William R. Hill Rock@donahue.com Donahue Gallagher Woods LLP www.donahue.com Experts Connection Presents: “Negotiating Executive Employment Agreements”
Negotiating Leverage • Your negotiating leverage will be affected by the context in which the negotiations take place • Consider: • Your skill set & experience • The longer you have been in the industry, the more negotiating leverage you will have • Industry norms • What are typical executive employment agreement provisions in the industry? • The economy and job market • Beware of new federal & state legislation that may affect your executive compensation package at publicly traded companies
The CEO • Martin J. Sullivan • President & CEO of AIG, Inc. from March 2005 to June 2008 • Mr. Sullivan replaced Maurice “Hank” Greenberg as President and CEO of AIG, Inc. in March 2005. He served in that position until Summer 2008, when he was ousted by the Board of Directors in the wake of AIG’s rapidly falling stock price. He ranked #168 on Forbes’ CEO Compensation list. • A link to Mr. Sullivan’s contract can be found on our website: http://www.donahue.com/EL-martin.htm Photo Credit: images.forbes.com
The Employment Offer • The employer will most likely offer you employment pursuant to an- • Offer Letter: outlines basic job title, compensation, term of the agreement, and grounds for termination • The letter may promise the opportunity to develop a comprehensive employment agreement with the Board of Directors • For example, Mr. Sullivan’s offer letter read: In further consideration of you accepting this position, the Compensation Committee of the Board of Directors hereby agrees to work with you to develop a comprehensive three year employment agreement containing terms appropriately suited to the president and chief executive officer to the Corporation • Comprehensive Employment Agreement: provisions will likely include salary, bonuses, severance in the event of termination, incentive compensation, retirement and stock-based compensation, intellectual property protections, & post-employment restrictive covenants
The Building Blocks of an Executive Employment Agreement- What is Negotiable? • Scope of the Employment • Term of the Agreement • Compensation, Benefits, & Perquisites • Grounds for Termination • Change of Control • Restrictive Covenants & Confidential Information • Dispute Resolution
Why Are Scope of Employment Provisions Important? • Every executive employment agreement should specify the scope of the executive’s employment • Scope of employment provisions should be clear and fully expressed in order to: • Formalize each party’s expectations • Aid in determining later whether an executive was terminated for failure to perform his or her duties (for “good cause”) • Other scope of employment clauses may include: • What entity the executive reports to • Whether the executive is a member of the Board of Directors • Location of the executive’s primary workplace & travel expectations
For example: • Mr. Sullivan's scope of employment clause reads as follows: • Executive shall serve as President & Chief Executive Officerof the Company. In such position, Executive shall have such duties and authority as are consistent therewith. Executive shall report to the Board. • During the Employment Term, Executive will devote his full business time and best efforts to the performance of his duties . . .[Executive] will not engage in any other business, profession or occupation for compensation or otherwise which would conflict or interfere with the rendition of such services, either directly or indirectly, without the prior written consent of the Board . . .nothing herein shall preclude Executive, subject to prior approval of the Board, from . . . [serving] on any board of directors or trustees of any business corporation or any charitable or not-for-profit organization or from managing his personal, financial and legal affairs; provided . . . that such activities do not conflict or interfere with the performance of Executive’s duties
“At-will” v. Contract Employment • Employment agreements are usually “at-will” or for a term of years as specified in the contract • In an at-will agreement, the employer or executive may terminate the relationship at any time for any reason • In contrast, if the agreement is for a specified term of years, the contract may only be terminated for reasons stated in the agreement or for reasons permitted under state law • Grounds for termination typically include: • “Good Cause” (as defined in the agreement) • Breach of fiduciary duties
Distinctions Between “At-Will” & Contract Employment • Duration • “At-will”: no set duration of time • Contract: employment is specified for a number of years (typically 3 to 5) • Termination • “At-will” employees may be terminated for any non-discriminatory reason • Contract employment agreements typically specify grounds for termination • This offers better security to the parties because the consequences of early termination are harsher for the party in breach of the contract
