A changing landscape for CIC protections: change-in-control compensation elements considered appropriate a few years ago may now generate criticism. Make sure your CIC arrangements operate the way you intend.

• Author: Silverman, Carol
• Position: EXECUTIVE COMPENSATION - Change-in-control

IN THE ONGOING DEBATE over what constitutes reasonable executive compensation, equity and accounting issues have grabbed the spotlight. A third issue--executive change-in-control (CIC) protection--is equally deserving of board attention, especially as merger and acquisition activity picks up. Several recent developments are changing the CIC landscape:

* Shareholder proposals seeking caps on executive CIC benefits and shareholder approval of new contracts are increasing in number and investor support. Institutional investors may withhold votes for directors who fail to implement proposals that receive majority approval.

* The Delaware Supreme Court refused to dismiss shareholder claims that directors at Disney knowingly or intentionally breached their "duty of care" in approving Michael Ovitz's employment and severance agreement and sent the case back to Chancery Court, where it is now being heard. This decision signals that this court may scrutinize a board's decision-making process in deciding how to apply the business judgment rule.

* The IRS updated its golden parachute excise tax regulations, confirming that payments for noncompete agreements can be excluded from parachute calculations as "reasonable compensation" for post-CIC services if an executive's ability to perform services is substantially constrained and the agreement is reasonably likely to be enforced. Replacing a pre-existing severance agreement with a post-transaction agreement, however, won't save compensation that is otherwise unreasonable. The rules may also increase the cost of accelerated vesting of equity awards and retirement plan age and service credits--both current common practices. In addition, as part of its audit initiative, IRS representatives have indicated that parachute tax mitigation strategies--particularly high valuations for noncompetes--will be closely scrutinized.

* The Tax Court also addressed "reasonable compensation" for post-CIC services. In the Square D case, the Tax Court stated that a comparison of compensation with that of other companies to determine "reason-ableness" requires a high degree of comparability among the companies, executives, and time periods.

* The SEC issued regulations making shareholder oversight of CIC arrangements easier. The regulations require disclosure of compensatory arrangements with executive officers, including CIC arrangements, by filing a Form 8-K within four business days of entering into the arrangement.

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