4000 - Advisory Opinions
Applicability of the golden parachute regulation to the proposed severance payment to a former executive of a national bank
January 23, 1997
Karen L. Main, Senior Attorney
I am writing in response to your request for a formal written determination from our office regarding the applicability of the golden parachute regulation, 12 C.F.R. Part 359, to the proposed severance payment to a former executive officer of a national bank.
I will begin with a recitation of the facts relevant to the consideration of this matter as set forth in your letter dated December 3, 1996 and its attachments. Your client, (the "Bank") and its shareholder, (the "Shareholder"), entered into a five year employment contract with (the "Officer") on December 28, 1995 (the "Employment Contract"). The Officer had been a senior executive officer of the Bank since its formation approximately ten years ago. On October 17, 1996, less than one year after executing the Employment Contract, the Officer voluntarily resigned as Chief Executive Officer of the Bank (and all other positions with the Bank and its Shareholder). At that time, the Bank and its Shareholder entered into a severance/settlement agreement and release (the "Agreement") whereby the Officer released the Bank from the Employment Contract and the Bank agreed to pay certain benefits to the Officer upon specified conditions.
There are two types of benefits contemplated by the Agreement: payment for (i) accumulated vacation and sick days and (ii) compensatory (or "comp") time. Due to his status as the highest ranking officer of the Bank, the Officer recorded his own vacation, sick and comp time. His records indicate that he believed that he was entitled to 102.5 vacation days, 61 sick days, and 2,350 hours of comp time. The Bank disputes these totals. The Bank has, however, agreed to the payment of benefits under the Agreement equal to ten months' salary at the base rate of pay.
Section 3 of the Agreement conditions the payment of the vacation/sick days and comp time on the approval of the Office of the Comptroller of the Currency (the "OCC"), the Bank's primary federal regulator, and the Federal Deposit Insurance Corporation (the "FDIC") (or unless and until the Boards of the Bank and its Shareholder are satisfied that no adverse action will be taken by any regulatory agency against the Bank or its affiliates).
A chapter of the Bank's Employee Manual (the "Manual") describes the Bank's vacation and sick leave policies. The Manual does not address comp time. The Bank has been in existence approximately ten years; since its inception, and continually thereafter, the Bank has paid all departing employees for accrued vacation time at the time of severance. This is permitted by the policy set forth in the Manual. The Manual provides that sick leave may be paid upon termination only with the approval of the Chief Executive Officer. For the last 4 years, all officers, but no non-officers, have been paid for accrued sick leave at termination.
Until 4 years ago, the Bank also paid departing employees for accumulated comp time. However, at that time, all comp time payments and accumulation were ostensibly discontinued. Nevertheless, since discontinuing the practice, the Bank has paid at least one departing employee-officer for accumulated comp time under the theory that her employment with the Bank pre-dated the discontinuation of the policy of paying Bank employees for comp time. The Officer's employment also began before the discontinuation of the comp time policy. However, since ending the accumulation of comp time, several other employees separated from the Bank and received no payment for accumulated comp time.
There are several other salient facts concerning the Bank and its regulatory/supervisory posture which should be noted. For purposes of applying the definition of "golden parachute payment" under section 359.1(f), the Bank would be deemed to be "in a troubled condition" and has a composite CAMEL rating of 4 as of its last examination which was conducted in the fall of 1995.1 Section 359.1(f)(1)(ii)(C) and -(D). The Officer's resignation come in the context of poor performance by the Bank as well as supervisory and Board discontent with the Officer's performance. And finally, you have received, on behalf of the Bank, assurances from the OCC that it will not object to the terms of the Agreement.
In your letter, you have asked me to assume that, unless excepted, the proposed payments would fall within the definition of a "golden parachute payment." Section 359.1(f). I believe that your assumption is correct. However, you have advanced the position that the proposed payments may be permitted under an exception to the definition of "golden parachute payment" found at section 359.1(f)(2)(v) which addresses a nondiscriminatory severance pay plan or arrangement. Therefore, I will proceed by discussing each aspect of the relevant exception and evaluating its applicability to the factual situation described hereinabove.
The exception under consideration is set forth as follows:
Any payment made pursuant to a nondiscriminary severance pay plan or arrangement which provides for payment of severance benefits to all eligible employees upon involuntary termination other than for cause, voluntary resignation, or early retirement; provided, however, that no employee shall receive any such payment which exceeds the base compensation paid to such employee during the twelve months . . . immediately preceding termination of employment, resignation or early retirement, and such severance pay plan or arrangement shall not have been adopted or modified to increase the amount or scope of severance benefits at a time when the insured depository institution . . . was in a condition specified in paragraph (f)(1)(ii) of this section . . . without the prior written consent of the appropriate federal banking agency.
1. The severance pay plan shall not have been adopted or modified while the Bank is in a condition specified in section 359.1(f)(1)(ii).
