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What is a Change of Control Agreement?

Jun 5, 2008
In the 1980s, corporate M&A activity intensified. Takeover targets seemed to be everywhere. Companies worried about protecting themselves and their best executives. Executives worried about keeping their jobs in the event of a takeover. Thus was born the change of control agreement, also known as a golden parachute agreement. A change of control agreement is an agreement, be it written or oral, formal or not, between a company and its individual executives that lays out a severance package for executives in the event of a change of control.

A change of control agreement memorializes the remunerative rights that an executive will enjoy should a change of control of his company occur and should be he fired without Cause or quit for Good Reason. The agreement exists for several reasons. First, it allows the executive to concentrate on his duties without worrying that he might be fired in the event of a change of control. To wit, the executive can dispassionately consider the future of the company, even in the face of a takeover, confident that his financial well-being is secure. Second, the agreement protects the company by assuring the executive's continued service. Third, it dissuades other companies from attempting a takeover; often, one of the prices of a takeover is that the hostile company must pay the benefits in the change of control agreement, as well as reconstitute the executive ranks.

The frequently cited Securities Exchange Act of 1934 is the benchmark for determining when a change of control has occurred. The predicate act in the agreement is a company undergoing a change of control, which can be one of several different events: 1) the sale, lease, or other conveyance of the company's assets; 2) the acquisition of 20% of the company's outstanding common stock in one year; 3) a merger or consolidation; 4) a change in the majority of the Board members; 5) a decision by the Board to dissolve or liquidate the company; 6) or a resolution by the Board that states that a change of control has occurred.

Over time, the change of control agreement has seen numerous modifications. One is the so-called double trigger. The single trigger agreement states that the severance package, usually an executive's base salary multiplied several times, plus company stock or an accelerated vesting of stock, would be paid out in the event of a change of control. The double trigger agreement, by contrast, pays the severance package in the event of a change of control and in the event that the executive is fired without Good Cause or quits with Good Reason. Two events must occur in the latter scenario.

The double trigger agreement has overtaken the single trigger in popularity. For it to work, however, Cause and Good Reason have to be clearly defined. Cause to fire an executive would be if he committed a crime or breached a fiduciary duty. Likewise, Good Reason for him to quit would be a reduction in pay or scope of duties, or onerous requirements being placed on his service to the company

Often, these agreements will mention, in addition to death and disability provisions and clauses about which side can modify the agreement (usually both, but sometimes the company unilaterally gross-up payments, whereby the company pays not only the severance package but also any taxes that would be due on the package, so the executive can enjoy the full benefit of the package.

Change of control agreements seem here to stay, as does the criticism that they protect incompetent executives and make consolidations that much harder.
About the Author
Mark Warner is a Legal Research Analyst for RealDealDocs.com. RealDealDocs gives you insider access to millions of legal documents drafted by the top law firms in the US. Search over 10 million Documents, Clauses, and Legal Agreements for Free at http://www.RealDealDocs.com
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