Will Your Bank Shoot Itself With a Single Trigger?

Here at Bank Director, we encourage readers to contact us with questions about issues they face as independent board members or members of management. We seek answers from experts and publish them for others in our membership program.

Our first question comes from a director of a privately owned Georgia bank:

“I am on the board of a local bank and the discussion involving change of control came up. We currently have a ‘double trigger’ regarding . . . key executives if a bank sale occurs. We have been counseled by our attorneys to change the document to a ‘single trigger’ in order to simplify the transaction and not put our executives in a difficult position of terminating in order to collect two or three times base earnings. What is the most common ‘trigger’ in banks today?”

BrentLongnecker.pngSo let’s retrace what the difference is: A single trigger is payment upon a change in control regardless of any change in employment status. A double trigger is payment upon a change in control followed by an involuntary termination of employment. Tips: Consider what constitutes a change in control, and consider the likelihood of the executive surviving the change in control. Consider position, age and the cost of severance to the deal. The trend today is double triggers; single triggers are out of favor.

Also, if this is a private bank, a single trigger may be worth considering IF it can get sound and enforceable non-compete and non-solicitation language signed by the departing executives. There is nothing worse than to give out a nice payment to executives—on behalf of the bank and its shareholders—only to see them set up shop “across the street” and begin competing and taking your people. Change-in-control monies have seeded more competition than most people would imagine, especially with banks!

—Brent M. Longnecker, chairman and CEO, Longnecker & Associates

DoreenLilienfield.pngChange-of-control protections can both ensure that executives provide an impartial consideration of strategic alternatives for a company without focusing on their own potential job loss, and serve as an effective retention tool for executives during uncertain times surrounding a potential transaction.

Executives are often eligible to receive enhanced severance benefits (typically a multiple of base salary and bonus) if their employment is involuntarily terminated (e.g., for cause or good reason) within a specified period following a transaction. In today’s market, there is minimal use of single trigger cash change in control payments, as they can undermine rather than foster the purposes noted above. Due to shareholder and shareholder advisor pressures, the use of single triggers for most types of change-in- control benefits has become fairly uncommon; however, notwithstanding plan design, equity awards may often accelerate at the time of a transaction, particularly in cash deals.

Some companies may elect to provide cash retention bonuses in lieu of, or in addition to, change-of- control severance benefits. Retention bonuses incentivize key individuals to remain with the company through the closing date or a specified milestone thereafter, and are also typically paid out on an involuntary termination prior to the payment date. The amount of any severance and other change-in- control benefits should be taken into consideration when determining retention bonuses.

—Doreen E. Lilienfeld, partner, executive compensation and employee benefits, Shearman & Sterling LLP

How Mergers Can Impact Deferred Compensation Plans: Part I

9-20-13-Equias.pngMany bank boards during merger discussions find themselves confronting the question of severance benefits and how that will impact the merger. What if the bank being sold has a Supplemental Executive Retirement Plan (SERP)? Could that trigger a so-called golden parachute clause with tax consequences for the acquiring bank? The answer is yes. In some cases, this could impact the negotiations. In a series of articles, Equias Alliance explains how Internal Revenue Service rules are triggered and what to do about it. This first article describes when a change-of-control triggers a parachute payment and subsequent excise taxes.

If our bank has a Supplemental Executive Retirement Plan (SERP) or other non-qualified deferred compensation (NQDC) arrangement, what is the potential impact on a merger with another bank?

If the plan agreement provides for accelerated vesting of the benefit upon a change in control (CIC), two things happen:

  1. The increase in the vested benefit must be immediately accrued as a liability.
  2. The acceleration, referred to as a parachute payment, must be included in the calculation of total parachute payments under Section 280G of the Internal Revenue Code (§280G). (Note: §280G does not apply to Subchapter S banks.)

But if the buyer pays for it, why should we be concerned?

These provisions can impact the price the buyer pays for your bank. A general rule of thumb is that if the cost of all severance benefits is less than 5 percent of the purchase price, it should not impact the price paid for the bank. When the cost exceeds 5 percent, it may impact the price, depending on many other factors. The board should be knowledgeable of the total impact compensation costs might have in the event of a CIC.

If the executive(s) plan on continuing to work for the buyer, does that reduce the impact?

No, both generally accepted accounting principles (GAAP) and §280G require that the present value of the vested benefits be measured and recognized at the date the CIC occurs, even if payments are to be made at a later date.

How do we determine the impact?

First, §280G is very detailed and complex. The bank should seek advice from its accountants and legal counsel.

That said, the income and excise taxes become payable if the total parachute payments equal or exceed three times the executives average W-2 compensation for the past five years. Be careful here as parachute payments are comprised of all forms of compensation, including severance payments, as well as the incremental value of stock options, restricted stock, medical benefits, and incremental accelerated vesting of SERPs and other NQDC arrangements.

Example #1:
The executive’s five-year average W-2 compensation is $100,000 and his parachute payments total $250,000.Three times his compensation is $300,000, so he is under the §280G limit. No excise taxes are due and the payments are fully deductible by the bank, but the present value of the additional benefit obligations created by the CIC still must be accrued for GAAP purposes.

Example #2:
Assume the same facts as #1, except the executive’s parachute payments total $500,000. Since the executive’s payments exceed the allowable amount, payments in excess of one times his salary will be subject to excise taxes. The excise taxes would total $80,000 ($500,000-$100,000) x 20 percent. In addition, he would also pay regular income taxes on the $500,000. The bank would only be able to deduct $100,000 of the compensation paid.

Can we reduce what’s considered to be a parachute payment by deferring payment?

No, the measurement for purposes of §280G is what he is entitled to after the CIC. The present value of the incremental increase in his vested SERP benefit has to be included even if he is to receive the money at a later date. For example, assume the executive is vested in an annual SERP benefit of $25,000 for 15 years, but upon a CIC he becomes entitled to an annual benefit of $60,000 per year. If the CIC occurs, he receives an incremental vested benefit of $35,000 per year, a total payment increase of $525,000, but using present value calculations, the increased value for parachute payment purposes would be around $395,000.

The intricacies associated with the implications of §280G are complex and not easily covered in limited space. Stay tuned for Part II of our series, which will explore what to do if your bank is impacted by §280G.

Equias Alliance offers securities through ProEquities, Inc. member FINRA & SIPC. Equias Alliance is independent of ProEquities, Inc. IRS Circular 230 Disclosure: As required by U.S. Treasury Regulations, we advise you that any tax advice contained in this communication is not intended to be used, and cannot be used, for the purpose of avoiding penalties under the Internal Revenue Code.