Section 162(m) Litigation: What We Know So Far

November 21, 2012

Publication| Corporate & Chancery Litigation

Over the past few years, enterprising plaintiffs’ lawyers have increasingly targeted companies and their directors in lawsuits alleging that they have materially misrepresented in proxy statements the deductibility of certain incentive compensation under Section 162(m) of the Internal Revenue Code. Remarkably, these cases are brought – purportedly on behalf of the company – before the Internal Revenue Service has questioned the company’s compensation plan or the deductibility of any compensation awards. Equally troubling, lawsuits challenging seemingly compliant plans are costly to defend, and some have withstood motions to dismiss.

Company counsel, compensation experts, and corporate and securities lawyers are likely to encounter these issues soon, if they have not already. Attorneys seeking guidance, however, will consult treatises in vain; the theories alleged are many and novel, and scant authority from the IRS exists.

Although the law remains unsettled, there are sufficient judicial decisions (primarily from the District of Delaware) from which to find useful guidance. This article sets forth some typical allegations found in complaints challenging Section 162(m) plans, discusses the courts’ treatment of various arguments that have been raised in motions to dismiss, describes what typical settlements look like, and provides practical advice to mitigate the risk of becoming the target of one of these lawsuits.

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