Termination • The typical executive employment agreement runs for a specified term of years • Therefore, much of the negotiation effort will go into the length of the term and provisions that address how the executive’s employment may be terminated • For example: • Cause: what kinds of activities or events give the employer the right to terminate the employment agreement for cause? • Good Reason: what kinds of activities or events give the executive the right to terminate the agreement? • Severance: what are the economic consequences of termination? • Specifying what constitutes “for cause” or “good reason” in the agreement helps to minimize disputes between the employer & executive upon termination • Specified term agreements may also be terminated for reasons of death or disability • In situations involving disability, the executive will typically be entitled to accrued salary and benefits, and continued medical and life insurance coverage
Termination For Cause • Negotiating the definition of “for cause” termination in the employment agreement is advantageous to the employee • The more discretion the employer has in determining whether the employee has breached his or her duties, the more likely it is that the executive can be terminated without the employer suffering economic consequences or fearing legal recourse • A good “for cause” provision provides a clear and specific definition of termination “for cause” • For example, Mr. Sullivan’s employment agreement provides that his employment may be terminated at any time “for cause.” Cause is defined as: • (I) Executive’s willful and continued failure to perform substantially his duties with the Company . . . (ii) willful malfeasance or willful misconduct that results in substantial damage to the Company . . . (iii) willful and material violation of a material provision of the Company’s Code of Conduct or the Director, Executive Officer and Senior Financial Officer Code of Business Conduct and Ethics . . . (iv) conviction of, or entry of a plea of guilty or no contest by Executive with respect to, a felony or any lesser crime of which fraud or dishonesty is a material element, (v) any willful failure by Executive to comply with [restrictive covenants] . . . (vi) Executive’s breach of [representations and warranties] • This is an example of a specific and objective definition of “for cause”
Consequences of Termination “For Cause” & Other “For Cause” Features • Typical consequences of being terminated “for cause” include: • Executive may only receive accrued salary and benefits • No severance • Mr. Sullivan’s contract reads: • If Executive is terminated for Cause . . . he shall be entitled to receive only his Base Salary through the date of termination and reimbursement for any unreimbursed business expenses properly incurred by Executive . . . Through the date of Executive’s termination, and he shall have no further rights to any compensation . . . Or any other benefits under this Agreements. All other benefits, if any, due Executive following Executive’s termination of employment for Cause . . . Shall be determined in accordance with the plans, policies and practices of the Company; provided, however, that Executive shall not participate in any severance plan, policy or program of the Company. • “For cause” provisions may require that the executive receive notice and an opportunity to correct the breaching behavior before being terminated • Encourages communication between the executive and the employer • Satisfies due process
Termination Without Cause or for Good Reason • In contract employment, if the employer terminates the agreement without cause, then the executive is typically entitled to the remainder of the compensation and benefits owed under the contract • On the other side of the equation, the agreement may specify what executive is entitled to if he or she should terminate his or her employment for “good reason” • Mr. Sullivan’s contract provides that, if the executive is terminated without cause or by the executive for good reason, the executive is entitled to: • (i) . . . a lump sum payment . . . [equal to the] Accrued obligations; (ii) the Pro-Rata Bonus . . .; (iii) subject to Executive’s continued compliance with [non-compete obligations], an amount equal to the greater of (A) $15,000,000, and (B) an amount equal to the sum of (I) three times the Base Salary . . . (II) three times the actual Annual Bonus paid with respect to the preceding fiscal year . . . (iv) continued health and life insurance Benefits for Executive . . . for a 36 month period. . . [unless the executive gets a new job] (v) 3 years of additional service credit and credit for 3 years of additional age under the Company’s employment pension plan . . . (vi) if, as of the date of such termination, (a) Executive is not eligible to participate in any retiree medical or life insurance program of the Company and (b) Executive would have at least 10 years service with the Company and reached at least age 55 if credited with three years of additional age and service, then the Company shall purchase for Executive a medical and/or life insurance policy
The Agreement Should Specify What Constitutes “Good Reason” by the Executive • Typically, the definition of “good reason” is negotiated • For example, in Mr. Sullivan’s contract, “good reason” is defined as: • (i) any change in the duties or responsibilities . . . of the Executive that is inconsistent [with Executive’s current duties & responsibilities] • (ii) a material and adverse change in Executive’s titles • (iii) any material breach of this Agreement by the Company • (iv) the failure of the Compensation Committee to adopt, by December 31, 2005 . . . An incentive compensation program . . . setting forth target awards that are . . . no less than $12,875,000 • (v) within 30 days following notice by the Compensation Committee to Executive of adoption of an incentive compensation program in respect of each of the 2006 and 2007 