This article is reprinted with permission from the
December 31, 1990
edition of

New York Law Journal.

1990 NLP IP Company.

 


Severance Arrangements

Series: Part I

By Joseph E. Bachelder.

 

THE FREQUENCY of executives severances appears to be at an all-time high. Today, close attention is being given to both planning for and responding to severance. Planning involves agreements, plans, programs and policies that employers enter into in anticipation of severance. Response involves the steps taken by the employer upon severance of an executive that go beyond the commitments already in effect.

This column will "inventory" the agreements, plans, programs and policies that cover aspects of severance and are entered into before the event. A future column will address employers' responses that may take place at the time of severance and go beyond what already has been put into place.

Some of the arrangements that may be involved in planning for severance are:

(1) Individual agreements unrelated to a broader compensation or benefit plan.
* Employer agreements
* Severance protection agreements
* Consulting agreements
* Change in control agreements

(2) Plans
* Retirement plans (qualified and non-qualified)
* Employee welfare benefit plans (which may include special executive welfare plans)
* Annual incentive plans
* Long-term incentive plans (e.g., stock option plans, restricted stock plans, etc.)

(3) Programs
* Outplacement
* Perquisites

(4) Policies
* Severance

The manner in which the foregoing arrangements may affect a severance will be examined in greater detail below. Other aspects of executive severance that may be involved in a particular case but are beyond the scope of this column include discrimination protections under federal and state laws and government-sponsored unemployment compensation.

It also noted that severance as used in this column means a termination by the employer "without cause." Excluded are terminations by the employer "for cause," terminations due to death or disability and voluntary terminations by executives, whether for "good reasons" or otherwise. 1

The common law definition of cause generally is broader than that given in employment agreements. In some states cause is treated as failure to meet the reasonable expectations of an employer for performance at the level for which the executive has been employed. Thus, failure to define "cause" in the employment agreement can be very adverse to the executive.

Individual Agreements

Employement Agreements. Severance clauses in employment agreements typically provide for continuation of salary and, in some cases, bonus amounts for a specified period. 2 Generally such clauses provide for continuation of employee benefits including, in some cases, continuing service credits under non-qualified pension plans and continuing coverage under at least some welfare benefit plans for the same period as the severance pay period. Consequences of severance to long-term incentives such as stock options and restricted stock are generally determined under the terms of such plans although in some cases specific provision is included in severance clauses of employment agreements.

Severance clauses may provide for offset against severance amounts in the event compensation is received from a new employer during the severance-pay period. Such clauses may even require the executive to make a responsible effort to find new employment. Employment agreements with severance clauses tend not to require an effort to find new employment or offset if new employment is found. Many agreements are silent on the subject. 3

Many employment agreements contain post-employment curbs on competition, disclosing confidential information and solicitation of the employer's employees and customers. If such a restriction is violated during the severance period most severance clauses in employment agreements provide that any continuing severance pay and benefits will cease.

Severance Protection Agreements. For this discussion, there are limited distinctions between severance clauses in employment agreements and agreements that provide severance protection only. Employment agreements tend to be for a specified period of years, although many are subject to automatic renewal unless one party notifies the other before the scheduled expiration that the agreement is not to renew ("evergreen" clauses). In contrast, severance-protection accords often provide protection during employment, however long, rather than for a specified period.

Consulting Agreements. It is not uncommon to provide a severance agreement in the form of a consulting agreement. Some companies view such a consulting agreement more favorably than a severance agreement for proxy reporting purposes. Occasionally, consulting agreements are entered into in conjunction with employment agreements, with the consulting agreement taking effect upon termination of the employment agreement. Consulting agreements associated with severance are more likely to arise in response to severance and will be dealt with in Part II.

Change-in-Control Agreements. It many ways, these agreements resemble severance agreements: They generally protect against severance within a specified period following an occurrence meeting the definition of a "change in control." 4 In some cases they exceed a severance agreement by requiring only a "single trigger" -- that is, the executive is entitled to leave at his own volition within a specified time after a change in control and collect the parachute benefits, frequently in a lump sum.

Many changes in control agreements are for a specified period of time. That is, if a change in control does not occur within, say, three years following the commencement of the agreement it expires. In some cases, the change-in-control agreement is a conditional employment agreement. Upon occurrence of a change in control as defined in the agreement it becomes operative as an employment agreement, not just a severance protection agreement. Finally, employment agreements themselves often contain change in control clauses providing protection similar to those provided by separate change-in-control agreements.

Severance Protection

Retirement Plan. Retirement plans, both tax-qualified and non-tax qualified (the latter frequently described as Supplemental Employee Retirement Plans, or SERPs) provide important, longer-term protection to many severed executives. This is particularly important to those executives within a few years of retirement. They may have less change of re-employment than younger executives, and they may be entitled to elect early retirement benefits rather than wait until normal retirement age (historically, in most industries, normal retirement age has been age 65, but today, in many cases, it is age 60). Typically available beginning at the age of 55, such early retirement benefits ordinarily are reduced in amount for early commencement. In some cases, if early retirement occurs after a specified age, frequently age 62, there is no actuarial reduction.

Employee Benefit Plans. These include plans providing life insurance, long-term disability protection and medical and hospitalization benefits. Such plans may provide for continuing coverage for a period following severance. Ordinarily, post-employment employer-paid benefit periods are relatively short (and, in some plans, may be nonexistent).

