Close Close

Financial Planning > Trusts and Estates > Trust Planning

Faced With A Hostile Takeover? Fight Back With A Rabbi (Trust)

Your article was successfully shared with the contacts you provided.

When a business falls under new management as a result of a merger or acquisition, its executives may well have reason to worry. Apart from the prospect of losing their jobs to counterparts at the acquiring firm, their non-qualified benefits packages could be substantially modified–or gutted entirely–if they’re not protected by a well designed Rabbi trust.

An executive at Wachovia Bank and Wilmington Trust offered these words of warning during an afternoon session of the Association for Advanced Life Underwriting, held in Washington last month. Titled “Don’t Let a Change in Control Turn Your COLI Business Upside Down,” the workshop explored issues to consider before, during and after a change in company management, how to select a trustee, and the role of the advisor when establishing a trust.

“Often when executive compensation arrangements are put together, a lot of time is spent on plan design, benefits, administration and the funding mechanism, but the trust itself is an after-thought,” said Peter Quinn, a senior vice president and managing director at Wachovia Bank, Winston-Salem, N.C. “Advisors need to point out to clients that there may be unintended consequences if trust protection issues aren’t addressed.”

Just as, Quinn added, the U.S. Department of Labor can require companies to honor their qualified plan commitments to employees under ERISA law, a “protective” Rabbi trust can assure that promises made to executives with respect to non-qualified compensation plans are fulfilled.

The need for such protections, he said, is evident during a “potential” change in control: the period between an acquisition or merger’s announcement and when the deal closes. Oftentimes, an acquiring company will seek to modify or scuttle the executive pay arrangements because the plans are at odds with the new management team’s corporate objectives.

“Before a change in control, a company has the flexibility to position the trust as needed and advisors can influence its design and benefit security features,” said Michael Hlavin, vice president of Wilmington Trust, Wilmington, Del. “But once a letter of intent or purchase agreement is inked, the trustee needs to step up fiduciary oversight and lock down the trust to protect its provisions.”

Quinn emphasized that language specifically covering a transitional period must be included in the trust document to restrict the acquiring company’s ability to make modifications. Among several “war stories” he recounted, one involved an international oil conglomerate that had simultaneously acquired two Wachovia clients. Though both firms had incorporated change in control language into their respective trust documents, only the one that adopted potential change in control provisions succeeded in fending off trust amendments that would have watered down its executives’ compensation arrangements.

After a change in control, said Quinn, the trustee or a pre-determined committee stipulated within the trust agreement may become responsible for investments or other trust-related decisions. In the event of disputes involving benefits, plan participants may be provided with a 3rd party to make a benefits determination or to offer a second opinion on benefit disputes.

“The point here is take decisions away from the company because you don’t know whether the acquirer is going to be friendly or hostile,” said Quinn. “So you want to establish a [trust] provision that says that all critical decisions relating to investments, amendments or a benefits determination are done by a third party.”

Should the trustee have responsibility for investments, said Quinn, the individual will have to determine investment strategy and, when necessary, create sufficient liquidity to make immediate payouts (as may be necessary when executives affiliated with the old management team depart following the change in control).

Quinn invoked a hypothetical example in which the trustee controls $25 million in corporate-owned life insurance policies that haven’t accumulated sufficient cash values to meet payout obligations. In this scenario, he said, it may be necessary to sell the contracts for their cash surrender value to achieve the needed liquidity.

To avoid this outcome, advisors should consult with corporate management at the time the trust is established to assess the potential financial impact of a change in control, as well as the type of policy and level of funding required to meet obligations to executives.

Also to consider at the outset is the history, financial stability and experience of the organization that will oversee the trust. The trustee, said Quinn, should thoroughly understand nonqualified plan issues and be prepared to work multiple asset types, including employer-owned life insurance, mutual funds and securities.

“The reality is that there are very few knowledgeable Rabbi trust providers in the marketplace,” said Quinn. “If you don’t have an experienced trustee, the result may be that poor decisions are made. Life insurance professionals need to engage clients in a dialogue on this issue.”

Hlavin agreed, adding that the trustee should also be independent and free of bias that could negatively impact the executive comp plan following a change in control.

“Many times a plan sponsor will put together an executive benefits program and select its commercial bank to act as the trustee,” said Hlavin. “But you potentially put the bank in an awkward situation if it has to oversee a change of control while still managing the banking relationship on the other side of the house. There should not be any perceived conflict of interest.”