Payment Upon Involuntary Termination For Any Reason

[Chaz]

If an employment agreement provides for a lump sum payment to be made upon an involuntary termination of employment for any reason, is that a substantial risk of forfeiture such that a specified employee would not have to wait six months for payment under the ST deferral exception?

The final regs state that "if a service provider's entitlement to the amount is conditioned on the occurrence of the service provider's involuntary separation WITHOUT CAUSE, the right is subject to a substantial risk of forfeiture if the possibility of forfeiture is substantial" (emphasis added).

Does this language necessarily mean that it follows that payments made upon ANY involuntary separation are NOT subject to a SRF?

If there is no SRF and therefore the ST deferral rule is inapplicable, am I right in concluding that the two-times exception still applies (because the payments are made under a plan "that provides for separation pay only upon an involuntary termination from service"? (There is no mention of "without cause.)

Thanks.

[Steelerfan]

I think you're getting caught up way too much in the "without cause" language. If there is cause for a termination, the executive will usually not receive payment. Any other involuntary termination (for reasons other than cause) should create a valid SRF--meaning that before you terminated you had no right to payment. So, I would say that if you truly have a right to payment upon an involuntary termination, you kill two birds with one stone, meaning that you can potentially have both the short term deferral and 2x/2year rule apply. I can't think of a situation where there would be no SRF, but the 2x/2year rule would still apply.

[Chaz]

I think you're getting caught up way too much in the "without cause" language. If there is cause for a termination, the executive will usually not receive payment. Any other involuntary termination (for reasons other than cause) should create a valid SRF--meaning that before you terminated you had no right to payment. So, I would say that if you truly have a right to payment upon an involuntary termination, you kill two birds with one stone, meaning that you can potentially have both the short term deferral and 2x/2year rule apply. I can't think of a situation where there would be no SRF, but the 2x/2year rule would still apply.

The employment agreement in question specifies a payment upon the executive's involuntary termination for "cause" (willful misconduct, etc.), albeit a smaller payment than he would get upon an involuntary termination without cause. Is this such a situation? Can we modify the agreement to take advantage of the ST deferral rule as well as the 2x rule?

[Steelerfan]

That's an interesting question, whether a payment conditioned on a termination for cause is a valid SRF. It seems the IRS assumes that standard practice is that "for cause" termination creates a forfeiture. If it creates a forfeiture, then it should follow that the right was not vested and therefore subject to SRF.

Without the benefit of research, it seems to me that there should still be an SRF unless the "cause" is considered within the control of the employee--an odd circumstance no doubt. I"d feel more comfortable putting the decision to pay in the hands of a compensation committee after termination rather than pay automatically upon termination for cause. That way you can say that the amount would have been forfieted but the compensation commitee decided to pay the bum anyway.

[Guest Harry O]

Straneg contract provision.

I would analyze this by trying to figure out under what circumstances would the guy NOT get paid something at termination of employment? Since everyone eventually terminates employment, if he will always get something regardless of the reason of his termination of employment there doesn't appear to be a SRF to that extent. If you can't realistically leave something on the table when you terminate, you don't have an SRF IMHO.

[Steelerfan]

I just read an article and the commentator stated that payments on termination for cause are not SRF (no authority cited). They are treated like a voluntary termination (not for good reason)

[jpod]

If that is what the article said, it's wrong. If the article said "there is no substantial risk of forfeiture if a forfeiture would occur ONLY upon termination for cause," then it's correct.

[Steelerfan]

If that is what the article said, it's wrong. If the article said "there is no substantial risk of forfeiture if a forfeiture would occur ONLY upon termination for cause," then it's correct.

Basically what they said was ""a fired for cause" clause does not raise a substantial risk of forfeiture."

Not sure I understand your distinction.

[Chaz]

If that is what the article said, it's wrong. If the article said "there is no substantial risk of forfeiture if a forfeiture would occur ONLY upon termination for cause," then it's correct.

