Canada: Surviving Change

Last Updated: November 29 2006
Article by Christina Medland

Originally published in A Director's Guide to Executive Compensation, November 2006.

Compensation Issues Arising in Transactions

Executive compensation continues to make headlines in Canada and the United States, with transaction incentives coming under particular scrutiny. Shareholders and members of the public continue to monitor the types and quantum of payments made to incoming and outgoing executives in connection with corporate transactions.

In some cases, payments to an executive following or in anticipation of a corporate transaction may amount to millions of dollars. For example, in 2005, Houston Explorations Co. entered into new employment agreements with some members of its executive team, including its president/CEO. The new employment arrangement with the president/CEO included a US$4.2 million dollar cash payment, and avoided a transaction bonus payment of up to US$7.5 million. Houston also disclosed that it expected to incur general and administrative expenses of about US$5.1 million in terminating the previous employment agreements and entering into new agreements with its executive team.1

In the fast-paced transactional setting, executives are often faced with the difficult task of simultaneously ensuring their own job security, defending the interests of their employer and maximizing shareholder value. Without proper retention mechanisms, a valuable member of management may react to resolve these conflicting goals by leaving the corporation at a time when it particularly needs that executive’s skills to complete the sale and provide transitional leadership.

Amounts paid to executives have increased exponentially in the past few years, and so too has the pressure on directors who make compensation decisions. Directors are required at all times to consider their fiduciary obligations to the company, while recommending that the company offer competitive remuneration to executives on both a transactional and an ongoing basis.

This newsletter issue explores the treatment of executive compensation in the context of corporate transactions, from the perspectives of both the employee and the directors who make compensation-related decisions. We focus on change-of-control agreements and transaction-based bonuses. We also highlight governance-related considerations and the role of experts as well as liability and indemnity issues that confront directors who approve compensation arrangements in the context of corporate transactions.

Change-of-Control Agreements

While a change of control may result in a significant number of employment terminations below the senior executive level, these are generally driven by business synergies, rather than by an acquiror’s hostile response to a difficult acquisition.

The situation is different for executives who may be at risk of losing their position after a transaction that they are expected to negotiate. As a result, to retain and motivate executives through this process, specific change-of-control protections may be agreed to.

There are three basic types of change of- control employment agreements: a "single trigger," a "double trigger" and a "walk window" agreement. Each is discussed in detail below.

Types of Agreements

Single-Trigger Agreement

A "single trigger" change-of-control provision gives an executive the right to resign for any reason (or for no reason), usually during a limited time period following a change of control (the "sunset period"). The sunset period generally ends between 12 and 24 months after the change of control.

Shareholders dislike single-trigger agreements because they (i) allow the executives to reduce the value of the business by resigning even if the acquiror wants them to stay; (ii) increase severance costs to the business; (iii) provide leverage to the executive team to negotiate enhanced employment arrangements post-acquisition if the acquiror wishes to retain them; and (iv) can motivate the executive team to support any transaction whether or not in the shareholders’ best interests.

As a result of unfavourable shareholder reaction, single-trigger change-of-control agreements have become much less common in the last five years. However, they are sometimes introduced for the CEO and other executives who have a front-line role during a hostile acquisition process.

Executives in these situations may be required by the board to aggressively defend the shareholders’ position. This will put the executives in a position of utmost hostility with the acquiror, effectively eliminating any possibility of continuing employment and making a single-trigger agreement the only effective way to protect the senior executive team from a hostile acquiror.

More recently, companies have sometimes introduced limited single change-of-control provisions that allow the executive to resign on a change of control that the board has determined is hostile (a "hostile single trigger") but that maintain a double-trigger change of control for friendly acquisitions (a "friendly double trigger").

Double-Trigger Agreement

A "double trigger" change-of-control clause requires the occurrence of two events to trigger severance: the first, a change of control; the second, a termination without cause or resignation based on adverse changes to the executive’s terms of employment ("good reason"). The termination or resignation must generally occur within the sunset period following the change of control (usually 12 to 24 months).

Good reason for resignation is usually specifically defined, as discussed in detail in the next section of this article.

Shareholders generally view double-trigger change-of-control agreements more favourably than single-trigger agreements. Double-trigger agreements provide a reasonable balance between protection of the executive and preservation of the value of the business. They give executives certainty regarding severance, which they can obtain on resignation for good reason or on termination. However, on a change of control that is not hostile or in which the acquiror wishes to retain the executive team, the members of the team are not permitted to resign without good reason.

A double-trigger change-of-control agreement provides a significant incentive to executives not to resign in the face of or following a change of control, because the termination benefits are payable only when there has been both a change of control and actual or constructive termination.

