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401 Chaos

Amending Change in Control Payouts Under 409A

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Would appreciate any thoughts on the following. Target company has accelerated vesting provisions that cause options and restricted stock to vest upon a Change in Control (CIC). Target also has a DB-style SERP that provides for accelerated vesting and some accelerated service credit plus automatic payout upon a CIC. The CIC definition is 409A compliant. Buyer, as term of the deal, will retain Target's employees but wishes Target's officers to voluntarily waive their rights to any single-trigger CIC benefits for double-triggers. If Target's officers are willing to do that as part of the deal, can it be safely done under 409A?

I wouldn't think amending vesting terms under the options would raise 409A issues per se. Seems neither a modification nor a typical extension of the option here as exercise price does not prolong the period of exercising options.

I know 409A doesn't typically govern restricted stock grants but what if individuals on eve of vesting of the shares due to CIC (and thus on the eve of taxable compensation) agree to amend the stock agreements and push back accelerated vesting rights so they only get acceleration if involuntarily terminated within a certain period following CIC? Some will likely stick around and vest on regular schedule without any acceleration but it is possible some will leave, possibly in 2011, which would seems to me may arguably result in a deferral of restricted stock income--i.e., you had a legally binding right to income that would have triggered upon CIC but you pushed back to a later year. If you amend the agreements before CIC is done, can you somehow avoid 409A issues?

What about the SERP? Is there any way for individuals to basically turn their back on the additional benefit and lump sum single trigger payments they would be entitled to upon a CIC? If you try to amend before CIC is certain, is that impermissible delay in payment and/or impermissible substitution of the original benefit. General plan would be for participants to get the same benefits as before without any additional increase for agreeing to change or for additional service--i.e., they don't get anything more for agreeing to waive the immediate CIC benefits (other than ability to have amounts deferred) since they would generally be given the right to the same accelerated benefits package if involuntarily terminated. (I suppose perhaps there would be some risk to them in agreeing to the waiver in that the amounts are unfunded so they might not be around at a later date. Also, I suppose the Buyer could terminate the individuals for cause or the officers could voluntarily resign after CIC such that they presumably wouldn't be entitled to the SERP benefits at that time but I don't think the Service would really view risk of forfeiture due to termination for cause or voluntary resignation as a substantial risk of forfeiture.

Thanks for any thoughts as to what others have done in these situations.

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Guest George Chimento

1. Waiving vesting is not effective under the regulations unless there is a substitution of a "materially greater" benefit, disregarding the value of future compensation that would otherwise be earned. (See the dfn. of "substantial risk of forfeiture" in the regulations.)

2. Essentially, you are hoping to postpone payment. I think the only way you can do that is with the 1 yr/5 yr procedure. If change in control intervenes, you are required to make the payout.

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Maybe the following 1.409A-3(i)(5)(iv)(B) will help:

(B) Certain nonvested compensation. Notwithstanding the provisions of § 1.409A-1(d) (definition of a substantial risk of forfeiture) that disregard the extension or modification of a condition for purposes of determining whether a condition on payment constitutes a substantial risk of forfeiture, a condition that is a substantial risk of forfeiture that otherwise would lapse as a result of a change in control event described in paragraph (i)(5)(v) or (i)(5)(vii) of this section may be extended or modified before and in connection with such event to provide for a condition on payment that will not lapse as a result of such change in control event, and such extended or modified condition will be treated as continuing to subject the amount to a substantial risk of forfeiture, provided that the transaction constituting the change in control event is a bona fide arm's length transaction between the service recipient or its shareholders and one or more parties who are unrelated to the service recipient and service provider (applying the rules of § 1.409A-1(f)(2)(ii)) and the modified or extended condition to which the payment is subject would otherwise be treated as a substantial risk of forfeiture under § 1.409A-1(d) (without regard to the provisions disregarding additions or extensions of forfeiture conditions). In such a case, the continued application of a fixed schedule of payments based upon the lapse of the substantial risk of forfeiture, so that payments commence upon the lapse of the modified or extended condition on payment, will not be treated as a change in the fixed schedule of payments for purposes of § 1.409A-2(b) (subsequent deferral elections) or paragraph (j) of this section (prohibition on the acceleration of payments).

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Guest Harry O

Stock options are generally not subject to 409A so waiving vesting should not be a problem.

Restricted stock is also generally not subject to 409A so taxation should be deferred as long as still subject to a SROF. See Section 83 regs on exchange of restricted property.

Don't see how you can defer SERP without violating 409A. Waiving additional benefits is ok (assuming no substitution or replacement problems) but too late to further defer payout.

My quick two cents.

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Thanks to all. I have been trying to figure out exactly what Treas. Reg. § 1.409A-3(i)(5)(iv)(B) really means in this particular context. It seems to me there may be reasonable argument that this permits an amendment of the single-trigger SERP rights to basically keep the regular vesting schedule (and thus continued service requirement) in place after a CIC but with a new right providing for accelerated vesting and payout upon an involuntary separation from service. Not completely comfortable with that but I'm wondering what 1.409A-3(i)(5)(iv)(B) is intended to provide if it would not permit some relief in this context, at least with respect to amounts not already vested.

Harry O, I'm not sure from your post whether you think 1.409A-3(i)(5)(iv)(B) would not be available to help at all with the SERP piece or would just only be available to help with the nonvested portion?

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Harry O,

Was just curious if your post should be read to suggest that 1.409A-3(i)(5)(iv)(B) is not available at all in this situation or just intended to suggest that it would not provide a complete fix for any SERP benefits that are already vested?

Thanks

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