Basically what they said was ""a fired for cause" clause does not raise a substantial risk of forfeiture."

Not sure I understand your distinction.

The distinction is that, if a payment will be forfeited ONLY if the service provider terminates for cause (i.e., if the service provider voluntarily terminates, he still gets the payment), as jpod states, there definitely is no SRF per the final regs. And the regs say that a payment payable only upon a termination of employment without cause IS a SRF. My question is whether there is a SRF if the service provider can only forfeit the payment if he voluntarily terminates employment; that is, even if he is terminated for cause, he still get paid.

In our case, the employment agreement we are reviewing states that, if the executive is terminated without cause, he is due, say, $500,000, and if he is terminated for "cause" (which is fairly broadly drawn to include general incompetence), he is due, say, $250,000.

In response to Harry O's comment, let's assume that the executive is not due a payment if he voluntarily terminates employment without good reason. Otherwise, I believe that the agreement provides that he is due at least something in every other event.

Note that we did not draft the agreement in question (god forbid); we are only reviewing for 409A compliance.

So any more comments? Does my agreement provide a SRF?

[jpod]

Whether a risk of forfeiture is "substantial" is a facts and circumstances issue. Generally speaking, if the individual would fofeit everything only if he voluntarily terminates without good reason (assuming it is a 409A-compliant definition of good reason), there is a SRF. Your case must involve a pubilc company, so it's not likely that there are any facts to suggest that the RF is not S.

[Guest jhall]

I'm not sure I'm following all of this but it seems to me based on the "without cause" phrasing in the the regulations that the simple answer to Chaz's question is that the 500,000 payment for involuntary termination w/out cause is probably clearly a SRF while the 250,000 payment for involuntary term w/ cause should not be considered to create a SRF. After all, even if the decision as to whether or not "cause" exists is in some objective body's discretion, it would be within the executive's ability to create "cause." Obviously, there would be other consequences to such actions that would hopefully prevent the executive from doing that and maybe those other factors give you enough to argue that the facts and circumstances still impose a SRF in that situation. I think the regs are trying to prevent having cause provisions drafted so broadly as to essentially give the executive the same as a walk away right.

If you have an agreement that simply provides for severance upon any involuntary termination without any attempt to qualify whether it is limited to cases "without cause," I think that raises a tougher question under a technical reading of the regulations. As I think others have noted, however, it seems to me it would be very strange for the company to actually pay out under that sort of provision if they terminated an executive for actual cause. That is to say, maybe you could almost read in an express understanding that it was only intended to be paid in "without cause" situations since that is the typical approach.

In an unusual situation like Chaz mentions where the company specifically provides for some payment in terminations for cause, seems that's an uphill battle to argue that there is a SRF.

[Guest Guy Incognito]

I'm not sure I'm following all of this but it seems to me based on the "without cause" phrasing in the the regulations that the simple answer to Chaz's question is that the 500,000 payment for involuntary termination w/out cause is probably clearly a SRF while the 250,000 payment for involuntary term w/ cause should not be considered to create a SRF. After all, even if the decision as to whether or not "cause" exists is in some objective body's discretion, it would be within the executive's ability to create "cause." Obviously, there would be other consequences to such actions that would hopefully prevent the executive from doing that and maybe those other factors give you enough to argue that the facts and circumstances still impose a SRF in that situation. I think the regs are trying to prevent having cause provisions drafted so broadly as to essentially give the executive the same as a walk away right.

If you have an agreement that simply provides for severance upon any involuntary termination without any attempt to qualify whether it is limited to cases "without cause," I think that raises a tougher question under a technical reading of the regulations. As I think others have noted, however, it seems to me it would be very strange for the company to actually pay out under that sort of provision if they terminated an executive for actual cause. That is to say, maybe you could almost read in an express understanding that it was only intended to be paid in "without cause" situations since that is the typical approach.