Walk-Window Agreement

A "walk window" is a modified single-trigger agreement. The executive is permitted to resign for any reason following a change of control, but only within a window that is delayed for 3 to 12 months following a change of control and that is open usually for 3 to 6 months.

A walk window can protect key or front-line executives who would inevitably be put in positions of extreme hostility with the acquiror; the provision allows them to focus on defending the organization and at the same time keeps the executive team in place for a sufficient period of time to allow the acquiror to transition to a new executive team. Walk windows can also give both the employer and the employee a period during which they may be able to work out the terms of an ongoing relationship.

Key Terms in Agreements

Any change-of-control agreement has four key terms: the definition of "change of control," the definition of "good reason," severance entitlements following the triggering events and acceleration of incentive compensation.

Change-of-Control Definition

What is intended to constitute a change of control should be clearly defined in the agreement and may include the following types of events: sale of all or substantially all of the assets of the business, sale of sufficient voting securities to elect the board of directors, merger or acquisition, a plan of arrangement, insolvency and a hostile proxy fight.

Change of control should be carefully defined to (i) avoid including internal reorganizations, mergers, reverse takeovers (where the subject company remains the dominant entity) and transfers among the group of entities controlled by a substantial shareholder; and (ii) cover changes of control structured in less traditional ways. Some definitions of change of control therefore include the board’s right to declare that a change of control has occurred or is about to occur.

Good Reason Definition

Generally, a double-trigger agreement allows an executive to resign for "good reason" or with "justification." Good reason and justification definitions codify what is otherwise constructive dismissal—generally a material adverse change to the employee’s terms and conditions of employment. A material adverse change can include a decrease in compensation, demotion, changes in reporting relationship and relocation of place of work. The definition of good reason may also include specific events that would not necessarily amount to constructive dismissal—for example, the CEO ceases to be a director of the company or, for a person who reports directly to the CEO, the CEO resigns or is fired.

A definition of good reason may answer questions that often arise in a merger—for example, whether the change from being CFO of a $100 million business to VP Finance of a $500 million business is a material adverse change in the terms and conditions of employment. Care should be taken to ensure that unintended results do not flow from the definition of good reason.

Severance Entitlements

Executive severance entitlements tend to be market-based, rather than based on the implied agreement to provide reasonable notice of termination of employment. It was common practice a number of years ago to provide for enhanced severance entitlements if an executive’s employment was terminated or the executive resigned following a change of control—for example, provisions entitling the CEO to 24 months’ compensation if his or her employment was terminated before a change of control would be increased to 36 months’ compensation if his or her employment was terminated within 24 months of a change of control.

It is difficult to find any compelling reason to support this type of increased severance and it may perversely motivate an executive to seek any change of control, whether or not in the shareholders’ best interests, in order to access enhanced severance. For these reasons, enhanced severance is now uncommon in change-of-control agreements.

It is, however, still usual after a change of control to provide for (i) vesting of incentive compensation to be accelerated to the date of termination or resignation for good reason; and (ii) the achievement of performance targets, if any, to be assumed. The change of control is outside the executive’s control, and may make the performance targets impossible to achieve or irrelevant. The executive’s termination is more likely to be based on business factors extrinsic to the executive’s performance.


When a corporation is considering an acquisition or other major corporate transaction or is the target of another corporation, transaction incentives such as bonuses may be appropriate to reward, motivate and, in certain circumstances, retain key members of management through the transaction process and beyond.

Transaction Bonus

A transaction bonus is designed both to retain the executive team during the difficult period before completion of the transaction and to reward the executive team for the results achieved on the transaction. Generally, a transaction bonus will be based at least in part on one or more of (i) total value of the transaction; (ii) value of the transaction in excess of a specified amount; and (iii) achievement of other objectives or milestones essential to the transaction. A transaction bonus is generally limited to those executives or members of senior management who can have a direct effect on the accomplishment of the transaction objectives.

Payment of a transaction bonus is generally conditional on (i) completion of the transaction; and (ii) the executive not resigning or being terminated for just cause before the payment date. The bonus payment date may be the closing date or, if retention of the executive team for a transaction period after closing is important, a later date, usually 3 to 12 months after closing.

The type of incentive bonus depends, in part, on the contribution the executive can make to the transaction and his or her historical relationship with the company.

Retention Bonus

A retention bonus program is often established in connection with a transaction. However, its focus is retention, rather than the achievement of transaction value or other objectives. A retention bonus will generally be offered to key senior management employees below executive level. These are employees who are important to the success of the business, but who do not have any direct effect on the accomplishment of the transaction objectives.

