It seems like only last week I was writing about a company that could have avoid substantial legal costs and headaches through better drafting (oops, it was only last week, see Poor Drafting of Employment Agreements Can Lead to Litigation. Last week we looked at equity incentive award agreements that could have been drafted better. Today, it’s an annual incentive bonus plan. Companies often do not have legal counsel review their bonus plans. Sometimes the plan is one a one-page summary—or even a couple slides from a PowerPoint handout. However, many legal complications can arise from bonus plans.
In Gregg Appliances, Inc. v. Underwood (Ind. Ct. App. July 22, 2016), a group of the company’s senior managers brought a class action after the company calculated their annual incentive bonus payouts by excluding nearly $40 million in life insurance proceeds it received after its executive chairman died from its 2012 earnings before interest, taxes, depreciation, and amortization (EBITDA). The trial court had granted summary judgment to the employees and the company had appealed.
The company had provided eligible employees with a document labeled Total Rewards Statement (TRS) and a letter from the company’s president and CEO, which included a table showing 2011 compensation and a table showing 2012 targets. The trial court viewed the TRS as a contract between the company and the covered employees. The court found that the TRS used the term “EBITDA,” and that the meaning of EBITDA was clear. The TRS made no reference to the possibility of adjustments.
The appellate court reversed the trial count and found in favor of the company. The appellate court emphasized the need to look at not just the terms of the contract, but also the intent of the parties and all circumstances surrounding the contract. The appellate court found “It is clear from the language in the TRS that the parties could not have intended life insurance proceeds would be included in EBITDA for purposes of determining a performance-based ‘incentive’ bonus.” The court looked at the TRS transmittal letter, which referred to the company’s growth and the importance of improving performance. The court also took into account the testimony of a company representative that the company previously had adjusted EBITDA to reflect accurately how the company was performing on a year-to-year basis, even when those adjustments resulted in higher bonuses.
The company won the case (so far). However, it won only after discovery, depositions, a trial, and an appeal. A little better drafting could have saved the company from all of the legal costs, wasted time, and ill feelings that ensued.