[co-authors: James Earle, Lynda Crouse]*

The sweeping federal stimulus bill known as the ‘‘Coronavirus Aid, Relief, and Economic Security Act’’ or ‘‘CARES Act’’ includes a provision intended to prevent federal loans or loan guarantees from being used to enhance senior executive compensation. This provision, while seemingly simple on its face, raises many interpretative questions, and prompt regulatory guidance will be necessary for its implementation.

Section 4004 of the CARES Act imposes the following compensation limits on employers receiving a loan or loan guarantee under the stimulus program:

• Limit on “total compensation” for any officer or employee who received “total compensation” in 2019 over $425,000 and up to $3 million: For any consecutive 12 months during the period beginning on the date of the stimulus loan or loan guarantee and ending one year after the loan or loan guarantee ceases to be outstanding (the Restriction Period), the officer or employee may not receive “total compensation” in excess of the “total compensation” received in 2019.

• Limit on “total compensation” for any officer or employee who received “total compensation” in 2019 over $3 million: For any consecutive 12 months during the Restriction Period, the officer or employee may not receive “total compensation” in excess of the sum of (1) $3 million and (2) 50 percent of the amount by which the individual’s “total compensation” for 2019 exceeded $3 million. For example, if 2019 “total compensation” was $5 million, the limit for any consecutive 12-months during the Restriction Period would be $4 million (i.e., $3 million plus 50 percent of the additional $2 million received in 2019).

• Limit on severance for any officer or employee who received “total compensation” in 2019 over $425,000: During the Restriction Period, the officer or employee may not receive “severance pay or other benefits upon termination of employment” that exceed two times the “maximum total compensation” received by the individual in 2019.

Section 4116 of the CARES Act provides similar limits for certain air carriers and contractors that receive financial support under the “Air Carrier Worker Support” provisions of the law, except that the Restriction Period is the two-year period from March 24, 2020 to March 24, 2022.

These provisions raise a number of interpretive issues that will require regulatory clarification, including:

The interpretation of “total compensation” and “severance pay or other benefits upon termination” will be crucial. The law defines “total compensation” to include “salary, bonuses, awards of stock, and other financial benefits.” However, it does not indicate whether total compensation will be measured when granted, vested or taxable, or by some other standard. The determination of how to count “total compensation” will be especially important for equity-based awards.

Moreover, the law does not define “severance pay or other benefits upon termination of employment.” Interpretive questions include whether accelerated vesting of equity-based awards (or other forms of unvested compensation) will be considered “severance pay” and, if so, how the value of accelerated vesting will be measured. Similarly, clarification is necessary regarding whether nonqualified retirement plan benefits will count as “benefits upon termination of employment.”

If total compensation is measured when taxable, there may be different outcomes for similarly paid executives. In that case, the lookback to 2019 compensation will yield different outcomes for similarly paid executives depending on, for example, whether the executives elected to defer any portion of their 2019 compensation, received a payout in 2019 of previously deferred compensation, exercised a nonqualified stock option granted in a prior year, made an 83(b) election with respect to the grant of restricted stock, etc.

If total compensation is measured when taxable, there will be opportunities for planning. The implementation of deferral arrangements will enable executives to postpone the recognition of income beyond the Restriction Period. It may still even be possible to implement such deferrals for certain 2020 compensation, especially for companies that do not have existing deferral programs. Any deferral strategy will need to consider compliance with Internal Revenue Code Section 409A.

The rolling 12-month compensation limitation also creates an opportunity for planning. Employers often have the flexibility to vary the timing of compensation within (and, occasionally, somewhat beyond) the calendar year. By framing the compensation limit with reference to consecutive 12-month periods (rather than the calendar year), there will be a need (and an opportunity) for employers to carefully manage payment timing.

Companies may need to negotiate with executives over existing compensation rights. There will be executives with preexisting compensation entitlements that exceed these compensation limits. To access federal loans and loan guarantees, companies may need to persuade executives to modify or forfeit these entitlements. Internal Revenue Code Section 409A may limit the permissible modifications.

Departing executives will have little incentive to agree to compensation modifications. For this reason, executive departures may present an obstacle for companies to access federal loans or loan guarantees. If a departing executive’s severance or termination rights will cause compensation limits to be exceeded, it may be necessary to complete the severance or termination before accessing the loan or loan guarantee. In some cases, this may require the acceleration of an executive’s departure.

Undoubtedly, there will be many more issues that must be resolved in connection with the implementation of the CARES Act executive compensation limits, and regulators will need to carefully balance competing policy objectives when drafting their interpretative guidance. We are following developments in this area closely and will report again as developments warrant.

* Troutman Sanders