fiscal years, Executive’s written notification to the Compensation Committee that such program is not acceptable to Executive; • (vi) any failure of the shareholders to re-elect Executive as a member of the Board or any failure of the Board to re-nominate Executive for election to the Board • (vii) any failure of the Board to consult with Executive prior to appointing a Chairman of the Board to replace the member of the Board holding such position on the Effective Date • (viii) the relocation of Executive's primary office to a location that is more than 35 miles from both of (A) the Company’s headquarters in New York, New York, unless such office is moved closer to Executive’s primary residence at the time of such relocation, and (B) Executive’s residence at the time of such relocation • Good reason may also include change-in-control of the company
Components of Executive Compensation • The components of an executive’s compensation package are varied and readily negotiable • Typically, compensation components include: • “Regular” compensation: includes annual salary with provisions for annual adjustments • Deferred compensation: compensation payable in monthly sums commencing upon retirement • Incentive compensation: can include provisions for annual cash profit-sharing bonuses tied to performance, stock bonuses, and stock option provisions • Purpose: give the executive incentive to see that the corporation remains profitable • Employee benefits, perquisites, & reimbursement of business expenses • Pre-term compensation or signing bonuses are also options • The new employer may compensate the executive for benefits that were forfeited as a result of the executive prematurely leaving the former employment • Also consider cash signing bonuses & relocation expenses • For example, Mr. Sullivan’s agreement reads: The Company shall pay Executive a transition bonus, in cash, in an amount equal to $4,875,000 . . . which shall be paid in four equal installments . . .
Executive Compensation: Tax Consequences • Generally, a corporation may deduct the compensation paid to its employees • However, 26 U.S.C. § 162(m) provides that corporate income tax deductions are not allowed for compensation to the CEO or the 4 highest compensated employees exceeding $1 million • There are exceptions to the tax deduction limitation. These exceptions include: • Performance-based compensation; remuneration paid on a commission basis; remuneration paid under binding contracts in effect on February 17, 1993; and income from certain pension plans, annuity plans, and trust funds • The exception for performance based-compensation allows the company to compensate its executives in excess of the $1 million deduction limit using equity based compensation • For example, stock options • Also, beware of new federal legislation affecting executive compensation packages at entities receiving federal assistance • Furthermore, if you are working for an international company note that the U.S. taxes all U.S. nationals on worldwide income. Double taxation can be avoided by: • The foreign tax credit: intended to reduce the double tax burden that would otherwise arise when foreign source income is taxed by both the United States and the foreign country from which the income is derived. • U.S. Tax treaties: the U.S. has tax treaties with various countries that provide residents or citizens of the U.S. are taxed at a reduced rate, or are exempt from foreign taxes, on certain items of income they receive from sources within foreign countries. For a list of countries the U.S. has treaties with see: http://www.irs.gov/businesses/international/article/0,,id=96739,00.html
Examples of Executive Compensation • Mr. Sullivan’s contract provides for: • Base Salary: During the Employment Term, the Company Shall pay Executive a base salary at the annual rate of $1,000,000, payable in regular installments in accordance with the Company’s usual payroll practices The Base Salary shall be be retroactive to the Effective Date. During the Employment Term, the Compensation committee of the Board shall review the Base Salary annually and may increase the Base Salary . . . • Long-Term and Equity-Based Incentives: During the Employment Term, Executive shall be eligible to participate in any long-term incentive compensation plans or equity-based compensation plans maintained by the Company on such basis as may be determined by the Compensation Committee; provided that, as of a date that is not later than March 31, 2006, Executive shall be granted awards in respect of fiscal year 2005 having a value, determined at the date of grant, as reasonably determined by the Compensation Committee, of no less than . . . • Annual Bonus: Executive may receive an additional annual cash bonus in respect of each full or partial fiscal year of the Company during the Employment Term, as determined in the sole discretion o the Compensation Committee based on its assessment of Company and individual performance in relation to performance targets, a subject evaluation of Executive’s performance and/or such other criteria as may be established by it. Notwithstanding the foregoing, during the Employment Term, Executive shall be eligible, with respect to each of fiscal years 2006 and 2007, for an annual cash bonus based on the attainment of targets established by the Compensation Committee, which, together with the target value of any long-term or equity-based award in respect of such year, shall have a total target value of $12,875,000.