In an unusual situation like Chaz mentions where the company specifically provides for some payment in terminations for cause, seems that's an uphill battle to argue that there is a SRF.

I am in complete agreement with jhall. The regs provide that if an executive’s entitlement to an amount is conditioned on the occurrence of the executive’s involuntary separation from service without cause, the right is subject to a SRF. I don't see how a termination for cause creates a SRF.

[jpod]

jhall: Let's go through this carefully. Assume an employment agreement that says the executive gets money if he/she is fired, with or without cause. If the executive quits, dies or leaves on account of disability, he/she gets nothing. Is the risk of forfeiting that money substantial? I think it is. You seem to be suggesting that the risk is very low (i.e., not substantial) that the employee would leave for reasons other than involuntary termination. That suggestion seems to be premised on your further assumption that the likelihood of a for cause termination is equivalent to the likelihood of a voluntary quit. So, for example, the employee is just as likely to terminate as a result of being fired for embezzling money, or for drinking on the job, or for doing anything else that constitutes "cause," as a result of quitting. Do you really believe that?

[Guest Guy Incognito]

jhall: Let's go through this carefully. Assume an employment agreement that says the executive gets money if he/she is fired, with or without cause. If the executive quits, dies or leaves on account of disability, he/she gets nothing. Is the risk of forfeiting that money substantial? I think it is. You seem to be suggesting that the risk is very low (i.e., not substantial) that the employee would leave for reasons other than involuntary termination. That suggestion seems to be premised on your further assumption that the likelihood of a for cause termination is equivalent to the likelihood of a voluntary quit. So, for example, the employee is just as likely to terminate as a result of being fired for embezzling money, or for drinking on the job, or for doing anything else that constitutes "cause," as a result of quitting. Do you really believe that?

So if an employment agreement provides that executive is entitled to receive his salary for X number of years if he is terminated for cause, you would tell the executive that this provision is 409A-compliant and there is no need to worry about any six-month delay here?

[Guest jhall]

Jpod,

I wouldn't disagree that there is a substantial likelihood that an individual might terminate for a variety of reasons other than being involuntarily terminated with cause. What I do believe, however, is that the Treasury folks probably had a reason for using the phrase "involuntary termination without cause" and I think an express provision that provides benefits upon an "involuntery termination with cause" or the like could present an uphill battle. I don't believe I said it was a lost cause for, as you noted, there are some facts and circumstances arguments to be made. Hopefully your rationale carries the day on that but I would have some concerns if I had an agreement with that sort of provision in it. It seems to me part of what factors into Treasury's thinking on this is not so much what the overall likelihood of forfeiture may actually be in a particular situation but the ability of the executive to cause the result to come about. So, is it unlikely that the executive may actually be terminated without cause--yes. On the other hand, is it possible for the exeuctive to easily create cause and get money--i think that is also clearly yes.

[Steelerfan]

Getting back to the OP, if the IRS looks at a termination for cause as the essential equivalent of voluntary termination, then the case is closed. This agreement will not have a valid SRF.

I'm assuming that the issue here is preservation of an SRF so the plan can be amended to comply with 409A. Unfortunately it seems hard to argue that an amount is subject to forfeiture if you can get paid under the ultimate forteiture provision known to man--the "bad boy" clause. I would feel uncomfortable concluding that an SRF exists. Good luck Chaz.

Not to mention if this is a public compnany, shareholders wouldn't be too happy that you paid out on firing for cause.

[jpod]

I am going to make one more point, in the form of a question, then I will retire from this discussion because it appears that the vote is a landslide against me.

If you believe that the IRS's definition of SRF requires you to have an exclusion for "for cause" terminations, then why did the IRS did not prescribe a minimum definition of "cause" that would satisfy this requirement?

[Steelerfan]

I am going to make one more point, in the form of a question, then I will retire from this discussion because it appears that the vote is a landslide against me.

