Earned & Vested, but for discovery of past misconduct?

[Christine Roberts]

Nonprofit executive enters into a severance agreement in 1997 that provides him with deferred compensation each year for the rest of his life, equalling approximately $4,000/months.

Severance agreement does not reserve right to amend or eliminate the benefit.

Severance agreement does not require future performance of services other than consulting services for one year following termination.

As of one year following formation of the agreement (i.e., December 1998), the promised benefit is completely "earned and vested," and, I would argue, exempt from 409A, but for the following language:

"in the event that EMPLOYER discovers that EXECUTIVE, during his term as Executive Director, has engaged in any acts of financial impropriety constituting intentional misconduct or gross neglect, the EMPLOYER reserves the right to terminate any future payments to EXECUTIVE."

In other words, this "risk of forfeiture" is based on past acts, whenever discovered by Employer. Is this a "substantial risk of forfeiture" such that 409A applies to the deferred compensation?

[david rigby]

Is there a "substantial" likelihood of discovering prior "intentional misconduct or gross neglect"?

(This may or may not be only a rhetorical question.)

[Kirk Maldonado]

The preamble to the proposed section 409A regulations provide as follows:

Some commentators also requested that arrangements involving rights to payments upon termination of services for good reason be treated as a right subject to a substantial risk of forfeiture. These arrangements are common, especially following a transaction resulting in a change in control of the service recipient. The Treasury Department and the IRS are not confident that amounts payable upon a voluntary separation from service, and amounts payable only upon a termination of services for good reason, always may be adequately distinguished. Furthermore, even if the types of good reasons sufficient to constitute a substantial risk of forfeiture could be elucidated, the application of such a rule would involve intensive factual determinations, leaving taxpayers uncertain in their planning and creating a significant potential for abuse. Accordingly, the regulations do not treat the right to a payment upon a separation from service for good reason categorically as a right subject to a substantial risk of forfeiture. However, the Treasury Department and the IRS request comments as to what further guidance may be useful with respect to arrangements containing these types of provisions.

I realize that this isn't exactly on point, but it does tend to indicate that they are skeptical that such a forfeiture provision constitutes a substantial risk of forfeiture. Given the fact that such forfeiture provisions are so rarely enforced, it is hard to argue with them.