The Advisors' Blog

– Lynn Jokela

I’ve blogged before about reports we’re seeing of executive and director pay cuts.   For companies thinking about potentially making pay cuts or salary reductions for employees, executives and possibly directors, this Simpson Thacher memo provides a thoughtful discussion of key issues companies should consider.  The memo reminds companies that existing contractual obligations with employees require careful review as many contain “constructive termination” or “good reason” protections that might be triggered by a reduction in compensation.  Here’s an excerpt:

The exact formulation of these provisions will vary, but, in the event the employer reduces pre-agreed elements of the employee’s compensation, they generally permit an employee to resign from employment as a result of “good reason” or “constructive termination” and receive severance payments and/or accelerated vesting. Occasionally, a “good reason” definition may contain an exception for a reduction that’s an across-the-board reduction affecting similarly-situated employees and/or that is not “material.” The uniqueness of COVID-19-related reductions may present challenging interpretation issues. Even if an employment agreement doesn’t contain a specific “constructive termination” or “good reason” protection, an employer’s unilateral decrease in an employee’s compensation levels could constitute a breach of contract (in which case the employee may have general damages claims) and/or violation of state wage laws (which may provide for significant liquidated damages).

To help avoid ambiguities and questions about whether a contractual provision is implicated, the memo suggests employers thinking about a reduction request each affected employee execute a consent agreeing to such reduction in advance of the reduction. By taking this preemptive step, an employer can obviate later disputes, including any claim for breach of contract.

A consent should expressly acknowledge the original and new compensation levels and specify when compensation will return to the original levels (if known) or that the reduction will continue indefinitely until further notice. The consent also should include a confirmation from the employee that they agree that the reduction doesn’t constitute “good reason” or a “constructive termination” (or term of similar meaning) under any agreement to which the employee is a party or any plan in which the employee participates, including any equity arrangements. The consent should also clarify whether the reduction will affect other compensation amounts that are based on percentages or multiples of base salary, such as 401(k) contributions by the employer or the calculation of annual bonuses and severance amounts.

The memo also covers considerations relating to the scope of changes, deferred compensation arrangements, severance and other retirement benefits, non-U.S. employees and collective bargaining agreements, SEC disclosure, requirements for employee notices, anti-discrimination laws and non-employee director compensation.