The Coronavirus Aid Relief and Economic Security Act (the “CARES Act”)1 is the third stimulus package passed by Congress to combat the effects of the coronavirus and is the largest monetary stimulus package in U.S. history. Included in the CARES Act are two provisions that limit the amount of compensation that may be paid to highly compensated officers and employees of businesses that receive assistance under Title IV of the CARES Act.2 While these compensation limits may appear straightforward, the provisions leave many important questions unanswered. This OnPoint explores certain key issues that remain open under the CARES Act compensation provisions.
The CARES Act is not the first time that Congress has focused on executive compensation in connection with the provision of economic relief for businesses that are in crisis. Notably, the conditions in the Troubled Assets Relief Program ("TARP"), which was established under the Emergency Economic Stabilization Act of 2008, included a number of compensation-related restrictions on participating financial institutions, and limited the ability of participating financial institutions to deduct certain types of compensation.3 Generally, these restrictions remained in effect until the financial institution no longer had an outstanding financial obligation to the Federal government.
The compensation limits under the CARES Act and the TARP legislation generally are not similar. In this regard, TARP was seen as a program to help fix a problem perceived to have been caused by the financial institutions seeking relief, and more specifically, by the executives and other highly compensated employees whose risk-taking Congress believed contributed to the financial downturn.4 As a result, it is not surprising that TARP limited its reach to senior executives and only a handful of other highly compensated employees. In addition, TARP focused specifically on incentive and retention compensation rather than on such things as base salary. The CARES Act, conversely, is part of a relief package for a global pandemic that no industry had a direct hand in creating. Thus, with the CARES Act, the focus seems more on the notion that a company in such dire financial straits that needs to avail itself of government funding should not be using relief funds for increased or otherwise high levels of compensation to highly compensated officers and employees, and instead should use relief funds to preserve the economic viability of the business and jobs.
Businesses Eligible for Relief
Under Title IV of the CARES Act, up to US$500 billion of funding is provided in the form of loans, loan guarantees and other investments in support of eligible businesses, states and municipalities that have incurred losses as the result of the coronavirus.5 Passenger and cargo air carriers, certain eligible businesses certified by the Federal Aviation Administration, ticket agents and national security related businesses may receive up to US$46 billion of this funding in the form of loans and loan guarantees, and US$454 billion (plus any amount unused from the US$46 billion pool) is available for loans, loan guarantees and other investments in programs or facilities established by the Board of Governors of the Federal Reserve System (the “Federal Reserve”) to provide liquidity to the financial system that supports lending to states, municipalities and any U.S. business that has not otherwise received adequate economic relief in the form of loans or loan guarantees under the CARES Act.6 In addition, the Secretary of the Department of the Treasury (“Treasury”) is authorized to provide financial assistance up to US$32 billion to passenger and cargo air carriers and to certain airline contractors that must be used exclusively for the continuation of employee salaries, wages and benefits.7
Applicable Limits on Compensation
The receipt of funds under Title IV of the CARES Act comes with strings attached, one of which is a limit on the amount of compensation that may be paid to highly compensated officers and employees. Each pool of money under Title IV is subject to its own separate, but similar, compensation limit.
If a loan or a loan guarantee is obtained from the US$500 billion pool, then the total compensation of any officer or employee whose 2019 total compensation exceeded US$425,000 must be limited from the time of the loan or loan guarantee until the date that is one year after the loan or loan guarantee is no longer outstanding as follows:
- (i) during any 12-consecutive-month period, the total compensation paid to that officer or employee from the eligible business may not exceed the individual’s 2019 total compensation from the eligible business;
- (ii) if the officer’s or employee’s 2019 total compensation was in excess of US$3 million, the individual’s total compensation during any 12-consecutive-month period may not exceed (x) US$3 million plus (y) 50 percent of the 2019 total compensation in excess of US$3 million; and
- (iii) severance pay or other benefits upon a termination of service may not exceed twice the individual’s maximum 2019 total compensation.8
For these purposes, “total compensation” is defined as including “salary, bonuses, awards of stock and other financial benefits” provided by an eligible business to an officer or employee.9 It is noted that the provision limiting compensation in excess of US$3 million will require actual pay-cuts for affected officers and employees. For example, if an employee’s 2019 total compensation was US$10 million and the employee is expected to receive US$10 million in total compensation during the compensation restriction period, the employee’s pay during the compensation restriction period would be limited under the CARES Act to US$6.5 million, i.e., US$3 million + (50 percent x (US$10 million - US$3 million)).
