What to Watch for with CEO Contracts
Pillsbury Winthrop Shaw Pittman, LLP
Employment contracts are becoming more the norm than the exception for chief executive officers in the association community. For some categories of nonprofit organizations, the prevalence of CEO employment contracts exceeds sixty percent. On the assumption that most association executives are familiar with common features of these contracts, here is a refresher outline of components that merit extra-careful review. Complex legal issues are sometimes raised in each area of the contract, so be sure to seek legal counsel before signing one.
CEO contracts typically cover ten areas of particular concern.
Compensation. Federal legislation passed in 1993 limits the amount of income that can be recognized in accruing retirement benefits in federally qualified pension programs. Many more recent association CEO contracts attempt to address and remedy the problem, which results in inequitable treatment for higher-paid CEOs. Among the possibilities are a separate increase in current salary or in post-employment severance; consulting or deferred compensation arrangements; or whole life insurance. Any of these can reflect the value of retirement benefits lost through the 1993 legislation.
Personal use of automobile. Internal Revenue Service requirements make clear that personal use of an employer-provided automobile, including routine commuting use, must be treated as taxable income for the employee and reported by the association on the employee’s Form W-2 compensation report. Consider ways to manage that tax liability in the context of the employment agreement, such as by providing for CEO reimbursement to the association for the estimated value of any personal use of the automobile.
Spouse travel. IRS regulations make it nearly certain that reimbursement by an association for travel expenses of the CEO's spouse will be considered taxable income to the CEO except in unusual circumstances. Again the amounts must appear on the employee’s Form W-2. The employment contract can deal with this problem by providing for an increase in the reimbursement to the CEO to account for the taxation of the spouse's reimbursed travel expenses.
Management. It is ordinarily in the best interests of both the association and the CEO for the contract to provide for the CEO's exclusive authority over engaging, advancing, compensating, assigning, and terminating all other employees so long as budget and legal restraints are observed. Note, however, that the 2008 version of the Form 990 return for exempt organizations encourages the practice whereby the governing board or compensation committee reviews not only the compensation of the CEO but also of other officers and key employees, with reference to comparability data and with the details of the review recorded.
Contract versus bylaws. Conflicts can sometimes arise between provisions in a CEO contract and provisions in the association's bylaws or other governing documents. Resolve these conflicts before entering into the employment contract.
Term. CEO contracts often run one, two, three, or more years. Increasingly, they are written as “evergreen” documents, automatically renewing year after year until either side cancels the contract, ordinarily by giving advance written notice. Another approach is a “rolling renewal” in which the current term of the agreement is extended each year such that the current term remains two, three, or more years.
Termination. CEO contracts often provide for "with cause" termination of the CEO, with no severance benefits, in circumstances of "impropriety, dishonesty, and moral turpitude.” These ambiguous references can lead to disputes. Make sure that the contract specifies "with cause" termination criteria (for example, embezzlement, or conviction of a felony) and includes an opportunity for the CEO to rebut any allegations of cause.
Many contracts provide for the payment of severance benefits to an association CEO who is terminated "without cause" - in other words, when the CEO is fired for no particular reason related to improprieties or performance deficiencies. Such a contract often extends for a several-year period and then must be renewed by the two parties - the association and the CEO - or the contract automatically expires. Ensure that the severance provided for termination without cause is also provided if the association does not renew the contract but instead simply allows it to expire.
Conflicts of interest. CEOs have been known to lose their positions when one of the association's volunteers expresses interest in replacing the CEO. One way to help prevent this possible conflict of interest is to state in the CEO contract that no volunteer who is, or might become, a candidate for the position may participate in negotiating the contract, setting the CEO's compensation, establishing goals, appraising the CEO's performance, or otherwise affecting termination without cause or nonrenewal.
Severance. Federal income tax laws generally provide that severance payments must be made to the former employee within two years of the date when employment ended. There can be two distinct motivations for an association to grant severance benefits: to smooth the CEO's transition to another position when termination is without cause or due to the association's nonrenewal of the contract, or to supplement retirement benefits.
Post-employment. Many contracts include post-employment consulting arrangements. It is in the best interests of both the former CEO and the association for the contract to specify the expected consulting time and the procedures for reimbursement of approved disbursements, assistants, travel, and the like.
Look in our Models and Samples section for model CEO employment contracts.
Jerry Jacobs is a partner at Pillsbury Winthrop Shaw Pittman, LLP. He can be reached at email@example.com.
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