The departure of an executive officer can be one of the most sensitive points in an executive’s lifecycle with a company. If not carefully managed by the company’s board, management and both internal and external advisors, it presents numerous pitfalls that can result in financial penalties for the company (and potentially the departing executive) as well as public disclosure by the company that risks scrutiny by regulators and investors.
Whether an executive officer’s departure is initiated by the executive or by the company, before engaging with an exiting executive the company should first quantify all potential payments and benefits to which the executive may become entitled depending on whether the executive’s termination is voluntary or involuntary and with or without cause or good reason. This will often involve coordination between the company’s internal and external human resources, compensation and legal advisors as well as the company’s board or compensation committee.
The company, along with its advisors, should review each agreement with the executive, including the executive’s employment agreement or offer letter, company bonus and severance plans or policies and any agreements providing for non-cash compensation such as equity award agreements, to determine how each agreement, plan or policy may apply to the circumstances of the executive’s departure. This review should also include a look at any restrictive covenants to which the executive officer may be subject and, in light of recent legal changes in this space, the enforceability of these covenants. Additionally, for public companies, if the executive is one of the company’s named executive officers, the quantum of payments and other benefits being offered to the departing executive should be compared against the amounts disclosed in the company’s most recent proxy statement (or other relevant prior public disclosure). It is also important that any separation package offered to a departing executive be reviewed by appropriate tax and legal advisors to ensure compliance with, or an exemption from or exception to, relevant provisions of the Internal Revenue Code.
Additionally, agreements with the company’s other executive officers should be reviewed to determine if any of their rights are triggered by the executive’s departure. For example, an executive may have the right to resign with good reason and terminate employment with severance if a particular executive officer is terminated or if reporting lines are changed as a result of a departure.
Internal and External Disclosure
When certain executive officers depart from a public company the immediate disclosure that companies must confront is current disclosure on a Form 8-K (or within a periodic disclosure if the timing of the departure aligns with the disclosure’s filing). Although at first blush the content of this disclosure appears relatively straightforward, it is sensitive disclosure, and recent actions by the SEC, as well as statements by ISS, heighten its sensitivity.
While the 8-K disclosure requirements appear on their face to be limited to the fact of the event and the date of its occurrence, if the executive officer is to receive severance payments or other compensation or benefits in connection with their termination and those amounts are not materially consistent with amounts previously disclosed by the company, the terms and conditions of these benefits must be briefly described as well. Even if not disclosed in an 8-K, the executive compensation disclosure included in a public company’s proxy statement requires disclosure of all material elements of the company’s compensation program, why the company chooses to pay each compensation element and the amounts actually paid to a named executive officer that departed during the covered period.
Notwithstanding that companies may conclude that the severance payments in connection with a termination are aligned with what has otherwise been previously disclosed and current disclosure is not required, recent SEC action has demonstrated that a company’s determination to not disclose this information may be subject to challenge. In light of this, companies should consider whether the benefits being provided to a departing executive are consistent with the disclosed reason for the executive’s departure (i.e., whether it was with or without cause and voluntary or involuntary). All disclosures and public statements should be vetted to ensure they are not contradictory as to the reasons for the executive officer’s departure, and care should be given to adequately documenting the reasons for terminating the executive officer and recording the factors considered in making the decision.
Considerations regarding a public company’s approach to the disclosure of executive officer terminations and severance go beyond the attention given by the SEC. It is the position of ISS that the payment of severance in connection with a voluntary resignation or retirement is a “problematic pay practice” that carries significant weight and may result in an adverse director vote recommendation. To that end, ISS advises that companies should not simply state that an executive officer “stepped down” or that the exit was “mutually agreed,” as this does not adequately indicate whether the termination was in fact involuntary. This position can be at odds with companies’ desire for sensitivity and nuance in the characterization of executive officer terminations, causing companies to weigh the risk of a negative vote recommendation from ISS against what the company thinks is the appropriate characterization of the termination.
Regulators and investors are not the only constituents interested in an executive officer’s departure. Whether a company is public or private, the most immediate impact of an executive’s departure will be felt by the company, its employees and its business. To ensure the seamless transition and smooth operation of the business, companies must consider—before an executive officer’s departure is even contemplated—a proper succession plan. The executive officer should agree to cooperate with the company after their departure, and, in some instances, it may be advisable to have the former executive officer remain as a consultant to ease the handoff to their successor. Additionally, a leader’s departure may impact the morale of the workforce. Representatives of management should be prepared with an internal communications strategy to explain the transition and answer any questions from team members.