On the other hand, many employers have added executive benefit programs that carry over into retirement. If an executive is severed after an age specified in such a program, he may be entitled to continuing benefit coverage. (Employers, as a result of recent accounting rule changes, may cut back on such programs.) In any event, most employees are eligible for continuation of group health insurance benefits during an 18-month period following termination, during which the employee pays the insurance premiums. 5

Annual Incentive Plans. Annual incentive arrangements may provide for pro-rata bonuses if an employee is terminated without cause during the year. Pro-rata means a fraction reflecting the period of the year during which the employee was employed. The bonus amount to which this is applied may be the prior year's bonus, an average of a number of years (more appropriate, perhaps, for a longer-term employee) or, occasionally a guaranteed minimum bonus. Most corporate executive bonus plans, however, do not provide such pro-rata bonus and some even require that the executive remain employed until the data the bonus is paid in the year following the year in which it is earned.

Long-Term Incentive Plans. Severance provisions associated with long term incentive plans vary considerably from company to company and even from plan to plan within a single company. A typical non-qualified stock option plan provision in this respect is one for continued exercisability for 90 days following termination. Such exercisability generally is limited to the extent the option is exercisable at the time of termination. It isnot uncommon to find this period limited to 30 days (and, in some cases, there may be no post-employment exercise right). 6 On the generous side are those plans that permit continuing exercise for the remaining period of the option. Some plans even provide that the portion of the option not exercisable at time of termination will become exercisable on the same schedule as would have applied if employment had not been terminated. Such a provision ordinarily is tied to post-employment restrictions such as a covenant not to compete for a period of time.

Restricted stock awards tend to require forfeiture of shares not vested at the time of termination. Many incentive programs -- such as those involving stock options and restricted stock -- provide that the plan committee or other person authorized to administer the plan may, at is discretion, accelerate the vesting of restricted shares or the accrual of option exercisability rights.

Special Programs

Outplacement. Most major corporations make arrangements for severed executives to receive a variety of services described under the heading of "outplacement." These include services of consultants who advise executives on how to locate new employment, provision of office space and secretarial assistance for a period of time (these arrangements are sometimes provided through the same firms that provide outplacement consulting) and reimbursement of certain expenses associated with job search.

Perquisites. Available to many executives, these include a variety of fringe benefits or so-called "perks." Use of a car, reimbursement of club dues, tax counseling and annual medical examinations are among popular forms of perquisites. Generally these end on, or shortly after, a severance (subject to special arrangements with individual executives: a frequent arrangement is sale of the car to the executive at a favorable price).

Many employers have severance policies applicable to executives as well as other employees. For example, such a policy may be one week, two weeks or one month for each year of employment. The policies vary in their formality. Some employers deny any policy regarding executives' severance, claiming they treat each case on its own merits. Others state the policy in a handbook of employee, or executive, benefits. 7


FOOTNOTES:

1 When defined in an employment agreement, "cause" generally means egregious behavior described in a variety of ways such as:
(i) commission of a serious crime (in some cases meaning conviction, in some cases meaning indictment and in some cases meaning occurrence without reference to a judgment by any criminal tribunal -- if a dispute occurs in the latter case, presumably the arbiter of the dispute between employer and former employee would decide the question as to whether a crime had occurred) or
(ii) occurrence, in connection with the carrying out of employment responsibilities, of gross misconduct or gross neglect by the employee resulting in harm to the employer. These definitions are by no means inclusive to the variety of definitions given to "cause" in employment agreements.

2 Severance survey data are rather limited. For golden parachutes, surveys include: Gilbert Dwyer & Co., Employment Contracts and "Golden Parachutes" in Corporate America (1986); Hewitt Associates, Competitive Practices in Change-in-Control Arrangements (1988); Executive Compensation Reports (DP Publication Co.) Some of the agreements involved in such surveys may contain severance provisions applicable absent changes in control, but most of the agreements are tied to changes in control. Some information can be obtained from proxies, since information can be obtained from proxies, since the proxy rules require disclosure of termination arrangements entered into with the individuals included in the cash compensation table of the proxy.

3 In the absence of any severance provision, New York requires a discharged employee to use reasonable diligence to seek comparable employment to mitigate his damages; however, a severance provision in an employment agreement is, in essence, a liquidated damage provision and thus eliminates the employee's duty to mitigate damages. Musman v. Modern Deb Inc. 50 AD2d 761, 377 NYS2d 17 (1st Dept. 1975); Boyle v. Petrie Stores Corp., 136 Misc2d 380, 518 NYS2d 854 (1987).

4 A variety of definitional formulations are used including: a percentage of the voting stock being acquired by a person or group of persons within the meaning of the federal securities laws; a merger or other reorganization in which the employer is not the surviving entity; disposition of all or substantially all of the assets of the employer; or adoption of a plan of liquidation of the employer.

5 Consolidated Omnibus Budget Reconciliation Act of 1985 (COBRA) (29 USCA 1161-67 (West 1985)) applies to employers with 20 or more employees but excludes churches, certain other tax-exempt organizations and federal employees. Employees not covered by COBRA may be eligible for continuation under state law.

6 An incentive stock option, as described in IRC 422A, be exercised within three months of a severance to qualify for treatment under IRC 421(a). (Post-termination exceptions are applicable in cases not germane to the subject of this column such as disability, IRC 422A[c]), or death, Treas. Reg. 14A422A-1, Q & A-2[b]).

7 Weiner v. McGraw-Hill Inc., 57 NY2d 458, 457 NYS2d 193 (1982) (stating that several sources, including the employee handbook, were useful in determining what the employer's severance policy was and how the employer would be bound by that policy).