April 18, 2019 . By Mark Poerio
A recent Law360 headline brought rabbi trusts immediately to mind. It reads "Ex-Manufacturing Co. CEO Says He's Owed $4.4M in Benefits" (4/10/2019).* Litigation sprung because the retired CEO expected to receive monthly supplemental retirement benefits over a period of 10 years, but his company suspended payment after 15 months. The disagreement seems to involve whether life insurance provided the employer with a "cash neutral" hedge against its liability to pay supplemental executive retirement plan ("SERP") benefits. If only the CEO could turn the clock back to the time of his retirement.
On the eve of terminating employment, most employers aim to assure a clean and friendly transition - and seek a general release of claims as a condition for severance and other exit benefits. Negotiations tend to involve a cooperative give and take. It is a ripe time for reasonable "asks" from both sides. That could be prime time for the establishment of a rabbi trust if an executive will not immediately collect all severance, deferred compensation, and other nonqualified plan benefits. Likewise, the lead-up to a merger or sale transaction may also warrant creation of a rabbi trust, because a target company's executives cannot always be confident that the buyer will honor (or not dispute) the post-closing payment of severance and other deferred benefits.
Interestingly, executives often underestimate -- or dismiss -- the value of rabbi trusts. That usually occurs because the most notable characteristic of a rabbi trust may be its inability to protect executives against the employer's bankruptcy or technical insolvency. Indeed, U.S. tax laws require that rabbi trust assets remain subject to the claim's of the employer's general creditors until the executive receives payment. It is common as a result to say that rabbi trusts merely provide "change of heart" protection. That protection can, however, be invaluable for an executive if significant severance, deferred compensation, or supplemental retirement benefits are not scheduled to be paid coincidentally with the executive's termination of employment.
For instance, consider the case of the manufacturing company CEO who is now suing in North Carolina district court to collect his $4.4M of supplemental benefits. If that amount had been deposited into an irrevocable rabbi trust at the time of his retirement (when relations were apparently friendly), he would have had both an independent source for continued payment of his supplemental retirement benefits (from an independent bank or other trustee), and his former employer would have had to seek injunctive relief in order to suspend payments. Instead, the manufacturing company was able to merely decide to cease paying benefits - forcing the executive to sue and to face waiting years to collect his benefits. The creation of a rabbi trust also provides an executive with leverage in future disputes (because the money would be locked into a trust). The trust agreement could even provide an executive with litigation protections, such as rights to recover attorney's fees under fair circumstances.
Overall, in the absence of misconduct or ill will, it is reasonable for an exiting executive to ask that the employer fund a rabbi trust with an amount sufficient to pay any severance, deferred compensation, or nonqualified plan benefits that are not paid in full at the time employment terminates. For executives who could be at-risk in a merger or sale transaction, a "springing" rabbi trust can provide welcome peace of mind. In that context, the rabbi trust is created but minimally funded before a transaction, and then "springs" into full funding as a condition for the closing of any merger or sale. Thoughtfully-constructed trust terms are able to protect executives against a change of heart by their employer or new management.
To make a long story short, the old saying "you don't ask; you don't get" may not date back to Confucius, but it is worth considering when executives face an exit from employment, or a possible merger or sale of their employer. See this web page for a list of other reasonable "asks" for executives to consider.
The Wagner Law Group is able to work with companies, individual executives, and teams of executives to develop rabbi trusts that broadly address the interests of all concerned.
*Note: The case referenced in the opening paragraph above is Colburn v. Hickory Springs Manufacturing Company et al., case number 4:19-cv-00051, in the U.S. District Court for the Eastern District of North Carolina.
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