payment question

I have a client who wants to give phantom stock to a director.

The phantom stock will vest and pay out upon a change in control.

However, the client wants to be able to remove the director at any time before the liquidity event but the director (now former) will still get paid out upon the change in control provided he hasn't violated his non-compete/non-disparagement, etc. agreement.

This feels problematic but I can't really pinpoint why except I don't know how the company can deduct any payment to this guy if he is no longer a director.  

What else am I not seeing?

I don't see any 409A issues there.

But I don't like it for other reasons, particularly if there are no time limits. Do they want to have an outstanding obligation to the former director for an unknown period of time? Right now they may feel he or she deserves a piece of the pie if there's a CIC, but will they feel that way in 5 years? Even if they think a CIC is likely in the near term the situation can change .

That said, I have seen it done before, despite my feedback.

You've simply converted a short term deferral into a 409A arrangement (payable for a permitted reason). I don't see an issue except that after you do this you can't change the timing without complying with the 409A rules. For example, if you later decided it was too long to be committed to this and wanted to cash him out, you wouldn't have that flexibility. 

Wouldn't the requirement for a change in control preserve the substantial risk of forfeiture? It sounds to me like the change in control itself is a separate vesting condition.

I don't see an issue either, except it's a bit unusual to have a CNTC, non-disparagement for a director.

We have done similar where client wanted and agree with all above comments. Would add that unless the c-in-c is imminent, you might to try to cap the value at whatever it is when the director leaves. Also, I have heard the argument (but never verified myself) that unless you say that even if a c-in-c has not yet occured, the interest will vest within a life-in-being plus 21 years, the agreement would violate rule against perpetuities. I guess it might in some states. More practically, you might want to provide for vesting at death, at least for some reduced benefit amount, since dealing with the contingent benefit as an asset of estate could get very complicated.

Thanks everyone.

 I understand that the IRS has expressed the opinion that a COC is NOT  a substantial risk of forfeiture unless you condition that it must occur within a fixed period such as 5 years.  This is on the theory that, at some point in the indefinite future, it is substantially certain that a company will undergo a COC.  This is NOT a concern, for example, if the vesting condition is an IPO.  It is not substantially certain that every company will have an IPO.

Don't see any problem with this director compensation being deductible by the company.

I agree that an outside timeframe is ideal (for the reason you mention and many others). On the other hand, I think you can probably get by without it depending on the circumstances. I work with many closely held/family owned companies, and we often carve out a CIC that transfers ownership to family members, related parties, estate planning trusts, etc. so it's only triggered when there is a true arm's-length sale to an unrelated third party for consideration. I don't think I've ever relied solely on that to delay a SROF, but I think you could take the position there is a substantial risk that such a transaction may never occur. 

4 hours ago, Linda Wilkins said:

 I understand that the IRS has expressed the opinion that a COC is NOT  a substantial risk of forfeiture unless you condition that it must occur within a fixed period such as 5 years.  This is on the theory that, at some point in the indefinite future, it is substantially certain that a company will undergo a COC.  This is NOT a concern, for example, if the vesting condition is an IPO.  It is not substantially certain that every company will have an IPO.

Linda, good point. I think I had heard that too at some point. But that just takes you out of the short-term deferral rule, right, assuming you were in it to begin with, because payment would be a lump sum within the short-term deferral period? As long as you pay only on a c-in-c, then even if you have deferred comp (because indefinite time-frame for c-in-c means no SRF), you would still have 409A-compliant deferred comp, I think.

On 12/11/2020 at 6:40 PM, mariemonroe said:

I have a client who wants to give phantom stock to a director.

The phantom stock will vest and pay out upon a change in control.

However, the client wants to be able to remove the director at any time before the liquidity event but the director (now former) will still get paid out upon the change in control provided he hasn't violated his non-compete/non-disparagement, etc. agreement.

This feels problematic but I can't really pinpoint why except I don't know how the company can deduct any payment to this guy if he is no longer a director.  

What else am I not seeing?

I have been searching for the best payment gateway for my business for a long time and finally came across the https://paymentgateway.me/ platform. Here I was able to study information about various payment gateways and stop choosing one of them.