Can awards be made subject to performance criteria, vesting schedules and forfeiture?
Other than ESPPs, US equity awards are universally subject to vesting schedules and forfeiture provisions, and often to performance criteria.
US public companies typically grant a portion of equity as time-based RSUs with the remainder (particularly for senior executives) as PSUs. PSUs vest over time, but performance thresholds such as those based upon relative total shareholder return (“TSR”) must also be reached for a pay out to be made.
Vesting of awards at private companies is usually time-based, but some private companies require an exit event such as a sale or initial public offering for an equity award to vest. Private equity-backed companies typically require an exit event for participants to obtain liquidity with a substantial portion of equity subject to attainment of pre-established multiple of invested capital (“MOIC”) and/or internal rate return (“IRR”) thresholds for vesting.
Share rights and shares are typically subject to forfeiture in the US upon termination of employment prior to satisfaction of time-based or performance-based vesting conditions. A participant’s rights to shares that do not vest because a time-based or performance-based condition is not satisfied will lapse.
In addition, awards are often subject to forfeiture for violation of restrictive covenants or if the participant’s employment is terminated by the employer for certain bad acts or omissions referred as a “for cause” termination. Forfeiture provisions are governed by state law and the provisions of the plan, grant agreements as well as employment agreements and separate non-disclosure/non-compete agreements.
The scope of employer remedies for violating restrictive covenants varies significantly on a state-by-state basis. For example, in some jurisdictions, prohibitions on the solicitation of clients and employees and non-competition provisions are only enforceable when the company is being sold and the participant is selling shares.
Equity rights can also be made subject to clawback if the awards paid were based upon financial results that had to be materially restated by the company.
There is nothing in Mexican law that may limit the possibility of a performance evaluation as a condition to participate or receive a benefit under an incentive plan. This may allow the employer or the company sponsoring the plan to make a subjective decision, but it is always advisable having support for such decision (i.e. performance assessments). Vesting schedule and forfeiture are also common terms in an incentive plan in Mexico, which are valid, provided they are not contrary to the general principle of “employees’ acquired rights”. This is, an employee may forfeit a grant or benefit according to the terms of the incentive plan, for failing to comply with a specific requirement (i.e. exercising a right within a certain period), but cancelling an already vested right without further support in the corresponding incentive plan, may be challenged before a Mexican labour court.
Typically awards are made subject to performance criteria as this helps measure the success of the business and the individual's own contribution to the respective success.
Also, subjecting awards to vesting schedules is almost always used for practical reasons, mainly for securing the employee fidelity / retention element, but also for allowing sufficient time for actual calculation of business performance indicators relevant for the incentive plan awards.
With respect to forfeiture, employers typically document incentive plans through internal regulations, internal policies / plans or other documents issued by the employer alone/ unilaterally (without requiring employee consent). This is intended for securing their unilateral character and therefore to showcase the employer's flexibility in unilaterally amending or even terminating the plans. Certain incentive plans however require employee consent, such as the relevant agreements executed in relation to share options. However, in these cases, as anticipated above, it is generally recommended that this is granted by a different entity than the employer to keep it completely separate from the employment relationship and from the individual employment agreement executed between the employee and the employer. This is meant to clarify that the relevant documents for implementing this compensation are civil / commercial agreements, outside the scope of the employment relationship (even if granted in consideration of the individual's capacity of employee of the employer). Nevertheless, case-by-case analysis is always recommmeded.
Yes. See question 2 and 4.
Yes, however, if granted on a regular basis, awards could be deemed to be a worker’s permanent right, in accordance with legislation. Therefore, it is important to understand the local legal system to know the potential consequences of granting and eliminating incentives, especially when they are cash-based.
Yes, companies have the discretion to decide performance criteria, vesting schedules and forfeiture under the employee incentive plan that apply to awards. The creation of the incentive plan could be discussed in the meeting of the employees or the employee representatives and the incentive plan and opinions could be rendered and equal consultations with the workers’ union or the employee representatives shall be made. Such incentive plan shall be approved by the meeting of shareholders and board of directors or other authorities stipulated in the articles of association of the company, and the public notice or the notice to the vestees should be made.
Awards can be made subject to performance criteria, vesting schedules and forfeiture. These aspects may have an impact on taxation. Awards can also be subject to a lock-up period.
The lock-up period during which the shares are not transferable should permit the reduction of the taxable basis. According to a safe harbour issued by the Dutch State Secretary of Finance a mandatory holding period will have the following effect on the value of listed shares for tax purposes:
Sale restriction in
Tax exempt discount
1 full year
2 full years
3 full years
4 full years
5 full years
Hence, to the extent an award is paid in shares, subject to a holding period of one year, the taxable benefit is set at the number of shares times the share price, minus a tax exempt rebate of 5.5%.
In case (i) the shares to which the incentive plan relates, are listed on a regulated market in the Netherlands or (ii) the MAR (as further described under number 13) applies to the relevant company, specific disclosure obligations have to be observed when the granted awards become unconditional (i.e. upon vesting).
In certain (very limited) circumstances the forfeiture of awards may be contrary to the principle of reasonableness and fairness (redelijkheid & billijkheid) and therefore not valid. Furthermore, in case of – in short – unfair dismissal, an employee can claim a fair compensation and the (potential) value and/or vesting of awards may be taken into account to determine the amount of fair compensation.
In Brazil it is common for share-based plans to have the awards subject to the company’s performance goals, vesting schedules and forfeiture upon termination of the participants’ relationship with the company. If the plan is characterised as compensation and the participant is an employee, the case law considers that the employee shall be entitled to a prorated portion of the award in the event of termination by the company without cause. Other situations involving an employment termination and payment of compensation/awards should be analysed on a case-by-case basis.
