The Impact of 409A on Severance Payments

Editor’s Note: The following post by Katrina Veldkamp, Associate in the Los Angeles office, appears in the latest issue of the California HR Newsletter.  To sign-up to receive the California HR Newsletter click here.

The Impact of 409A on Severance Payments

The Issue: An employment agreement conditions severance payments to an executive on her signing a release. Can this create a tax problem for the executive under the non-qualified deferred compensation rules of the Internal Revenue Code?

The Solution: Yes, unless the provisions of the employment agreement are properly drafted and the parties comply with the terms of the agreement.

Analysis: Code Section 409A (409A) governs the terms and operation of “non-qualified deferred compensation plans” and imposes restrictions on the reasons for and timing of deferred payments.  Neither the employee nor the employer may accelerate or defer the receipt of deferred compensation (with some exceptions not applicable here).

Failure to comply with 409A leads to serious tax consequences for the executive, including acceleration of income and a 20% tax penalty.  California imposes its own 5% tax penalty for failure to comply with 409A.

Termination of employment is a permissible payment event.  If the employment agreement provides that severance will be paid within 2-1/2 months after termination with no conditions, the payment isn’t subject to 409A.  If the  agreement provides for a series of payments equal to not more than twice the executive’s pay (or the qualified plan compensation limit, currently $260,000) and they are to be paid within two years after termination, there is no problem.

The concern with conditioning severance pay on an executive signing a release is that if there is no time limit on when the release must be signed, the employee can affect the timing of payment by either signing the release quickly or delaying to a later date.  This violates the strict requirements of 409A.  It is important to recognize that it is not the employee’s action or inaction that is the problem; it is the provision in the employment agreement.

The remedy is simple.  The employment agreement must specify (or be amended to specify) a fixed payment date after termination of employment (either 60 or 90 days) or a specified period no longer than 90 days when the severance payment will be made or commence (with special rules if the payment period can go into another tax
year).  If the executive fails to sign and return the release by the commencement date, the severance must be forfeited.

Employers should tread carefully when dealing with the complicated requirements of 409A.  If an employment agreement provides for any post-termination payment, it should be reviewed for compliance with 409A.

Forum Selection Clauses and Non-Compete Agreements

Editor’s Note: The following post by Kate Gold, Partner in the Los Angeles office, appears in the latest issue of the California HR Newsletter.  To sign-up to receive the California HR Newsletter click here.

Forum Selection Clauses and Non-Compete Agreements

The Issue: You are a California employer with out-of-state headquarters, and your executive works and lives in California.  Your employment agreement has a one-year post-termination non-compete. Can you enforce it?

The Solution: In general, no, but the answer may depend on whether you have a valid forum selection and choice of law clause that provides for resolution in a state that permits reasonable post-termination non-competes.

Analysis: In general, California employers cannot enforce post-termination non-competes and a party cannot circumvent California restrictions on non-competition with a choice of law provision designating a more non-compete friendly jurisdiction.  However, the Supreme Court’s recent decision in Atlantic Marine Construction Co.,
Inc. v. U.S. District Court for the Western District of Texas,
134 S. Ct. 568, 571 U.S. ___ (Dec. 3, 2013) held that contractual forum selection clauses should be enforced in all but the most exceptional cases, and therefore may be helpful to employers who seek to enforce non-competes against employees who work or live in states, like California, that disfavor restrictive covenants.

Indeed, some recent California federal district court cases have focused on whether the employment agreement has an out-of-state forum selection and choice of law clause.  In Meras Engineering, Inc. v CH20, Inc., the Washington-based employer was permitted to enforce its Washington forum selection and choice of law clauses against its California sales associates who left for a California competitor.  The Washington court concluded it was proper to apply Washington law as provided by the employment agreements.  The California court dismissed the California employees’ lawsuit in favor of the Washington forum selection clause.

