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Oracle Corp.’s recent hostile offer for PeopleSoft Inc. served as a rude awakening for executives and employees in the technology sector. High-tech company employees were once considered indifferent to takeovers, because they were generally needed to continue to run the acquired business and in any event could readily find new jobs in the event that they were fired following an acquisition. However, uncertainty in the tech job market and declines in the value of employees’ stock options have made target company employees more vulnerable to loss of both their jobs and their anticipated compensation. Accordingly, high tech companies are becoming increasingly aware that they may need to consider adopting measures to deal with potential hostile takeover proposals in order to protect their employees adequately. Many technology companies do not provide severance protection or vesting of equity compensation in connection with a change in control. In light of the developments highlighted by Oracle’s bid for PeopleSoft, technology companies should consider adopting reasonable change in control protections for their executives and other employees. The adoption or amendment of change in control arrangements is generally within the ambit of the business judgment rule, particularly where adopted or amended outside of the context of a pending or threatened takeover. Over the years, a generally consistent form of change in control employment agreement has emerged among companies in a broad range of industries outside of the technology sector. Typically, this agreement becomes effective only upon a change in control or in the event of a termination of employment in anticipation of a change in control. The agreement usually provides for a three-year term after the change in control, during which time the status quo is preserved for the employee in terms of duties, responsibilities and employee benefits. In the event that the employee is fired without cause or suffers a constructive termination during the term, the employee would become entitled to certain severance benefits (typically two or three times annual cash pay). Many option plans of technology companies provide that, upon a change in control, options may be assumed by the acquirer and, if they are not so assumed, they vest, become exercisable for a number of days prior to consummation of the deal (e.g., 15 days) and then terminate upon consummation of the deal. Under such option provisions, acquirers may terminate an employee’s options without providing the employee any consideration for the loss of the future value of the option. This termination could be a particularly harsh result for employees who hold underwater options. In order to protect against this, we generally recommend to our clients that acquirers not be provided with the right to unilaterally terminate an employee’s option in the event of a stock-for-stock deal. Technology companies should, instead, consider vesting options and providing an extended exercise period (e.g., two years following termination of employment, but not beyond the end of the option term) upon a constructive termination, or a termination of employment without cause, within a specified period following a merger, and may wish to consider providing that, upon a change in control, all options vest and remain exercisable for an extended period. Although automatic vesting on a change in control has not historically been market practice in the tech sector, this is common practice for financial services and industrial companies. Finally, in furtherance of their takeover preparedness objectives, tech companies with large numbers of underwater options may wish to consider an option exchange program whereby employees are permitted to relinquish underwater options in exchange for fewer at-the-money options or shares of restricted stock. This will better ensure that, in the event of a takeover, employees are properly incentivized to achieve the best price for the company and that they have reason to stay with the company through the transition period following the merger. In addition, the exchange offer would reduce dilution at the target and subsequently the combined entity. Companies are advised to consult with their accountants to make sure that they understand the accounting consequences of amending their option plans or providing for exchange offers. We note that the proposed NYSE and NASD shareholder approval rules may impact the ability to do such exchanges without an express plan provision or shareholder approval. Michael S. Katzke is a partner and Jeremy L. Goldstein is an associate at Wachtell, Lipton, Rosen & Katz (www.wlrk.com). If you are interested in submitting an article to law.com, please click here for our submission guidelines.

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