Skip to content

Careful planning needed to fire the CEO

One of the greatest challenges in the life of an in-house counsel is to successfully navigate the multiple conflicts and other challenges raised by succession of the chief executive officer. We have all seen, on the one hand, stocks dramatically plummet, and companies and reputations utterly destroyed when handled poorly, and on the other hand companies strengthened when properly executed.

CEO succession, and for that matter senior executive succession in general, requires an interdisciplinary approach, involving corporate, securities, employment, benefits, and tax issues to be thoughtfully evaluated. On top of that the expectations of shareholders, shareholder activists, employees, customers and suppliers, board members, the outgoing and incoming CEO (including their egos!), and the ever-present media need to also be carefully considered.

Role assignment

The circumstances of the termination may be such that in-house counsel does not have the requisite objectivity to carry out his or her duties. The extent of the role in-house counsel should play in supporting the succession will depend on a variety of factors such as his or her role in the termination, relationship with the CEO and board, contractual arrangements in place that affect counsel personally, and knowledge of the company.

Where there is actual conflict, or the risk of perceived conflict, it would be prudent to retain external counsel either to wholly displace in-house counsel or provide him or her with objective guidance.

Important decisions will have to be taken early on in the termination process such as who will provide the board with a roadmap of the issues involved. What needs to be considered before determining grounds for termination? Who will provide the CEO with notice of termination? Will a committee of the board be appointed to oversee the process or will the chairperson, or a subset of the directors move the process forward and ensure all arrangements, policies, procedures, and legislative requirements are followed? Who will make the determination as to whether in-house counsel is conflicted?

Fundamental decisions on role assignment will need to be carefully considered to ensure a high level of objectivity.

Pre-existing agreements

CEOs typically have a multitude of contractual arrangements in place, such as executive employment agreements, change of control, bonus and pension arrangements, stock options, and noncompetition agreements. The company’s charter and bylaws, board committee charters, and employee handbooks may also contain provisions with regard to procedures to be followed in the event of termination, such as who has the authority to negotiate terms, how to effect notification, and the amount of say the CEO has in the process.

The arrangements rarely dovetail effectively. Most likely the arrangements were put in place at various times and contain provisions which are often inconsistent if not contradictory. Legal counsel will need to be objective in providing the board (and the CEO) with an assimilation as to what the arrangements provide.

Constructing a roadmap

It would be prudent to construct a roadmap of the procedural and substantive requirements that need to be followed in the termination process and to have a clear understanding of how they affect the various issues. Ideally this should be done even before termination is a possibility, simply as part of the CEO succession plan.

For example, does the employment or severance agreement provide for notice of termination, is there a cure period, and other formalities which need to be followed? Being aware of the decisions that must be made as well as their dependencies and timing is critical to ensure a smooth transition.

Some of the key considerations are as follows:

• External disclosure requirements

Key to constructing an orderly roadmap is having an understanding of all external reporting requirements.

In the United States, a Form 8-K must be filed within four business days following the determination that the CEO will be terminated. The 8-K must disclose the fact of the termination and the date of its occurrence. Note that the triggering event is the determination that the CEO will be terminated, not the actual termination.

All new material agreements entered into in connection with the termination must also be disclosed within four business days. This means negotiations need to be handled very methodically. If it is determined the CEO will be terminated and there has not been a meeting of the minds within the four days, the potential for the termination to go sideways is greatly increased.

The domino effect of not having all terms locked down by the disclosure date can have a significant effect on the company’s stock price, and the reputation of those involved and can lead to protracted, costly litigation. Typically, counsel should be providing advice on how each of the salient issues and cautioning the board and CEO to not cross the line with regard to determining that the CEO will be terminated, if at all possible.

• Reason for termination

Determining whether the company has parted ways with the CEO for cause, without cause, or resignation is easier said than done.

Because of the high threshold required to establish cause and the potential for litigation most terminations are not based on just cause. CEOs are typically let go due to misalignment with the board or shareholders on strategic or operational matters, poor financial performance, power struggles, disagreements on successors and the like where cause is not alleged.

In such cases the board needs to be clear, and ideally may want to strive to reach agreement with the CEO, as to whether termination was without cause, because of constructive dismissal, or a resignation.

Resignations are troublesome. In many cases a CEO who has resigned is not entitled to severance. Emotions can run high and there have been many cases where a CEO has walked out of a meeting uttering “I give up” or “I am done” and then sought to backpedal to avoid triggering a resignation. In such cases the board, legal counsel, and the CEO can be faced with a quandary: has the CEO effectively resigned, or did matters reach the breaking point such that he or she was constructively dismissed or dismissed without cause?

Another common context involves the termination of a CEO at a time where the company’s stock is undervalued and the CEO is holding onto significant stock options or shares he or she was required to purchase for corporate governance reasons equivalent to a multiple of his or her salary in the company’s stock. In such cases, the CEO will expect to be adequately compensated on termination and may be at odds with the board’s or legal counsel’s views on the grounds for termination, particularly where the CEO has objectively resigned.

Occasionally compensation or benefits might be provided other than those that are contractually required. These could be in the form of additional severance benefits for example, or an extension of the stock option exercise period, or forbearance in regard to the forfeiture of equity rights. The rationale for such extras needs to be objectively thought through, and consideration given to anticipated shareholder, executive, and employee reaction.

Consulting with corporate governance institutions such as Institutional Shareholder Services Inc. or compensation consultants regarding “say on pay” may be appropriate. Legal counsel is well positioned to have those discussions and to properly benchmark potential payments and other benefits to be paid to the CEO.

As well as grounds for termination, legal counsel should provide advice to the board with regard to whether there is any possibility the CEO may claim discrimination or retaliation under harassment or whistleblower legislation. Boards can easily be blindsided by such claims particularly if they have been out of touch with the day to day management of the company.

• Transition period

Post-termination arrangements may be subject to criticism if they appear to be nothing other than a veiled mechanism to provide a departing CEO with additional severance benefits.

If the decision is taken to keep the CEO on for a transition period there should be a genuine need. Deliverables or responsibilities should be identified and there should be accountability.

Mundane practical matters such as whether the CEO will work onsite, have access to the company’s IT network, be an insider for purposes of trading in the company’s stock, and the decision-making authority he or she will hold onto can have important legal and practical effects.

Legal counsel may need to push back on the parties’ expectations as such arrangements are being put in place. Difficult discussions may be required such as whether the contractual arrangements require a non-disparagement provision, and a release of past claims, which may be offensive to the CEO, but necessary in the company’s best interests as the parties start to pull apart.


SPECIAL REPORTS



Save

PROFESSIONAL DEVELOPMENT