Similarly, in two other recent California district court cases, Plaintiffs were former California employees who signed employment agreements with restrictive covenants and Pennsylvania forum selection clauses.  In both cases, the employees argued the cases should not be transferred because the more restrictive covenant friendly Pennsylvania courts would enforce the non-compete, which contravenes a strong California public policy.  Both California courts however, focused on the reasonableness of the forum selection clause, rather than on the clauses’ effect.  Both found that the possibility a Pennsylvania court might apply Pennsylvania law to the non-compete clause was not a sufficient basis to invalidate the forum selection clause.

In light of these recent cases, California employers should consider whether they have a reasonable and enforceable basis for selecting an alternative forum and choice of law for their executive agreements, and, in consultation with
counsel, draft carefully tailored restrictive covenants that comply with that state’s law.

Obligations for Employers Before, During and After a Storm

By: William R. Horwitz

As cleanup from the Nor’easter that pummeled the East Coast last week continues, and the prospect of more snow looms, we hope that you and your families, as well as your businesses and employees, are safe and warm and that the lights are on. As this has been one of the more problematic winters in recent memory, we wanted to remind employers of some of their obligations before, during and after a storm.

Temporary Closings

Unless your agreements or policies provide otherwise, you are generally not required to pay non-exempt employees when they are not working. Therefore, if your business is closed and your employees do not report to work, you are not obligated to pay non-exempt employees. However, make sure that these employees are not checking work e-mails, communicating with supervisors about work-related issues or otherwise working from home, because non-exempt employees are entitled to receive pay for these activities even if they do not physically report to work.

Note that some states require an employer to pay employees for reporting to work, even if the business closes and the employer sends them home. For example, a New Jersey employer must pay employees who report to work at least one hour of pay. A New York employer must pay employees who report to work at least four hours of pay (or the number of hours in the scheduled shift if it is less than four hours). With regard to exempt employees, they are generally entitled to receive their full salaries, even if the business is closed – at least if the shutdown lasts for less than a week. If a business is closed for an entire week and an exempt employee performs absolutely no work during that time, the employer is generally not required to pay the employee for the week.

When a business is temporarily closed, the employer can require exempt employees to use accrued vacation time for the time off, but this requirement should be set forth clearly in the Employee Handbook and any employment contracts.

Cleanup

After a storm passes, employees whose homes remain without power, who are repairing damage to their property or whose children’s schools remain closed, may seek additional time off from work. While an employer that can afford to do so may allow additional flexibility to these employees in order to give them peace of mind and boost their loyalty and morale, these requests may otherwise be handled pursuant to the employer’s contracts and policies.

Other Issues

In addition to the above general points, employers should also be aware of state laws that affect certain employees and certain industries. For instance, in New York and New Jersey, the prohibition against mandatory overtime for health care personnel includes an exception for a declared state of emergency. New Jersey also provides protections for employees who miss work because of their responsibilities as volunteer first responders.

Conclusion

Extreme weather and natural disasters that disrupt business create big headaches for employers and employees. We recommend clear and consistent communication with your employees to avoid confusion about your expectations. Also, maintaining sound employment policies and consulting with counsel when issues arise is critical for avoiding additional headaches resulting from ensuing workplace legal liability.

Webinar – 2014 CFO Alliance Sentiment Study Results

Drinker Biddle partnered with The CFO Alliance to collect survey responses from a broad sample of more than 500 senior financial executives across the United States in order to provide insights into the strategic planning and financial outlook of these executives.

Please join Labor & Employment Group co-chairs Cheryl Orr and Tom Barton, along with several of their partners from across the firm, for a one-hour webinar presentation on the results of The CFO Sentiment Study followed by a live Q&A. Participation and feedback is appreciated, as we will be creating a series of live and online events, discussions, and other materials centered on the top issues and opportunities for business leaders.

Date: Thursday, February 20, 2014
Time: 1:30 p.m. Eastern

Topics include:
•     Human Capital
•     Technology
•     Growth
•     Economic & Political Outlook
•     Financing & Budgeting
•     Risk
•     Trade
•     Government Regulation