The following article is adapted and reprinted from the M&A Tax Report, Vol. 8, No. 9, April 2000, Panel Publishers, New York, NY.


By Robert W. Wood

I wish I could say I coined the phrase, but the golden parachute has landed in Europe. See Raghaven and Sims, "Golden Parachutes: Emerging European Deals," Wall Street Journal, Feb. 14, 2000, p. A17. It's no secret that European mergers have exploded, in some cases being bigger than US deals (witness the Mannesmann/Vodaphone deal). In mid-February it was disclosed that Mannesmann AG's supervisory board awarded Klaus Esser (Mannesmann's Chief Executive) an appreciation award of $16.04 million. The award was made on February 4, the day Mannesmann's board approved Vodaphone's $181 billion takeover of Mannesmann. Id.

But the Mannesmann/Vodaphone deal wasn't the only one to invoke the golden parachute notion. Philippe Jaffre of Elf Aquitaine reportedly received $37.6 million, including unvested options, after Elf Aquitaine was acquired by TotalFina SA last fall. Andre Levy-Lang of Paribas reportedly received 100 million french francs after Paribas was bought by Banque Nationale de Paris SA. Id. The rules are different in Europe, of course, but in the US, such rich packages prompt tax concerns as well as shareholders' rights queries.

Maybe the Europeans are just wising up to what has been a US trend for many years. When Deutsche Bank bought Bankers Trust, Bankers Trust CEO Frank Newman got a salary and bonus guarantee of $11 million per year for five years. Hardly a guarantee of five years of employment, however, the deal guaranteed the money whether he worked or quit (subject to certain conditions). As we all know by now, less than a month after the acquisition, Newman quit. Not a bad retirement, to receive $11 million per year through 2003 plus millions of dollars more in deferred compensation and payments triggered by the change in control. For details, see Colvin, "Value Drive: The Big Payoff," Fortune, Feb. 21, 2000, p. 78.

But this was hardly an isolated deal. On Ameritech's acquisition by SBC, Ameritech CEO Richard Notebaert received a special $2.5 million bonus. Although he was permitted to continue as executive after the merger, he was also allowed to quit, serving as a consultant for two years for a guaranteed $7 million. Under his arrangement, if he did quit, he would be treated as if he had been fired without cause (an interesting turn of phrase), entitling him to severance pay of approximately $15 million. This truly is the case of someone not being able to afford to work. Id.

And, when NationsBank and Bank of America merged (NationsBank acquiring Bank of America), BofA CEO David Coulter was guranteed $5 million per year for life (yes, for life) whether he worked or not. About a month after the deal closed, he quit (again, understandably). Id. It may be a dim memory, but a few years back, Aetna purchased U.S. Healthcare. U.S. Healthcare's CEO received severance pay (as if he had been fired), plus $25 million, and a jet with an approximate value of another $25 million. Not convinced this was a sweet deal? Aetna agreed to pay the jet's operating costs for five years. Id.

Obviously, some boards will not approve these ridiculous payments. And, when the target CEO is slated to become the CEO of the combined enterprise, the issue often just doesn't arise.

Golden Parachute Fundamentals

Regardless of what terms one uses, the tax rules governing golden parachute payments are pretty straightforward. Section 280G of the Code makes payments of so-called "excess parachute payment" nondeductible to the paying corporation. Furthermore, this slap on the wrists was (and still is) coupled with the nondeductible 20% excise tax on excess parachute payments imposed by Section 4999(a). Between nondeductibility for the payment itself, and a 20% excise tax (that itself is also nondeductible), the cost of paying such amounts is admittedly steep.

This harsh regime applies only to "excess" parachute payments. A parachute payment is defined as any compensatory payment to or for the benefit of a disqualified person (officer, shareholder, key employee or highly compensated person performing personal services for the corporation) under the following circumstances:

Determining whether a payment constitutes a parachute payment is typically rather easy. Significantly, however, a parachute payment normally does not include payments to or from qualified pension and profit-sharing plans, annuity plans and simplified employee pensions. (See I.R.C. §280G(b)(6).) This latter exemption may allow some flexibility for those who are not "weighed down" with plan contributions that are already long ago maxed out.

Gilding to Excess?

Since it is only "excess" parachute payments that are sanctioned, the definition of excess is important. A parachute payment is "excess" if: (1) it is made to a "disqualified individual;" (2) the payment is contingent on a change in the control or ownership of the corporation; and (3) the present value of the payment is at least three times the individual's "base amount." This base amount is essentially annualized compensation for the individual for a five-year period ending before the date of the change in control.

One feature of such agreement that is now relatively common is some type of savings clause. A savings clause in a contract might say that, notwithstanding any other arrangement or commitment, the company will have no liability to pay an excess parachute payment that would incur the wrath of the nondeductible excise tax.

Who Pays the Parachute Payment?

Interestingly, a recent court case holds that golden parachute payments under Section 280G of the Code are not limited to contract payments made by the target corporation. The court in this case held that either the target or the acquiring corporation can make the parachute payments subject to these rules. The case is Henry S. Hemingway v. United States, No. 2:97-CV-374(C) (D. Utah, June 16, 1999), Tax Analysts Doc. No. 2000-2935, 2000 TNT 20-38.

In this case, Hemingway was board chairman of two banks which were slated to be acquired by Key Corp. He was to be paid amounts by the two banks on acquisition. Interestingly, he also entered into an agreement with Key Corp. to provide consulting services and not to compete. The set of contracts with Key Corp. involved Hemingway being paid substantial amounts over the next ten years. This set of contracts with Key Corp. provided that if Key Corp. acquired the banks, the first contracts (with his banks) would become void. They also stated that if Key Corp. did not acquire the banks, the second contracts would become void. This actually was a rather creative use of contingent contracts, designed to reward the executive, but not to hit him with a slug of cash with each of the entities.

As it happened, Key Corp. did acquire both banks, and for 1989 through 1994 tax years, Hemingway received payments from Key Corp. under the second set of contracts. Predictably, the IRS assessed excise taxes under Section 4999, ruling that the payments from Key Corp. were golden parachute payments. Hemingway died, but his estate commenced a refund suit and moved for summary judgment. The estate argued that the payments were not parachute payments because they were not paid pursuant to contracts with the target corporations.

The district court denied the summary judgment motion, rejecting the argument by the taxpayer that as a matter of law, payments by an acquiring company do not constitute parachute payments under Section 280G. The court ruled that Section 280G applies to any payment contingent on a change in the corporation's ownership or control. Section 280G, said the court, does not specify whether an agreement by an acquiring corporation can constitute a parachute contract. The court, though, found that it could.

Of course, the court was able to rely on the services statement in regulations section 1.280G-1, which states that parachute payments include payments made by both the target and the acquiring corporation!

Europe vs. US: Who's Bigger?

Maybe we have more reason to care about the tax rules governing golden parachute payments in the US, but there have long been suggestions that dealmania (for lack of a better term) may grow even bigger in Europe than in the US. In 1999, the value of mergers in Europe hit $1.5 trillion (yes, trillion). This approaches the record $1.9 trillion deal value in the US for 1998. Earlier this year, predictions were that deals involving European companies will approach the $2 trillion mark this year. See "The Big Grab," Business Week, Jan. 24, 2000, p. 130.

Golden Parachutes Land in Europe, Vol. 8, No. 9, M&A Tax Report (April 2000), p. 1.