If you believe that the IRS's definition of SRF requires you to have an exclusion for "for cause" terminations, then why did the IRS did not prescribe a minimum definition of "cause" that would satisfy this requirement?

to your question, I really think the IRS never considered that an employer would want to pay someone who was terminated for cause.

Actually I'm flipping to your side based on an old case I found, EDWARD L. BURNETTA, O.D. P.A. v. COMMR., 68 TC 387 (1977).

It was a funded nonqualified deferred comp plan analyzed under Sec 83. The court ruled that a discharge for cause provision did not create an SRF such that contributions to the trust were not includible in income. But it is clear under the facts and rationale that if an employee terminated voluntarily, nonvested benefits would still be forfeitable. Therefore, despite the "for cause" termination provision, benefits were still subject to SRF by virtue of the standard vesting schedule (2 years) under the plan, which would be forfeited if an employee voluntarily left within 2 years. Past 2 years, benefits were vested despite the bad boy clause.

Although I've still never seen any cases (and I checked the Utz Executive comp litigation articles) where anyone gets paid after a for cause termination, I'm willing to admint that there could be an SRF, but I'd call the IRS and talk to an agent about it.

[Chaz]

I am going to make one more point, in the form of a question, then I will retire from this discussion because it appears that the vote is a landslide against me.

If you believe that the IRS's definition of SRF requires you to have an exclusion for "for cause" terminations, then why did the IRS did not prescribe a minimum definition of "cause" that would satisfy this requirement?

jpod,

Don't give up so easily. I'm with you on this (although I am in the minority in the office here). I have question along the lines where you are going:

Take the traditional "bad boy" clause: No payment upon conviction of a felony, willfully disobeying an lawful order of a superior, commission of an act of moral turpitude or a "wide stance," etc. In all other cases of involuntary termination, the executive gets paid. No argument that this is a SRF(?)

So, if an executive is a "specified employee" and decides he wants to leave but also wants to get paid under the agreement, all he has to do is generally be incompetent, then he gets fired and paid off. He wouldn't have to wait the six months to get paid if payment is made during the ST Deferral period.

But if another agreement provides that the executive gets a payment if he is terminated for "cause," which definition includes general incompetence, jhall, steelerfan, etc. are saying that there is no SRF and he would have to wait the six months.

But in either case, the ability to "create the cause" is the same. Although the IRS/Treasury Department's use of the phrase "involuntary termination without cause" gives me pause, the result of the above scenarios doesn't make sense.

Just my thoughts . . . .

[WRITTEN BEFORE STEELERFAN'S LATEST]

[Steelerfan]

If you break down this question in it's simplist form, the confusion comes down to the fact that in NQDC plans, the absence or presence of an SRF is not a critical taxation event, as it is under section 83. E.G. Under section 83, there was no SRF if a transferee was required to give the property back upon termination for cause because (as others have pointed out) the likelihood of that happening is too remote for the risk of forfeiture to be "substantial." But that fact had an immediate impact on taxation. Whereas in NQDC plan, we can get tax deferral with or without an SRF.

So if you draft a NQDC plan to say, "l hereby promise to pay YYZ $1 dollar when you terminate employment unless you are involuntarily terminated for cause", we wouldn't normally care if there was an SRF since tax on the dollar would be deferred by virtue of the unfunded promise to pay. But if I put the dollar in trust, is there an SRF to prevent taxation? No because section 83 says the risk is not substantial. But if I add a provision to say that YYZ also won't get the dollar if he leaves employment voluntarily, does that create an SRF? It should, based on the regulations. So the question is whether or not the presence of a payment upon a termination for cause abrogates the SRF. I don't see how, you still lose it if you leave voluntarily.

That's the long way of trying to prove what jpod and chaz were saying.

[Steelerfan]

I asked this question today at a TEI breakfast with a prominent speaker (not with the IRS, but used to be). She asked the IRS about this and said they are taking the position that not only would it not be an SRF, but that 409A plans cannot even have such a provision because the employer has discretion over whether a termination is for cause and it would be an alternative payment schedule upon separation. A lot of compnanies apparently had such provisions in their plans under the rationale that the company would rather cash out a criminal than have to keep the money earning interest while some corporate $%$bag sits in jail. Now they must be removed.

