in contrast to being secured, bankers are being paid ‘at risk’, in the form of cash bonuses, RSUs, and LTIPs, which can now make up the larger portion of total remuneration for many in the banking sector, particularly senior bankers.

This means a larger share of a banker’s total remuneration will be subject to discretion, performance conditions, deferral, malus and clawback, which may not be applied for a number of years. This has important consequences when assessing the certainty and stability of earnings in financial remedy proceedings and is relevant in the context of financial disclosure, spousal maintenance calculations, and any assessment of future income capacity.

Impact on future or existing spousal maintenance orders

In the context of clients going through divorce and financial proceedings, remuneration structures must be carefully considered to assess an appropriate level of spousal maintenance, where there is insufficient capital to achieve an income clean break.

Base salaries and fixed pay allowances had represented a level of remuneration with a greater degree of certainty. However, bonuses and awards of deferred remuneration represent discretionary and variable remuneration with far less guarantee.

Whilst each case will be dealt with uniquely to the circumstances arising, in cases involving base salary/fixed pay allowances and bonuses, one approach the court can take is to assess a specified level of spousal maintenance from the fixed portion of remuneration, and a variable sum from the bonus/discretionary remuneration. This is intended to share the risk of the more uncertain element of the remuneration.

The proportion paid from the bonus may be expressed as a percentage, sometimes subject to a cap and typically with the percentage declining over time – in some cases to reflect both the expectation that the recipient spouse will return to work and increase their earnings over time, and the post-separation endeavours of the paying party. In any spousal maintenance award, both the quantum and term will be assessed by reference to the resources of both parties (to include income and capital resources), together with both parties’ expenditure needs – there is no guiding formula that applies as is the case in relation to child maintenance.

Where remuneration is structured by way of a fixed monthly sum from the base salary and fixed pay allowance, that is normally attributed to meeting budgeted day to day expenditure needs (such as housing and living costs), with any proportion of the bonus typically allocated to the more discretionary elements of spending (such as holidays) if that cannot be met from the base salary and fixed base allowance. If it is the case that the assessed budgeted needs can be met entirely from the base salary and fixed pay allowance, there may be no proportion of bonus that is payable.

The impact of the removal and phasing out of the fixed pay allowance by many leading banks is that many existing spousal maintenance awards may have to be reassessed to take account of the higher proportion of remuneration awarded ‘at risk’. For those clients in the process of divorce and financial proceedings who are looking to negotiate such awards, if there is any prospect of their fixed pay allowance being removed, it is important for that to be ascertained so that negotiations can be approached with that being fully considered.

RSUs and LTIPs

RSUs and LTIPs add an additional layer of complexity. ‘Carried interest’ is also relevant in the private equity sector; however, that is a whole topic in its own right and will be addressed in a separate article.

RSUs and LTIPs are a form of deferred compensation which is not immediately liquid and will ‘vest’ or become payable over several years, subject to vesting conditions and typically linked to performance or retention. In the context of divorce and financial proceedings the following considerations can arise in relation to these deferred awards:

• Award date: It may be the case that the RSUs/LTIPs have been ‘awarded’ during the marriage, but that the future vesting conditions are performance related. These performance related conditions may relate to work undertaken in the period post-separation, with arguments being raised about whether those awards are considered marital (and subject to an equal division) or non-marital (which may not be subject to equal sharing), due to post-separation endeavours and, if so, what division is appropriate.
• Liquid and illiquid division: In some cases, a negotiation may result in one party receiving the deferred awards with the other party receiving a greater proportion of the liquid assets, rather than the net value of the awards being shared in specie at the time of vesting/cashing in. In such cases, consideration needs to be given to whether any form of discount should be applied to take account of risk and illiquidity. There are different ways in which the court can approach any discount deemed appropriate, including applying a percentage discount to all the deferred awards, or a percentage discount with a greater discount applied to the stock vesting in the later years, particularly if there are performance related conditions attached to them.
• Tax: The notional value of any stock must take account of anticipated income tax and National Insurance which is expected to be payable when the stock vests. For any stock which has already vested, capital gains tax considerations may also be relevant, if there has been an increase in value to the stock between vesting and realisation. However, with increasing numbers of bankers relocating abroad to tax havens, sometimes part way through proceedings the tax position may well change, with the notional value of the stock becoming more valuable if the UK tax considerations fall away.

Top tips for dealing with bankers’ remuneration structures

• Financial disclosure: Seek to ascertain early in the financial disclosure process whether there is any prospect of the fixed pay allowance element of any remuneration package being removed and if so, the timing of this. If the fixed pay allowance has already been removed, seek clarity as to the expected policy applying to the award of cash bonuses and other discretionary compensation.
• Clarity of disclosure: If you are the party in receipt of the remuneration, prepare disclosure in relation to remuneration structures with clarity. The clearer the disclosure, the reduced likelihood of lengthy questionnaires being raised or a delay in negotiations being progressed. Disclosure should include copies of current and historic remuneration statements. In relation to deferred compensation, a clear schedule should be prepared to include the award and vesting dates, notional tax applicable, and a clear summary of vesting conditions. Ensure that any schedules are supported by source documentation which can be easily cross referenced.
• Performance related vesting: If any of the vesting conditions are performance related, ensure those are clearly identified, together with the source documentation.
• Tax: Ensure that tax considerations are not overlooked, including the implications of income tax/National Insurance on vesting and capital gains tax on any vested shares being cashed in. If there is a prospect of the recipient party moving abroad, ensure that the tax savings applying in that jurisdiction are considered in computing the notional value of the assets, which may be significant.
• Double counting: If one party is receiving all, or part of their share of the deferred compensation as part of their capital share, care should be given to ensure that compensation once ‘vested’ is not then double counted in an assessment of their income for the purpose of calculating maintenance orders (whether spousal or child maintenance).

At Penningtons Manches Cooper we combine our family and employment law expertise in relation to such remuneration plans, to provide tailored advice to our family law clients in the context of divorce and financial proceedings.