Rothman Gordon: Executive Severance Packages: Reforming Them, Negotiating Them in a Bad Economy

Executive Severance Packages: Reforming Them, Negotiating Them in a Bad Economy

Prepared originally for the Pennsylvania Bar Insititute's (PBI) 9th Annual Employment Law Institute April 29 & 30, 2003 in Philadelphia and used again for PBI's Employment Law Institute West in Pittsburgh on November 18 & 19, 2003.

Fact gathering and evaluation:
1. What is happening to the executive and why? What are the business reasons? If representing the employer, will they withstand scrutiny and are they adequately documented?
2. Does anything that is happening appear to raise colorable claims? Review all potentially applicable exceptions to at will employment. Counsel for employers should do this before the fact; counsel for employees will normally be doing this after the fact except in those rare cases when the executive seeks counsel prior to loss of employment.
3. If representing the employer, and if the employer wants to separate and obtain a release of claims, think through a package that addresses the needs of the business and the executive. If representing the executive, what sources of negotiation leverage exist? Legal claims? Goodwill? Short term mutual needs?
4. Has the termination happened or does it appear to be in the works? Is there room to look at options involving preservation of employment such as a contract for a defined role for a limited term, followed by a severance?
5. If representing the executive, what are the executive's career needs and goals, and what is the executive's economic staying power? Both employer and employee counsel should inventory any unusual points of sensitivity for either the executive or the company. Answers to these kinds of questions may dictate strategy options and the time frame within which the matter should be brought to resolution if possible.
6. Preparing to address compensation and benefit issues:
  1. If representing the employee, is there a need for consultation with a tax and benefit specialist or a financial planner? Upper level executives often have both tax advisors and financial planners with whom they are comfortable dealing. Counsel representing the employer will normally have access to company personnel who are expert in the company's benefit plans.
  2. If representing the employee, have the client provide copies of all applicable plan documents. If the client does not have them, ask the client to request them, or request them on the client's behalf in accordance with ERISA.
  3. Counsel for executives can find themselves playing very different roles, depending on the desires and needs of the executive. Some executive clients will have a very good understanding of the separation issues as well as the compensation and benefit issues and may be turning to the lawyer representing them for strategic advice on negotiations which they intend to conduct themselves, or to help memorialize the deal. Other executives will desire active representation from counsel, with legal counsel acting in the role of the spokesperson in the negotiations.
  4. The timing of the separation and the executive's status as the result of the separation can have significant benefit implications which should be examined on a benefit by benefit basis.
    1. Timing: For example, the timing of the termination could impact whether or not certain stock option grants vest.
    2. Status on separation: How the separation is characterized, and whether the executive is eligible to retire, could have significant results with regard to the exercise period for the options.
    3. As a result of current economic conditions, many stock options are underwater. Therefore, possibilities for increasing the available exercise period can have desirable consequences for the executive.
7. Checklist of some types of compensation and benefit issues to look for in executive terminations:
  1. Salary, commissions, accrued vacation, accrued sick leave.
    1. Commission payment problems are common for persons compensated on a commission basis.
    2. Accrued vacation should be paid, accrued sick leave is usually not.
  2. Severance.
    1. Is there a severance pay plan or program? If so, and if releases of claims are not required as a condition to receive severance, does the company desire/is the executive in a position to negotiate above the plan amounts in order to provide consideration to support a release of claims?
    2. Can the severance be structured over time to provide more beneficial tax treatment or better opportunities for benefit eligibility? Constructive receipt is a potential tax risk. If the severance is structured, counsel for the executive should evaluate with the executive risks with regard to ultimate receipt of the funds (either because of employer insolvency or the risk of the employer looking for a way to avoid the obligation) which make a lump sum payment more attractive. If representing the company, spreading the payments over time can have desirable cash flow consequences and can provide potentially immediate leverage in the area of executive compliance with terms of the separation agreement.
    3. Are there other opportunities for more beneficial tax treatment, e.g. medical expenses, the potential existence of personal injury claims, etc.?
