Substantial Risk of Forfeiture and Restricted Stock

[Chaz]

Equity comp plan provides for accelerated vesting upon participant's retirement (age 65 or older). Over age 65 participant receives restricted stock award with three year vesting. As such, despite the three-year vesting provision, because the participant is over age 65 participant can retire at any time and the restricted award will vest. Therefore the three year provision is essentially meaningless except to the extent that the participant cannot transfer the shares while remaining in employment before three years is up.

Is there a "substantial risk of forfeiture" under 409A because the award is not "conditioned on the performance of substantial future services" such that the award must comply with 409A's requirements? I think that the answer is different than it would be merely under Section 83 but I don't know what the answer is.

This seems to be a basic question but I can't find any authority that discusses it. I only find discussion stating that restricted stock subject to a SRF does not constitute deferred compensation. But I know that already. See page 41 of the final regs.

Any thoughts are appreciated.

[Just Me]

I don't think there is a substantial risk of forfeiture for 409A purposes, because it's not conditioned on the performance of substantial future services or a the occurance of a condition related to the purpose of the transfer. In addition, since it is not BOTH non-transferrable and subject to a substantial risk of forfeiture, it would be currently taxable under Section 83. Looks like all you have is a current (taxable) transfer of stock that has restrictions on transferrability. Not such a good deal for the recipient.

[Chaz]

Thanks for the quick answer. If it is taxable under Section 83, which I feared, then 409A isn't an issue at all (because there is no deferral of compensation). But I suspect that there are 100s if not 1000s of equity comp plans with provisions for acceleration of vesting upon retirement and I also suspect that many of the sponsors of these plans do not immediately tax the retirement-eligible grantees. Does anyone have any thoughts on this?

[Just Me]

As a general rule, we don't recommend providing for a lapse of the substantial risk of forfeiture upon reaching retirement age for this very reason, just death, disabilty, change of control, and either time-based or performance based vesting. I wouldn't be surprised if not all agreements have been drafted taking this into consideration, however. And I am sure the IRS looks at this in audit situations.

[Steelerfan]

Thanks for the quick answer. If it is taxable under Section 83, which I feared, then 409A isn't an issue at all (because there is no deferral of compensation). But I suspect that there are 100s if not 1000s of equity comp plans with provisions for acceleration of vesting upon retirement and I also suspect that many of the sponsors of these plans do not immediately tax the retirement-eligible grantees. Does anyone have any thoughts on this?

When someone is retirement eligible, you could have their "vesting" event become contingent on an approval process that might keep the SRF going. Just a thought.

[Steelerfan]

As an afterthought, shouldn't the accelerated vesting occur only if the person acually retires, not just reaches NRA. In that case it seems like you could avoid immediate taxation when they reach 65, because theys still have to perform services.

Then if the person retires unvested, subject them to a convenant not to compete while at the same time draft and implement a procedure to require the grantee to request board or HR approval to pay when the original vesting period is over.

If the approving person or body denies the request, then forfeit. Thoughts, reactions?

[Just Me]

If the agreement provides for vesting upon actual retirement following attainment of a specified age, and nothing else, then the substantial risk of forfeiture lapses under Section 83 at the specified age. If there is something more, such as an approval process to designate the termination as a retirement, then perhaps you have a tenuous argument that there is a substantial risk of forfeiture, but I would be concerned about whether, in practice, a denial is ever given, and more importantly, I'd be very wary if the employee had substantial influence in the organization such as the CEO. Would the company really say that a CEO terminating employment at age 67, for example, was not "retiring"? If there is an ongoing non-compete, that might work as long as the shares remain nontransferrable during the noncompete period and the company can demonstrate that actual claw-backs occur in practice upon breach of the agreement (i.e., is the provision more than illusory).

[Steelerfan]

I agree with the risks you point out, but would suggest that company approval be tied not to whether there was a "retirement", but to whether the person who retired should be "vested" when the restriced period is over, taking all factors into consideration, including adherence to noncompetes. I think this is common, especially given Section 83 allows a SRF for refraining from the performance of services.

[Guest Harry O]

Making restricted stock vest when someone "actually retires" is not a SRF, especially when someone already satisified the employer's definition of retirement. Everyone eventually retires in that case . . .

Adding a covenant not to compete is always a little dicey when you are talking about employees over age 65. Obviously the covenant must be bona fide. The older an employee is, the less likely he or she is to actually compete with the employer. This is a facts and circumstances determination.