Protecting Your Rights in Mergers & Acquisitions

For my executive clients, M&A activity usually raises questions about current and future employment. Changes in corporate control ("CIC") can mean executing on a previous "golden parachute" or negotiating a new employment contract --- and in some cases, both. These transactions have always required great care to ensure that no rights get lost in the rush to close a deal or move on to the next opportunity. Now, to add to the complexity, the past year has seen radical changes to the laws that govern executive compensation planning. New tax laws on stock options and deferred compensation, final accounting rules for equity compensation, judicial decisions interpreting enforceability of non-competes and non-solicits, and emerging securities law on compensation disclosure: all powerfully combine to impact any executive whose compensation will be affected by M&A activity.

It's not possible (or necessary) to give you a complete treatise on the rules here. However, I've jotted down a few notes that I hope you will find useful in your approach to negotiating in the M&A context. One caveat: company founders should be aware that special rules (not discussed here) may apply to govern their personal negotiating flexibility when engaging in M&A on behalf of their company. Founders and major shareholders have fiduciary obligations that must always be weighed in the balance with personal protections.

Pre-M&A Checklist For Executives

• What does your current employment agreement say? Many executives have employment contracts that dictate the terms and obligations of their continuing employment (and termination of their employment) post-CIC. Those who do not have detailed employment agreements may be surprised to find that their treatment will be governed by default to other company documents (e.g., general RIF/severance policies, noncompete/nonsolicit clauses in the standard employee confidentiality agreement, CIC provisions embedded in stock option plans and agreements). Whether staying or going, all executives need to carefully review the applicable documents and make sure they fully understand their rights and alternatives before making any commitments for the future.


• Action Item: If you anticipate any M&A activity, proactively review all documents well in advance to thoroughly understand exactly what you are entitled to before considering/responding to any employment or severance offer.


• Does the Buyer's employment offer -- of the Seller's termination offer -- satisfy promises previously made to you? In the rush to closing, executives sometimes discover-- too late! --that key provisions affecting their compensation have been misconstrued by the acquirer or negotiated away by the seller. This can result in different benefits than those offered to the executive by the original employer. For example, company-wide severance plans may be narrowly interpreted to over-ride individual contract provisions. Promised incentive bonuses or payments may be subsumed by new company plans. Bargained-for executive benefits (e.g., special relocation packages, reimbursement arrangements) that should have been assumed by the acquirer may terminate at closing and be superceded by generic corporate policy.


• Action Item: Identify, assert and leverage all of the terms that apply to you prior to closing so that nothing falls between the cracks.


• Are there specific actions you need tot ake to assert or preserve your rights? When equity awards accelerate or terminate on a CIC, they may require immediate assertion to be valid. A frequent - and frequently painful -- problem occurs when executives fail to timely exercise options that accelerate and then terminate on a CIC, and later realize that they have lost all rights to the equity after closing. Other types of restricted stock rights may also require special attention (for example, exercising performance units or stock appreciation rights). And COBRA and other insurance benefits for yourself and your dependents require that paperwork be submitted within a certain time period in order to prevent gaps in (or loss of) coverage.


• Action Item: Closely read all information provided by the company regarding deadlines and get specific answers to any questions you have about timing to ensure you maximize your financial benefits and ownership rights.


• Are there any special tax consequences that need to be considered? The American Jobs Creation Act of 2004 made enormous changes to the tax rules for nonqualified deferred compensation. Many techniques that were de rigueur in executive comp planning will now result in immediate taxation plus mind-boggling penalties (i.e., interest plus 20% plus ordinary tax due) if improperly structured. For example, golden parachute provisions are frequently drafted to allow executives to avoid excise taxes at termination by making an election to receive severance in the form of installment payments. Now such payments are likely to be fully taxable at the time of termination. Similarly, many plans (including individual agreements) that provide for elective deferrals of bonuses, severance payments or nonqualified retirement payments will now be subject to current taxation. Although some plans will be grandfathered under the old deferral rules through the end of 2005, the majority will be subject to the new rules as of January 1.


• Action Item: Make sure that you understand how the new rules impact your personal situation before signing up to deferred payment plans, whether for future performance bonuses or severance payments.


• How much negotiating power do you have in the circumstances? Clients frequently ask me to describe a "standard" package, but it's an impossible task. The ability to negotiate compensation --with or without an M&A transaction in the works-- depends on a wide range of factors, with the executive's personal strengths on one end of the scale and the company's legal limitations on the other. Just a few examples: are there current comparable executives who already have a single form of executive agreement in place? are you arguing against a historical company precedent or a corporate-wide policy that has been publicly announced for this specific deal? in the case of a separation package, does your employer have a specific reason for concern (i.e., you have an actionable claim) that makes your willingness to sign a release an especially valuable bargaining chip? Moreover, although post-Enron reforms have focused largely on public companies, private companies (both closely-held and venture-backed) are not exempt from the new rules mentioned above. In fact, all companies are now subject to some degree of tax, accounting, securities and state contract laws that may restrict their boards from approving certain types of executive compensation. These restrictions will limit the company's alternatives even when your arguments are persuasive.


• Action Item: Do your homework before beginning discussions to know which elements of the package are reasonably negotiable (or open to creative fixes) and which are lost causes due to external limitations.

To discuss the checklist or any other issues related to protecting your individual rights in the M&A setting, call Alisa Baker at (415) 391-3510 or send her an email.