In order to focus the discussion on the documents which are relevant to this analysis, the various components of this exception will not be examined in the order in which they appear in the definition. Rather, I will begin by reviewing the last requirement as set forth above.
Such severance pay plan or arrangement shall not have been adopted or modified to increase the amount or scope of severance benefits at a time when the insured depository institution is in a [troubled condition or has a rating of 4 or 5 under the Uniform Financial Institutions Rating System].
Section 359.1(f)(2)(v). According to your letter, the Bank would be deemed to be in a troubled condition as a result of its last examination in the fall of 1995. Moreover, during one of our telephone conversations, you informed me that the Bank's CAMEL rating is a 4 as a consequence of that examination. Both the Employment Contract and the Agreement were entered into subsequent to these two events, and therefore, could not be considered as a "severance pay plan" or "arrangement" for purposes of this exception.
In order to determine what payment(s) to the Officer, if any, are authorized pursuant to this exception, the Bank must rely upon the benefits/payments to employees which are provided for the relevant portions of the Bank's Manual. The Manual and the policies described therein pre-date the circumstances (the Bank's troubled condition and the CAMEL 4 rating) which dictate that the provisions of the Employment Contract and the Agreement can not be controlling in the instant case.
2. The nondiscriminatory severance pay plan or arrangement must provide for payment of severance benefits to all eligible employees.
For the reason set forth above, the Employment Contract and the Agreement cannot serve as the basis of the Bank's payment to the Officer. Moreover, the provisions of the Employment Contract governing the Officer's compensation upon termination are not applicable to the situation described in your letter. The Employment Contract provides for the Officer's compensation in the event of involuntary termination by the Bank (not for cause) or as a result of a change in control. It is also worth noting that the Agreement does not satisfy the definition of "nondiscriminatory" as set forth in section 359.1(j). The definition of "nondiscriminatory" requires that,
the plan, contract or arrangement . . . applies to all employees of an insured depository institution . . . who meet reasonable and customary eligibility requirements . . . such as minimum length of service requirements. [It] may provide different benefits based only on objective criteria such as salary, total compensation, length of service, job grade or classification, which are applied on a proportionate basis.
Section 359.1(j). The Agreement provides for the payment to the Officer of vacation time, sick leave and comp time. First, the Agreement only applies to the Officer--not to all employees of the Bank who meet reasonable and customary eligibility requirements. And it provides him with benefits/compensation which are not afforded to other employees of the Bank, e.g., the payment of comp time is no longer offered to other Bank employees--not even to Bank officers. Only the provisions of the Bank's manual can serve as the basis for a nondiscriminatory severance pay plan or arrangement.
Having determined that any payment made to the Officer will have to be in accordance with the applicable provisions of the Bank's Manual in order to satisfy the exception for a nondiscriminatory severance pay arrangement found in section 359.1(f)(2)(v), it is now possible to determine what proposed payments to the Officer would be authorized. As set forth in the Manual, all employees are entitled to receive payment for accrued annual vacation upon their termination (except for reason of gross misconduct). The policies governing the accrual and payment for annual vacation apply to all employees of the Bank who meet reasonable and customary eligibility requirements such as minimum length of service. In addition, the benefits offered thereby are based on objective criteria such as salary, total compensation, length of service, job grade or classification. According to your letter, it has been the policy of the Bank to pay all departing employees for the accrued vacation time since the Bank's inception. This practice conforms with the definition of "nondiscriminatory" set forth above, and satisfies the requirement that the severance benefits be offered to all eligible employees. Therefore, the annual vacation policy outlined in the Bank's Manual, while not a formal, written severance plan, does constitute a severance pay "arrangement" for purposes of section 359.1(f)(2)(v). Therefore, the Officer would be entitled to receive payment for his accrued vacation time provided that the Bank and the Officer can reach agreement as to how much vacation time the Officer has actually earned.
With respect to any accumulated sick leave, the Manual states that,
no payment shall be made for accrued sick leave of an employee upon termination of his employment with the Bank. Exceptions to this policy must be approved by the Chief Executive Officer.
Manual, paragraph 301. For the last 4 years, all officers, but no non-officers, have been paid for accrued sick leave at termination. The definition of "nondiscriminatory" in section 359.1(j) states that the severance pay arrangement in question may provide different benefits to groups of employees (with certain group size restrictions)--such as would appear to be the case at the Bank with respect to the payment for accumulated sick leave. However, the Bank's practice of basing the payment of sick leave on the approval of the Chief Executive Officer does not conform with the definition's requirement that the different benefits be "based only on objective criteria such as salary, total compensation, length of service, job grade or classification." Section 359.1(j). Leaving the determination of whether to compensate a departing Bank employee for accumulated sick leave to the discretion of the Bank's Chief Executive Officer is not an objective standard under the definition of "nondiscriminatory" set forth in the regulation. Therefore, payment of the Officer's accumulated sick leave would not be authorized pursuant to the Bank's nondiscriminatory severance pay arrangement and, therefore, does not fall within the exception.
