ALI-ABA Course of Study Executive Compensation: Strategy, Design, and Implementation June 18-19, 2009 New York, New York

Transcription

1 499 ALI-ABA Course of Study Executive Compensation: Strategy, Design, and Implementation June 18-19, 2009 New York, New York Executive Compensation Merger and Acquisition Issues By Joseph M. Yaffe James D.C. Barrall David T. Della Rocca Latham & Watkins LLP Menlo Park, California

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3 501 EXECUTIVE COMPENSATION ISSUES IN MERGERS AND ACQUISITIONS* I. INTRODUCTION A. General. Executive compensation issues arise in every M&A transaction and can result in significant liabilities. The following provides a brief overview of executive compensation issues in stock transactions (e.g., mergers and stock acquisitions) and asset transactions. B. Types of Plans. The following are different categories of employee benefit and compensation plans and arrangements that one may encounter in an M&A transaction: 1. Cash Compensation Plans and Severance Plans. Cash plans and severance plans are plans that provide for cash compensation, severance benefits, change in control benefits, commissions, bonuses and deferred compensation. 2. Equity Incentive Plans. Equity incentive plans provide for stock-based awards such as stock options, stock appreciation rights, restricted stock and restricted stock units. 3. Retirement Plans. Retirement plans are plans that provide retirement benefits and are generally categorized as defined contribution plans or defined benefit plans. Such plans may be tax-qualified, which means that they are subject to extensive regulation under both the Employee Retirement Income Security Act of 1974, as amended ( ERISA ), and the Internal Revenue Code of 1986, as amended (the Code ), or may be non-qualified. a. Defined Benefit Plans. Defined Benefit Plans calculate the amount that each participant will receive upon distribution using a formula, which usually takes into account age, length of service, and compensation of a participant at the time of retirement or termination of employment. As discussed further below, defined benefit plans may be the source of material liabilities in a merger and acquisition transaction if such plans are not sufficiently funded. b. Defined Contribution Plans. Defined Contribution Plans maintain individual accounts for each participant. Participants in a defined contribution plan receive only the amounts credited to his or her account, plus any investment gains and less any investment losses, upon distribution. Examples of defined contribution plans include profit sharing plans and 401(k) plans. 4. Welfare Plans. Welfare plans are plans that provide for benefits such as medical (including retiree medical), dental, vision, unemployment, disability (long-term or shortterm), accidental death and dismemberment, and life insurance. 1

4 502 * The authors thank their colleagues, Nancy Liao and Keith Ranta, for their contribution to these materials 2

5 International Benefit Plans. Plans maintained outside of the United States may also give rise to significant liabilities and complications. A Buyer should focus on non-u.s. benefit plans in connection with its diligence as such plans may have unfunded liabilities and such liabilities may be understated in Target s financials. In addition, many countries have more onerous rules regarding Buyer s obligation to maintain existing compensation and benefit arrangements and certain post-closing changes to such arrangements may be prohibited. C. Types of Transactions. M&A transactions generally fall within two categories: 1. Stock/Merger Transactions. Stock transactions may take the form of stock purchases, mergers, and tender offers. As discussed below, in general, buyers in stock transactions assume all obligations of sellers by operation of law. a. General. By operation of law, when an acquiring company ( Buyer ) acquires a corporation by purchasing its stock from the selling company or stockholders ( Seller ) or by merger, Buyer acquires all obligations, assets and liabilities of the acquired company ( Target ). Accordingly, Buyer assumes Target s obligations to its employees and liabilities under Target s pension, profit sharing, welfare, fringe benefit, stock options and other compensation plans and policies. In addition, Buyer can acquire statutory benefit plan liabilities for plans maintained by members of Target s controlled group, as discussed below. Benefit plan obligations and liabilities are created by the terms of plans and contracts and imposed by applicable laws, such as ERISA, the Code, the National Labor Relations Act (the NLRA ), and federal and state securities laws. Employee benefit plan obligations and liabilities can be substantial and, while rare, have been known to exceed the purchase price paid for Target. b. Buyer Concerns. Buyer s objective is to discover all potential obligations and liabilities and make certain that they are reflected in the purchase price. Buyer generally will require Seller to make extensive representations and warranties as to absence of obligations and liabilities, the truth of which is a condition to closing of the acquisition and sometimes subject to indemnity. Representations can give Buyer a legal exit from the deal or leverage to renegotiate the purchase price if post-signing diligence or events disclose obligations or liabilities which are inconsistent with Seller s representations. Seller s representations may also create a basis for Buyer to make indemnification claims after the closing to the extent that representations survive the closing. Ideally, employee plan representations should survive closing until expiration of all applicable statutes of limitation. Most of the diligence, negotiating and drafting work is on Buyer s side, given that Buyer is more at risk of acquiring unknown obligations or liabilities than Seller is at risk of giving away unknown assets. Buyer has to take the initiative in asking the right questions, negotiating the benefit plan deal and drafting appropriate contractual provisions. c. Seller Concerns. Seller will want to make certain that it receives value for all benefit plan assets which will be transferred to Buyer in the deal (such as excess assets in overfunded defined benefit pension plans). Seller will also want to limit its 3