As an incentive arrangement, stock units are useful and easy to explain: cash payments are made at a future date, indexed to the value of the underlying employer stock. However, there are several traps for the unwary associated with stock units that require careful attention to the valuation date prior to payout.
Trap 1: Are your Restricted Stock Units actually deferred compensation that is subject to Section 409A? If there are U.S. taxpayers participating in your plan, then you have likely already subjected it to review to determine if it complies with U.S. tax rules on deferred compensation under Section 409A of the Internal Revenue Code. (December 31, 2010 is the deadline for making corrections to the document without additional penalties.) U.S. citizens and green card holders are subject to U.S. tax, regardless of where in the world they may be employed.
Trap 2: Is your valuation date clearly stated? A stock unit plan must identify the date and method to value the stock units in order to pay the unit holder. But what if the units are being paid early due to certain termination events? Or what if payment is delayed due to the six-month delay imposed on “key employees” under Section 409A of the Code? The valuation date for those events should be addressed in the plan text, as well as normal payment timing.
Case in Point: In the first case of its kind to address the 409A delay, a United States federal court in the 11th circuit dismissed a claim by the Company to recoup part of the amounts paid in satisfaction of RSUs to its former CEO after his retirement (Graphic Packaging Holding Co. v. Humphrey, 11th Cir., No. 10-12015, unpublished decision 11/16/10). The payout had been delayed for six-months due to Section 409A restrictions, however, after it paid the executive the Company claimed that it made a mistake in valuing the RSUs as of his retirement date rather than on the payment date (six months after retirement). The stock value dropped significantly during those six-months and the Company sought to recover the overpayment, which was significant: about $542,000.
The plan document did not specify the valuation date; it was silent. And there was no prior experience applying the mandatory six-month delay to show a pattern or practice to demonstrate intent. So the court concluded that Graphic Packaging failed to produce sufficient evidence showing that valuing the RSUs on the date of Humphrey’s retirement was a mistake. This result would have been avoided if the plan had specified the valuation date for the RSUs.
The case serves as a useful reminder that it is not enough to adopt the appropriate amendment to impose a six-month delay required by Section 409A. The amount payable at the end of the delay must also be clear.