We continue our blog series on COVID-19 implications on executive compensation matters with a post that addresses considerations relating to amending performance goals under equity and other incentive awards.

Setting meaningful and effective performance goals often requires significant focus and analysis by compensation committees with the assistance of their advisors

We continue our blog series on COVID-19 implications on executive compensation matters with a post that addresses salary or wage reductions on a company-wide or targeted basis.

Companies impacted by the COVID-19 pandemic, including the concomitant widespread shelter in place orders, may be considering pay cuts for some or all of their workforce, either in addition to or instead of furloughs and layoffs.  In implementing salary or wage reductions, companies should be mindful of federal, state and local wage and hour and labor laws, consent and notice requirements under contractual agreements with individual employees or groups of employees, tax implications on subsequent “make-whole” or “make-up” payments, impact on employee benefit plan participation, governance considerations, and disclosure requirements for public companies.

Prior to implementing salary or wage reductions, companies should:

  • IDENTIFY affected employees and applicable state or local law:
    • Who are the employees affected by potential salary or wage reductions? Are they exempt or non-exempt? Are they part-time or full-time? How many employees are affected at any single location? Will company executives be impacted?
    • Is the salary or wage reduction being undertaken in connection with a reduction in hours? If so, is the reduction proportionate?
    • What state or local law is applicable to the employee’s employment?
    • What are the state and local requirements for the notice, if any, that must be provided to employees prior to or following a wage reduction?
    • Would a reduction result in the employee’s wage falling below the threshold level for exempt classification (currently $684 per week under federal law)?
  • REVIEW the potential effects of a salary or wage reduction under applicable law, contract, agreements, offer letters, and employee benefit plans:
    • Is the employee a party to an employment agreement, offer letter, or other agreement or arrangement that sets base salary? If so, does it expressly provide that base salary cannot be reduced, such that it would need to be amended?
    • Is the employee covered by an agreement, offer letter, or plan with a “good reason” or similar definition that would trigger severance, equity award accelerated vesting, or other rights as a result of a salary reduction? Is there an exception for across-the-board salary reductions and, if so, whether a limit or such reduction applies?
    • Does the employee participate in employee benefit plans and programs (e.g., group health plans, retirement plans, 401(k) plans, severance benefits, and vacation programs) that may be impacted by a reduction in hours and/or salary or wage reduction? For example, salary reductions may reduce an employee’s severance entitlement, pension accrual or matching contribution.
    • Does the company’s employee handbook address salary or wages during a leave of absence or furlough?
  • ACT to execute waivers, deliver notices, take action with respect to employee benefit plans and, for publicly traded companies, provide disclosure of the salary reduction where necessary:
    • Obtain consents to salary or wage reductions and waivers of “good reason” from employees as needed.
    • Provide advance notice in accordance with applicable state and local requirements.
    • Take any necessary actions under employee benefit plans and programs to continue or end coverage/participation, as applicable.
    • Prepare and file disclosure if/as required for public companies (e.g., Form 8-K, press release).
    • Consider creating a working group including representatives from HR, legal, and investor relations to coordinate actions and communications to internal and external interested parties.

COVID-19 has had significant impacts on all aspects of business.  While employers are assessing how to handle immediate employee needs related to sick leave, family leave and benefits claims, employers should also consider the impact that changes in their workforce or economic conditions will have on their compensation plans and programs.

This blog post addresses one of those compensation issues that many companies are currently grappling with – whether a temporary leave of absence or furlough triggers forfeiture, payment, vesting, or other treatment under compensation arrangements.

In following blog posts, we will address other compensation issues, including:

  • Effect of salary reductions on compensation arrangements (including “good reason” triggers);
  • Limitations on amendment of equity awards and performance goals; and
  • Funding and termination of nonqualified deferred compensation plans (“NQDC plans”) and limitations on such actions.

Is a leave of absence or furlough a “termination of employment” or “separation from service”?

Many employment agreements, severance plans, equity awards and other compensation arrangements provide for partial or full vesting or payment of amounts upon an employee’s termination of employment or separation from service.

Although many employees have experienced a significant decline or cessation of work in connection with the COVID-19 outbreak, such employees may not have necessarily had a separation from service or termination of employment under the terms of the applicable compensation arrangement.

As a general matter, employers with compensation arrangements with separation from service or termination of employment triggers who have employees who are being placed on leave, reduced hours or furlough should take the following steps, preferably before or as soon as possible after implementing any workforce changes:

The Internal Revenue Service (the “IRS”) has issued Notice 2017-75 (the “Notice”), which provides certain limited relief from the strict requirements of Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”), in order to pay income taxes on deferrals attributable to services performed before 2009 that

In general, proposed rulemaking issued in December 2008 with respect to income inclusion under Section 409A of the Internal Revenue Code of 1986, as amended (available here) provides that if there is a Section 409A violation in a taxable year, all compensation deferred under the applicable nonqualified deferred compensation arrangement for that taxable year and all preceding years is includible in the service provider’s gross income to the extent not subject to a substantial risk of forfeiture (i.e., vested) and not previously included in gross income in a prior taxable year. Although the proposed income inclusion regulations appear to permit the correction of certain plan provisions that do not comply with Section 409A without penalty as long as the underlying amounts are unvested, they include certain anti-abuse provisions intended to prevent impermissible changes in the time or form of payment.

Pursuant to the final regulations under Section 409A of the Internal Revenue Code of 1986, as amended, a termination of employment generally occurs at such time as the employer and employee reasonably anticipate that the level of services to be performed after such time, whether as an employee or an independent contractor, would permanently decrease to no more than 20% of the average level of services performed over the immediately preceding 36-month period (or, if services were performed for less than 36 months, over the full period of services). Further, an independent contractor has a separation from service when there is a good faith and complete termination of the underlying contractual relationship.

The Internal Revenue Service (IRS) recently issued proposed Treasury Regulations (available here) that would clarify certain provisions of the final regulations under Section 409A of the Internal Revenue Code of 1986, as amended (the “Code”). The proposed regulations also would expand the anti-abuse provisions of proposed rulemaking issued in