This practice note provides guidance on the executive compensation issues that frequently arise in corporate transactions involving public companies. It explains how to handle the most important executive compensation issues in a typical merger, acquisition, or other corporate transaction. In addition to general transaction-related matters, tax-related considerations are discussed pertaining to parachute payments under I.R.C. §§ 280G and 4999 (Section 280G) and nonqualified deferred compensation under I.R.C. § 409A (Section 409A) and relevant considerations relating to the compensation deduction limitation for public companies under I.R.C. § 162(m) (Section 162(m)), which was significantly modified for tax years beginning after 2017 by the Tax Cuts and Jobs Act (Pub. L. No. 115-97) (the 2017 Tax Act).

The practice note discusses the following topics:

  • Initial Considerations
  • Due Diligence Considerations
  • Section 280G Parachute Payments
  • Section 409A Nonqualified Deferred Compensation
  • Section 162(m) Compensation Deduction Limitation
  • Equity Award Considerations

For discussion of employee retirement plan benefits in corporate transactions, see Retirement Plan Issues in Corporate Transactions.

Initial Considerations

When approaching a corporate transaction involving a public company, you should first identify a few critical characteristics of the transaction that will help you understand the overall structure and determine the relevant considerations and alternatives relating to executive compensation matters. These considerations include the structure of the transaction, the types of parties (i.e., the parties' organizational structure and whether they are public or private), and the business purpose of the transaction.

Structure of the Transaction

First, you will need to consider the structure of the transaction. Public company transactions can take many forms, including equity acquisitions/dispositions, asset acquisitions/dispositions, mergers, spin-offs, and combinations of the foregoing. One of the most important distinctions between these different deal structures is whether the assets and liabilities will transfer automatically to the buyer or surviving entity as a matter of law.

Common types of corporate transactions include:

  • Stock sale. This transaction occurs when one company acquires the stock or other equity interests of another company. This may be the stock of the seller/target or of a subsidiary or other related entity.
  • Asset sale. This transaction occurs when one company acquires all or a portion of the assets of another company. Counsel should note that assets can include stock in a subsidiary or another entity, which raises many of the same issues that are raised by a stock transaction.
  • Merger. This transaction occurs when one company merges into another company. This raises many of the same issues as a stock transaction. Mergers are structured in different ways and it is important to understand the structure of the merger to determine how to address executive compensation matters during and following the merger. Common types of mergers include:
    • Direct merger. A direct merger occurs when the target company merges into the acquiring company, without using a merger subsidiary. This is not a very common structure in public company transactions.
    • Forward triangular merger. A forward triangular merger occurs when a subsidiary of the acquiring company merges with the target company and the subsidiary is the surviving entity after the merger.
    • Reverse triangular merger. A reverse triangular merger occurs when the acquiring company creates a subsidiary to merge with the target and the target is the surviving entity after the merger. This is easier to accomplish than a direct merger because the subsidiary has only one shareholder and the identity of the target does not change. This is a very common structure for public company transactions.
  • Spin-off. This transaction occurs with the creation of an independent company through the sale or distribution of shares of an existing business or division of a parent company.

All of these types of transactions can raise issues with executive compensation arrangements. For convenience, this practice note describes all transactions involving equity as stock transactions, but the same considerations generally will also apply in the context of transactions involving the sale or disposition of other types of equity interests, such as partnership interests.

Stock Transactions

In a stock transaction where the target company employs the employees and maintains the benefit plans, the target company will continue to employ the employees and maintain the compensation and benefit plans, absent some agreement of the parties to the contrary. Similarly, in a merger of the target company into another entity, the surviving entity (which may also be the target company depending on the structure of the transaction) will step into the shoes of the target company and will, as a matter of law, become the employer of the employees and will maintain the compensation and benefit plans.

In a stock transaction or merger where the employees are employed-and the compensation and benefit plans are maintained-at a parent level or by another affiliated company, the compensation and benefits matters will typically be addressed in a manner like an asset transaction.

Asset Transactions

In an asset transaction, the employees and the compensation and benefit plans generally will not move to the buyer as a matter of law and instead the parties will negotiate the treatment of those matters and reflect the outcome in the operative documents. Employees of the target company who transfer to the buyer (or any affiliate of the buyer) will experience a technical termination of employment with the seller. Such termination of employment will impact the alternatives that may be available with respect to the benefits of such individuals. Although the buyer may agree to assume certain compensation and benefits obligations of the target company, this is not legally required and would be subject to the negotiation of the parties. A spin-off may be treated like an asset transaction depending on the actions taken prior to the spin-off to divide up benefit plans and employees.

Types of Parties

In addition to identifying the structure of the transaction, you should ascertain the types of parties involved in the transaction. It is important to determine whether the buyer and seller/target are public or private companies and the organizational structure of the companies, such as corporations, partnerships, limited liability companies (and whether such LLCs are taxed as a partnership or corporation), disregarded entities, etc.

As described later in this practice note, there are specific considerations that apply to public companies for purposes of the parachute payment rules of Section 280G, the deferred compensation rules of Section 409A, and the compensation deduction limitation rules of Section 162(m) of the Internal Revenue Code (the Code). Further, in certain cases, the rules discussed in this practice note do not apply unless the entity in question is a corporation. This practice note discusses these issues in the context of transactions where one or both parties to the transaction are publicly traded.

Business Purposes

Counsel should understand the parties' purposes for entering into the transaction. For example, is the buyer purchasing a business for primarily strategic reasons (i.e., an operational business) or is the buyer a financial investor (e.g., private equity fund)? You will be in a better position to advise your client as to certain positions to take on executive compensation and other benefit issues when you know the intent of the parties with respect to the business. This knowledge will help you to develop a strategy for employees and compensation and benefit plans that will work for all parties to the transaction.

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Originally Published by Lexis Nexis Practical Guidance.

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