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Understanding Change-in-Control Agreements

Understanding Change-in-Control Agreements:

Understanding Change in Control agreements, also labeled œgolden parachute agreements, arose out of the hostile takeovers that began in the 1970’s through the early nineties. In the midst of friendly takeovers in recent years, executives now demand protections for their continued employment, equity, deferred compensation and retirement benefits, in the event of a change in control of the company. A crystal ball is obviously not effective in predicting the future, so executives demand change in control agreements in order to provide some measure of predictability for the future, in exchange for the increased risk. Companies routinely enter into these agreements to avert the executive(s) departure during change in control events and provide continuity in management.

œNaturally, threats to both the economic and noneconomic incentives to remain arise. On the economic side, the executive faces the loss of his salary, retirement benefits, vacation pay, and other advantages. From the noneconomic perspective, the executive’s job security is threatened, as well as career advancement commensurate with seniority and skills, marketability, professional respect, and satisfaction of working at a prestigious company. . . Golden parachutes help offset these problems. The golden parachute shifts the risk of displacement from the executive to the corporation. The plan’s payment is intended to compensate the executive for most of the economic loss and some of the noneconomic loss associated with forced departure. The executive, therefore, remains at ease. He or she continues to acquire firm-specific knowledge, and the management team remains efficient and profitable. International Insurance Co., v Johns, 874 F.2d 1447, 1464-65 (11th Cir.1989)(internal citations omitted).

There exist various opinions about the effect of these agreements on executive objectivity. Change in control agreements generally motivate the executive to act in the best interests of the shareholders, by removing the distraction of post change in control uncertainties faced by the executive with regard to his compensation. See Fenoglio v. Augat, Inc. 254 F3d 368 (1st Cir.2001). If the executive is confident his change in control agreement will produce a substantial golden parachute payment, and a grossed up payment to account for excise taxes, his personal interests will be aligned more closely with the shareholders.


Understanding Change in Control Agreements may differ from company to company. Whether the agreement is used to defend against an unreasonable tender offer (œpoison pill) or used to instill general confidence in its key management employees, each company will draft language that best serves the reasonable short and long-term interests of the shareholders. The analytical legal theories (œthe business judgment rule and œthe reasonable relationship test) used to determine the enforceability of these agreements is outside the scope of this article.

As in all contractual transactions, the actual written provisions govern. The following is an example of a change in control definition:

œChange of Control means

(a) any œperson (as such term is used in Sections 13(d) and 14(d) of the Securities Exchange Act of 1934, as amended (the œExchange Act)), other than a trustee or other fiduciary holding securities of the Company under an employee benefit plan of the Company, becomes the œbeneficial owner (as defined in Rule 13d-3 promulgated under the Exchange Act), directly or indirectly, of securities of the Company representing 50% or more of (A) the outstanding shares of common stock of the Company or (B) the combined voting power of the Company’s then-outstanding securities;

(b) the Company is party to a merger or consolidation, or series of related transactions, which results in the voting securities of the Company outstanding immediately prior thereto failing to continue to represent (either by remaining outstanding or by being converted into voting securities of the surviving or another entity) at least fifty (50%) percent of the combined voting power of the voting securities of the Company or such surviving or other entity outstanding immediately after such merger or consolidation;

(c) the sale or disposition of all or substantially all of the Company’s assets (or consummation of any transaction, or series of related transactions, having similar effect);

(d) there occurs a change in the composition of the Board of Directors of the Company within a two-year period, as a result of which fewer than a majority of the directors are Incumbent Directors;

(e) the dissolution or liquidation of the Company; or

(f) any transaction or series of related transactions that has the substantial effect of any one or more of the foregoing.

When reviewing similar provisions, the executive and his/her counsel must carefully consider each word and how it is used in the agreement. Slight changes in language can have an enormous and sometimes costly impact to the executive. Remember, the terms define the œintent of the parties. If a specific term is not in the agreement, it will not be enforced. Similarly, if the controversial term is somehow negotiated into the agreement, the executive or the company will be hard press to remove the term once a dispute arises.


Golden parachute payments are triggered in one of three ways, and each is precipitated by specifically identified change in control events. There is the œsingle trigger, where the executive voluntarily resigns at his/her leisure and demands payment. The single trigger favors the executive because of the automatic nature of the change in control definition, i.e. he or she is financially protected. The executive has less concern for the future of the company after a change in control, and depending on the contractual language the executive can become reemployed the very next day.

