Like other top executives, many CFOs have employment agreements that provide for severance and/or notice pay if they are terminated without cause or if they leave with good reason. But such agreements and related deferred or equity plans do not necessarily protect unvested deferred or equity compensation. In the context of either type of termination, unvested amounts may be forfeited at the time of separation.
That’s not always true. As the recent Massachusetts case, Suzuki v. Abiomed, Inc., illustrates, the implied covenant of good faith and fair dealing may be used to protect an executive’s unvested performance-based equity awards and, by extension, other performance-based deferred compensation.
In Suzuki, the executive, a vice president of a health-care technology company, alleged that his termination was undertaken in bad faith to deprive him of compensation due for his past labor. Specifically, the executive alleged that he was terminated: (1) after performing much of the work necessary to achieve the business objectives to which the vesting of his equity was tied; and (2) because he refused to agree to a mid-contract reduction in the compensation to which he was entitled under his existing employment agreement.
In its defense, the company alleged, among other things, that it was within its rights to terminate the executive’s employment at any time because, under the agreement, the company had the right to terminate without cause.
The company further argued that the performance-based contingencies to which the equity grant was tied had not occurred prior to termination and, in fact, did not occur until 15 months after the termination. The Suzuki court found both of the company’s arguments unpersuasive. The court observed:
“… [E]very contract implies good faith and fair dealing between the parties to it…. The implied covenant provides that neither party shall do anything that will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.… This guarantees that the parties remain faithful to the intended and agreed expectations of the parties in their performance.”
In denying the company’s motion to dismiss, the court distinguished between performance-based vesting and time-based vesting. It held that, “while [the executive]’s actual realization of any value of the shares promised him in [his employment agreement] could only take place in the future, those shares served as a ‘continuing inducement’ for work towards” the performance measures, “and they functioned as a part of [his] ‘day-to-day compensation’ for work performed.”
When Does “Good Faith and Fair Dealing” Apply?
It is important to remember that all employment is contractual in nature. The covenant of good faith and fair dealing has been applied to executive employment agreements, even in situations where the employment is terminable at-will. The covenant protects against one party robbing the other of the fruits of the contract. Even when making decisions regarding termination, including job-performance evaluations, an employer subject to the covenant must act in “good faith.”
As the Suzuki court pointed out, there are two common situations in which the covenant applies:
- “Bad faith” – An employer may be liable for breach of covenant of good faith and fair dealing when it terminates an at-will employee for the purpose of depriving the executive of benefits or compensation due or forthcoming at the time of the termination.
- Without “good cause” – A breach of the covenant may also occur in situations where any employer terminates an executive without “good cause,” thus “depriv[ing] the employee of clearly identifiable future compensation reflective of the employee’s past services.”
Bottom Line for Departing CFOs
First and foremost, and whenever possible, CFOs should negotiate (or renegotiate) for protection of deferred and equity compensation upon termination, such as for accelerated vesting of grants and extended exercise of options.
If the termination is either without cause by the employer or with good reason by the executive, accelerated vesting and extended exercise are not uncommon. On the contrary, they are often permissible and, indeed, contemplated under compensation plan rules.
Second, CFOs must know their rights under contract law. All employment is contractual in nature, even at-will employment, and almost every contract carries with it the covenant of good faith and fair dealing.
A breach of the covenant of good faith and fair dealing claim may arise from a bad faith termination of employment, such as the intent to rob an executive of his or her labor, even if the termination is permitted under the express terms of the employment agreement.