As businesses struggle to attract and retain talent, and employers are faced with challenges such as “quiet quitting” and high employee turn-over, many business owners are left wondering how they can help ensure key employees remain with their organization. Although offering signing bonuses, performance bonuses, flexible and work-from-home arrangements, and attractive benefits can be strong tools in incentivizing employees to stick with a company, a tool often under-utilized by companies are Retention Agreements (including “Change-In-Control Agreements”).
A Retention Agreement is a contract entered into between an employer and an employee that promises the employee a “retention bonus” in exchange for the employee’s continued service to the employer during, and through, a pre-determined period of time known as the “retention period” or “retention date.” For example, a standard provision in a Retention Agreement might state the following:
Retention Bonus. If Employee remains continuously employed with the Company through July 31,2023 (the “Retention Date”), or if the Company terminates Employee’s employment without Cause prior to the Retention Date, Employee shall be eligible for an incentive bonus of ten thousand dollars ($10,000). The incentive bonus shall be paid within thirty (30) days following the Retention Date.
Although Retention Agreements are most often offered to a company’s executive employees, Retention Agreements can also be used to help incentivize non-executive or non c-suite employees to remain with a company. Additionally, a retention bonus can take the form of a cash bonus, grant of equity, or guaranteed promotion. Likewise, a retention bonus can also be a pre-set amount, or can be tied to a performance measurement, such as the sale price of the company in an acquisition or change-in-control. Given the flexibility in structuring Retention Agreements, such agreements can be especially useful for companies experiencing high employee turnover, going through periods of uncertainty, or contemplating or negotiation a merger or acquisition.
A Change-In-Control Agreement is a type of Retention Agreement that is conditioned on an employee staying with a company through a “change-in-control” event, such as a merger or acquisition. For example, a simple “Change-In-Control” definition might state:
The term “Change-in-Control” means an event whereby a person (or group), who is not an affiliate of the Company, acquires (i) stock of the Company or any parent entity of the Company that constitutes more than fifty percent (50%) of the total fair market value or total voting power of the stock of the Company or parent entity (as applicable) or (ii) assets of the Company or parent entity that have a total fair market value (giving effect to any liabilities owed) of fifty percent (50%) or more of the total gross fair market value of all of the assets of the Company or parent entity immediately prior to such acquisition.
“Change-In-Control” definitions should be carefully drafted however to ensure compliance with applicable laws and to ensure that key events are either included, or excluded, from the agreement.
Although Retention Agreements can easily be used by companies experiencing high employee turnover to incentivize employees to remain with the company through a set period of time, Retention Agreements are especially useful for companies hoping to increase their value when seeking, or going through, an acquisition. Such agreements not only provide assurance to a selling company that its key employees will remain with the company through the closing of the sale or acquisition—helping ensure continued operations by employees who may otherwise be wary of potential layoffs or other changes that often accompany new ownership—but can also be structured so that the retention bonus payable to eligible employees is based off of, or tied to, the net profits or sale price of the company, a payment structure that can encourage employees to maximize their efforts to, in turn, help maximize the value of the company. Likewise, Retention Agreements can also be structured to help assure a potential buyer that the company’s key employees will remain in the company’s employ for a period of time following the closing of the acquisition, an assurance that is attractive to many buyers wary of having to replace experienced employees who are vital to a company’s culture or success.
Retention Agreements are most often offered to key employees on an individual basis, either as a stand-alone agreement or as part of an employee’s underlying employment agreement. However, some companies opt to create common retention bonus plans for all, or some, of their employees. Although a company plan may allow for streamlined or simplified management and accounting, it does carry an increased risk of triggering reporting and compliance requirements under various federal and state laws such as the Employee Retirement Income Security Act of 1974 (29U.S.C. § 1001 et seq.), more commonly known as “ERISA.” Accordingly, where a group plan is pursued, the company must be careful to structure the plan in a manner such that it is excluded from, or complies with, applicable federal and state law, including ERISA.
Regardless of whether an individual or group plan is offered to employees, Retention and Change-In-Control Agreements must be carefully drafted to ensure compliance with numerous federal laws. For example, in addition to ERISA requirements, payments made under a Retention Agreement or Change-In-Control Agreement can trigger tax implications for employees under Internal Revenue Code Sections 409A (see 26 USCS §409A, governing deferred compensation) and 280G (see 28 USCS §280G, governing golden parachute payments). Accordingly, it is imperative that Retention and Change-In-Control Agreements be carefully drafted to ensure compliance with such laws. Failure to do so can result in significant adverse tax consequences for employees and significant penalties, fines, or enforcement consequences for employers.
In addition to federal laws, Retention and Change-In-Control Agreements may be subject to additional requirements under state law. For example, although some Retention and Change-In-Control Agreements condition an employee’s receipt of a retention bonus on the employee being employed through both the (i) retention period and (ii) the date of payment, some states, such as Colorado, prohibit employers from conditioning payment of a vested retention bonus on an employee remaining with the company through the date of payment (See C.R.S. § 8-4-109. See also, Hofer v. Polly Little Realtors, Inc., 37 Colo App. 86 (1975) (“The wording of [C.R.S.§ 8-4-109] provides that wages or compensation for labor or services earned and unpaid at the time of discharge of an employee by an employer are due and payable immediately.”)). Accordingly, it is essential for employers to ensure any Retention or Change-In-Control Agreement is drafted in a manner that complies with applicable local law.
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