Corporate Board Member’s Jamie Reeves recently interviewed James L. Hauser, partner at Brown Rudnick, about the recent spotlight on change-in-control agreements and steps directors can take to prepare them well in advance of M&A negotiations laid out on the boardroom table.
What is the primary purpose of a change-in-control agreement?
A change-in-control agreement is a contractual agreement intended to provide a company’s employee with employment security and certainty in the event of a change of [company] control by providing severance and related benefits in event of termination or reduction in post-closing compensation, duties or responsibilities. The company ensures that the executives’ focus on maximizing shareholder value by completing the change of control transaction instead of the executive worrying about their personal situation and whether they will have a job with successor entity upon the transaction’s closing. Typically the agreements are provided to senior management.
With M&A activities expected to pick up over the next year or so, do you think shareholder concerns with golden parachutes or change-in-control agreements will be in the spotlight more? Why is it important for boards today to focus on these agreements well before any M&A negotiations are actually hammered out?
First, it can affect deal pricing. If a buyer begins diligence and structures an offer for a certain amount of consideration and subsequent to such offer the seller changes its change-in-control agreements to provide additional severance or benefits, then the buyer may likely view that as increasing the price it is paying as it effectively adds additional cost to the buyer. Second, it may also put the buyer in a difficult position because the buyer loses the ability to negotiate a retention deal with the executives if [change-in-control agreements] are added after an offer has been made. Third, from the seller’s viewpoint, once its board starts negotiating a sale of a company and then layer in additional change-in-control agreements or add new agreements it puts the company at a disadvantage because management now is most likely already concerned about their personal employment situation and may already be looking for new employment.
What steps can directors take to prepare for change-in-control agreements?
The first step is to review what change in control agreements are currently in place. For a public company this is something that the compensation committee and the board is likely doing annually now because of the enhanced SEC executive compensation disclosure rules.
Second step is to review very closely what the triggers are for the payment of the severance benefits that may be in place today. Is it a single trigger that provides for severance just on the change of control, or is it a double trigger which requires both a change in control and some additional contractually determined event, such as a termination without cause or good reason?
Third, the board should closely close review the definitions of cause and good reason to make sure that they understand what events may trigger the executives’ entitlement to payments.
Finally, closely scrutinize the potential economic value of severance including accelerated vesting of equity instruments at different deal prices, value of post-employment health and welfare benefit continuation, severance multiples as well as the treatment of “golden parachute” excise taxes if applicable. What has happened over the last several years for public companies is that the proxy advisory services, in particular ISS, have deemed a tax gross-up for golden parachute excise taxes to be a “poor pay practice,” and as a result many public companies have ceased to offer both tax gross-ups.
Are there any upcoming regulatory issues that will affect change-in-control agreements going forward and should be on boards’ radars?
Yes, beginning in 2011 the SEC, under the Dodd- Frank Act, released guidance on the advisory votes on say-on-golden parachutes. This new rule requires a public company when seeking shareholders’ approval of a merger or transaction to disclose any golden parachute related payments and subject to a non-binding advisory vote. This rule became effective for all transactions on or after April 25, 2011.
The second issue for public companies, which we still don’t have any guidance on currently, is the implementation of claw backs in executive employment agreements. The SEC is supposed to issue that guidance sometime in the first half of 2012. This very likely will impact both existing change of control agreements or new agreements, There may be others depending on Congressional activity relative to executive compensation matters.
Can you think of any topics that we have not touched on that would be of interest to corporate boards?
Yes, addressing these changes of control agreements preemptively will help to ensure that the transaction moves smoothly. The second critical takeaway is for board to be informed of what is currently in place so they are not surprised by the events or amounts paid that are triggered by a change of control.
Topic tags: board of directors, corporate governance, change-in-control agreements, golden parachutes, M&A