Public companies that pay any executive more than $1 million in compensation annually are likely aware of the deduction limitation imposed by Section 162(m) of the Internal Revenue Code of 1986 ("Section 162(m)"). Likewise, most of such companies are also familiar with the exception to this deduction limitation for certain performance-based compensation paid to those executives. However, many companies are not aware that in certain situations, shareholder approval may be needed every five years in order to continue to receive the benefit of the performance-based compensation exception.
Section 162(m) generally disallows a deduction for compensation paid in excess of $1 million per year to the Chief Executive Officer and the other three highest paid executives, excluding the Chief Financial Officer, of any publicly-held corporation. However, certain performance-based compensation is excepted from that deduction limitation where (i) the compensation is paid solely on account of one or more performance goals; (ii) the performance goals are determined by a committee of the corporation's board of directors comprised solely of two or more outside directors; (iii) the material terms of the performance goals are disclosed to, and approved by, the company's shareholders before the compensation is paid; and (iv) the compensation committee certifies, prior to the payment of such compensation, that the performance goals were in fact satisfied.
Unless the material terms of the performance goals are changed by the compensation committee, no additional shareholder disclosure or approval is generally needed. However, where the compensation committee has the authority to change the targets under a performance goal after shareholder approval of the goal, the Section 162(m) regulations require that material terms of the performance goal must be disclosed to, and reapproved by, the corporation's shareholders no later than the first shareholder meeting that occurs in the fifth year following the year in which the shareholders had previously approved the goal. For example, if Company X's Compensation Committee retained the authority to change the targets under the performance goals, and those goals were last disclosed to and subsequently approved by Company X's shareholders in 2003, the material terms of the performance goals would need to be approved again no later than the first shareholder meeting occurring in 2009.
With the 2009 proxy season quickly approaching, consider making a New Year's resolution to review your company's incentive and other executive compensation plans to determine whether shareholder reapproval of the material terms of the performance goals is required by Section 162(m). As the rules and regulations under Section 162(m) can be complex, and there are additional circumstances in which shareholder approval might also be required, White & Case would be pleased to review your plans for compliance with Section 162(m).