- Boards should consider contractual obligations, governance and reporting standards, and communication strategies before replacing a CEO.
- The time required to prepare and announce a change can be quite long due to legal obligations, negotiations with outgoing and incoming CEOs, and the need to reach consensus within the board of directors.
- Boards should understand the legal implications that replacing a CEO may have on the rights of other executives and on existing non-competition agreements.
- Communications about the transition in regulatory filings and internal and external announcements should be unambiguous while avoiding legal pitfalls
CEO transition is a complex process and often faces business and legal challenges. Boards must navigate a web of contractual obligations, corporate governance requirements, reporting standards, as well as communications with shareholders, employees and other stakeholders. Based on our work with boards, here is a list of common mistakes companies make along the way. Avoiding them will minimize legal risks and ensure a successful transition.
Speed is often important in a transition, but some elements require sufficient time to execute and require thoughtful board deliberation. Boards should consider contractual and legal notice periods, carefully consider when to brief the outgoing CEO, and engage and communicate with the internal team. They should also determine if there are notice obligations or other timing considerations regarding the new CEO.
Board and committee meetings will need to be properly scheduled and announced (which can be difficult if the current CEO must be legally notified before the board is ready to act). The outgoing CEO’s terms of departure will often be heavily negotiated and will usually be documented in a separation agreement. Similarly, the new CEO’s terms of employment and compensation will typically be negotiated and documented. Internal and external communications plans will need to be developed and approved along with required securities information. What triggers the requirement to make these deposits, and when, should be carefully understood and considered in discussions within the board and with various stakeholders. Each of these critical steps usually takes longer than expected.
Exclude relevant stakeholders from the process (or include them too late)
The CEO transition is ultimately the responsibility of the board, but it requires coordination with internal stakeholders (the company’s communications, HR, finance, and legal teams, for example) as well as with external stakeholders (for example, public relations consultants, compensation consultants and external legal departments). Advice). Boards often attempt to minimize stakeholder participation to ensure confidentiality. While confidentiality is essential, as the process progresses – and well before a public announcement – boards should ensure they receive advice from the right internal and external experts at every stage so that the transition goes smoothly. rolls out smoothly.
Ignoring company obligations to the current CEO
A clear understanding of the company’s obligations to its current CEO under his employment contract, stock awards, severance plans, and other arrangements is key to structuring the CEO’s termination. The board should have access to a quantitative analysis of the compensation due to the outgoing CEO and the potential cost to the company of changes to existing agreements. Failure to perform outstanding contractual obligations to the CEO may result in financial liabilities and litigation (including litigation) and, in some cases, may excuse non-performance by the CEO.
Underestimating the need to formulate a detailed offer to the future CEO
Similarly, the advice of the Compensation Committee’s external consultant in formulating the proposed compensation arrangement for the new CEO is essential. The board should have a clear understanding of the existing compensation arrangements for the new CEO. This will allow the board to properly assess and negotiate employment terms, address the need for “compensatory” equity compensation awards, if any, as well as understand the limitations of the company’s existing compensation programs. business.
Leaving ambiguous the reasons for the CEO’s dismissal
When firing a CEO, the Securities and Exchange Commission and proxy advisory firms expect the company to clearly and accurately disclose the reasons for the termination, including whether the termination is voluntary or involuntary and whether it is motivated or not. Failure to do so can create ambiguity and potentially expose the business to legal action. It can also lead to disputes over severance pay and other termination rights.
Often we find that there is no consensus among board members on any of these decisions, which is why it can remain ambiguous. And reaching consensus that is appropriately and accurately recorded in board minutes can take time. But skipping this step and not having a well-thought-out, documented basis for the board’s conclusions can lead to later criticism of the board and legal action against board members. Internal communications should also be drafted to alleviate confusion about the reasons for the CEO’s termination.
Rush communications or transition plan
A well-structured communication plan is essential to manage expectations and relationships with internal and external stakeholders during a transition to CEO. Boards should ensure that the communications plan is proactive and comprehensive, and meets any disclosure or reporting requirements. Failure to do so may result in reputational damage and, potentially, legal action.
Separately, boards should consider whether the outgoing CEO should remain available to consult or otherwise assist in the transfer of knowledge or functions to the incoming CEO. The company may also want the outgoing CEO’s cooperation with pending or anticipated litigation. These types of arrangements can help with an orderly transition and should be incorporated into written agreements with the outgoing CEO.
Overlooking the legal implications of public announcements
Boards should carefully consider the legal implications of public announcements related to a CEO transition. There can be tensions between frank and mandatory securities disclosure, on the one hand, and respecting confidentiality clauses in employment contracts and preventing defamatory statements, on the other.
Failing to consider how the rights of other senior executives may be triggered by the CEO’s dismissal
A CEO’s termination may trigger contractual rights for other senior executives within the organization, such as “just cause” clauses. Counsel should carefully review the terms of these employment contracts to ensure compliance and avoid potential litigation. In addition to any legal rights, the impact of a CEO transition on the retention of other key executives (who often were or saw themselves as CEO candidates) should also be considered, and a plan should be developed to address these concerns through compensation. or some other way.
Neglecting the impact of termination on non-competitions and covenants
The nature of a CEO’s release may affect the enforceability of non-competition and other restrictive covenants. In some states, for example, non-competition and other similar clauses may not be enforceable against an employee who is terminated without cause.