Exec Pay Proves a Point of Contention in Bank M&A

Two executives have sued Capital Bank Financial in Coral Gables, Fla., saying a company that it bought last fall violated their change-in-control agreements.

The seller, Southern Community Financial in Winston-Salem, N.C., "unceremoniously fired" Scott Bauer and Jeff Clark last year after they refused to relinquish their rights to severance pay, according to a lawsuit the two executives filed Friday in federal court. Capital Bank played a critical role in their dismissal, the suit says.

The clash shows the challenges that pay agreements present in bank M&A, industry observers say. Intended to push executives to favor higher premiums over job security, they often influence how much buyers will pay shareholders. Banks with big change-in-control agreements should expect lower offers.

"These are things that we all look at," says Ralph "Chip" MacDonald, a lawyer at Jones Day in Atlanta. Acquirers "look at how many agreements are in place, the dollar value" and various accounting and regulatory issues.

The Treasury Department and the Federal Deposit Insurance Corp. have rules that could require a buyer to secure regulatory approval before taking over a seller's change-in-control agreement, MacDonald says. "Large change-in-control agreements are never approved," he says. "So you want to clear those out before the deal is completed."

Such payments are among the "hidden surprises" consolidators should expect, David Gaines, chief financial officer of Park Sterling in Charlotte, N.C., said during a recent conference hosted by the North Carolina Bankers Association. "We've been nipped by some of these things, and we've been fortunate to discover some before we got nipped," he said.

Bauer, ousted as Southern Community's CEO before the sale to Capital Bank closed, and Clark, who was president, claim that their former employer said its participation in the Troubled Asset Relief Program barred it from providing them with termination benefits.

The lawsuit, filed in U.S. District Court for the Middle District of North Carolina, says that rule was moot because Capital Bank did not participate in Tarp. "Restrictions on certain executive compensation payments for banks that received Tarp funds do not apply if the bank is acquired by an institution that is not" in the program, the lawsuit claims.

The lawsuit also sheds light on an unusual courtship between Capital, led by Eugene Taylor and backed by Carlyle Group, and Southern Community, a $1.5 billion-asset company that struggled following the financial crisis. Bauer and Clark claim they were kept out of the loop on negotiations after setting up a meeting between board members and Capital's managers.

Afterward, William Ward, Southern Community's chairman, "directed and controlled all future discussions," the lawsuit claims. Ward, a professor and orthopedic surgeon who replaced Bauer as chairman in 2011, allegedly told Bauer and Clark "that they were not to be involved" with discussions.

The lawsuit also claims that Southern Community's board persuaded Capital to raise its offer by 8% and replace a 60% stock consideration with a 100% cash payout. "Southern Community never demanded of Capital Bank that it assume the … agreements of more than 80 other employees," the lawsuit claims.

The lawsuit seeks unspecified damages, though it claims that Bauer was entitled to $4.9 million and Clark was due $2.6 million under their change-in-control agreements.

Chris Graebe, a lawyer at Graebe Hanna & Sullivan who represents Bauer and Clark, said they would not comment further. A source familiar with the matter says the executives, who formed a consulting firm earlier this year, did not receive severance when they were fired. Ken Posner, Capital Bank's chief analytics officer, said the $7.1 billion-asset company does not comment on litigation.

"It is unfortunate that they couldn't come up with some sort of compromise before they went to court," MacDonald says.

Bauer and Clark are the latest executives to file a lawsuit against Capital Bank seeking change-in-control benefits. Grant Yarber, a former Capital Bank CEO, sued his former employer last year in U.S. District Court for the Western District of North Carolina, in an effort to gain more than $1 million in severance pay.

Judge James Dever 3rd dismissed the lawsuit in March, noting that Yarber signed away his rights and was fired as an at-will employee after his bank was acquired.