Upon reaching a letter of intent to acquire or sell a financial institution, many bank directors will breathe a sigh of relief. Following the economic challenges of the past several years, the directors of each institution have charted a course for their banks that will likely result in their respective shareholders realizing the benefits of a strategic combination. Although directors should be focused on “big picture” issues during the negotiation of a definitive agreement, they should not overlook the resolution of the many issues that can arise from executive compensation arrangements in a potential transaction. While often seemingly minor, compensation matters can raise unexpected issues that can delay or de-rail a transaction.

Procedural Issues

In addition to considering the economic features of a proposed merger, directors should also consider their individual interests in the transaction, including the potential payout of supplemental retirement plans, deferred fee arrangements, stock options, and organizer warrants that are not available to the “rank and file” of the company’s shareholder base. These arrangements may pose conflicts of interest for members of the board and are subject to different types of disclosure:

Disclosure of potential conflicts:  Early in the negotiation of a potential sale, individual directors should identify deal features that may create the appearance of a conflict of interest or an actual conflict of interest. With help from legal counsel, these personal interests should be disclosed and documented in the board resolutions approving the transaction. Appropriate disclosure and documentation of these actual or potential conflicts usually resolves these issues, but if significant conflicts exist, counsel may advise the use of a special committee or special voting thresholds for the transaction.

Shareholder disclosures:  While specific requirements may vary for private and publicly-traded companies, compensatory arrangements for directors and officers will need to be disclosed in detail as part of proxy materials mailed to shareholders. In particular, the SEC has begun requiring detailed compensation disclosures for directors and officers, even for deal consideration issued to these individuals simply by virtue of being a shareholder.

Cultural Issues

Directors of the selling bank should also monitor the negotiation of new employment contracts for selected members of its management team. Typically, these contracts will be completed prior to the seller’s entry into a definitive agreement and will indicate which members of its management team will be retained for a transition period or even long-term following the completion of the transaction. The cultural issues arising from the negotiation of these contracts can also require additional attention be paid to those who will not be offered positions following the transaction. These short-term employees can play an important role in preserving the value of the organization prior to closing and may even have value in terms of assisting with the integration of the two institutions, so providing them with clear roles and concrete expectations early in the process can resolve many issues.

Tax Issues

Responsible choices made to manage the economic crisis, including the suspension of director pay, may give rise to unexpected tax issues that must be resolved as the definitive agreement is negotiated. Here are some examples:

Golden parachutes:”  If applicable, Section 280G of the Internal Revenue Code will treat most transaction-related payments or accelerated vesting of options or warrants for directors or officers as parachute payments. If these payments exceed a certain percentage the individual’s average compensation over the past five years, then both the individual and the bank will be subject to significant tax penalties with respect to those parachute payments. When financial institutions have previously suspended director compensation, 280G presents an even greater challenge because directors in those situations have little or no average compensation history

Existing compensation arrangements are often highly problematic for a transaction, so developing a strategy for managing the procedural, cultural and tax implications of these arrangements early in the negotiations is key. Resolving these issues can take time and effort, but if the parties do so successfully, they will have taken an important step toward consummating a successful transaction.

This article was originally published on BankDirector.com.