Although I'm still not sure why the company wouldn't rather forfeit than pay out (unless it's salary deferal or earned bonus money). I also don't understand why a termination for cause is more discretionary than an involuntary termination without cause. Any ideas?

She also said that even though she has gotten a lot of questions on this, the IRS thinks it's a stupid question.

[Chaz]

I asked this question today at a TEI breakfast with a prominent speaker (not with the IRS, but used to be). She asked the IRS about this and said they are taking the position that not only would it not be an SRF, but that 409A plans cannot even have such a provision because the employer has discretion over whether a termination is for cause and it would be an alternative payment schedule upon separation. A lot of compnanies apparently had such provisions in their plans under the rationale that the company would rather cash out a criminal than have to keep the money earning interest while some corporate $%$bag sits in jail. Now they must be removed.

Although I'm still not sure why the company wouldn't rather forfeit than pay out (unless it's salary deferal or earned bonus money). I also don't understand why a termination for cause is more discretionary than an involuntary termination without cause. Any ideas?

She also said that even though she has gotten a lot of questions on this, the IRS thinks it's a stupid question.

Steelerfan - After reading your first paragraph (and right after I exclaimed "Wow!"), I thought of the exact question you pose in the second paragraph.

And assuming that the IRS sticks with this position, can my plan even be fixed?

[jpod]

Steelerfan: the use of the concepts of "cash out" and "discretion" suggest to me that the IRS was answering a different question, or didn't understand the question. The question is very simply stated: will a payment that is vested only upon involuntary termination, whether or not for "cause," be considered to be subject to a SRF? There is no discretion involved here, other than the employer's discretion to fire someone. If this was the question asked, and the IRS person truly understand the question, she's wrong.

[Steelerfan]

Steelerfan: the use of the concepts of "cash out" and "discretion" suggest to me that the IRS was answering a different question, or didn't understand the question. The question is very simply stated: will a payment that is vested only upon involuntary termination, whether or not for "cause," be considered to be subject to a SRF? There is no discretion involved here, other than the employer's discretion to fire someone. If this was the question asked, and the IRS person truly understand the question, she's wrong.

to anwer your question directly, the regs do say that only an involuntary separation from service without cause creates an SRF. Using that as a starting point doesn't bode well. Maybe that's why they think it's a stupid question. It seems that you would have to specify that the involuntary termination must not be for cause to have an SRF,

The question originally raised was not an SRF question, that's true. But based on the IRS answer, the rationale suggests no SRF because of the "discretion" they feel is involved. I think it has to do with the employer's additional discretion to determine if cause exists and then whether to act on it by firing the employee thus causing a distributions to occur in violation of 409A, as opposed to using there unilateral authority to fire. This thinking wasn't clear to a lot of people and that's why the IRS was approached about it. The IRS thinks it's obvious, but it doesn't make much sense to me.

But maybe the argument is fruitless since a payment upon an involuntary termination for cause is not considered an enumerated payment event under IRS interpretation, and so you can't (according to them) have such a provision added in your plan. The way I understood it you couldn't even have it in your plan if it were the only payment event. However, I don't think this means you couldn't make a distribution after a termination for cause if the plan provides for payment upon separation from service as defined in 409A, and you met the definition-- it just wouldn't create an SRF because that definition includes voluntary separations.

[Steelerfan]

One final comment on this (as the horse is probably dead already). I think the most important statement in this thread is when jhall said "It seems to me part of what factors into Treasury's thinking on this is not so much what the overall likelihood of forfeiture may actually be in a particular situation but the ability of the executive to cause the result to come about."

