Key Employee Terminations: Protecting Your Client and Avoiding Pitfalls

1. Key Employee Terminations: Protecting Your Client and Avoiding Pitfalls October 28, 2009 Jeffrey R. Capwell Bruce M. Steen jcapwell@mcguirewoods.com bsteen@mcguirewoods.com

2. Background • Why is this topic relevant? • Impact of current economic environment on executive employment • Increased regulatory complexity around termination arrangements • Evolving legal standards • What is at stake for the employer? • Protection of valuable business interests (trade secrets, customers/clients, etc.) • Reputation and goodwill • Benefits and compensation costs • Regulatory and accounting considerations (e.g., Section 409A)

3. Neal Sadaka was Right:“Breaking Up is Hard to Do”

4. “Forget Everything you Learned in High School”“Avoid the Perp Walk at all Costs” • The Liability Risks • The Relationship Costs • The Reputational Costs

5. “Remember Everything you Learned in Kindergarten” • “This is not just about being nice” • It’s about how: • Your clients perceive you • Your employees perceive you • Your competitors perceive you • The marketplace perceives you

6. “The Bucket List”or“The 3 Questions you should ask before you let a key employee walk out the door” • What information do I need to do business tomorrow? • How do I best get that information? • The “joint statement”

7. “The Paper Chase”“Did you do your assignment Mr. Hart?” • To compete or not compete? • “Solicitation” is such an ugly word • I can keep a secret • If you cannot say anything nice … • Mutual releases – “not!” • Integration clauses – do your homework

8. “We can still be friends” • Carefully define the duty to cooperate: • Extent of access • Compensation for access • Compensation for cooperation

9. Code Section 409A • Broadly applies to many compensation arrangements • Post-termination pay and benefits payable over more than a single tax year may be covered by Section 409A • Exceptions are limited • Strict requirements for compliance • Covered arrangement must be in writing and include certain specified provisions • Limited ability to correct errors, particularly document errors • Severe consequences of noncompliance • Immediate income inclusion • Additional 20% tax • Premium interest tax (underpayment rate plus 1%) • Aggregation rule = amounts under similar arrangements are combined with those under the noncompliant arrangement into a single “plan” • What’s at stake for the employer?

10. Exempt Severance Arrangements • The 2 x 2 exception • All payments made by end of second year following year of termination • Severance limited to two times the lesser of (1) annualized comp for year before year of termination or (2) $245,000 (for 2009 and 2010) • Termination is involuntary (or under a qualifying good reason definition) • The short-term deferral exception • Termination is involuntary (or under a qualifying good reason definition) • All payments will made by no later than 2.5 months following the end of year in which termination occurs • Benefit-specific exceptions • Certain deductible expenses reimbursed or provided in-kind • Reasonable outplacement and moving expenses • Certain medical expenses • Benefits with a value not in excess of $16,500 (for 2009)

11. Requirements for Non-Exempt Arrangements • Restrictions on employee deferral elections • Limited exception for entirely new severance promises • Payment requirements • “separation from service” trigger strictly defined • No acceleration and limited right to defer • Six-month delay in payments to “specified employees” • Common problems areas • Healthcare continuation beyond COBRA period • Open-ended release provisions • Time or manner of payment elections • Terminations that don’t qualify as a separation from service

12. The Substitution Trap • Substituting a new payment right for an existing Section 409A payment right is treated as payment of the original payment right • Substitution can result in violation of a Section 409A requirement (Ex. = changing the period of monthly payments from 4 years to 3 years would violate anti-acceleration rule) • Presumption that new right is a substitution if proximate to a forfeiture or voluntary relinquishment of the original payment right • Examples • Accelerations or deferrals that comply with timing rules • Reductions or offsets • Loans

13. A Template for Applying Section 409A to Separation Pay • Is the target executive already covered under a separation pay arrangement? • Need to parse out all of the separate payment promises that may apply • Are pre-existing arrangements covered by Section 409A? • Strict operational compliance necessary • Will a new separation pay promise be created as a result of the termination? • If yes, will the new promise replace or modify any existing promise? • Consider how the substitution rule may apply • Consider appropriate contractual protections

14. Other Considerations • Corporate governance • Which parties need to be involved in developing and approving the separation pay? (Disney cases and their progeny) • Evolving “best practices” in negotiating termination pay • ERISA • “Top-hat” plan exception • ERISA claims procedure as a tool to bar state law contract claims • Golden parachute tax • Relationship of termination to a change in control event (before or after the change) • Interplay with Section 409A

15. Other Considerations • Financial accounting • Typically an issue with respect to modification of equity compensation • Public disclosure • Form 8-K triggering events • Separate trigger for termination and entry into a material compensation arrangement • Considerations associated with term sheets • Proxy statement considerations • Effect of termination on NEO status

16. Considerations for TARP Employers • Prohibition on “golden parachutes” • Flat ban on any “departure-related” payment, regardless of amount or type of compensation • Applies to “senior executive officers” and the next five “most highly compensated employees” (up to a total of 10 employees) • Bars current or deferred payments • Limited exceptions: • Payments from qualified plans, etc. • Payments for “services performed or benefits accrued” • Why this rule may matter even after TARP ends

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