Incorporation of definitions by reference

[Guest CABatty]

Are 409A-compliant definitions required to be spelled out in the plan document, or can the document incorporate them by reference? For example, would a plan that had a non-409A compliant definition of "Change in Control" be compliant if it provided that payments were made upon a CIC only if it qualified as a change in control under 409A?

This might be kind of obvious, but I'd appreciate any thoughts / opinions on what is required.

[Steelerfan]

Are 409A-compliant definitions required to be spelled out in the plan document, or can the document incorporate them by reference? For example, would a plan that had a non-409A compliant definition of "Change in Control" be compliant if it provided that payments were made upon a CIC only if it qualified as a change in control under 409A?

This might be kind of obvious, but I'd appreciate any thoughts / opinions on what is required.

We've taken the position that incorporation by reference is permissible. All of the guidance to date has indicated that the written plan document requirement should be (and is) limited to the material terms of form and timing of elections and payments, how much or formula, and the six month delay rule. Beyond that I don't think the IRS cares.

[Everett Moreland]

I agree with Steelerfan on incorporation by reference. You might consider the following:

1. The regs have 5 options in defining "separation from service" and 4 in defining "change in control." It makes sense to me to specify what the plan does for each option, to avoid ambiguity.

2. All employers and employees know what "separation from service" and "change in control" means--It means what they think it means. So failing to torture the employer and employee by including the referenced regulations in an appendix or separate document makes it more likely that the plan will not be administered as required by 409A.

[Guest CMC]

Anyone care to weigh in on just how important they think it is to conform to 409A definitions in an employment agreement setting? Take, for example, a situation where an EA promises additional severance -- 2xs base pay rather than 1xs -- where termination occurs w/in 18 months of a CIC. I've got one colleague who suggests that the distribution event here is the termination itself, so that it really doesn't matter whether the CIC definition conforms to the 409A definition. I've got a second colleague who counters that the definition does matter -- that but for the CIC, the second year's worth of severance wouldn't be triggered -- and that, b/c of the difference the definition makes in the amount of the benefits, the better practice is to be sure that the agreement's CIC definition is at least as rigorous as the 409A definition. I'd be interested in whether folks are inclined to agree with Colleague #1 or Colleague #2.

Thanks in advance for your thoughts!

[Everett Moreland]

CMC: If I understand your question, I agree with both of your colleagues, because they seem to be saying different things. #1 seems to be saying that the definition of "change in control" for purposes of the amount to be paid on severance need not be the 409A definition. I agree. #2 seems to be saying that the definition of "change in control" needs to be clear ("at least as rigorous as the 409A definition"), not that it needs to be the same as the 409A definition. I agree.

[Guest CMC]

I don't think they think they are saying the same thing. Might be I need to explain a bit more. We have reviewed an EA provisoin providing that an Exec gets greater severance benefits where termination occurs w/in 18 months of a CIC. CIC is defined to include a change in effective control where a person acquires 20% or more of the voting power of the company. 20% is less rigorous than the 30%-or-more-of-the-voting-power that is part of the 409A definition of CIC.

#1 thinks the less rigorous definition is o.k., maintaining that it is the termination that triggers the payout of severance benefits. #2 thinks the 20% needs to be increased to 30% (or more), noting that, while it is the termination that precipitates some payout, as to the additional severance benefits -- the ones the Exec would not get but for the CIC -- the CIC really is the trigger.

Is that clearer?

[Guest CABatty]

I agree with colleague #1, that the payment trigger would be the separation from service rather than the change in control, but without knowing the form of payment I can't say whether I agree or disagree with colleague #2.

If I'm reading your example correctly, the Exec receives an increased amount of severance if he terminates employment within 18 months after a change in control, but the definition of "change in control" is not 409A-compliant. In that instance, the change in control is only a vesting event - it doesn't trigger payment since the Exec only receives the increased severance if he separates from service within that time period. Since it's a vesting event and not a payment event, the CIC definition doesn't have to be 409A compliant.