I think that is what's going on here and this seems to be at least one of the reasons the IRS did not adopt the commentator's suggestion that the section 83 definition be used--because 409A serves a different purpose. For example, when interpreting section 83, the tax court in Burnetta ruled that the possibility of a termination for cause was too remote to present a substantial risk that amounts will be forfeited. If you take the inverse of that logically, you could say that a payment that vests on a termination for cause should be subject to SRF because the likelihood of such a termination is so remote that the payment might not ever vest. Now this may sound overly obvious from here on out, but note that forfeiture and payment are not the same thing. And (especially with recent goings on in the corp world) the IRS might naturally be of the opinion that the inclination of a corporation to pay (even in the face of criminal activity) is greater than the inclination to forfeit. Thus, where a payment would vest on termination for cause, the possibility of termination for cause might naturally become much less remote (perhaps a little too conveniently) in an effort to get around 409A (after all when was the last time you heard of an exec trying to get terminated for cause so he could forfeit his benefits?). And that's really all they appear to care about-that no one get around 409A.

That being said, maybe there is a chance that under pre-409A law an SRF could still exist despite a payment on term for cause??

[Guest Perseo]

I am late to this game, and stunned by the report that the IRS views this as a no brainer that a payout authorized for any involuntary termination -- including cause -- would not qualify as an SRF under 409A.

Just a small point, mentioned at places in the above threads but (it strikes me) at times lost:

The provision of the regs (p 259 in my print out) says "f a service provider's entitlement to the amount is conditioned on the occurrence of the service provider's involuntary separation from service without cause, the right is subject to a substantial risk of forfeiture if the possibility of forfeiture is substantial."

This does not literally address the issue of whether involuntary termination for cause could be an SRF, unless we apply the rule "Expresio unios est exclusio alterius."

A friend of mine describes these regs as "prohibiting someone from sticking a pencil in his eye in order to claim an exemption for blindness." This would be a perfect example: The employee can control his termination by engaging in embezzlement or a wide stance (someone said this above -- very funny) etc.

The company still gets to decide whether to fire the guy. Voluntarily quitting to avoid embarrassment is an alternative and -- voila -- that would forfeit the compensation. It seems that the theory that a "for cause" provision authorizing a payout gives the employee a way to control his leaving and getting paid is sort of the flip side of "good reason." If so, the absence of a definition of cause is a huge omission, if the IRS really intended this.

Contrary to what the IRS says, I am throwing in with the view that involuntary termination that does not make the distinction between cause and bad events less than cause still qualifies as an SRF. The reference on p. 259 was just an errant one, reflecting the by far most common structure of these arrangements but not setting down a hard and fast rule that involuntary termination for cause cannot constitute a 409A SRF.

This kind of debate shows why we need a release defining, for example, death. This thing is moving beyond tragedy to farce.

[Guest CABatty]

This kind of debate shows why we need a release defining, for example, death. This thing is moving beyond tragedy to farce.

Perseo, you're in luck - we do have a definition of "death", in case you haven't seen it.

(yes, it's a joke)

notice2007_90.pdf

[Steelerfan]

The regs state generally that conditions under the discretionary control of the employee (other than the decision whether or not to continue working) do not create an SRF. Regardless of the absurdity of an employee being in discretionary control of the "cause" event, note that only conditions that relate to the performance of services, such as continued substantial performance or meeting a performance goal can create and SRF. (these are ideas borrowed from the section 83 concept).

I agree it should be cleared up, but those rules can be interpreted to reach the result the IRS wants without defining cause. A payment conditioned on termination for cause, regardless of the definition, is NOT conditioned on an event that is related to the performance of services. The event--Cause--has nothing to do with the employee's performance or the employment relationship.

You might get clarification from the IRS but it might not be what you're looking for.

Also, are you willing to take the risk of drafting your plan to provide for payment upon involuntary termination (without mentioning cause or not cause), only to have the IRS subject your plan to 409A because you didn't make the clarification stated clearly in the regs that the an involuntary termination NOT FOR CAUSE is what creates an SRF?