Just Desserts: Executive Compensation Legal Issues, Best Practices and Trends for March 5, 2014
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1 Just Desserts: Executive Compensation Legal Issues,
2 Just Desserts: Executive Compensation Legal Issues, Stephen Gleave Terra Klinck John Prezioso Richelle Pollard
3 Incentive Compensation and the Employment Relationship: Legal Issues
4 Legal Issues Establishing a New Incentive Compensation Plan Tax and other design considerations Other Legal Issues Relating to New and Existing Arrangements Employment, human rights, estate planning, family law and other legal issues
5 Legal Issues Establishing a New Incentive Compensation Plan Considerations include: Alignment with short-, mid- and long-term organizational goals Ability, desire/aversion to grant real equity Retention Tax rules drive time horizon, choice of plan type
6 Legal Issues Establishing a New Incentive Compensation Plan The Income Tax Act (ITA) salary deferral arrangement (SDA) rules limit income deferral, impose harsh treatment Deferred amounts are taxed immediately, even though they may not actually be received until later SDA is defined very broadly; exceptions are limited Two key exceptions for cash payments: Deferral of bonus for up to 3 years "Prescribed plan or arrangement" (e.g. deferred share unit (DSU) plans)
7 Legal Issues Establishing a New Incentive Compensation Plan ITA provides favourable treatment for share option plans Deferral of income inclusion if optioned shares' FMV on grant date exceeds exercise price Value of acquired shares, less exercise price paid for them, is included in income when shares acquired Further deferral available for shares of CCPCs Deduction equal to 50% of benefit if certain conditions are met CRA administrative relief for stock appreciation rights Right to receive payment equal to increase in share price after grant date Indefinite deferral permitted if conditions met
8 Legal Issues Establishing a New Incentive Compensation Plan Short Term Medium Term Long Term Cash Bonus Restricted Share Units Performance Share Units Stock Options, Share-Settled RSUs Share Purchase Restricted Stock Stock Appreciation Rights Performance Appreciation Rights Deferred Share Units
9 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Employment Law Human Rights Estate Planning Family Law
10 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Employment Law Treatment of cash bonus payments for pension purposes, if applicable Payment of vacation pay on bonus Treatment of incentive pay during the reasonable notice period Restrictive covenants during and post-employment Claw-backs and offsets
11 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Human Rights Treatment of disabled employees and leaves of absence Suspension or continuation of vesting Proration and payment of awards Integration with disability benefits
12 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Human Rights Rights and entitlements on termination of employment versus "retirement" What does it mean to "retire"? Actual commencement of a monthly pension required? Reduced or unreduced? Mere eligibility for a monthly pension? Age and service milestones
13 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Estate Planning Ontario Succession Law Reform Act permits beneficiary designation by written instrument Applies to a broad range of plans established for employees, directors and others Other provinces have similar legislation
14 Legal Issues Other Legal Issues Relating to New and Existing Arrangements Estate Planning Upon participant's death, amounts are paid directly to the employee's designated beneficiary Bypassing participant's estate can avoid estate taxes, which may be desirable for some participants Employer considerations: Administration, storage of designation forms requires resources and could give rise to risk if forms are unclear, forgotten, etc. Would-be beneficiaries under the estate can challenge the validity of a designation; employer can be caught in the middle of estate litigation
15 10 Ways to Leave your Employer and (Try To) Keep Your Incentive Pay
16 The 10 Ways 1. Restraint of trade 2. Penalty clauses 3. Forfeiture 4. Unconscionability 5. Imposing new terms mid-employment
17 The 10 Ways 6. Lack of consideration 7. Ambiguity 8. Failing to bring the term to the employee's attention 9. Wrongful dismissal 10. Termination for cause
18 Case Study # 1 Samuel resigns his employment as a senior investment professional at a bank to start up his own hedge fund. He loses his LTIP as a result of the resignation. He writes to General Counsel to express his view that it is unfair for him to lose the payments because the unvested units relate to three years in which he contributed to the business and he worked hard to earn those units. The former employer points to the express language in the plan, which states that upon resignation, all unvested units will be immediately forfeited.
19 Case Study # 1 (continued) Meanwhile the next day, Jane resigns to join a competing bank. General Counsel is asked by the business to write to Jane to express the view that her competition against the bank is grounds for loss of her unvested long-term incentive payments and that she has no right to receive a prorated amount of her annual cash bonus. Jane's lawyer responds to say that departing employees always receive a pro-rated cash bonus based on the months worked in a year and, additionally, the denial of the longterm and short-term bonuses for competing against the bank is an unlawful restraint of trade.