The compensation limits do not apply to employees whose compensation is determined under a collective bargaining agreement that was in effect prior to March 1, 2020, unless that employee’s 2019 total compensation exceeded US$3 million.10 In addition, the compensation limits applicable to eligible businesses that receive assistance under the US$32 billion pool available exclusively to passenger and cargo air carriers and certain airline contractors are the same as those described above, with two differences.11 First, the period during which compensation is required to be limited is from March 24, 2020 until March 24, 2022.12 Second, the carve-out for collectively-bargained employees also applies to employees and officers whose 2019 total compensation exceeded US$3 million.13
The following table summarizes the compensation limits applicable to each of the US$500 billion pool and the US$32 billion pool:
Employees Covered (for convenience, the term “employees” in this table includes officers)
- US$500 Billion Pool: All employees whose 2019 total compensation exceeded US$425,000
- US$32 Billion Pool: All employees whose 2019 total compensation exceeded US$425,000
Compensation Restriction Period
- US$500 Billion Pool: For the duration of the loan or loan guarantee, and one year thereafter
- US$32 Billion Pool: March 24, 2020 to March 24, 2022
- US$500 Billion Pool: Total compensation for any 12-month period during the compensation restriction period cannot exceed 2019 total compensation
- US$32 Billion Pool: Total compensation for any 12-month period during the compensation restriction period cannot exceed 2019 total compensation
Additional Limit for Employees Whose 2019 Total Compensation Exceeded US$3 Million
- US$500 Billion Pool: Total compensation for any 12-month period during the compensation restriction period for any such employee may not be greater than US$3 million, plus 50 percent of such employee’s 2019 total compensation
- US$32 Billion Pool: Total compensation for any 12-month period during the compensation restriction period for any such employee may not be greater than US$3 million, plus 50 percent of such employee’s 2019 total compensation
- US$500 Billion Pool: Severance pay and other benefits may not exceed twice the employee’s maximum 2019 total compensation
- US$32 Billion Pool: Severance pay and other benefits may not exceed twice the employee’s maximum 2019 total compensation
Exclusion for Certain Union Employees
- US$500 Billion Pool: Yes, if their 2019 total compensation did not exceed US$3 million
- US$32 Billion Pool: Yes, regardless of 2019 total compensation
Certain Open Issues
While the CARES Act itself is detailed and extensive, the compensation limits under Title IV of the CARES Act are relatively short, comprising less than four pages of legislative text. This lack of detail raises questions about how a number of these provisions will be interpreted and applied. A significant concern for many eligible businesses will be the need to certify compliance with the compensation limits without fully being able to understand what that will entail. As of April 20, 2020, Treasury and the Federal Reserve have issued guidance on Title IV of the CARES Act, but none of that guidance clarifies the compensation limits.14
While there are numerous questions for interpretation that will depend on the compensation structure and practices of each individual eligible business, we highlight below some of the key open issues.
It is presently unclear just what constitutes “salary, bonuses, awards of stock and other financial benefits” for purposes of determining total compensation. Treasury might follow the approach taken in the TARP regulations and define total compensation by reference to reporting rules of the Securities and Exchange Commission (the “SEC”) applicable to executive compensation (although there was express statutory support for doing so under the TARP legislation).15 Importantly, not all eligible businesses will currently be reporting companies under the securities laws, and thus will not have had the experience of engaging in the rigors of making even certain basic determinations required by those rules. In addition, even for those businesses that are well versed in those rules, and that are accustomed to reporting compensation in this manner, the expanded scope of potentially covered individuals likely will result in new operational and recordkeeping tasks.
Preexisting Compensation Arrangements
The treatment of existing compensation arrangements is presently unclear. It remains to be seen whether these will be carved out of the CARES Act’s compensation limits. TARP expressly carved out from its compensation limits those bonus payments that were required to be paid pursuant to preexisting written employment contracts.16 By contrast, the CARES Act does not provide an express carve-out. If upcoming guidance does not provide for grandfather or other traditional relief, eligible businesses seeking relief under Title IV of the CARES Act will be in the difficult position of potentially having to breach existing employment and other compensation contracts in order to qualify for relief. Will Section 409A of the Internal Revenue Code of 1986 (the “Code”) present special challenges in connection with attempts to address issues like these? In some cases, a failure to meet the terms of previously agreed upon provisions of compensatory arrangements could even amount to a constructive discharge or “good reason” (or otherwise to facts and circumstances that could render an employee a so-called “good leaver”), thereby providing employees with special rights, such as the ability to resign and qualify for severance, or to become vested in bonus, equity-based or other awards and benefits. In addition, a question might arise as to whether any additional amounts due would themselves be deemed to be compensation for purposes of the CARES Act.
