Considering Select Employment Issues for Real Estate Executives

By Michael Scheinberg, Partner, Pircher Nichols & Meeks

With the unprecedented changes in our economy and the new opportunities in real estate investment and management, many executives are moving to new positions or re-negotiating and formalizing their existing relationships. Here are some business issues for the executive to consider in employment, profit sharing and non-compete agreements.

Timing is everything. If there is a broader transaction involving the employer, get an early start on the employment agreements so that they do not become a critical path item.

Look at the basic terms. Of course, the basic employment terms will be specified: base salary, vacation time and reimbursements (that is, vehicle, phone and club expenses). Other important terms (especially if the executive is leaving another position) include methodology for salary increases, the minimum term, bonus commitment or opportunity, and terms for incentive compensation (profit sharing).

Consider incentive compensation. In real estate enterprises, incentive compensation often consists of a share of earnings or of “promote” (such as a share of profits over that attributable to capital investment). Of course, an outright allocation of a profit share is best. Otherwise, standards for vesting should be objective and not discretionary and can include watershed events in the employer’s business plan (that is, raising capital, making investments, selling assets, and achieving return objectives), or periodic vesting where the executive should seek monthly rather than annual vesting to reduce any incentive to terminate prior to a next vesting level.

Delineate authority and duties. The authority and duties of the executive, as well as the employer’s performance standards and policies, should be described in detail and should not be subject to arbitrary changes imposed on the executive. This can help align the executive’s real-world experience with the executive’s expectations, and establish benchmarks against which the executive’s performance (and cure rights for “cause” allegations) can be measured.

Establish constructive termination and severance standards. Severance should be payable if the executive’s employment is terminated by reason of a constructive termination or without cause. Severance can include salary, bonus and vesting of some incentive compensation. Common constructive termination events include decrease in the executive’s salary, benefits or authority, geographic relocation, and failure to pay minimum discretionary bonus. Other events to consider include change of control of the employer, a major decision impasse between the executive and the employer’s board or other controlling officers or owners, and other employer defaults. Additionally, some or all of the severance items might be payable on death or disability of the executive.

Include what is known as a most-favored nations clause. The document should include a provision that executive’s employment package will be enhanced to match any better compensation terms paid to any other executive of similar stature within the employer affiliate group.

Remember the non-compete agreement. Employment documents often require a time commitment (100 percent of working time) and restrict the executive’s ability to compete with the employer’s business, to hire employees of the employer or its affiliates or to use confidential information. The executive should negotiate for exceptions, during the term of employment, for prior investments and commitments, including community service activities, and relief from the non-compete restrictions after some time-certain or where the employment is terminated by reason of constructive termination or without cause.

Understand existing agreements. Existing employment and profit sharing arrangements should be reviewed. For example, some agreements condition payment on current employment, and the executive might need to address his before giving notice. This might be relevant even where the executive is to be employed by an employer affiliated with but different from the prior employer.

Establish that the employer is creditworthy. The executive should be sure that the entity that is the employer is adequately capitalized and not separate from employer affiliates with assets and/or revenue streams.

Think about tax considerations. The executive should consult with tax advisors, especially in structuring incentive compensation. In particular, the executive should consider whether to make an election under Internal Revenue Code Section 83(b) to currently recognize the fair market value of equity interests received, whether the executive is an employee for federal tax purposes or is a partner in an entity treated as a partnership for federal income tax purposes, which may impose additional tax filing requirements, and seek protections against additional tax on deferred compensation under Section 409A of the Internal Revenue Code.