However, if the agreement provides that the Exec receives installment payments upon a regular separation from service and a lump sum upon a separation from service within 18 months after a change in control, then the definition of "change in control" has to be compliant with 409A or else you violate the single time and form of payment rule.

Make sense?

[Guest CMC]

CABatty: You seem to be saying that if the CIC definition changes the time or form of payout, the definition must be 409A-compliant, but that if it only changes the amount of payment it need not be.

In our EA, CIC triggers more/different benefits as follows:

what would otherwise be 2 yrs of severance payable in a lump sum becomes 3 years payable in a lump sum;

what would otherwise be 2 yrs of continued participation in group health and other welfare benefits (or equivalent) becomes 3 yrs;

new right to continued perquisites (financial planning services, executive health program and club membership fees) for up to 3 years arises; and

new right to outplacement services arises.

#2 says that what he's hung up on -- and this may be what you are eluding to in your answer --is Treas. Reg. 1.409A-3©'s notation about tying separation of service to a change in control (see bottom of second column and top of third column on page 19310 in Federal Register version). That suggests that while a CIC that merely increases the amount of severance (which is what's going on with the lump sum severance above) may o.k., a CIC that increases the time frame/schedule of payments (as with the welfare plans above) may cause the definition of CIC to be important. Seems to me definition may also be important where a CIC is the deciding factor in whether certain benefits (the perks and outplacement services above) are paid out at all.

[Steelerfan]

Seems to me definition may also be important where a CIC is the deciding factor in whether certain benefits (the perks and outplacement services above) are paid out at all.

I'm not sure I agree with that statement. If CIC is a deciding factor in whether benefits are paid out at all looks like CIC is a vesting event and not a payment event. Without knowing more I agree with CABatty, looks more like CIC is a vesting event and not a payment event.

[Guest jhall]

What about a provision that provides that upon an involuntary separation from service not following a change in control the executive receives 12 months severance paid out in monthly installments but upon an involuntary termination within 12 months of a change in control, the executive receives 24 months of severance paid out in monthly installments.

In that case, the form of the payments is the same and the CIC does not determine whether severance benefits will be paid or not but the amount of severance--and thus the time or schedule of payments--is different for severance following a change in control. While the regular severance payments will be made over 12 months, the change in control severance benefits will take an additional 12 months. Would that constitute a different "time of payment" under 1.409A-3©?

[Guest CABatty]

Actually, I think in jhall's example where the length of the installment payments differs it would be two different times and forms of payment. I raised that same question in another thread (Single Time and Form of Payment) in the context of a separation from service due to non-409A compliant disability, and the general consensus was that the different length of installments would be different times and forms of payment.

Also, on p. 19306 of the Federal Register version of the regs (Section on installments - sorry, don't really feel like going through and figuring out the cite), it says that "a series of installment payments paid over a predetermined period and a series of installment payments over a shorter or longer period, or a series of installment payments over the same predetermined period but with a differenc commencement date, are different times and forms of payment."

So, to have different installment periods the CIC definition would have to be 409A-compliant. However, in jhall's example, depending on the amounts of the severance the payments may qualify for the 2x/2year exemption for severance paid upon an involuntary separation, which would avoid the issue altogether.

as for CMC's example.....I still think a non-409A compliant definition of CIC for the lump sum payment would work. The continuation of health insurance and welfare benefits I assume are going to be reimbursements / payments for COBRA continuation coverage unless the terms of the plan allow terminated employees to continue to participate, which I doubt, and so that benefit could be excluded through the COBRA exclusion and then the payments would be paid as a fixed time or schedule according to the reimbursement rules. The right to continued perquisites looks like an in-kind benefit that could be structured as a fixed time or schedule according to the reimbursement / in-kind benefit rules. Same thing for the outplacement services. But that all depends on the facts.

As for the definition of CIC being important in deciding whether benefits are paid, I agree with Steelerfan that the CIC is still just a vesting event. Would the executive receive the benefits upon the CIC regardless of whether the exec separated from service?