Rank and file employees who may have lost their job or had hours reduced probably don’t care about the effects of the economic downturn resulting from the COVID-19 Pandemic (Pandemic) on executives and key management employees.  However, business owners who have provided such employees with employment agreements, deferred and/or incentive compensation, and perhaps equity or phantom equity compensation do have an interest in the effects of the Pandemic on these employees. This article is Part 1 of a series of blog articles that will address implications the Pandemic may have on executives and key employees in private companies (Executives).  In Part 1 we discuss how employment agreements of Executives will play an important role in any attempt to reduce their compensation and/or adjust incentive compensation.

Reducing Executive Pay.  Employers are reducing their workforce and reducing working hours for employees due to both government orders and the economic fallout from the Pandemic.  Many Executives have employment agreements with their employer.  These often set forth the Executive’s base salary and various forms of bonus or incentive compensation.  While the agreement may provide that the employment is “at will” and it may be terminated by either party with or without cause, it also often provides for severance pay if the agreement is terminated by the employer without cause.  Also, many agreements provide the Executive can receive the severance pay if the Executive terminates the agreement for “good reason”.  Good reason is usually defined to include an employer initiated material change in the circumstances of the Executive’s employment including changes in duties, pay, or place of performance.

Therefore, if the employment agreement permits the employer to reduce the Executive’s salary and other compensation, doing such may give the Executive good reason to terminate the agreement triggering a severance pay obligation.

Some employment agreements may not be “at will” but have a term and cannot be terminated early without cause such as committing a crime or fraud. Typically, doing so requires payment of the Executive’s compensation to the end of  the term even if no longer performing services.

For these reasons, any employment agreements should be reviewed before any attempt to reduce compensation thereunder.  They will likely require the Executive’s agreement to a change.  Many Executives are voluntarily agreeing to a reduction in compensation during these extraordinary times as a sign of good faith.  In either case, the terms of the reduced pay should be negotiated and an amendment to the employment agreement setting forth the terms should be drafted and executed.  This amendment should also provide a mechanism for compensation to return to normal, as well.  It should also be remembered that if the amendment provides that some or all of the reduction in compensation will be paid to the Executive at a future time when the Pandemic is over, that this may be a deferred compensation arrangement that is subject to Internal Revenue Code section 409A, if the compensation is paid in a subsequent year.

Changing Incentive Compensation.  Executives often have certain incentive pay arrangements such as bonuses based on the performance of the business.  A simple example would be that the Executive will earn a bonus equal to 10% of all sales revenue over 105% of the previous year’s sales.  The Pandemic’s effect on the business may be such that it is impossible for the Executive to earn this bonus.   Nonetheless, the Executive may be working even harder just to keep the business afloat during these difficult times.

The employer could simply take the position that if the sales didn’t increase no bonus is due.  Or the employer could take the opportunity to work with the Executive to amend the incentive compensation formula to a more realistic goal or simply substitute a simpler cash bonus instead.

Conclusion.  While the economic downturn resulting from the Pandemic has serious effects on businesses that may cause them to consider adjusting Executive compensation and perks, the Executive likely has legal rights which should be considered.  For this reason, employment agreements and incentive compensation documents should be reviewed with legal counsel to minimize the risk of unintended adverse consequences.  Stay tuned for Part 2 dealing with the effects of the Pandemic on deferred compensation arrangements of Executives.