Mergers and acquisitions can give rise to many legal and financial complexities related to executive compensation.
“The key thing from acquirers’ point of view is to understand what their objectives are with respect to executive compensation,” says Elizabeth Boyd, a pensions, benefits and executive compensation partner at Blake, Cassels & Graydon LLP. “Decisions must be made regarding equity incentives, complicated tax implications and employment law considerations.”
The main consideration regarding equity incentives is whether employers want to continue, replace or cancel programs and whether they want to provide more attractive equity-based compensation to certain executives.
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“The analysis always begins by asking what the commercial deal is and whether the acquirer wants to keep certain option holders engaged,” says Dov Begun, a partner at Osler, Hoskin & Harcourt LLP.
Whether the transaction is a share purchase, asset purchase, or amalgamation can drive different outcomes, he adds, noting the terms of the existing compensation plan may have provisions affecting change of control, the right to roll over the options, cash-out conditions, accelerated vesting or forced exercise of options.
It’s only once the acquirer understands these basic elements that tax considerations come into play. “The most important thing is to accommodate the commercial deal, which means that tax is not necessarily what drives the executive compensation elements of a transaction,” Begun says.
Tax considerations are almost always significant — and complicated. “While an option holder can claim a deduction of up to 50 per cent on the option benefit if the underlying shares meet the ‘prescribed share’ requirements in the Income Tax Act, material changes to Canada’s tax deduction rules in 2021 and proposed harmonization with the new capital gains tax rules can complicate the deduction — assuming it’s available at all once the complex conditions for eligibility have been examined,” says Boyd.
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Generally speaking, common shares will qualify for the deduction, but repurchase rights to investors or companies that are attached to the shares can interfere with it, she explains.
It’s important for buyers in share transactions to examine tax withholding obligations associated with options closely because they inherit these liabilities from the vendor, adds Boyd.
From an employment law perspective, the areas of focus are change of control, restrictive covenants and termination provisions. “On an asset purchase, and even on a share purchase when a new company is incorporated to hold the shares, the buyer has to enter into new agreements with the executives affected,” says Andrea York, national leader of Blake, Cassels & Graydon’s employment and labour group.
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Buyers also need to familiarize themselves with existing change of control clauses. “Senior executives may have special deals on change of control, which the buyer would want to identify to determine how much equity will go to that executive if [they stay] on and also provide guidance on the liability if the executive is not retained,” Boyd says.
With respect to existing restrictive covenants and non-compete agreements, buyers should examine their enforceability. “The scope of employment restrictive covenants, where they are allowed, must be narrow and reasonable in time, geography and restricted activities to be enforceable,” says York.
And while Ontario banned non-compete agreements as of Oct. 25, 2021, there are exceptions for high-ranking executives and purchasers who stay on as employees after a sale. The difficulty is that the scope of these exceptions isn’t clear. “The exceptions are still subject to interpretation and so far, we have no judicial interpretations of their precise meaning,” she says.
However, the negotiations that transpire between executives and acquirers regarding equity compensation can be telling. “This aspect of the negotiations is the overarching discussion affecting executive retention,” says Antigoni Michalopoulos, a director in PwC Canada’s tax group. “It’s an opportunity that allows parties who want to play ball to show good faith and build trust.”
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