Retention bonuses are usually a fixed amount or a percentage of salary ranging from 10% to 100%, depending on the retention risk and the employee’s importance to the business. Retention bonuses should be sufficient in size to retain most key management, but do not need to be so large as to guarantee 100% retention.

Whether or not a transaction closes, retention bonuses are generally paid at the earlier of (i) the end of a fixed period, which should be a reasonable estimate of the time required to complete the transaction plus a margin; and (ii) a short transition period, which is usually one to three months after the closing. Retention bonuses are not paid to employees who resign or are terminated for just cause before the payment date.

Directors’ Standard of Care and the Role of Experts

The standard of care required of directors, as a matter of corporate law, is that in carrying out their duties and exercising their powers, directors must (i) act honestly and in good faith and with a view to the best interests of the corporation; and (ii) exercise the care, diligence and skill that a reasonably prudent person would exercise in comparable circumstances.2 This same standard of care is required of directors in fulfilling their compensation governance obligations.

The role of experts has become vital for directors in meeting the requisite standard of care. In addition to the rules regarding compensation committees, National Policy 58-201, Corporate Governance Guidelines, states that the compensation committee should be authorized to engage and compensate outside advisers, as necessary to carry out its duties.3

Directors are increasingly turning to experts for advice in meeting their standard of care in balancing their duties to shareholders and their interest in satisfying management. Boards and committees can benefit from the knowledge and insight of compensation experts regarding various forms of compensation; their legal, regulatory, tax and securities ramifications; and prevailing market practices.

The board or the compensation committee should retain the expert and ensure that the expert reports to and consults directly with the board or committee. Any consultation by an expert with the executives should be done under the supervision of the board or compensation committee. The board or committee members should ask questions to ensure that they understand the proposed compensation; the amount of the compensation in both good and bad business scenarios is appropriate; the expert’s advice is independent; and the compensation is in line with that of the appropriate peer group.

Indemnities and Liability Insurance for Directors

Like executives, directors are also vulnerable when a change of control takes place. Their risk of being subject to claims increases as new owners step in and re-examine the directors’ actions, particularly those in defence of a hostile acquisition. In addition, indemnities and directors’ and officers’ insurance may be reduced or eliminated by the new board.

Directors’ and officers’ insurance is generally provided on a "claims made," rather than on a "claims incurred" basis. This means that individuals who cease to be directors are not automatically covered for their acts and omissions while they were directors, particularly if the insurance policy is cancelled. This may sometimes be rectified through non-cancellable insurance, extended reporting insurance or prepaid insurance. In practice, however, insurance can be expensive to obtain and the required coverage may not be available at all.

Indemnities provided only in the organization’s by-laws can be changed by the organization. For this reason, a contractual indemnity will generally be preferable for directors.

Setting an amount aside for directors’ indemnity may also protect the directors against steps the new board may take or omit to take that may increase directors’ personal liability in circumstances in which they should legally be entitled to an indemnity. The escrow would generally be for the duration of the applicable limitation period to ensure protection for the directors.

Directors who provide protection for themselves should always be concerned about how their actions will be viewed. However, courts accord considerable deference to the business decisions of boards. Board decisions that are made honestly, in good faith and with a view to the best interests of the company will generally not be overridden by the court.

Recent case law in Canada suggests that directors and officers may meet the standard for the application of the business judgment rule even when a board’s decision benefits the directors and officers. Accordingly, if the board is able to show that it thoughtfully weighed the alternatives and set aside funds for good business reasons, a court may uphold the board’s decision as reasonable even though the escrow provides a benefit to the directors at the expense of the company.4

In insolvency proceedings, courts have accepted that, in order to retain directors during an insolvency, it may be necessary to approve a charge on the assets of the insolvent company or the establishment of an escrow fund. In the insolvency proceedings of Stelco, the directors obtained a court order setting aside $10 million in trust for indemnity costs.


1. Dow Jones News Wires, "Houston Exploration Signs New Employment Pact with Execs" Dow Jones Corporate Filings Alert, 11 February 2005.

2. Ontario Business Corporations Act, R.S.O. 1990, c. B.16 at s. 134(1).

3. National Policy 58-201, Corporate Governance Guidelines (June 30, 2005) at s. 3.16 [NP 58-201], as set out in National Instrument 58-101, Disclosure of Corporate Governance Practices (2005) 28 O.S.C.B. 3615.

4. Peoples Department Stores Inc. (Trustee of) v. Wise, [2004] 3 S.C.R. 461.

Thank you to Tara Sastri for her valuable contribution to this newsletter.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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