Failed Change in Control

[Christine Roberts]

NQDC plan provides that the plan must terminate within 30 days of a change in control and provides for a benefit to otherwise ineligible employees, upon a change in control.

Employer negotiates stock sale of entire company; seller will not exist after sale and buyer will not assume seller's obligations under plan. Plan terminates and benefits are distributed.

Change in control transaction falls through.

Is this a 409A violation?

If so, is it something that foreseeably could be corrected through the proposed 409A voluntary compliance program?

Plan also allows for discretionary termination but 409A prevents distribution of benefitsfor 12 months unless benefits would have been distributed had plan not terminated, and in this scenario benefits are already distributed.

[Chaz]

An initial question: What exactly is the definition of "change in control" in your NQDC plan?

If it is merely entering into an agreement to sell and the agreement, in fact, is executed, then a change in control has indeed occurred (whether closing ever happens), and in my view, payment can be made using the ST deferral exception (if the payment is made in time) because the CIC is a vesting event.

If the CIC is defined as the closing of the transaction, then more analysis is needed.

[Christine Roberts]

An initial question: What exactly is the definition of "change in control" in your NQDC plan?

If it is merely entering into an agreement to sell and the agreement, in fact, is executed, then a change in control has indeed occurred (whether closing ever happens), and in my view, payment can be made using the ST deferral exception (if the payment is made in time) because the CIC is a vesting event.

If the CIC is defined as the closing of the transaction, then more analysis is needed.

Plan defines CIC as a change in ownership or effective control of the corporation, or in the ownership of a substantial portion of the assets of the corporation as such terms are defined in Internal Revenue Code Section 409A(a)(2)(v) and Proposed Treasury Regulations Section 1.409A-3(g)(5)(v) through (vii), as such provisions may be amended from time to time or finalized.

The applicable final reg provides that a change in the ownership of a corporation occurs on the date that any one person, or more than one person acting as a group (as defined in paragraph (i)(5)(v)(B) of this section), acquires ownership of stock of the corporation that, together with stock held by such person or group, constitutes more than 50 percent of the total fair market value or total voting power of the stock of such corporation.

I don't think that this would ordinarily happen (>50% ownership) before closing. But I am a benefits atty. not an M&A expert...

[Chaz]

I don't know all your facts but based on your posts it seems to me that the plan termination was premature and really didn't happen (because there was no CIC as appears likely).

Perhaps you can take the position that the payment upon the CIC is subject to a SRF and is payable within the ST deferral period (and is thus outside of 409A and the CIC is not the payment event). Instead of the distributions being made because of the termination of the plan, the company can determine that the payments were made because the company decided to accelerate vesting, which is permitted under 409A. Of course, there are corporate governance issues with this and I really don't know your facts, but this is a possible approach, I think.

[Christine Roberts]

I don't know all your facts but based on your posts it seems to me that the plan termination was premature and really didn't happen (because there was no CIC as appears likely).

Perhaps you can take the position that the payment upon the CIC is subject to a SRF and is payable within the ST deferral period (and is thus outside of 409A and the CIC is not the payment event). Instead of the distributions being made because of the termination of the plan, the company can determine that the payments were made because the company decided to accelerate vesting, which is permitted under 409A. Of course, there are corporate governance issues with this and I really don't know your facts, but this is a possible approach, I think.

I posed this question during the ALI-ABA Fall Employee Benefits Update webcast and William C. Schmidt, IRS Senior Counsel, Exec. Compensation, basically said its a drafting problem because the plan allows for distribution on the basis of a threatened or imminent change in control, not a CIC as defined in the final regulations (requiring actual >50% ownership by the acquirer). The final regulations still define a distribution due to a CIC as one occuring "within the 30 days preceding or the 12 months following a change in control event " ......so I don't know how the 30-day prior component can be based on anything but an anticipatory CIC, but obviously did not have a chance to pursue this further under the circumstances.

[Chaz]

I guess my "CIC" as a vesting event and payments being made in the ST deferral period idea was a non-starter?

[Steelerfan]

I don't understand his response, or really the question maybe. Why would a plan provide for payment on the possibility of a change in control; don't believe i've ever heard of that. It's rather obvious that you'd have to have a 409A compliant definition in order to distribute, and that the CIC would have to occur. Also, how is this not an operational error? But I agree with you, it seems the IRS would have to allow you to unwind the transaction (practicalities aside) if the CIC didn't occur within 30 days. Maybe the lesson is not to actually distribute until the CIC occurs, then all you would have to do is undo the termination resolution.

Also, chaz's idea of STD sounds promising but only if there would have been no right to the payment but for the CIC. It almost sounds in your OP that some participants would have no LBR to the compensation unless a CIC occurs. If that is the case, the STD could apply.

[Guest CABatty]

I guess my "CIC" as a vesting event and payments being made in the ST deferral period idea was a non-starter?

How is the CIC a substantial risk of forfeiture when the benefits were paid even though the CIC never occurred? The contemplation of the CIC could be the vesting event, but I don't think that would qualify as a SRF under 409A.

I agree that it sounds promising, but...

[Chaz]

Let me explain.

Clearly, a change in control can be a vesting event if there is no right to a payment before the "CIC." In such a case, a CIC can be defined pretty much as whatever you want and need not meet the 409A definition as long as there is a SRF. It's outside of 409A if the amounts are paid within the ST deferral period.

If such is the case (I agree that vesting upon "contemplation" of a CIC is not a SRF, but, for instance, entering into an agreement and plan of merger is, even if the deal ends up falling apart), an employer can determine that payment be made even if the CIC didn't occur (in a sense, it is an acceleration of vesting).

That was my suggestion, although I noted that I did not have all the facts of her situation. The OP stated that the arrangement "provides for a benefit to otherwise ineligible employees, upon a change in control," which is why I think that the ST deferral rule may be useful for those employees, at least.

[Steelerfan]

The STD rule can also apply if payment is made withing 2.5 months after the year in which the person obtains a legally binding right to payment. So, it might be easier on these "facts" to argue that otherwise ineligible employees who become eligible had no legally binding right to the payment prior to the CIC rather than subject to SRF. After all, how can a payment be subject to forfeiture if you were not eligible for the payment in the first place?

[Chaz]

The STD rule can also apply if payment is made withing 2.5 months after the year in which the person obtains a legally binding right to payment. So, it might be easier on these "facts" to argue that otherwise ineligible employees who become eligible had no legally binding right to the payment prior to the CIC rather than subject to SRF. After all, how can a payment be subject to forfeiture if you were not eligible for the payment in the first place?

Good point. It's REALLY not a 409A issue in that case.