The œdouble trigger is more common and favors the company. This trigger requires a termination without cause or with good reason by executive, and a defined period of payment of generally one year. Unlike the single trigger, the executive cannot voluntarily resign. His participation in the existing company and future company is mandated by the agreement. However, the executive still receives a great deal of protection while the change in control takes place. The company will clearly desire to retain the executive’s loyalty and commitment, and will reward the executive well after the change in control is completed. Such an outcome is attractive in order to maintain continuity and retention of key management personnel.

In Buckhorn, Inc. v. Ropak Corp, the court held that a double trigger change in control payment was valid because œthe Court believes that this provision reasonably advances the shareholders’ interest in retaining key management personnel in their present positions during a critical transition period, without unduly entrenching management or over-burdening Ropak. 656 F.Supp. 209, at *232 to*233. However, the court invalidated the single trigger change in control provision adopted by the Board of Directors as not a reasonable response to a takeover threat.

The following language is an example of a double trigger change in control provision:

(b) If the Executive’s employment with the Company shall be terminated
for any reason other than as specified in Section 3(a), the Executive shall be
entitled to the following:
(i) the Employer shall pay the Executive all Accrued Compensation and a Pro Rata Bonus;

(ii) the Employer shall pay the Executive as severance pay and in lieu of any further compensation for periods subsequent to the Termination Date, in a single payment an amount in cash equal to two and a half (2 1/2) times the sum of (A) the Base Amount and (B) the Bonus Amount; provided, however, if an employment agreement is in existence between the Company and the Executive on the Termination Date, any amount due the Executive under this Section 3(b)(ii) shall be reduced by the amount of Base Amount and Bonus Amount paid as severance pay to Executive pursuant to such employment agreement in lieu of compensation for periods subsequent to the Termination Date.

(iii) for thirty (30) months following the Termination Date, (the œContinuation Period), the Employer shall at its expense continue on behalf of the Executive and his dependents and beneficiaries the medical, dental, life, disability and hospitalization benefits provided (A) to the Executive at any time during the 90-day period prior to the Change in Control or at any time thereafter (and if different benefits were paid during such period, such of those benefits as are elected by the Executive) or (B) to other similarly situated executives who continue in the employ of the Company during the Continuation Period. The coverage and benefits (including deductibles and costs) provided in this Section 3(b)(iii) during the Continuation Period shall be no less favorable to the Executive and his dependents and beneficiaries than the most favorable of such coverages and benefits during any of the periods referred to in clauses (A) and (B) above. The Employer’s obligation hereunder with respect to the foregoing benefits shall be compromised to the extent that the Executive obtains any such benefits pursuant to a subsequent employer’s benefit plans, in which case the Employer may reduce the coverage of any benefits it is required to provide the Executive hereunder as long as the aggregate coverages and benefits of the combined benefits plans is no less favorable to the Executive than the coverages and benefits required to be provided hereunder. This subsection (iii) shall not be interpreted so as to limit any benefits to which the Executive, his dependents or beneficiaries may be otherwise entitled under any of the Company’s employee benefit plans, programs or practices following the Executive’s termination of employment, including without limitation, retiree medical and life insurance benefits;

(iv) all theretofore unvested share options, restricted options,
restricted share and other awards issued to the Executive pursuant to the Company’s Share Option and Share Award Plan, and all unvested benefits under any split dollar life insurance policies insuring the Executive’s life, shall immediately become 100% vested; and

(v) a payment from the Employer equal to the unvested amount
contained in the Executive’s accounts in the Company’s 401(k) plan (or any other qualified plan of the Company or an affiliate) which he or she will forfeit as a result of his or her termination.

Finally, the œmodified trigger, also company friendly, requires a termination without cause or good reason. However, the executive’s resignation occurs only during the œopen window period (typically 30 days) after six to twelve months have elapsed since the change in control. During this transition period, the company benefits from continued performance. Similar to the single and double trigger, the executive still obtains financial security through the modified trigger provision.

The following language is an example of a modified trigger change in control provision:
œTermination Upon Change of Control means:
(a) any termination of the employment of Executive by the Company without Cause during the period commencing on or after the date that the Company first publicly announces a definitive agreement that would result in a Change of Control (even though still subject to approval by the Company’s stockholders and other conditions and contingencies) and ending on the date which is twelve (12) months following a Change of Control; or
(b) any resignation by Executive based on a Diminution of Responsibilities where (i) such Diminution of Responsibilities occurs during the period commencing on or after the date that the Company first publicly announces a definitive agreement that would result in a Change of Control (even though still subject to approval by the Company’s stockholders and other conditions and contingencies) and ending on the date which is twelve (12) months following the Change of Control, and (ii) such resignation occurs within one-hundred and twenty (120) days following such Diminution of Responsibilities.

