Triggering Executive Severance to Protect Your Interests in Case of COVID-19 or other Changed Circumstances
We are in the middle of a once-in-a-lifetime kind of crisis that is unexpected and unprecedented. So many businesses that had been thriving in a robust economy as recently as January and February 2020, were shut down almost on a moment’s notice and remained so for months until the states have begun to reopen. Employees were laid off, furloughed, or had their hours reduced. Unemployment has reached levels not seen since the depth of the Great Depression of the 1930s.
As a CEO, C-suite, or other senior executives, your own employment may also have been impacted in a very negative way as well. Your compensation may have been reduced, or your duties and work conditions may have changed in drastic ways. Perhaps, you have been laid off as well.
In circumstances where the company has taken an unexpected downturn, whether from Covid-19 or otherwise, that has negatively impacted your working situation, as a C-level or senior executive, what are your options? That may depend on your executive employment contract terms.
This article starts with a discussion of the impact of changed circumstances on your executive compensation, equity, and working conditions. In doing so, more is discussed than just COVID-19, with a number of other concrete examples of C-level and senior executive’s dashed expectations from some of the author’s other client representations, in past years, where because of those changes, the job became much less desirable than was reasonably expected. So, what can you do about those changed circumstances? We conclude with proactive steps you can take in your executive employment negotiations to protect yourself in the event of such changed circumstances in the future.
Impact on your compensation
Your executive compensation package is likely to consist of a mix of base salary, annual bonus, equity and/or other long-term incentives. When an unexpected business downturn occurs, whether from the pandemic or otherwise, it can have a huge negative impact on revenue, through no fault of yours.
If a substantial component of your compensation is revenue-driven bonuses, it is unlikely any of your targets will be met and it may be one or more years before you see any bonus at all. Alternatively, if a significant component of your expected income is equity, such as restricted stock, RSUs, stock options, LLC incentive units, or even phantom stock, your loss could be even greater. Often a C-level executive joins a company because of the opportunity for exponential growth in equity. Also, if that equity is properly structured, when the executive cashes out, the equity proceeds might be taxable as capital gains rather than much higher as ordinary income. Here again, as with the bonus, a severe downturn in the company’s prospects may well mean that rather than the exponential growth expected in the near term, the executive equity not only does not rise but significantly declines in value. Stock Options are under water and even other forms of equity that retain some value are worth vastly less than what the executive expected.
Impact on your work conditions and duties
As revenues decline and companies contract in size and workforce, executives’ responsibilities change from growing revenue to reducing production and the workforce. Looking at the COVID-19 crisis, in industries that are devastated by COVID-19, such as airlines, travel, restaurant, retail or entertainment, that change may not be reversible in the near term.
Consider a case where a senior executive with an excellent track record of building travel and leisure companies was brought on to bring that kind of growth to a company with a big opportunity in that space. Due to COVID-19, his duties changed from presiding over growth to presiding over layoffs, not to mention the losses in his compensation as discussed above.
Other Circumstances of Dashed Expectations
So far in this article we have focused on the economic downturn posed by the current pandemic. But the problem of joining a company with expectations of growth that the executive relies on, only to find that this reliance is misplaced can occur in other circumstances too. Here are just a few examples of other situations of dashed expectations from some of my other past executive representations:
- Loss of Key Customer – Taking a position on the expectation that the company will provide exclusive services to a very large single customer, and then during year two of the contract that exclusivity is lost and the company must scramble for new customers and downsize big-time.
- Loss of Regulatory Approval – Taking a position with a life science company to scale up production based on the past successful trials and the expectation of demand for the drug, only to encounter new and damaging data, with loss of expected regulatory approval, that will long defer production and imperils needed financing forcing downsizing.
- Disclosure of Financial Fraud – Taking a position based on representations of a company, growing and in strong financial position, only to find that on closer examination of the books and records, financial statements had been falsified and the company was actually in dire economic straits, so the executive found himself in a salvage operation to keep the company afloat.
- Loss of “Key Man” – Taking a position because of a charismatic leader, rainmaker, brilliant scientist or well-connected individual, whose presence is critical to the organization and soon in the contract that key person a/k/a “key man” leaves, causing a serious blow to morale and prospects to those who remain. In my representations, the key executives that left were men but they could just as easily have been women executives. In my representations, the executives were CEOs, chief marketing or sales officers that left. But hereto the key person might be a CTO, CSO, CIO, CFO or a COO as well.
Triggering Severance in Changed Circumstances
In these circumstances of dashed expectations, it is often the case that CEO, C-level or senior executive would be better off to move on to a new employment situation much closer to the situation the executive thought he or she was getting into in the first place, a situation that much better matches the executive’s skills and expectations than where he or she is now given the changed circumstances. This is especially so if the situation is unlikely to change soon.
In these circumstances where position of the company or the executive’s role is much worse than expected through no fault of the executive, where the executive wants to move on, it is certainly helpful to the executive if he or she has an employment contract that facilitates that move.
To facilitate your move, when you negotiate the terms of your original job offer or employment agreement, you want to get into your document a severance trigger under your control that gives you the right to terminate the executive contract and trigger severance for “good reason.” What is good reason? Any material reduction in your base compensation or duties and responsibilities.
Drastic external circumstances such as COVID-19 can be a severance trigger because your duties and work conditions no longer match what you had signed up for in your employment contract. To make that trigger effective, you need to spell out in the contract duties and working conditions that are important to you. Thus, failure by the company to meet those conditions would allow you to give your notice and if not cured, then terminate the contract.
There are other severance triggers also. Consider the four non-COVID-19 circumstances of dashed expectations I described earlier. You want contract terms to include company obligations which, if unmet, can be your trigger for severance, if you are taking this position in reliance on any of these company actions:
- Keeping a major customer account
- Retaining the services of a key man or woman executive
- Keeping or achieving regulatory approval
- Keeping or retaining a key source of funding
- Possessing the positive financial position represented to you, a position on which you can build for growth
Negotiation of Robust Severance Terms to make you whole
At the same time in your job offer and employment contract negotiations, you want to achieve, if possible, robust severance agreement terms if you do have to exercise any of these severance triggers. These include not only a substantial period of continued base pay and benefits, but prorated bonus, LTI and accelerated equity, and also waiver of any obligations to pay back a sign-on bonus or relocation costs. Further details on what to seek in your severance package are described in my earlier CEOWorld article on executive severance terms.
When you go into a new position, you always want to succeed. But if, once on the job, the chances for success are daunting because of dashed expectations, it is important to have a contract that will enable you to move on and still be whole as you do so. Thus, in negotiating the job offer and terms for a new C-level or senior executive position, it is wise to consider engaging the services of an experienced executive employment attorney to aid you to develop severance terms in the event of a future exit and ideally to also include severance triggers tailored to your situation in the event of dashed expectations.
Written by Robert A. Adelson, Esq. Here’s what you’ve missed?
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