Benefits & Perquisites • The types of benefits available to employees are numerous • Typically, benefits include executive pension & health plans, vacation, sick leave, Supplemental Executive Retirement Plans (SERPs), & sabbatical leave • For example: • Employee Benefits:During the Employment Term, Executive shall be entitled to participate in the Company’s employee benefit plan (other than any severance or change-in-control plan) as in effect from time to time on the same basis as those benefits are generally made available to other senior executives of the company. • Vacation: Executive shall be entitled to four weeks annual paid vacation in accordance with the vacation policy of the Company. • Perquisites: During the Employment Term, Executive shall be entitled to participate in all of the Company’s perquisite plans, programs and arrangements that are generally provided by the Company to other senior executives from time to time, including, without limitation, the provision of financial and tax planning assistance
Non-Compete Provisions, Non-Solicitation & Protection of Confidential Information
Restrictive Covenants: What do they entail and are they enforceable? • This area of employment agreements has the potential for disputes between the employer and the employee • The employer’s interest in having these provisions = restricting the executive’s behavior after the term of employment is over • Don’t want the executive to disclose trade secrets or confidential information • Don’t want the executive to join a competitor or steal employees from the employer • Whether or not these provisions are enforceable depends on state law • CA courts tend to uphold provisions protecting the employer’s trade secrets • However, CA courts dislike non-compete provisions • CA Business & Professions Code § 16600 states: Except as provided in this chapter, every contract by which anyone is restrained from engaging in a lawful profession, trade, or business of any kind is to that extent void. • The Courts have held that under CA law, as a general proposition, individuals have the right to freely pursue the livelihood of their choice • However, this freedom does have limits • Under California law, employer may, under some circumstances, contractually prohibit employee from soliciting its clients or raiding its workforce for a limited period of time following termination of employment.
Sample Provisions • Non-Competition/Non-Solicitation: While employed by the Company and for a period of 12 months (18 months in the event of termination by Executive for Good Reason . . .) following the date Executive ceases to be employed by the Company, if such termination occurs during the Employment Term . . ., Executive will not directly or indirectly, (w) engage in any “Competitive Business” for executive’s own account, (x) enter the employ of, or render any services to, any person engaged in any Competitive Business, (y) acquire a financial interest in, or otherwise become actively involved with, any person engaged in any Competitive Business, directly or indirectly, as an individual, partner, shareholder, officer, director , principal, agent, trustee or consultant, or (z) interfere with business relationships . . . Between the Company and customers or suppliers of, or consultants to the Company. • Confidentiality:Executive shall not, without the prior written consent of the Company, use, divulge, disclose or make accessible to any other person, firm, partnership, corporation or other entity, any “Confidential Information” . . . except while employed by the Company, in furtherance of the business of and fort he benefit of the Company, or any “Personal Information” . . . ; provided that Executive may disclose such information when required to do so . . . • Developments: All discoveries, inventions, ideas, technology, formulas, designs, software, programs, algorithms, products, systems, applications, processes, procedures, methods and improvements and enhancements conceived, developed or otherwise made or created or produced by Executive alone or with others, and in any way relating to the business or any proposed business of the Company of which Executive has been made aware, or the products or services of the company of which Executive has been made aware, whether or not subject to patent, copyrights or other protection and whether or not reduced to tangible form, at any time during the Employment, shall be the sole and exclusive property of the Company. Executive agrees to, and hereby does, assign to the Company, without any further consideration, all of Executive’s right, title and interest through in the world in and to all Developments.
The Importance of Dispute Resolution Provisions • Dispute resolution provisions specify the method for resolving disputes between the parties • Litigation v. alternative dispute resolution • Dispute resolution provisions are important for: • Predictability • Efficiency • It is critical to specify the location of dispute resolution and the law governing disputes • Also specify the scope of the dispute resolution provision • Mr. Sullivan’s contract for provides for arbitration in the event of a dispute: • Any dispute between the parties to this agreement in connection with, arising out of or asserting breach of this agreement or any statutory or common law claim by Executive relating to Executive’s employment under this Agreement or rights under this Agreement . . . Shall be exclusively resolved by binding statutory arbitration. Such dispute shall be submitted to arbitration in New York, New York, before a panel of three neutral arbitrators in accordance with the Commercial rules of the American Arbitration Association then in effect, and the arbitration determination resulting from any such submission shall be final and binding upon the parties. • This agreement shall be governed by and construed in accordance with the laws of the State of New York • Dispute resolution provisions may also include a provision for legal fees. For example: • In the event of any contest or dispute relating to this Agreement or the termination of Executive’s employment hereunder, the Company shall reimburse 100% of Executive’s reasonable legal fees if Executive substantially prevails in such contest or dispute..
