In light of robust merger and acquisition activity, companies should review their compensation and benefits programs to understand the effect that a change-in-control transaction would have. Often, in the face of an impending change-in-control transaction or at the time that a company puts itself into play, it may be too late to implement new programs or make changes to existing programs. Companies should consider change-in-control implications at the time that they adopt plans or, where applicable, at the time awards under those plans are made.Many compensation components can be affected by a change-in-control transaction, including equity awards (in particular, those that are unvested), cash-based incentive awards (both annual and long-term) for then-in-progress performance periods, deferred compensation (and any funding of deferred compensation), severance entitlements and triggers, and noncompetition and similar restrictions. Tax considerations and, in particular, the golden parachute rules of section 280G of the Internal Revenue Code must also be taken into account.
We will focus on many of these considerations in future posts. For today, we will touch on the treatment of unvested equity awards. In years past, when the prevalent form of equity award was the plain-vanilla time-based stock option, and when institutional shareholders were not so vocal, the governing documents for the vast majority of these awards provided for immediate, “single-trigger” vesting upon a change-in-control transaction. In today’s more complex world, where options and time vesting have been supplemented with or replaced by full-value stock awards and performance vesting, and where institutional shareholders regularly voice their views, single-trigger vesting is not a foregone conclusion.
Institutional shareholders clearly favor “double trigger” vesting, where a participant stays on the same vesting schedule and acceleration (if any) occurs only after a change-in-control termination of employment under “good leaver” circumstances (e.g., termination by the acquiror without cause, or, in some cases, resignation by the participant for “good reason”). Applying this approach to time-vested awards is straightforward; however, it may not be so simple for performance-vested awards. Where performance metrics do not lend themselves to measurement after a change-in-control structure, different approaches can be taken, including vesting at target level of performance or vesting based on actual level of performance through the date of the transaction. This applies in either case, with or without proration based on the portion of the performance period completed through closing of the transaction. Often, the portion of the award that is considered earned, based either on assumed target performance, actual performance, or some other approach, will not vest immediately but will time-vest based on the original performance period, with possible double-trigger accelerated vesting on good leaver termination of employment before that date.
In a change-in-control transaction where the award is not otherwise to continue or be assumed by an acquiror, such as an all-cash deal for 100% of the target company’s stock, many plans provide for single-trigger acceleration of time and performance awards (assuming target or some other level of achievement), and institutional shareholders do not seem to take issue with this approach. However, even in this scenario, an emerging trend seems to apply the double-trigger approach to the resulting cash that otherwise would be paid for unvested awards (e.g., the cash-out payment is deferred and paid only if and when the participant would otherwise have vested, subject to double-trigger acceleration upon a good leaver termination of employment). Notably, this approach raises potential issues under section 409A of the Internal Revenue Code that need to be carefully considered.