Deferred Compensation Plans – Common Types

Deferred compensation plans are used by businesses to compensate and incentivize their employees without offering the employees equity ownership in the business. A deferred compensation plan for an executive allows the business to retain talent by compensating the executive over a longer period of time such as during their retirement.

The following are some common types of deferred compensation plans:

Phantom Share Plan

  • Imitates equity ownership by issuing ‘shares’ that have a value connected to the fair market value of the outstanding stock of the company
  • Phantom ‘shares’ can be issued pro-rata to employees or can be tied to productivity; vesting is usually by meeting performance standards or over a certain length of time
  • The value of the phantom shares increase or decrease together with the fair market value of the business
  • Payments tied to the phantom shares are forfeited if the employee leaves prior to the occurrence of a payment trigger
  • Typical payment triggers are the sale of the business, retirement, death or disability and payment on a certain future date
  • The amount of the payment received is equal to the per-share value of the company on the trigger date
  • Employer receives no income tax deduction until a payment is made to employee; employee defers income tax until payment is received or the date the payment is not subject to forfeiture by employee

Long Term Incentive Plan

  • Rewards employee performance; not connected to the financial success of the company or the fair market value of the company stock
  • Typically paid over a period of 3-5 years; can be very structured with complicated payment schedules
  • No vesting; employees must be employed on December 31 of the year in which performance is measured to receive plan payments; payment forfeited if not employed on December 31
  • Payment equal to a percentage of employee’s regular salary
  • Employer receives income tax deduction when payment is made to employee; employee incurs income tax upon receipt of payment

Nonqualified Deferred Compensation Plan

  • Non-qualified plans avoid limitations placed on other types of qualified retirement accounts such as 401k
  • Non-qualified plans may limit participation to certain executives, make larger contributions and require longer vesting periods than qualified plans
  • Employee may defer income tax over a longer period of time as payments to employee are deferred
  • Appealing option for employees who have maxed out their contributions to qualified plans
  • Business segregates funds to pay awards; funds remain subject to creditors of the business and therefore subject to a substantial risk of forfeiture; resulting in no income tax due to employee on the award of deferred compensation
  • Vesting periods can be a substantial length of time (15 years)
  • Payments can be accelerated if there is a change of control event
  • Typical payment triggers are the later of two events: a fixed date, retirement, death, disability, change in control, termination of services
  • Payment amount is equal to a set formula which the business uses to make annual contributions of cash to the plan
  • Payment is generally in the form of an annuity or a lump sum; employee has the option to choose the form of payment
  • Employers can not deduct amounts contributed to the plan and payments are not subject to income tax by employee until they are distributed; however the employee is required to pay FICA taxes up and until payment is received

Trademark: ‘’ trademarks OK with Supreme Court

Recently, the U.S. Supreme Court ruled that a generic word and .com when used together, such as in the company name “”, could be eligible for exclusive U.S. trademark protection. This decision overturned a long standing U.S. Patent and Trademark Office (“USPTO”) prohibition on granting U.S. trademark registration for trademarks that contained a generic word and .com.

The Supreme Court ruled that a generic word and .com when combined together would only be considered generic, and therefore not registrable, if when combined they have a generic meaning to consumers as a class of services instead of a specific class member or business providing the services. This ruling may allow for additional .com trademarks to be registered with the USPTO and for new arguments that any generic term may become a trademark if consumers perceive it to be a particular source of goods or services.

In the present case, the online hotel reservation company “” sought U.S. trademark registration for its company name which contained the generic term “booking” as used in the online hotel reservation industry. The company argued that consumers did not perceive “” as a class of services related to booking hotel rooms, but rather as a distinct, individual and separate business which provided online hotel reservation booking services. argued that a consumer’s perception of the generic term is integral to determining if a trademark is generic.

The Supreme Court agreed with and lower court rulings which had found that consumers did not identify as a class of hotel reservation services but rather as a distinct business that offers online hotel reservation services. Therefore, was registrable as a protected trademark in the U.S. even though it contained the generic word “booking” as used in the travel industry for reserving hotel rooms. In explaining its reasoning, the court stated the ruling is limited to a situation where consumers perceived the generic term as identifying either (i) a class in general or (ii) a specific class member. If consumers perceive the trademark to represent a class rather than a specific, distinct class member or business then the term (and trademark) is not registrable as it is considered generic.

In further explaining its reasoning, the Supreme Court stated that internet domain names are unique because only one entity can be assigned the domain name, unlike a trade name which in many states including Colorado is not exclusive to the holder of the trade name. As a result, the Court observed, consumers understand that a particular domain name could identify a unique source, rather than only identifying a generic class of goods or services. The Court also noted that the USPTO’s understanding of past Supreme Court precedent related to the registration of generic terms as protected trademarks was “flawed” because it excluded consumer perception as a factor in determining whether a trademark or particular term is generic.

Closely Held Business – 7 Duties to Minority Owners

Generally, the majority owners of a closely held (private, non-public) business have certain legal obligations to the minority owners preventing the majority owners from abusing their position and taking certain corporate actions without the approval of the minority owners.

For example, in a general partnership where one partner owns 51% of the ownership interests in the partnership and the other partner owns 49% of the ownership interests, absent a written agreement to the contrary, in most jurisdictions the 51% owner has strict obligations and duties of loyalty, care and good faith to the 49% owner and to the business itself.

The concept of a majority owner having duties and obligations directly to minority owners arose in partnership law to prevent a majority owner from oppressing the rights of the minority owner. Certain legal doctrines such as the free transferability of business property and the business judgment rule frequently led to situations where the minority owner’s interest in the value of a business was diluted, significantly reduced in value or even made worthless, without the consent of the minority owner.