Limitations on Executive Compensation • How will the new federal bailout legislation affect executive compensation plans? • Emergency Economic Stabilization Act of 2008 (EESA) • Includes the Troubled Assets Relief Program (TARP) • American Recovery and Reinvestment Act of 2009 (ARRA) • Become familiar with the ins and outs of how this legislation affects executive compensation • Also familiarize yourself with state laws regarding executive compensation • For example, California recently enacted the Higher Education Governance and Accountability Act, which requires public disclosure of executive compensation at the University of California and California State University
Emergency Economic Stabilization Act & American Recovery & Reinvestment Act • EESA was enacted in 2008 as a response to the global financial crisis. It authorized the United States to spend money to purchase distressed assets and inject money into troubled financial institutions through TARP • TARP set out important requirements regarding executive compensation for institutions that participate in the program • In 2009, President Obama signed into law the American Recovery and Reinvestment Act, which amended the provisions of TARP addressing executive compensation. TARP now directs the Secretary of the Treasury to establish standards regarding executive compensation. Those standards include: • (a) Limits on compensation that exclude incentives for senior executive officers of the TARP recipient to take unnecessary and excessive risks that threaten the value of such recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding • (b) A provision for the recovery by such TARP recipient of any bonus, retention award, or incentive compensation paid to a senior executive officer and any of the next 20 most highly-compensated employees of the TARP recipient based on statements of earnings, revenues, gains, or other criteria that are later found to be materially inaccurate
(c) A prohibition on such TARP recipient making any golden parachute payment to a senior executive officer or any of the next 5 most highly-compensated employees of the TARP recipient during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding • A Golden Parachute Payment is defined as: any payment to a senior executive officer for departure from a company for any reason, except for payments for services performed or benefits accrued • (d) A prohibition on such TARP recipient paying or accruing any bonus, retention award, or incentive compensation during the period in which any obligation arising from financial assistance provided under the TARP remains outstanding, except that any prohibition developed under this paragraph shall not apply to the payment of long-term restricted stock by such TARP recipient, provided that such long-term restricted stock- (I) does not fully vest during the period in which any obligation arising from financial assistance provided to that TARP recipient remains outstanding; (II) has a value in an amount that is not greater than 1/3 of the total amount of annual compensation of the employee receiving the stock and (III) is subject to such other terms and conditions as the Secretary may determine is in the public interest • (e) A prohibition on any compensation plan that would encourage manipulation of the reported earnings of such TARP recipient to enhance the compensation of any of its employees • (f) A requirement for the establishment of a Board Compensation Committee that meets the requirements of subsection (c)
Additional Limits on Executive Compensation & Recently Enacted Rules on TARP Standards of Executive Compensation • The ARRA further requires that the Board Compensation Committee puts in place a company-wide policy regarding excessive or luxury expenditures, as identified by the Secretary, which may include excessive expenditures on entertainment or events, office & facility renovations, aviation or other transportation services, or other activities that are not reasonable expenditures • Furthermore, the there must be annual shareholder approval of executive compensation • Finally, on June 10, 2009, the Treasury Department released its Interim Final Rule on TARP standards for executive compensation • A copy of the Interim Final Rule may be found at: http://www.ustreas.gov/press/releases/tg165.htm • Importantly, the Interim Final Rule appointed Kenneth R. Feinberg as the Special Master to ensure compensation plans are consistent with the public interest • Review payments & compensation plans for the executives and the 100 most highly compensated employees of TARP recipients that have received “exceptional” assistance from the federal government • Make sure to stay tuned for further developments in this area, as it is likely that future legislation will designate “pay czars” to review executive compensation packages at other publicly traded companies, not just those that are receiving TARP money
Closing Remarks • Helpful resources include: • The Uniform Trade Secrets Act, available at: http://www.nccusl.org/Update/ActSearchResults.aspx?ActId=37 • The Model Business Corporation Act, available at: http://www.abanet.org/buslaw/committees/CL270000pub/nosearch/mbca/assembled/20051201000001.pdf • Data on Executive Pay, available at: http://www.aflcio.org/corporatewatch/paywatch/ • SEC filing information, available at: http://www.sec.gov/edgar.shtml • For additional information, you may consult your local legal library. Two helpful treatises on employment agreements include: • Executive and Professional Employment Contracts, by L.J. Kutten & Bernard D. Reams, Jr • Corporate Counsel's Guide to Employment Contracts, published by Thomson West