Equity and Equity-Based Awards
Similarly, there is uncertainty regarding the treatment of equity and equity-based awards. How are such awards to be taken into account for purposes of determining total compensation? How will stock rights (i.e., stock options and stock appreciation rights) be treated under the CARES Act? Are there implications under Section 409A of the Code to any adjustments that might be made? Will accounting rules be applied, as is the case for certain reporting of executive compensation under the SEC’s rules? Will compensation taken into account over the vesting period be recognized in the year of grant as can be the case under the SEC’s rules or be taken into account when the award is included in the grantee’s taxable income? Will there be special rules in the case of awards granted prior to the enactment of the CARES Act or prior to when an eligible business obtained relief under Title IV of the CARES Act? It is also important to note that not all employers and other payors of compensation are traditional corporations. Thus, for example, a service provider may receive net profits interests, carried interests or other non-corporate interests. It is unclear how the CARES Act rules would specifically apply in the non-corporate context.
Another source of uncertainty is how the compensation of new hires in 2019 will be handled. Will their compensation be annualized? In order to ensure that employees intended to be covered by the compensation limits are covered, and that such employees are not penalized for not working with the eligible business for the entire 2019 calendar year, we would think it would be reasonable to expect that some type of annualization will be utilized. Will the regulators look to other annualization rules, such as those found under Section 280G of the Code?
Application in M&A Transactions
How will the applicable principles be applied in the context of a corporate transaction? For example, if only one of the companies involved in a merger or acquisition transaction is subject to the compensation limits at the time of the transaction, will the other company become subject to the compensation limits? Will it matter whether the transaction is structured as a merger, or a stock or asset acquisition (or in some other way)?
Application to Related Employers
Will the compensation limits be applied to limit the total compensation paid by all related employers, and if so, will relatedness be determined by the 80 percent control tests applied commonly to employee benefit plans, or will a more broad definition apply, as is the case in other areas of the CARES Act?17 The regulations under TARP applied the controlled group rules under Sections 414(b) and 414(c) of the Code, with a reduction in the relatedness threshold from 80 percent to 50 percent.18 Nothing in the CARES Act currently indicates that any relatedness rules will apply to the compensation limits. In addition, where it becomes necessary to identify “officers” in the context of an affiliated group, will that determination be made by looking at each individual entity, by reference to the rules under the Code provisions governing tax-qualified retirement plans, by reference to the SEC’s rules or in some other way?
Questions could arise regarding how the rules will apply with respect to incoming new officers and employees. Will all officers and employees hired on or after January 1, 2020 be excluded from the compensation limits? Because the compensation limits under the CARES Act apply based on total compensation received from the eligible business in calendar year 2019, the statute arguably indicates that the compensation limits are only applicable to those officers and employees who are employed by the business prior to January 1, 2020. Therefore, any officer or employee hired on or after January 1, 2020 would seemingly not be subject to the compensation limits under the CARES Act. It is noted that there is some precedent for a result of this nature. For example, under Section 414(q) of the Code (which applies for purposes of, among other things, the important anti-discrimination rules of Sections 401(a)(4) and 410(b) of the Code), a person generally is a highly compensated employee for a particular year based on the compensation paid by the company in the immediately preceding year (and new hires are generally therefore nonhighly compensated employees).
Receipt of Deferred Compensation
Unlike the TARP legislation, the CARES Act explicitly limits only compensation “received,” and does not specifically include a limit on accruing compensation during the restriction period. However, it is less clear when total compensation will be treated as being “received” for purposes of the CARES Act. Significant amounts of compensation for many individuals may be accrued prior to receipt by the officer or employee, and it is presently unclear how deferrals will be treated for CARES Act purposes. How this question is resolved has an impact on many forms of compensation, including bonuses, equity-based and other incentive programs and certain retirement benefits. In addition, how will Section 409A of the Code be applied to compensation that cannot be paid under the CARES Act? For example, will employees be permitted or required to defer compensation otherwise owed to them that would exceed the compensation limit to a later period when such compensation limit would not apply? There again could be implications here for many different types of compensation.
The compensation limits imposed by the CARES Act on eligible businesses seeking relief under Title IV of the CARES Act leave many unanswered questions that will hopefully be answered in additional guidance. As the rules develop, eligible businesses that have sought or expect to seek financial assistance should consider reviewing sooner rather than later their existing compensation arrangements to identify which highly compensated officers and employees may be affected and to determine whether any changes may be required to be made to those arrangements (and if so, what steps may be necessary to implement those changes).
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If you would like to discuss any aspect of the compensation-related provisions of the CARES Act, please contact any of the Dechert lawyers listed below or any Dechert lawyer with whom you regularly work.