20 Case Study # 2 Randy resigns to start up a rival firm. The executive compensation plan states any resignation results in loss of shares that are held in trust for the employee, as well as forfeiture of a large number of unvested long-term compensation units. The employer has a practice of requiring employees to sign annual attestations that they have read the plan and understand that resignation results in loss of the shares and deferred compensation. The plan also states that its fundamental purpose is to align employees' interests with the long term interests of the employer, including retention of key employees and ensuring that they make decisions in the long-term interest of the employer.
21 Case Study # 2 (cont'd.) There is no doubt that Randy is aware of the provisions; he has profited under the plan over the last decade. He states that he knows a resignation causes the loss of the shares of unvested units, but he needs the money to fund his new business. General Counsel looks through the attestations and finds that the first one signed by Randy has a handwritten note saying "I really don't like this resignation piece, but I guess I have no choice."
22 Case Study # 3 A large financial institution decides that it must amend its compensation plan to bring it in line with the markets. A sweeping number of changes are introduced, including the mixture of salary, annual cash bonus, and long term incentive pay. There is an immediate 15% salary increase for participants, and the opportunity to earn greater annual cash bonuses and more incentive pay is offered. However, the employer seeks to gain some advantages for itself by tightening up the situations in which a departing employee is paid the bonuses, and, more importantly, introducing a claw-back provision to reclaim any bonuses paid to an employee where it is subsequently discovered that the employee has committed fraud or a material breach of the code of conduct for employees.
23 Lessons Learned: Design, Implementation and Ongoing Administration Tips
24 Lessons Learned: Design, Implementation and Ongoing Administration Tips 1. The Plan Terms are Paramount Generally there is a legal presumption that employees are entitled to participate in bonus and equity compensation plans during the common law reasonable notice period Courts often expressly or implicitly apply the contra proferentem rule Only very clear contractual language can override these hurdles
25 Lessons Learned: Design, Implementation and Ongoing Administration Tips "If the option holder's employment with the corporation and/or subsidiary, as the case may be, is terminated for any reason other than set forth in paragraphs 6, 7 or 8 above, whether such termination be voluntary or involuntary, without his having fully exercised his option, the option shall be cancelled and he shall have no further rights to exercise his option or any part thereof and all of his rights hereunder shall terminate as of the effective date of such termination." [emphasis added] Veer v. Dover Corp. (Canada) Ltd. (Ont. CA) (1999)
26 Lessons Learned: Design, Implementation and Ongoing Administration Tips "If an optionee ceases to be employed by the Corporation for cause or if an optionee is removed from office as a director or becomes disqualified from being a director by law, any option or the unexercised portion thereof granted to such optionee shall terminate forthwith. If an optionee ceases to be employed by the Corporation otherwise than by reason of death or termination for cause, or if an optionee ceases to be a director other than by reason of death, removal or disqualification, any option of unexercised portion thereof held by such optionee at the effective date thereof may be exercised in whole or in part for a period of thirty (30) days thereafter." [emphasis added] Gryba v. Moneta Porcupine Mines Ltd. (Ont. CA) (2000)
27 Lessons Learned: Design, Implementation and Ongoing Administration Tips Not enough to refer to "date of termination" if employer wants participation in the plan for all purposes to cease once employee ceases to provide services Termination needs to be very clearly defined alternative is to refer to date notice is given Need to customize global plans for Canadian employees
28 Lessons Learned: Design, Implementation and Ongoing Administration Tips 2. Ensure employees are aware of and understand the plan terms Employers may not be able to rely upon clear plan language unless terms were brought to employees' attention Give employees a copy of the plan text, or at least make text available Annual grant agreements which describe key terms and require sign-back are a good practice However, be careful of communications/illustrations which could be construed as guarantees
29 Lessons Learned: Design, Implementation and Ongoing Administration Tips 3. Exercise caution when making changes to an existing program Need to provide (and document) consideration At a minimum, employees need to be advised of changes Consider whether in the circumstances it is advisable to obtain employees' express consent to the change
30 Lessons Learned: Design, Implementation and Ongoing Administration Tips 4. Claw-backs, offsets and post-employment conditions Claw-backs and offsets provisions have become more prevalent (following U.S. post-enron) They need to be measured in scope, drafted carefully Desirable to obtain specific "consent" in writing Be careful of the precedents you create by entering into settlements
31 Lessons Learned: Design, Implementation and Ongoing Administration Tips 5. Ensure design is consistent with the underlying objectives of plan terms The plan's "purpose clause" matters The law on unconscionability and related topics is evolving More plans will be tested in coming years The more evidence that can be brought to bear on why a "forfeiture" provision is integral to the plan's design, the less likely a court will be to interfere with the plan's express terms
32 Incentive Compensation Arrangements: Ethical and Professional Issues
33 Incentive Compensation Arrangements: Ethical and Professional Issues Fact Pattern X Co. has recently been the subject of takeover speculation. Eager to retain its top personnel, the Board decides to make an award of share units to its CEO and select key employees to ensure they remain committed to X. Co.'s success. After leaving the Board meeting at which the awards were approved in principle, the CEO asks General Counsel (GC) to prepare the template award agreement for the Board's approval, leaving the award amounts and other details to be filled in by the CEO and Board. It is not initially clear whether the GC will be one of the award recipients, as various issues are still to be decided. Late for a tee time, the CEO mutters something about including restrictive covenants in the award agreement, and hands you a "template" that appears to be an excerpt from the CEO's own employment agreement. The CEO wonders aloud whether the covenants are overbroad, then looks to you for your thoughts, before rushing off to the links.