The duties of loyalty, care and good faith between partners in a partnership have also been applied to corporate shareholders. Although many states follow the modern Delaware approach of eliminating these duties for shareholders of a closely held corporation, the concepts have now made their way into corporate law in the form of a general duty of shareholders of a corporation to treat each other with “utmost good faith and fair dealing”, especially in the case of a closely held corporation.

The following examples are 7 situations where the majority owner has been found to have either (a) violated their duty of loyalty, care or good faith or (b) have not acted with the ‘utmost good faith and fair dealing’ in relation to the minority owner of a business:

  • Attempting to force a buyout of the minority owner by eliminating salary, distributions or dividends
  • Diluting a minority owner’s interest by issuing additional voting shares to force a buyout at low prices
  • Denying the minority owner access to important financial, tax or business enterprise information
  • Removing a minority interest from ongoing participation in management and decision making
  • Locking an employee out of a business, a workstation or any other type of shared company facility
  • Usurping and diverting corporate opportunities for the benefit of the majority owner instead of first offering the opportunities to the business
  • Diluting the minority’s ownership interest at unfair prices in order to force a buyout

Reviewing a Contract – 5 Key Terms to Consider

1. Order of Preference Clauses

Many times a contract will reference another contract within its terms and conditions. Examples include Service Agreements which can also include signed Statements of Work, signed Purchase Orders and other documents containing supplemental terms and conditions to a Service Agreement. When reviewing a contract that mentions, includes or incorporates the terms of another contract, the ‘order of preference’ clause in the contract will instruct the parties about which contract, and what specific contract terms, have priority in relation to each other. This clause is especially important to review when there is a dispute or disagreement between the parties and a question arises regarding the order in which several contracts, or certain specific contract terms, should be applied.

2. Governing Law

The ‘governing law’ clause instructs the parties about what laws govern the terms and conditions of a contract. Although the laws of the jurisdiction where the contract is performed can serve as the governing law, the parties are free to choose the laws of a particular state or country to govern their contractual relationship. For example, in international contracts it is typical for the laws of the State of New York to be chosen by the parties as the governing law of the contract even though the contract will be performed in another state or country other than New York. The choice of New York laws to govern the contract gives the parties confidence about what laws would be implemented in the event of a dispute between the contracting parties. However, this choice could also lead to significant unknown cost and expense if the parties are unfamiliar with New York laws and have no specific business in New York. For this reason it is important to review carefully the choice of the governing law of the contract prior to entering into any contractual relationship.

3. Subcontracting Provisions

It is common for a business to use subcontractors rather than employees to perform all or some portion of a contract. Before hiring a subcontractor, it is important to check the relevant contract to determine if there is a prohibition against subcontracting contained in the contract. Many contracts prohibit the use of subcontractors without the prior written consent and approval of all of the other parties to the contract. These clauses can sometimes give the non-subcontracting parties sole, subjective discretion to approve or disapprove of a particular subcontractor.

4. Non-Violation Clauses

Most contracts contain language requiring the parties to affirm and agree they each have not violated the terms and conditions of any contracts with unrelated third parties by entering into the current contract. Therefore, it is important to check carefully whether the contract being reviewed conflicts with the terms and conditions of any other contracts of the business. Due to the many different types of contracts entered into by a business there is a good chance that some of the terms and conditions of the different contracts will conflict with each other. If there are conflicts with previously signed agreements, then these conflicts may have already unintentionally caused a breach of the contract at hand, as well as the previously signed contracts, without any knowledge of such a breach occurring. In certain situations, the existence of a previous, continuing, non-remedied breach could make those specific contracts difficult or impossible to enforce in the future.

5. Indemnification

The allocation of risk between the parties is an essential function of any contract. By entering into a written contract the parties are generally attempting to allocate the risks, costs, expenses and uncertainties of a business relationship in the form of a written agreement between the parties. Many times these risks are unforeseen or unknown on the date the contract is formed. An indemnification clause is one method parties to a contract use to allocate unforeseen risk between the parties. An indemnification clause requires a party to pay for the costs, expenses and legal fees of the other party to the contract in the event of a legal claim filed against the other party which was caused by the indemnifying party. These clauses can require a party to contract to expend a considerable amount of funds, costs and expenses in defense of a third party legal claim. They should be reviewed carefully any time a contract is being reviewed to ensure the indemnification requirements are thoroughly understood by the parties.

LLC – Distribution of Non-Cash Assets – Deemed Distributions

In general, distributions of property other than cash from an LLC taxed as a partnership are tax-free to the members. This feature of an LLC is one reason why a business operating as an LLC may choose to be taxed as a partnership rather than a corporation.

There are five circumstances in which a distribution of property other than cash to an LLC member can trigger gain recognition for the LLC or an LLC member. A distribution of property to an LLC member that results in such member’s share of the profits or losses of the LLC to be reduced can result in one of the five circumstances where a member or LLC must recognize gain on a distribution of assets to a member.

I.R.C. Section 752 generally requires an LLC taxed as a partnership to determine the amount of liabilities that can be allocated to an LLC member for income tax purposes by reference to such member’s share of LLC profits or losses. Any reduction in an LLC member’s share of liabilities of the LLC is treated as a distribution of money, i.e. a “deemed distribution”, to such LLC member.

If the amount of the deemed distribution exceeds the LLC member’s tax basis in the member’s LLC membership interest, such member will recognize gain equal to the amount the deemed distribution of cash exceeds the member’s LLC membership interest tax basis.