Golden Parachute Payments – Shareholder Approval Exception

John Hodnette is a man with brown hair and blue eyes. He is pictured wearing a dark blue jacket, white shirt, and pale blue and pink tie. He is smiling and standing against a grey background.By John G. Hodnette

Sections 280G and 4999 impose a 20% excise tax in addition to regular income taxes on individuals who receive an excess parachute payment upon a change of control or sale of a substantial portion of the assets of a corporation. Section 280G also prohibits the corporation from deducting the payment. However, there are notable exceptions to these general rules, including the shareholder voting exception in Section 280G(b)(5)(B).

Only officers, certain shareholders, and the highest paid group of individuals of a corporation are subject to the golden parachute rules. Parachute payments are limited by definition to payments equal to or exceeding three times the individual’s base salary. However, even if the Section 280G rules would generally apply, there may be an opportunity for the corporation to apply the shareholder approval exception. The exception applies only to corporations whose stock is not readily tradable on an established securities market, as defined in Treas. Reg. § 1.897-1(m). A corporation is treated as having regularly traded stock if either (i) it is a member of an affiliated group of corporations and stock of any member of such group is readily tradable on an established securities market, or (ii) its parent corporation has any ownership that is readily tradable on an established securities market and the stock of the corporation constitutes a substantial portion of the fair market value of the assets of the parent corporation.

Under the shareholder approval exception, a corporation can avoid golden parachute treatment of a payment if (i) the payment is approved in a vote separate from the vote approving the change of control transaction, (ii) the persons who own (before the change of control) more than 75% of the voting power of the corporation approve the payment, (iii) adequate disclosures are made to all persons entitled to vote of all material facts concerning all payments that would otherwise be parachute payments, and (iv) the vote determines the right of the recipients to receive the payment or (if the payment has already been made) the right to retain such payment.

The recipients of what, absent the vote, would be parachute payments are not entitled to vote on the approval of the payments. In addition, the constructive ownership rules of Section 318(a) apply in determining who may vote for this purpose. There is an exception to the prohibition on voting by recipients if all of the voting stock would be prohibited from taking part in the vote, which may occur as to a closely held corporation where all owners are also executives who receive parachute payments.

John G. Hodnette is an attorney with Johnston Allison Hord in Charlotte.