The term œTermination Upon Change of Control shall not include any other termination, including a termination of the employment of Executive (1) by the Company for Cause; (2) by the Company as a result of the Disability of Executive; (3) as a result of the death of Executive; or (4) as a result of the voluntary termination of employment by Executive for reasons other than a Diminution of Responsibilities.


Once the change in control and trigger provisions have been met, the golden parachute payment must be determined. In 1984, Congress passed the Deficit Reduction Act as a tax penalty in reaction to a period of intense corporate takeover activity, where entrenched management teams used golden parachutes to remain in control. Senate Comm. on Finance, 98th Congress, Deficit Reduction Act of 1984, Explanation of Provisions Approved by the Committee on March 21, 1984. The Act created two new Internal Revenue Code Sections 280G, disallowing deductions for excess parachute payments, and Section 4999, which applied a 20% excise tax on the executive for excess parachute payments. The specific provisions of the two sections can be summarized in the following manner:
A ˜parachute payment’ is any payment to a ˜disqualified individual’ in the nature of compensation, if such payment is contingent on a change in control of the corporation and the aggregate present value of all such payments equals or exceeds three times the individual’s ˜base amount.’ The base amount is the individual’s average compensation includible in gross income for the five taxable years preceding the taxable year in which the change in control occurs. An œexcess parachute payment’ is any parachute payment in excess of the portion of the base amount allocated to such payment. A ˜disqualified individual’ is any individual who is an employee or independent contractor of a corporation and who is an officer, shareholder, or highly compensated individual.

The Golden Parachute Provisions: Time for Repeal? Virginia Tax Review at *129, Fall 2001, Bruce A. Wolk. Calculating the excess parachute payment and base amount can be difficult. Each calculation is dependent on the makeup of the payments, the value of other benefits and the executives combined income tax rate. Such calculations are outside the scope of this article. However, œit is important to emphasize that once the three-times base amount threshold is equaled or exceeded, it is not the excess over this threshold that is penalized, but the excess over the base amount. Id. at *131.


In the event of breach of contract in the parachute agreement, a federal statute provides additional protection beyond ordinary contract law, as specified in the choice of law provision of the agreement. These agreements are generally governed by the Employee Retirement Income Security Act (ERISA), 29 U.S.C. § 1001 et.seq. ERISA treats change in control agreements as employee welfare benefit plans:

Any plan, fund, or program which was heretofore or is hereafter established or maintained by an employer or by an employee organization, or by both, to the extent that such plan, fund or program was established or is maintained for the purpose of providing for its participants or their beneficiaries . . . any benefit described in section 186(c) of this title. . .
29 U.S.C. § 1002(1) (1988 Supp.).

In a breach of contract case, a court will decide the dispute based on the evidence of what the parties intended prior to ratifying the agreement. In the ERISA context, the executive can further allege legal arguments based on the fiduciary relationship; one where the company owed a fiduciary obligation to pay benefits in the event of a change in control. This modifies the original arms-length transaction to one of a beneficiary and trustee relationship. Where the trustee must protect the best interests of the beneficiary, the executive.

In order to usurp the ERISA fiduciary schema, the executive must first establish that the change in control agreement is a welfare benefit plan. A œplan under ERISA is established if from surrounding circumstances a reasonable person can ascertain the [1] intended benefits, [2] a class of beneficiaries, [3] a source of financing, and [4] procedures for receiving benefits. Purser v. ENRON Corp., 1988 WL 220238 at *3 (W.D.Pa.1988).

The œintended benefits equates to the golden parachute payment the executive will or should receive. In examining the change in control agreement, the company may limit it to one executive, or apply to œkey management personnel. If the agreement does not supply a source of funding, under ERISA golden parachutes would be paid out of general corporate assets. Fort Halifax Packing Co., Inc. v. Coyne, 96 L.Ed.2d 1, 15 (S.Ct.1987). The method of computing benefits is set forth in the specifically identified change in control provisions.

Although an examination of the fiduciary relationship is outside the scope of this article, the executive must understand there is possibly more to the enforceability of the change in control agreement than previously suspected. The ERISA component can have an enormous impact on how parachute payment will be adjudicated.

If you would like more information about understanding change in control agreements, please contact our Employment Law Attorneys at  Carey & Associates, P.C.  at

Understanding Change in Control Agreements “ Resource:

Definition of Change in Control  

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