Below is a top five list of key U.S. executive compensation issues to keep in mind as you work on cross-border M&A transactions involving U.S. executives and key employees and their compensation arrangements. This list is not intended to be exhaustive, but rather should serve as a quick guide for highlighting some of the more common issues that arise in cross-border M&A transactions from a U.S. compensation perspective. Given that each transaction is unique, the scope of issues that may ultimately need to be addressed will depend on the particular facts and circumstances of your transaction.
- Treatment of Equity Awards in Transaction. Consideration should be given as to how equity awards held by U.S. employees and other service providers will be treated in the transaction from a tax, employment and corporate law perspective. Equity awards may be cashed out, assumed by the acquirer, or substituted or replaced with new equity awards issued by the acquirer, each of which has different tax consequences and tax rules that may apply depending on the structure. In addition, equity awards may be subject to accelerated vesting either as a result of the transaction (single trigger) or upon a termination of employment that occurs in connection with the transaction (double trigger). It is common for U.S. executives to be contractually entitled to some type of accelerated vesting either pursuant to an award agreement or an employment, severance or similar contract with the company.
- Purchase Price Holdback Arrangements. If a transaction provides for a holdback structure that subjects a portion of the purchase price consideration payable to key employees to re-vesting, the holdback structure should be designed in a tax-efficient manner. The key issue from a U.S. tax perspective is seeking to design the payments to be taxable upon receipt as purchase price consideration at capital gains tax rates (up to 20%) which is not subject to income tax withholding, as opposed to compensation income at ordinary income tax rates (up to 37%) which is subject to income tax withholding.
- Golden Parachute Provisions of Section 280G. Certain compensatory payments to “disqualified individuals” (including officers, highly compensated individuals and 1% stockholders) that are contingent upon a change in control of a corporation may be subject to the “golden parachute” provisions under Section 280G of the U.S. Internal Revenue Code (the Code), which may result in a 20% excise tax imposed on the individual taxpayer, and a loss of tax deduction by the corporation. If a disqualified individual has “excess parachute payments” (which generally refer to change in control payments that exceed three times the disqualified individual’s base amount (or average compensation over the previous five years)), then the excise tax, and the loss of tax deduction, will apply to change in control payments that exceed one times the individual’s base amount. Notably, the corporation must withhold the excise tax and golden parachute "payments" may include accelerated vesting. Although no longer as common as they used to be, some executives may be contractually entitled to a tax gross-up payment intended to eliminate the impact of the excise tax on the executive, which could cause the cost of the transaction to increase. Privately-held corporations may avoid application of Section 280G by obtaining approval of any excess parachute payments by stockholders owning more than 75% of the voting power of the corporation, so long as the disqualified individual agrees to forfeit any right to receive the excess parachute payments if such stockholder approval is not obtained. Note that Section 280G may apply even in the event that a non-U.S. corporation acquires or merges with another non-U.S. corporation to the extent that (1) any U.S. taxpayers are disqualified individuals receiving parachute payments, or (2) the corporation takes a U.S. tax deduction for compensation paid to any disqualified individuals.
- Deferred Compensation Rules of Section 409A. Section 409A of the Code broadly applies to any plan, agreement or arrangement where a service provider (including employees, directors and independent contractors) has a legally binding right during a taxable year to compensation that is or may be payable in a subsequent year, unless specifically excluded. The penalty for failure to comply with Section 409A is immediate taxation on vested deferred compensation (even if the deferred amounts are not then paid) and payment by the individual service provider of a 20 percent penalty tax and interest (California imposes an additional 5% penalty tax). While the burden to comply primarily falls on the individual, the company would also be subject to certain tax reporting and withholding obligations and may be subject to penalties for failure to report and withhold on the proper amounts. The complex rules of, and myriad of exemptions and exceptions under, Section 409A impact not only traditional deferred compensation arrangements, but also arrangements that are not conventionally considered deferred compensation, such as employment, consulting, severance, equity incentive, cash incentive, retention, transaction-based and retirement arrangements, to name a few, all of which must be reviewed in the course of diligence to assess any risk of exposure. Section 409A may also impose limitations on the treatment of equity awards and other transaction consideration payable in connection with a transaction, as well as on any amendments that the acquirer might wish to make to the compensatory arrangements of employees it wishes to retain.
- Retention and Employment Arrangements. Acquirers will typically review the existing terms of employment, severance, retention, incentive or similar contracts with executives and key employees, from both a legal and a commercial perspective, in determining whether to enter new offer letters or retention awards or to amend existing contracts in connection with the closing of the transaction. It is common for U.S. executives to have “good leaver” provisions in their compensation arrangements that contractually entitle the executive to receive separation payments upon an involuntary termination of employment, including a resignation for “good reason.” Good reason could include, for example, a material diminution of the executive’s title, authorities, duties or responsibilities (including due solely to a change in the employer from a public to a private entity as a result of the transaction) depending on the terms of the contract. If the transaction would trigger an executive’s right to resign for good reason, the acquirer may seek to enter into a waiver agreement with the executive to waive such right in exchange for the right to receive certain consideration at or following the closing. In addition, any new or modified arrangements should be reviewed for compliance with Section 409A and other U.S. law.
Please feel free to reach out to a member of our U.S. compensation team for advice on these issues or any others that arise in your cross-border M&A transactions. The above is just a high level summary of some very complex and sophisticated requirements.