Section 409A Issues for International Banks

Michael J. CollinsGibson, Dunn & Crutcher

Washington, DCmcollins@gibsondunn.com / (202) 887-3551

Severance Arrangements

• In general, if either (i) severance is paid over time (rather than in a lump sum) or (ii) severance triggers are too “employee-friendly,” 409A needs to be considered

• Key consequences if 409A applies:– Six-month delay for specified employees of

public companies– Restrictions on ability to restructure payments

(e.g., change from installments to lump sum)

Severance Arrangements (cont’d)

• Special exceptions apply for separation pay payable only in connection with “involuntary” terminations– If severance is paid in a lump sum (or otherwise

during the short-term deferral period), it may be excluded from 409A

– In addition, it is excluded to the extent it is no more than the two times the lesser of (i) the employee’s average compensation or (ii) the Code section 401(a)(17) limit for the year ($230,000 for 2008) and is paid within two years of separation

Severance Arrangements (cont’d)

• A “good reason”/constructive termination provision may be equivalent to an involuntary termination– Generally, facts and circumstances test: Is the separation from service

effectively an involuntary separation?• Rules also provide a good reason safe harbor:

– Employee must actually terminate employment within a limited period of time (not to exceed two years) following the initial existence of the good reason condition;

– Amount, time and form of payment must be identical to that available upon a "without cause" termination;

– Employee must be required to provide notice of the existence of the good reason provision within a period not to exceed 90 days of its initial existence, and the employer must be provided a 30-day "cure" period; and

– Good reason must consist of one or more of six enumerated conditions arising without the consent of the employee (material diminution in base comp, required relocation, etc.).

Equity Compensation

• Some forms of equity are excluded from 409A because they are “property” for tax rules – in particular, restricted stock

• Some other forms of equity may be excluded as well – For example, restricted stock units (RSUs)/phantom

shares if paid during the short-term deferral period– However, if delivery of shares is delayed to a

subsequent year, the RSUs/phantom shares generally would be subject to 409A

• Six-month delay; 409A-required change in control definition, restrictions on changing payment date, etc.

Stock Options

• Options and stock appreciation rights/SARs (defined as “stock rights”) generally are exempt from 409A if (i) they are issued with respect to service recipient stock, and (ii) the exercise price is at least equal to FMV as of the grant date– Stock rights subject to Section 409A typically

would violate 409A absent unusual provisions (e.g., “hard-wiring” exercise date)

Stock Options (cont’d)

• Service recipient stock– Any class of common stock (regardless of whether publicly

traded, transferability restrictions, aggregate value or buyback rights)

– No dividend preferences– Liquidation preference ok

• Stock can be of any corporation in a chain of organizations all of which have a controlling interest in another organization, beginning with the parent organization and ending with the organization for which the grantee was providing services as of the date of grant of the stock right. – Controlling interest threshold 50%– Can be as low as 20% if legitimate business criteria (e.g., a

former employee transferred to a 20%-owned joint venture)

Stock Options (cont’d)

• FMV may be determined based upon the last sale before or the first sale after the grant, the closing price on the trading day before or the trading day of the grant, the arithmetic mean of the high and low prices on the trading day before or the trading day of the grant, or any other reasonable method using actual transactions in the stock.

• Can use average over up to 30 days before or after grant, as long as irrevocable commitment to grant before period commences if period is before actual grant date

Stock Rights Modifications/Extensions

• A stock right is considered a new grant if there is a “modification”

• Generous rule for extensions – not a 409A-implicated extension if extend to no later than longest term of initial grant (but no more than 10 years from grant)

• Generally can substitute rights in connection with corporate transactions if rules are satisfied

Reimbursements/Fringe Benefits

• Nontaxable benefits are excluded from 409A

• Other exclusions from 409A include:– Reimbursement of excludable expenses and

in-kind benefits within a limited period of time following termination

– Medical benefits during “COBRA” period– De minimis amount up to Code section 402(g)

limit

Reimbursements (cont’d)

• Reimbursements not otherwise exempt comply with “fixed payment date” rule under 409A if:– Payable for an objectively prescribed period (which

can be for the lifetime of the service provider); and– Amount of reimbursable expenses incurred or in-kind

benefits available in one taxable year cannot affect the amount of reimbursable expenses or in-kind benefits available in a different taxable year (lifetime maximum for medical benefits ok)

Reimbursements (cont’d)

• Some key items for international banks that these rules apply to:– Tax preparation fees– Moving expenses– Outplacement