1) See Dechert OnPoint: Congress Formulates Retirement-Related and Executive Compensation Provisions for the COVID-19 Stimulus Bill for a summary of the retirement-related and executive compensation provisions in the CARES Act as passed by the Senate on March 25, 2020.
2) Title IV of the CARES Act is itself called the Coronavirus Economic Stabilization Act of 2020.
3) See 12 U.S.C. § 5221(b)(3); Code §§ 162(m)(5), 280G(e).
4) For example, the Financial Crisis Inquiry Commission, the bipartisan effort empowered by Congress to investigate the causes of the 2008-2009 financial crisis, wrote in its final report, “Compensation systems – designed in an environment of cheap money, intense competition, and light regulations – too often rewarded the quick deal, the short-term gain – without proper consideration of long term consequences.” See Financial Crisis Inquiry Commission, The Financial Crisis Inquiry Report: Final Report of the National Commission on the Causes of the Financial and Economic Crisis in the United States, available here.
5) CARES Act § 4003(a).
6) CARES Act § 4003(b). Assistance under the US$454 billion pool may be provided by purchasing obligations or other interests directly from issuers of such obligations or other interests, purchasing obligations or other interests in secondary markets or otherwise, or making loans. CARES Act § 4003(b)(4)(A), (B) and (C).
7) CARES Act § 4112(a).
8) CARES Act § 4004(a). The CARES Act provision that sets forth the compensation limits for the US$500 billion pool provides that such limits apply to certain eligible businesses receiving a loan or a loan guarantee. See CARES Act §4004(a) (applying the compensation limits to loans or loan guarantees under Section 4003(b)(1), (2) or (3) of Title IV of the CARES Act). This provision, therefore, would not on its face apply to an eligible business receiving an “other investment.” However, a separate CARES Act provision requires eligible businesses receiving an “other investment” to comply with such compensation limits. See CARES Act § 4003(c)(3)(A)(ii)(III) (applying the compensation limits of Section 4004 of Title IV of the CARES Act to loans, loan guarantees and other investments under Section 4003(b)(4) of Title IV of the CARES Act of a program or facility that provides direct loans). Given that the compensation restriction period for the US$500 billion pool is based on the duration of a loan or loan guarantee, the compensation limits likely do not apply to eligible businesses receiving an “other investment” that is not in the form of a loan or loan guarantee, but the language of Title IV of the CARES Act is unclear.
9) CARES Act § 4004(b).
10) CARES Act § 4004(a)(1).
11) See CARES Act § 4116.
12) CARES Act § 4116(a).
13) CARES Act § 4116(a).
14) See Treasury, Procedures and Minimum Requirements for Loans to Air Carriers and Eligible Businesses and National Security Businesses under Division A, Title IV, Subtitle A of the Coronavirus Aid, Relief, and Economic Security Act (Mar. 30, 2020), available here; Treasury, Q&A on Payroll Support to Air Carriers and Contractors Under Division A, Title IV, Subtitle B of the CARES Act (Apr. 2, 2020), available here; Treasury, Q&A on Payroll Support to Air Carriers and Contractors (Apr. 3, 2020), available here; Treasury, FAQs: Application Procedures for Payroll Support to Air Carriers and Contractors (Apr. 3, 2020), available here; Treasury, Q&A: Loans to Air Carriers and Eligible Businesses and National Security Businesses (Apr. 6, 2020); and Treasury, Q&A: Loans to Air Carriers and Eligible Businesses and National Security Businesses (Apr. 10, 2020), available here; see also Federal Reserve, Main Street Expanded Loan Facility (Apr. 9, 2020), available here; Federal Reserve, Main Street New Loan Facility (Apr. 9, 2020), available here; Federal Reserve, Report to Congress Pursuant to Section 13(3) of the Federal Reserve Act: Main Street New Loan Facility (Apr. 16, 2020), available here; and Federal Reserve, Report to Congress Pursuant to Section 13(3) of the Federal Reserve Act: Main Street Expanded Loan Facility (Apr. 16, 2020), available here.
15) See 12 U.S.C. § 5221(a)(1) (defining “senior executive officer” to mean “an individual who is 1 of the top 5 most highly paid executives of a public company, whose compensation is required to be disclosed pursuant to the Securities Exchange Act of 1934 . . . ”; see also 31 C.F.R. § 30.1, Q-1 (defining the terms “annual compensation” and “most highly compensated employee”).
16) 12 U.S.C. § 5221(b)(3)(D)(iii).
17) A broader application of relatedness rules could even result in some or all portfolio companies of a private equity sponsor being subject to these compensation limits if just one portfolio company of that private equity sponsor receives funding under Title IV of the CARES Act.
18) 31 C.F.R. § 30.1, Q-1 (defining the term “TARP recipient”).