Payment Agreements with Acquiring Corporation May Be Golden Parachute Payments

As of 1987, H was chairman of two banks, CSB and IBT. In 1987, CSB and IBT entered into negotiations with Corporation K, to be acquired by K.

In 1987, H entered into a contract with CSB, under which he provided consulting services and which included a covenant not to compete with CSB for three years. He later entered into a similar six-year contract with CSB and K, which would go into effect if K acquired CSB. K merged with CSB in 1987.

In 1988, H entered into a similar arrangement with IBT; ultimately, his contract was for consulting services and not to compete with K for 10 years. Again, this contract would go into effect only if K acquired IBT. K merged with IBT in 1988.

From 1989–1994, H received payments under his CSB and IBT contracts. In 1995, the IRS audited H and determined that the payments received from K were "golden parachute payments," under Sec. 280G, and subject to the Sec. 4999 excise tax on "excess parachute payments." H challenged this determination, arguing that, because the payments were made pursuant to an agreement with the acquiring company (K) and not the target companies, they did not come under Sec. 280G.

The District Court (opinion Campbell, J.) holds for the Service; Secs. 280G and 4999 are not limited to payment contracts made by a target company, but apply to all payment agreements contingent on a change of control.

Sec. 280G(b)(2)(A) defines "parachute payment" as follows:

(A) In general.—The term "parachute payment" means any payment in the nature of compensation to (or for the benefit of) a disqualified individual if—(i) [sic] such payment is contingent on a change—(I) in the ownership or effective control of the corporation, or (II) in the ownership of a substantial portion of the assets of the corporation, and (ii) the aggregate present value of the payments in the nature of compensation to (or for the benefit of) such individual which are contingent on such change equals or exceeds an amount equal to 3 times the base amount.

The statute does not specify whether an agreement by an acquiring corporation can constitute a parachute payment contract. However, the statute is written broadly to cover "any payment" contingent on a change in corporate ownership or control. The plain language would seem to encompass agreements between acquiring companies and employees of the target company.

The legislative history of Sec. 280G indicates that it has a dual purpose. First, Congress intended to discourage the use of parachute payment contracts between a corporation and its officers to defend against hostile takeovers. In enacting Sec. 280G, Congress clearly intended to penalize "agreements between a corporation and its top officers that guarantee those officers continued employment, payment of a lump sum or other benefits in the event of a change of corporate ownership." However, Congress did not limit the scope of Sec. 280G to these types of parachute payment contracts.

Second, Sec. 280G was also intended to discourage employees of the target corporation from entering into contracts with the acquiring corporation that would handsomely reward those employees if an acquisition took place. The Joint Committee on Taxation noted that "Congress was concerned that the existence of such arrangements tended to encourage the executives and other key personnel involved to favor a proposed takeover that might not be in the best interests of the shareholders or others." For example, an employee of a target corporation might tend to support an unfavorable takeover if the employee entered into an employment agreement, consulting agreement not to compete or similar arrangement with the acquiring company for a term of three years before the takeover occurred. This is precisely the type of parachute payment contract at issue in this case.

Prop. Regs. Sec. 1.280G-1, Q&A-10, also supports an interpretation of "parachute payments" that includes both payments made by the target corporation and payments made by the acquiring corporation. It states that "parachute payments" under Sec. 280G may be paid directly or indirectly by the corporation experiencing a change in ownership or control or "by a person acquiring ownership or effective control of that corporation or ownership of a substantial portion of that corporation's assets."

The plain language of Sec. 280G, its legislative history and the regulations indicate that Secs. 280G and 4999 are not limited to payment contracts made by the target corporation. To the contrary, the tax penalty applies to all payment agreements contingent on a change of control of the employee's corporation. Therefore, payment agreements entered into by an acquiring corporation may constitute parachute payments.

Henry Hemingway, DC Utah, 6/16/99