In most Japanese companies, awards are a separate issue from the other incentive plan alternatives such as bonus and share option plans. Awards may be considered as proof of excellent performance but will not be subject to performance criteria, vesting schedules and forfeiture.
Yes, it is common to include performance criteria, vesting schedules and forfeiture in the different incentive schemes.
In some cases, there may be conditions linked to shares that are already purchased or awarded to the employee, with a claw-back clause if performance criteria, financial results or continued employment are not met. Such cases may lead to negative overall tax consequences since an award may be taxable as employment income, but a loss due to a claw-back in some cases may be treated as a capital loss with lower effective tax reduction.
It is common for some of the share option plans outlined at question 2 above (especially CSOP and PSPs) to specify that awards are subject to performance criteria, vesting schedules and forfeiture. Such terms are required under many corporate governance rules and institutional investor committee guidelines. Some plans include provisions under which awards (or shares acquired pursuant to awards) can be "clawed back" in the event of misconduct or material misstatement of financial information.
SAYE and (usually) SIP are not granted subject to performance conditions however awards/shares can be forfeited in certain circumstances.
Performance criteria, vesting schedules and forfeiture can be subject to agreement. In case of a share option plan (equity)the waiting period before exercising is at least four years (Section 193 para. 2 No. 4 Stock Corporation Act). In this case as well as in the case of a virtual share option plan the parties usually agree on conditions for forfeiture in case of termination of the employment relationship and for vesting-periods. In practice, performance criteria is more commonly a subject to bonus agreements. Nevertheless, the determination of vesting-periods itself may be made subject to performance. In this respect, acceleration clauses may be included in the contract. The acceleration clause stipulates that the vesting period is shortened if initially specified performance criteria are met.
Forfeiture clauses may be included in the incentive plan. The participation in the incentive plan can be linked to the continuation of the employment relationship. In this matter the forfeiture clause must be clearly and comprehensibly worded, otherwise it risks being deemed invalid. The cases in which forfeiture might occur must be precisely identified and listed (to prevent invalidity due to Section 307 para. 1 German Civil Code). A forfeiture clause usually differentiates between the reason for the employees leave (differing between “good” and “bad” leavers). In cases, in which the employee leaves on his or her own responsibility, the entitlements might forfeit without compensation entirely or only with respect to vested rights. The forfeiture clauses are legitimate due to the purpose of the participation program, which requires the existence of an unterminated employment relationship. However, the agreement of the aforementioned forfeiture clause in case of a “bad” leaver contains an obstacle for termination by preventing the employee from termination in order not to lose the monetary benefit. In this respect the clause must be limited in time. A forfeiture period of up to five years is permissible, but the employee must be reimbursed for respective expenses incurred. This also applies in cases, in which the company terminates the employment relationship.
It is also possible that the parties agree on a reduction in the number of shares or share options if the employee is absent within the subscription period (reduction pro rata temporis). However, if the employee is absent due to illness, Section 4 of the Continued Remuneration Act must be taken into account, which stipulates that only a quarter of the employee's remuneration may be reduced due to absence.
Also the performance of the company (e.g. net profit goals) itself can be chosen as a criteria to be taken into consideration to reward the employee in case of a successful year, e.g. by granting a specific amount or a percentage of the annual profit.
Yes, awards are often subject to performance criteria, vesting schedules (mandatory for free-shares in order to benefit from the favourable social and tax regimes) and presence conditions, which, if not complied with, entail forfeiture.
As far as presence conditions are concerned, they must not be purely potestative (i.e. dependent solely on the employer's will) and must not correspond to an unlawful financial penalty which is prohibited under French law (the clause providing for the loss of options/shares only in the event of dismissal for misconduct is not valid. On the contrary, a clause provided the loss in case of dismissal whatever its ground, is valid).
Note that French law prohibits financial penalties. Thus, the plan cannot provide for the loss of the benefit of the plan in the event of the employee's fault.
In general terms, companies may establish specific performance criteria, vesting schedules and forfeiture conditions when implementing incentive plans. The key issues is that these conditions are clearly stated and the employee knows them before the accrual period.
Cash incentive plan such as commissions, incentives or bonus are usually linked to performance conditions without prejudice of the accrual period stated to meet the targets. Otherwise, share option plans usually are linked to vesting schedules as a tool to retain employees and to align their aims with the company's.
Yes. Awards may be subject to performance criteria, and to the fulfilment of specific goals. It is important to bear in mind that all incentives granted due to performance are considered as salary payments, and must be included in the base to calculate other labour related obligations. The parties of an employment contract may agree forfeiture or situations in which the incentive plans will not be paid if certain requirements are not accomplished.
Awards can be subject to different criteria, provided that the conditions are legally and don’t imply a discriminatory treatment or the nonfulfillment of mandatory conditions required for certain employment related agreements, such as minimum-stay clauses (although the awarding can be subject to presence conditions).
Clauses providing for the loss of benefits in the event of dismissal are not allowed, unless the loss is due to the nonfulfillment of a minimum period of service required to all beneficiaries.
Awards can be made subject to performance criteria, vesting schedules and forfeiture, and this can be regulated by agreement between the parties. An award may also be differentiated according to the performance of the respective individual beneficiary.
Awards may be subjected to performance criteria, vesting schedule and forfeiture. Such awards should be clearly determined in writing beforehand in order to prevent dispute between the parties.