34 Incentive Compensation Arrangements: Ethical and Professional Issues As member of the bar, what ethical and professional issues must the GC consider when acting on the CEO's instructions?
35 Incentive Compensation Arrangements: Ethical and Professional Issues 1. The client is the corporation LSUC Rules of Professional Conduct 2.02 QUALITY OF SERVICE When Client an Organization 2.02 (1.1) Notwithstanding that the instructions may be received from an officer, employee, agent, or representative, when a lawyer is employed or retained by an organization, including a corporation, in exercising his or her duties and in providing professional services, the lawyer shall act for the organization. Commentary to Rule 2.02(1.1) A lawyer acting for an organization should keep in mind that the organization, as such, is the client and that a corporate client has a legal personality distinct from its shareholders, officers, directors, and employees. [G]iven that an organization depends upon persons to give instructions, the lawyer should ensure that the person giving instructions for the organization is acting within that person's actual or ostensible authority.
36 Incentive Compensation Arrangements: Ethical and Professional Issues 1. The client is the corporation Liaise directly with the Board? Request a copy of the minutes to ensure the award agreement reflects the Board's intentions?
37 Incentive Compensation Arrangements: Ethical and Professional Issues 2. Avoid conflicts of interest [ 2.04] LSUC Rules of Professional Conduct 2.04 AVOIDANCE OF CONFLICTS OF INTEREST (1) In this rule A "conflict of interest" or a "conflicting interest" means an interest (a) that would be likely to affect adversely a lawyer's judgment on behalf of, or loyalty to, a client or prospective client, or (b) that a lawyer might be prompted to prefer to the interests of a client or prospective client. (3) A lawyer shall not act or continue to act in a matter when there is or is likely to be a conflicting interest unless, after disclosure adequate to make an informed decision, the client or prospective client consents.
38 Incentive Compensation Arrangements: Ethical and Professional Issues 2. Avoid conflicts of interest [ 2.04] If the GC is a potential awardee, is it necessary for GC to arrange outside counsel?
39 Incentive Compensation Arrangements: Ethical and Professional Issues 3. Be mindful of confidentiality obligations [ 2.03] LSUC Rules of Professional Conduct 2.03 CONFIDENTIALITY 2.03 (1) A lawyer at all times shall hold in strict confidence all information concerning the business and affairs of the client acquired in the course of the professional relationship and shall not divulge any such information unless expressly or impliedly authorized by the client or required by law to do so.
40 Incentive Compensation Arrangements: Ethical and Professional Issues 3. Be mindful of confidentiality obligations [ 2.03] Don't overshare legal advice; colleagues can become potential plaintiffs
41 Incentive Compensation Arrangements: Ethical and Professional Issues 4. Refer colleagues to independent legal counsel for advice on their own arrangements [ 2.04(14)] LSUC Rules of Professional Conduct UNREPRESENTED PERSONS 2.04(14) When a lawyer is dealing on a client's behalf with an unrepresented person, the lawyer shall (a) urge the unrepresented person to obtain independent legal representation, (b) take care to see that the unrepresented person is not proceeding under the impression that his or her interests will be protected by the lawyer, and (c) make clear to the unrepresented person that the lawyer is acting exclusively in the interests of the client and accordingly his or her comments may be partisan.
42 Just Desserts: Executive Compensation Legal Issues,
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