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How To Handle No-Cut Employment Contracts In Hard Times

Law360

Publication
April 8, 2020
News outlets have been replete with stories lately about sports stars, high- level executives and in-house counsel foregoing salaries or taking pay cuts in light of the economic hardships wrought by the coronavirus pandemic. These moves may be motivated by kindness or by the economic impact on the employer, and they seem like the right thing to do.

But suppose you have a number of executives who are the fortunate beneficiary of a long-term, so-called no-cut contract for which they bargained dearly long before the current crisis? Should the employer — be it the NBA or American Airlines — be able to force the executive to take a pay cut when the employment agreement doesn't allow it?

Lenders, borrowers, landlords, renters and many other parties to various commercial agreements have been racing to have their hawk-eyed lawyers pore over these agreements to see whether there are ways either to postpone or altogether escape obligations that in the current economic environment are ruinous or at least onerous. Most of these efforts have focused on so-called force majeure or material adverse change clauses.

But employment agreements historically have not contained these types of clauses. Because these types of agreements are considered personal services contracts, the types of escape clauses contained therein typically have focused on specific actions or omissions of the executive or, in some rare cases, the employer.

Moreover, employment agreements in the mergers and acquisitions context often are a form of purchase price paid to the sellers of the business and therefore are intended to go unpaid in the rarest of situations. Few acquisition agreements permit recapture of purchase price for events that occur post-closing, so why should employment agreements negotiated as part of the deal be any different when they are in essence part and parcel of the purchase price?

Thus, many executive employment agreements permit the employer to terminate the agreement for any or no reason (at will, as it is commonly called), but if the termination is without cause, the employer typically continues to be obligated to pay at least the base salary for the remainder of the term, if not other compensation such as bonuses. In addition, unvested equity grants may accelerate, which can result in significant additional compensation to the executive.

The list of "cause" events can range from the obvious (being convicted of a felony, committing fraud against the company) to the questionable (some hospitals are firing doctors for complaining about deplorable working conditions in their facilities). Much depends on the importance and notoriety of the employee. If the transgression involves a rock-start CEO or a famous movie star, then lesser offenses such as public displays of drunkenness may be sufficient to constitute cause (the so-called morals clauses in many artists' contracts), even if these transgressions occur outside of business hours and only tangentially affect the business.

Rare is the employment agreement that defines "cause" by reference to an event outside of the executive's control, such as a pandemic or a stock market crash. Although these events
 
may seriously impact the employer and may indirectly affect the executive's anticipated bonus or the value of his or her company equity, generally speaking the executive's base salary at least is sacrosanct.

So, what if your company is considering asking executives to take a significant pay cut because of the impact of the crisis on its business? Certainly that is a prudent request for any company to make in difficult economic times.

As the executive, refusing to go along even if legally entitled to may be perceived as selfish and not in keeping with team spirit, especially if others similarly situated already have agreed. My advice is to set aside emotions and for both parties to treat the request like any other business transaction and negotiate the terms.

If you are the employer, recognize that existing employment agreements need to be taken into account. Many employment agreements permit an executive to terminate the agreement for "good reason," in which case the agreement is considered terminated "without cause," entitling the executive to base salary and perhaps other compensation for the remaining term of the agreement.

Such a termination also may accelerate unvested equity grants and void noncompetition and other restrictive covenants in the agreement. A reduction in salary is almost always considered "good reason" under these provisions, so be careful not to inadvertently trigger this escape clause by unilaterally reducing an executive's compensation.

If you are the employee, first make sure everyone is giving their pound of flesh. You may want to include a most favored nation or nondiscrimination clause for chump insurance.

Second, try to make the pay cut a deferral rather than a permanent loss of the reduction in salary. Lenders who forbear on loans do not forgive the underlying debt or the interest thereon, nor should you.

Third, make sure there is an objective end date to the reduction in salary, such as when the bars reopen.

Fourth, now is the time to ask for some other benefits, such as an extension of the term or the guarantee of a pro-rated bonus based on results up to the date of the pay cut.

Interestingly, the recently passed Coronavirus Aid, Relief, and Economic Security Act makes the receipt of loans, loan guarantees and investments by the U.S. government in certain eligible businesses contingent on limits on, among other things, increases in executive compensation over certain thresholds for a year after the loan is repaid. I imagine that
many companies that are considering these government benefits will now have to negotiate with executives that have employment agreements to make sure the companies comply with these limits.

So whether you are the employer or the employee, recognize that contracts are still valid notwithstanding the crisis. Consider an approach that balances the difficult times we are experiencing with bargained for contractual obligations. Remember, the kindest cut is one mutually negotiated.
 

*This article was republished with permission from Law360*

 

This information is intended to inform our clients and other friends about legal developments, including recent decisions of various municipalities, legislative, and administrative bodies. Because of the rapidly changing landscape related to COVID-19, we intend to send out regular updates. The information we provide is not intended as legal advice and viewers/readers should not rely on information contained in these materials to make business or legal decisions. Before making any legal decisions, consult your lawyer. Please do not hesitate to contact us should you need assistance responding to the many issues which have arisen, and will continue to arise, out of this situation.

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