Last Friday's blog, "Executive Does the Right Thing – and Gets Screwed for It," resulted in significant reader comments. The first group of comments could be fairly summarized by the following statement from Alisa Baker of Levine & Baker LLP:
"That sad truth (from my perspective) is that this kind of thing happens all the time. Acquirers are always trying to wring concessions from management, and the investors are more than happy to throw the executive team under the bus. . . . Mr. Yarber needed his own lawyer counseling him to hold out against the chair's threats, and letting him know there would be a great lawsuit if the company actually fired him on the eve of the acquisition solely for refusing to give up his rights under his employment agreement."
The second category of comments asked me to elaborate on my statement that this was "a factual situation many executives and companies find themselves in from time to time." In addition to the acquisition scenario illustrated so well by the Yarber case, we also see this issue arise in an acquisition, where the parties seek to qualify for the private company/shareholder approval exemption from the golden parachute tax of Code Sec. 280G. Under Sec. 280G(b)(5), "parachute payment" does not include any payment to a disqualified individual from a private company if (i) such payment was approved by a vote of the persons who owned, immediately before the change, more than 75% of the voting power of the company, and (ii) there was adequate disclosure to shareholders of all material facts concerning payments that (but for this exemption) would be parachute payments to the disqualified individual. Regulations under Sec. 280G make it clear that the shareholder vote must determine the right to the payment not just its qualification for the exemption, i.e., if 75% shareholders do not vote in favor, the payments cannot be made. Thus, the executive must unconditionally relinquish his/her right to the potential parachute payments.
Under the typical scenario, certain executives of a target company have golden parachute agreements that could result in excise taxes under Sec. 280G, often with gross-up provisions. The acquirer is okay with the payment themselves, but does not want to pay the gross-up or lose its deduction for the payments. Therefore, the target company asks its executives to irrevocably waive their rights to the change in control severance payments unless 75% of selling shareholders approve the payments, and suggests, in a way that is not legally binding, that it will vote its [generally controlling] stake in favor of the payments.
When I first faced a situation of this kind 20 years ago and asked: since the waiver has to be complete and irrevocable, and there can be no side promises to make the executive whole, what in the world would prevent the acquirer from not voting its stake in favor of the new severance payment promises and, thus, avoiding the payments entirely? One of my corporate/private equity partners answered me by stating that any firm that failed to vote its share in favor of the new severance payments in this situation would never be able to do another deal, because no one – especially not the executives – would trust them.