    4. If payments over time are ultimately more desirable than the alternatives, counsel for the executive should look for ways to protect the executive from bad-faith non-compliance by the company, such as acceleration clauses or attorney fees awarded to the non-breaching party. If there is a risk of default, counsel for the executive should look for ways to limit or eliminate the risk. Getting the cash up front is the simplest way. If this cannot happen, is there a reliable guarantor available? Are there options such as purchase of an annuity which shift the obligation away from the employer?
  3. Incentive compensation.
    1. Review terms of the plan. Termination may impact the executive's eligibility for incentive compensation.
    2. If the executive has served for less than the period covered by the incentive pay plan, is the executive eligible for incentive compensation? This may become a point in the separation negotiations.
    3. If the employer is amenable to paying a prorated bonus, the calculations and payment may normally occur on a schedule which makes payment due long after the termination. Counsel for the executive may find that the executive has no confidence that he or she will be fairly treated in the incentive pay calculation. Sometimes this can be addressed through an agreed sum in lieu of the bonus with past bonuses forming a point of reference.
  4. Compensation involving equity.
    1. Restricted stock.
    2. Incentive stock options.
    3. Non-qualified stock options.
    4. Stock appreciation rights.
    5. A not uncommon problem in separations in a bad economy is dealing with the tax consequences of loan forgiveness involving loans offered to purchase equity.
  5. Retirement benefits.
    1. Pension.
    2. 401(k)'s.
    3. Supplemental Executive Retirement Programs ("SERP's").
    4. Can the executive be bridged into early retirement?
  6. Deferred compensation.
    1. Executive will want to secure his deferred compensation if there is a risk of insolvency.
    2. Options include deferring income into a trust which may be structured as a Rabbi trust to avoid current tax consequences, or purchasing an annuity, which can have current tax consequences. Specialized tax advice is crucial in these areas.
  7. Insurance issues.
    1. Health insurance. Will it be continued for a period of time at employer expense? Will the employer pay the COBRA premium or deem the employee's termination to be later than the date of his release from work duties?
    2. Life insurance. Sometimes life insurance is used as a compensation vehicle.
    3. Disability insurance.
  8. Other benefits and perks.
    1. Cars.
    2. Club memberships.
    3. Professional memberships.
    4. Tuition benefits.
  9. Attorney fees.
    1. Is each party to bear his or her own fees in connection with the separation agreement?
    2. The employer may be willing to pay up to a certain amount for legal services to the employee in connection with the separation.
8. Checklist of some types of non-economic issues to look for in executive terminations:
  1. Releases and covenants not to sue.
    1. Is it an individual termination or a termination in connection with an exit incentive program or other employment termination program offered to a group or class of employees? Which it is affects time periods for consideration of the release and informational requirements under OWBPA and regulations.
    2. Employee may not release future claims but may agree to perform future employment related actions such as retirement or termination of employment at a future date. 29 C.F.R. Section 1625.22(c).
    3. No interference with filing a charge at the EEOC or participating in any investigation or proceeding conducted by the EEOC.
    4. Under Oubre v. Entergy Operations, Inc., 522 U.S. 422 (1998), a person challenging the validity of a release need not tender back the consideration offered to support the release. The EEOC's 2001 regulations expand on the Oubre holding and indicate that the waiver agreement may not impose any penalty on the individual's right to challenge the agreement including requiring the employee to tender back consideration received or permitting the employer to recover attorney fees because of the filing of an ADEA suit.
    5. Defendant employers should be sure to obtain a release which specifically releases and waives all claims for attorney fees, costs or expenses, including expert witness fees. In the absence of such a provision, a prevailing party can petition a court for fees.
    6. Should the releases be mutual or if not completely mutual should there be a limited release from the employer in favor of the executive?
  2. Restrictive covenants.
    1. Employers should use the separation agreement and the consideration being supplied to the executive under the agreement as a vehicle to confirm post employment restrictions as a hedge against enforcement problems which might arise, for example, if the executive is being terminated for performance reasons.
    2. Executives may want to negotiate a lessening of restrictions contained in prior agreements. If so, make sure the new restrictions entirely replace and supersede the older, broader ones.
