Loans Under Section 4003 or 4116 of the CARES Act: Beware of Executive Compensation Limits

Businesses that avail themselves of financial assistance under Section 4003 or 4116 of the CARES Act must limit compensation and severance paid to certain officers and employees.

Key Takeaways

Receipt of a loan or loan guarantee under Section 4003 or 4116 of the CARES Act is dependent on compliance with new restrictions on executive compensation. Companies considering taking financial assistance under these provisions of the CARES Act will need to consider the impact of the executive compensation restrictions and whether and how the restrictions can be implemented under existing contractual arrangements. These restrictions do not apply to SBA loans under the CARES Act (generally applicable to companies with no more than 500 employees). (See our LawFlash on loans under Sections 4003 and 4116 of the CARES Act.)

Restrictions on Compensation and Severance Benefits

Section 4003 of the CARES Act authorizes the US Treasury Department to offer up to $500 billion in loans, loan guarantees, and other investments in support of eligible businesses that are impacted by the coronavirus (COVID-19) pandemic (e.g., air carriers, businesses critical to national security, and other businesses impacted by the pandemic). Section 4116 of the CARES Act allows financial assistance to eligible air carriers and related contractors.

A company that takes a loan (or loan guarantee) under these provisions must agree to limit the total compensation and the severance pay or other benefits upon termination of employment of certain employees during a restriction period. Companies will have to review existing contractual obligations to employees (employment agreements, equity grants, etc.) to determine whether the limitations can be applied under existing arrangements and, if not, whether and how those arrangements can be modified.

Covered Employees:The restrictions apply to officers and employees whose total compensation exceeded $425,000 in the 2019 calendar year.

Total Compensation Limitations: Under the restrictions, officers and employees whose 2019 total compensation

• exceeded $425,000 but was less than $3 million are prohibited from receiving total compensation each year during the restriction period in excess of the total compensation such employee received in 2019.
• exceeded $3 million are prohibited from receiving total compensation each year during the restriction period in excess of the sum of:

• $3 million, plus
• 50% of the amount by which the employee’s 2019 total compensation exceeded $3 million.

As an example, an employee whose total compensation in 2019 was $6 million cannot receive more than $4.5 million of total compensation in any 12 consecutive months during the restriction period.

The annual compensation limitations are applied to total compensation during any 12 consecutive month period during the restriction period.

Severance Pay Limitations: During the restriction period, officers and employees whose 2019 total compensation exceeded $425,000 are prohibited from receiving severance pay or other benefits upon termination of employment that exceeds two times the employee’s 2019 total compensation.

Restriction Period:

• For businesses covered under Section 4004 of the CARES Act, the restriction period is the period beginning on the date the company executes the applicable loan agreement and ending on the first anniversary of the date on which the loan is no longer outstanding.
• For businesses covered under Section 4116 of the CARES Act (e.g., air carriers and related contractors), the restriction period is the two-year period beginning March 24, 2020, and ending March 24, 2022.

Total Compensation: Total compensation is defined as salary, bonuses, awards of stock, and other financial benefits.

Collective Bargaining Agreements: Collectively bargained employees are not subject to the compensation restrictions if their compensation was determined under a collective bargaining agreement that was in place prior to March 27, 2020.

Unanswered Questions

Many important questions are left unanswered by the CARES Act, which will require regulatory guidance. For example:

• Will stock awards (restricted stock units, performance units, stock options, etc.) be valued based on their grant date value or based on when the stock award is paid?
• What is included in “other financial benefits” in the total compensation definition?
• Is total compensation determined before or after deductions, deferrals, and other adjustments? Is it based on when earned, when granted, or when received?
• Is compensation attributable to past years included as total compensation in the year paid?
• Can employees elect to defer compensation to avoid the restrictions (subject to compliance with Section 409A)?
• Do the limitations apply to employees who were hired during the 2019 calendar year? If so, is 2019 compensation annualized? What about employees hired after 2019?
• What penalties will apply to companies that violate the compensation restrictions?

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Contacts

New York
Craig Bitman

Philadelphia
Amy Pocino Kelly
Mims Maynard Zabriskie
David Zelikoff

Washington, DC
Jonathan Zimmerman