Summary

  • Executives are sometimes offered retention arrangements if a change of control is on the cards.
  • Sometimes this leads to criticism, as in Billabong’s case.
  • Despite that, these arrangements can be essential for a company facing a takeover bid.

When Billabong International released its annual report in August, it was criticised for entering into retention arrangements with a number of senior executives.

The company said the arrangements were made 'given the need to retain key senior executives to manage business, and drive the transformation strategy, during the ongoing change of group control activity'.

Under the arrangements, executives were entitled to an amount of up to 6 months’ base salary, payable if the executives were retained until the earlier of a change of control or 30 June 2013. For the CEO, additional non-financial performance hurdles were included which related to the development and execution of the company’s transformation strategy. As part of the arrangements, the normal short term incentives available to executives were reduced by an equivalent amount.

The arrangements resulted in a series of payments in a mix of cash and deferred equity, the value of which ranged from $91,000 to $650,000 per executive.

The AFR’s Chanticleer column said that shareholders will be 'shocked' to see the retention payments in a year when the company had $867 million in impairments and significant items because of poor governance and mistakes by past management. Chanticleer went on to say:

'It is difficult to find any circumstances under which retention payments are in the interests of shareholders. Executives are well remunerated for running a business and the pay packets are meant to be in alignment with the interest of shareholders.'

Is this criticism justified?

Retention arrangements are entered far more frequently than Chanticleer’s comments seem to imply.

Giving certainty to key employees in the face of a takeover threat is often in the interests of the company. A retention arrangement is intended to allow the executives to focus on their jobs and not to be distracted by the possibility of being retrenched after a change of control, which may make them susceptible to employment offers from other entities. The last thing a company needs when trying to protect shareholders’ interests under a change of control proposal is the departure of key staff.

Given a takeover proposal may play out over many months, these factors are very real. Billabong is merely one of many companies who have offered retention arrangements to key staff when confronted by a change of control process.

Some legal rules

Apart from the directors ensuring that they discharge their duties and the arrangements are in the interests of the company, there are a number of legal rules that regulate retention arrangements, including:

  • if the executive is a director, the arrangement must be justified as part of the executive’s 'reasonable remuneration' under the related party transaction rules in the Corporations Act,
  • if the arrangement contemplates the payment being made on termination, the arrangement must satisfy the rules which prohibit a company paying a termination benefit in excess of 12 months' average annual base salary without shareholder approval,
  • an agreement to pay a benefit to a director which is entered into within 12 months' after the start of a takeover bid or when directors have reason to believe a takeover bid is to be made may be declared void if the court considers the benefit is ‘unfair or unconscionable’ having regard to the interest of the company. To my knowledge, no orders have ever been made under this rule (which has been around since at least the early 1980s). It is generally thought that this rule would have no operation if the agreement can be justified as being in the interest of the company, and
  • finally, under the ASX listing rules, a company cannot agree to pay termination benefits that will increase upon a change in control of the company. For this reason, retention arrangements usually provide for the payment to be made at a particular date or earlier (if the executive is terminated, other than for cause).

Provided companies bear in mind these rules, a retention arrangement for key staff may be exactly what is needed to keep the business going and produce an optimum outcome for shareholders.