Donald Schiller, partner on Schiller, Ducanto and Fleck gives you three tips to avoid overlook practical issues while dealing with stock options.
By Donald C. Schiller, Family Lawyer
Stock options are a growing tool being used by companies as a source for executive and employee compensation. Effectively, they give the employee a chance to profit in the growth of a company’s value in addition to earning a salary. At the time of dissolution, stock options may be one of the more substantial assets a couple has in their marriage. Dealing with stock options can be very complex, in part because each company may make their own terms concerning the awarding and exercise of options, and the development of the law relating to options in a marital dissolution at its early stages. The subject of stock options is well covered in articles and treatises, and it is not the purpose of this “hot tip” to define or explain them. This tip is intended to raise your consciousness to a few practical issues that are too often overlooked.
1. Watch for Reload Provisions in Stock Options
Some companies use reload stock option grants. Typically the “reload” means that if the employee in exercising a current stock option pays for the price of the option using the company’s own stock instead of cash, the employee will automatically be given new options for future exercise. Since stock options are generally not assignable, most settlements provide for the employee to provide the non-employee divorced spouse with a division of the proceeds of the exercise of stock options on an “if, as and when” basis. The employee spouse could, on exercising the options that were divided by the divorce judgment, use corporate stock, pay for the exercise, and without disclosing it retain for himself all of the reloaded options that are actually an outgrowth of the divided marital options.
2. Stock Options Lost When Employee/Spouse Leaves the Company
Assume that employee/husband has an option grant to purchase 1000 shares of ABC Corporation. According to the grant, the husband must remain employed for three more years before the options are exercisable. The husband and wife are to divide equally the options upon dissolution. At the time of dissolution the husband has to remain employed for two more years before his options are exercisable. One year after the divorce, the husband leaves ABC Corporation and goes to work at XYZ Company. The ABC Corporation options become worthless. Unless the Marital Settlement Agreement provides for more, the spouse gets nothing, but the former employee is likely to have received something of value that caused him/her to leave ABC Corporation to join XYZ Company. The former husband, therefore, did receive something of value for losing the ABC Corporation options, but the former wife did not. Marital Settlement Agreements should be drafted to prevent this type of unfair result.
3. Not All Time Rule Formulas are The Same
How does one characterize stock acquired from an employee stock option granted to the employee before the marriage, but that required continued service after the marriage before becoming exercisable? How does one characterize stock options that are granted during the marriage that require the employee’s continued service after the dissolution before they become exercisable? To resolve these issues, attorneys frequently employ a time rule formula that determines a portion of the stock or options as marital, and the remaining portion as non-marital. It is important for the attorney to not use just the same time rule formula used or cited in a prior case as the basis for making allocations of marital and non-marital portions in all cases. There are different time rule formulas that courts have employed, which may achieve very different results. Attached is a sampling of time rule formulas.
Samples Of Time Rule Formulas
1. In measuring unvested options that were granted during marriage but solely to encourage future employment efforts, the following formula is frequently cited (Garcia, supra, citing In re Marriage of Harrison, 179 Cal.App. 3d 1216, 225 Cal. Rptr. 234, and In re Marriage of Nelson, 177 C.A.3d 150 (1986):
|Marital Share =||# of months from date of grant until (dissolution) separation|
|# of months from date of grant until vesting|
2. In measuring when unvested options are in consideration of worked performed and like a salary bonus (In re Marriage of Hug, 201 Cal. Reptr. 681, 685) formula:
|Marital Share =||# of months of employment during marriage prior to separation (divorce)|
|# of months husband employed until options vest|
3. The Supreme Court of Nebraska in Davidson v. Davidson, 254 Neb. 656, 578 N.W.2d 848 (Neb. S.Ct. 1998), (a marital property state) reviewed a number of different formulas:
(a) Regarding grants during marriage vesting after dissolution where for future services:
|Marital portion =||# of months from date of grant
|# of months from date of grant until
option vests(similar to #1 above)
(b) Regarding grant before marriage vesting during marriage or grant during marriage, including pre-marriage services:
|Marital portion =||# of months from date of marriage to grant|
|# of months from date of employment to grant|
(c) Regarding grant before marriage vesting during marriage where grant was to encourage future efforts:
|Marital portion =||# of months from marriage to vesting|
|# of months from grant to vesting|
(d) Regarding grant for past service where the employee has had previous option grants:
|Marital portion =||# of months since last grant (while married or marriage date if later)
until date of current grant
|# of months from last grant until date of current grant|
Donald C. Schiller is a partner of Schiller DuCanto & Fleck LLP, the largest matrimonial law firm in the U.S. He also teaches Divorce Law at the University of Chicago Law School. He has served as President of the Illinois State Bar Association and Chair of the ABA Family Law Section. He is listed in Best Lawyers In America, Super Lawyers and Leading Lawyers magazines. www.sdflaw.com