Finally, with respect to comp time, there is no provision for the payment of comp time in the Bank's Manual, and the Bank has not paid comp time to employees upon termination (with one exception) for the last 4 years. Therefore, the payment of comp time to the Officer would not be authorized pursuant to section 359.1(f)(2)(v).
3. The payment shall be made upon involuntary termination other than for cause, voluntary resignation, or early retirement.
One of the attachments to your letter is a copy of the Officer's resignation letter, dated October 17, 1996, addressed to the Bank's and the Shareholder's Boards of Directors. The Officer's letter and the Agreement both recite that the Officer resigned voluntarily. Although the Agreement can not serve as the basis for providing compensation to the Officer under Part 359, it does support the position that the Officer's departure from the Bank was due to his voluntary resignation. You have previously disclosed to me in our telephone conversations, and have noted in your letter that the Officer's resignation came in the context of poor performance by the Bank, and supervisory and Board discontent with the Officer's performance. There is, as you point out, a "for cause" termination provision in the Employment Contract. You note, however, that the Bank/Shareholder and the Officer do not believe that the Officer's termination is governed by that provision. I would agree with your assertion. The Officer voluntarily proffered his resignation, and the executed Agreement evidences the Bank's and Shareholder's acceptance thereof. To quote from your letter, "the context and environment do not change the fact of voluntary resignation."
4. No employee shall receive any payment which exceeds the base compensation paid to such employee during the 12 months immediately preceding termination of employment.
The Officer's base compensation during the twelve months preceding his resignation was $120,000 per year. The payment of benefits contemplated by the Agreement would be for a total of ten months salary at the base rate of pay. However, as discussed in section 2, above, the payment of accumulated sick leave as well as comp time can not be supported under the "nondiscriminatory severance pay plan" exception. Therefore, it appears likely that the Officer will receive a smaller sum than the ten months salary contemplated under the Agreement, and will meet the requirement of section 359.1(f)(2)(v). In order to comply with this condition of the exception, the amount of the vacation leave to be paid to the Officer can not exceed his $120,000 annual salary.
There is one other section of Part 359 which should be addressed in connection with your request. Section 359.4(a)(1) provides that an insured depository institution may make a golden parachute payment if and to the extent that,
[t]he appropriate federal banking agency, with the written concurrence of the [FDIC], determines that such a payment or agreement is permissible.
Clearly, the payment of the proposed sick leave and comp time would fall within the definition of a golden parachute payment under section 359.1(f)(1). In order for the Bank to be able to pay the Officer for the sick leave and comp time as set forth in the Agreement, the Bank or the Officer would have to make a request pursuant to section 359.4(a)(1) to the appropriate federal banking agency, with the written concurrence of the FDIC, to determine that the proposed payments would be permissible. The Bank or the Officer would also have to make certain representations regarding the Officer's performance of his duties and responsibilities vis-a-vis the Bank (breach of trust or fiduciary duty, insider abuse, responsibility for causing the Bank to be in a troubled condition) and whether he has committed any violations of applicable federal or state banking laws or regulations. See section 359.4(a)(4)(i)--(iv).
You have included as another attachment to your letter a copy of a letter from the OCC's Southeastern District office, dated October 31, 1996, which states that the OCC "will not interpose any objection to the terms of this [A]greement." However, in order to satisfy fully the terms of section 359.4(a)(1), the Bank or the Officer would have to submit a written request to the appropriate FDIC Regional Office to obtain the FDIC's written concurrence that the payment of the Officer's accrued sick leave and comp time by the Bank would be permissible. The decision to pursue this course of action must be made by the Bank and its Shareholder, and is independent of the determinations made herein. In the alternative, the Officer can elect to make this request pursuant to section 359.4(a)(1) and -(a)(4) on his own initiative.
In summation, the policies set forth in the Bank's Manual serve as the basis for a "nondiscriminatory severance pay plan or arrangement" pursuant to the exception found at section 359.1(f)(2)(v). In accordance with those policies, the Bank would be authorized to make payment to the Officer for the accrued vacation time. However, in order to pay the Officer for the accrued sick leave and comp time which are additional components of the compensation package provided by the Agreement, the Bank (or the Officer) must submit an additional request to the FDIC's Regional Officer under section 359.4(a)(1) for its consideration and concurrence.
I trust that this discussion is responsive to your inquiry. Please feel free to call me if you have any further questions regarding this matter. This opinion is based solely upon the facts presented to the FDIC in your letter and the accompanying attachments. We reserve the right to review this conclusion if there is any material change in the facts and circumstances from those set forth above.
1Hereinafter, all references to sections will be to 12 C.F.R. unless otherwise noted. Therefore, this portion of subsequent citations will be omitted. Go back to Text