Published:

05/13/2011 09:35pm

10 Questions You Need to Ask About Change Of Control Provisions

ACTUAL CASE HISTORY: Thomas, 51, was the Chief Operating Officer of a New England-based manufacturer of electronic switches used primarily in the defense industry. He'd been recruited to the position three years earlier from a large defense contractor that was a large customer of the company. Though the company was publicly owned, with its shares traded on a major exchange, most of the company's stock rested in the hands of the grandchildren of the company's original founder.

Prodded by the grandchildren, who felt their holdings were underachieving, the company's Board of Directors retained an investment banking firm to consider various "strategic alternatives." To Thomas, the future was pretty clear: the company would likely be merged with a larger competitor, or sold to a more diversified defense contractor. And he knew, too, that with a change in the ownership or control of the company, it was likely he'd be either replaced or his role would be severely diminished.

Thomas wasn't too concerned about his own situation, though, because his employment contract contained a "Change of Control" (commonly referred to as "COC") provision that provided that, should the company be sold or otherwise experience a major change in its ownership, control or Board composition, he would be entitled to receive a generous separation package including two years' severance pay, full benefits, and immediate vesting of his considerable stock options. That package would permit him to consider his next career move without concern for his family's financial well-being. Though he saw nothing to be concerned about, Thomas nevertheless consulted us to have his employment contract reviewed, with particular focus on the intricacies of his "Change of Control" provision.

It was a good thing he did, for the convoluted manner in which his contract was drafted hid certain potential pitfalls; in fact, Thomas's COC provision did not provide him with the protections he thought it did. First, it defined a Change Of Control very narrowly; we reviewed with Thomas the many other types of corporate transactions that might take place, some of which were not covered by his contract provision. Second, our review revealed that his COC protections were not triggered by mere Change Of Control, as Thomas thought, but required, in addition, the occurrence of a second event, as well, from a list that included his termination, a reduction in his compensation, a decrease in his overall responsibilities, and a relocation of his primary office. Third, the second "triggering" event had to take place within six months of the initial Change Of Control.

Four months later, the deal was struck: the company was acquired by Thomas's former employer, and through a successful tender offer of the outstanding stock, it was to become a wholly-owned subsidiary. Thomas had no desire to return to his former employer in this way, and saw his COC arrangements to be far more attractive an alternative. A problem arose, though: no second "triggering" event was scheduled to take place: his office was not to be relocated, and his responsibilities were, in fact, expanded, now to include two other subsidiaries. However, Thomas's new compensation program was arguably less remunerative, as the acquiring company didn't have a stock option program, and future bonuses were not going to be on scale with his former bonuses.

Through a simple memo to the acquiring company's senior management team, carefully drafted to follow the terms of the COC provision in Thomas's contract, transmitted within the necessary deadlines, he achieved his goal: an amicable separation, two years' compensation and substantial stock option acceleration. But attention to detail, and careful analysis, of his COC provision did make the difference.

LESSON TO LEARN: Businesses change hands in many different ways and for many different reasons, including mergers, acquisitions, going public, being taken private, sales of subsidiaries, strategic combinations, Board re-compositions, and entry of new management, among othe