  3. Confidential company information and return of documents.
    1. Employers normally confirm these obligations in the separation agreement.
    2. Counsel for the executive should scrutinize the language for overbreadth, and should identify any other agreements which the executive signed which deal with confidentiality obligations. To avoid inconsistent obligations or ambiguity, both parties may find it desirable to express one set of obligations in the final agreement and to extinguish all the others by operation of a merger and integration clause or specifically. The executive must be able to discuss his work record in job interviews and to sell himself or herself aggressively.
    3. The employer will usually want the employee to return all documents he or she has in a home office. The employee should be ready to do this as well as to delete any such documents on the employee's home computer.
    4. Even if the separation agreement does not contain confidentiality provisions, counsel for the executive should advise the client about an employee's common law duties to a former employer.
  4. Confidentiality of the separation agreement.
    1. Should there be mutual, although not mirror image, obligations?
    2. If representing the executives, don't forget the obvious exclusions which are often forgotten, permitting the executive to pay his taxes, apply for unemployment, and enforce the agreement without committing technical breaches. If there are post employment restrictions, both parties will want the executive to be able to disclose those to potential future employers for purposes of compliance with the terms.
  5. Resignations.
    1. Employers may want resignations from corporate boards and committees.
    2. The executive may have other community or professional group memberships where he or she functioned in part as a company representative. The company may want these memberships/positions transitioned, and the executive may find them valuable for networking purposes.
  6. Packaging the termination.
    1. What opportunities exist for packaging the termination so that adverse impact on the executive's future employability is minimized? Examples: layoff or restructuring, resignation, change of philosophy, etc.
    2. References.
      1. The executive will want to assure good references and the company may want to avoid giving information other than confirmation of positions held and dates of employment.
      2. If there is agreement on how references will be handled, the process should be natural for the business community and should not send up red flags, i.e. a "to whom it may concern" letter would be inappropriate in a small, closed business community where everyone talks to one another.
      3. If an agreed letter is used, counsel for the employee should seek to have it be personally addressed to the individual requesting the reference and should seek a commitment that oral statements will not be inconsistent with the text or tone of the letter.
      4. Anticipate and deal with the kinds of questions which may be asked about a former employee, such as, is the individual eligible for rehire. This may need to be specifically scripted, since many agreements require the executive to promise to not seek re-employment.
    3. Non-disparagement.
      1. Employers often seek non-disparagement promises from employees.
      2. Employees will want mutuality.
      3. If the employer is reluctant to grant complete mutuality, sometimes a mutually acceptable compromise is for the employer to agree to bind a small list of specifically named managers who the employer can then advise as to the company's obligation.
    4. Continued use of office, telephone, and support services-may be useful to the executive in getting a job.
  7. Indemnification.
    1. What is the executive's potential exposure?
    2. What is the level of indemnification provided through the company's by-laws, policies, and insurance policies?
  8. Future cooperation/consultation.
    1. Does the company anticipate needing the executive's cooperation in legal proceedings or for transition purposes?
    2. How should this be compensated:
      1. During the period for which severance is provided?
      2. After the period for which severance is provided?
  9. Unemployment compensation.
    1. Is the employee eligible? Salary continuation v. severance, resignation problems.
    2. Will the employer agree not to contest?
  10. Dispute resolution.
    1. Do alternatives to court enforcement make sense? Arbitration? Mandatory mediation prior to arbitration?
    2. Employers should normally exempt sections of the separation agreement dealing with non-competition, non-solicitation, and protection of company confidential information from the arbitration clause in order to be free to seek injunctive relief.
    3. Consider the deterrent effect of fee shifting provisions, particularly if either party believes the other might act in bad faith.
Negotiation Ideas
1. Who plays what role? Pluses and minuses of negotiation by the executive; pluses and minuses of negotiation by the lawyer.
2. Prepare a negotiation strategy based on a sound evaluation of the case, the company's and/or executive's staying power, timelines, opening positions, desired settlement ranges, and the company's and/or executive's best alternatives to a negotiated resolution.
3. Consider mediation. It provides a highly efficient way to resolve most employment disputes.

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