Do participants in incentive plans have a right to compensation for loss of their awards when their employment terminates? Does the reason for the termination matter?
In the US, employees are usually employed “at will” meaning that either the employer or the employee may terminate the employment relationship at any time without prior notice for any reason or for no reason at all. Absent a contractual provision to the contrary (such as in an employment agreement, severance agreement, plan rules or a grant agreement), any shares that are then unvested will lapse and be forfeited.
Contracts between the employer and the participant may, however, specify that if the termination is by the employer “without cause” or by the employee for “good reason,” then the participant may be entitled to all or a portion of an otherwise unvested equity award.
Regardless of contractual provisions, it is not uncommon for participants to assert that they were terminated by the company, or constructively discharged, for reasons prohibited by law such as discrimination due to age, gender, race, sexual orientation, whistle blower status and the like, and therefore unlawfully deprived of continued vesting of equity and the grant of future awards.
Because the US does not maintain a “loser pays” approach to attorney’s fees, employment litigation thrives. Plaintiffs routinely seek recompense for equity awards.
Many US employers confront this situation by obtaining a release of all employment and compensation claims in exchange for the payment of cash severance benefits.
Most incentive plans in Mexico provide that the employee’s participation entails the understanding and assumption that there may be a risk of loss on the grant of shares or options to purchase shares. This is a valid term in an incentive plan and the employer or the company responsible for the plan does not need to guarantee a gain or compensation for loss, at any time during participation. This would not having to compensate for loss when employment terminates, regardless the cause may be.
Since, as a rule, incentive plans are not expressly required / provided by law, the eligibility and granting rules can arguably be unilaterally established by the employer as designer and issuer of the incentive plan. Typically, in practice, employers implement several eligibility and granting conditions, including that the individual is still employee of the company upon certain events (such as vesting, payment etc.), the employee is not on notice for termination etc. The reason for termination is also relevant, as plans usually "sanction" terminations initiated by the employee (via resignation) or related to the person of the employee (for example, disciplinary termination, poor performance termination, etc.) and, arguably, not necessarily restructurings. This is because the aim of the plan is to incentivise good performers with long-term loyalty towards the employer.
Therefore, in cases in which the employees fail to observe the "continued employment"-related conditions, they are not granted the award. In principle, they should have no right for compensation for loss of their award in these cases, but it depends on how the plan and conditions are drafted. In some cases, a pro-rated amount may be exceptionally granted, however, it depends on the conditions in the plan.
The Danish Stock Option Act
For Incentive Plans entered into prior to 1 January 2019, the previous Danish Share Option Act applies under which Shares are subject to a good/bad leaver assessment, which cannot be deviated from to the detriment of the employee.
An employee is considered a good leaver, if:
- the employment is terminated due to the employment being terminated by the employer without this being a result of the employee’s breach of duties (e.g. redundancy or change of personnel for operational requirements); or
- the employee terminates the employment due to the employer’s breach of the employment agreement.
An employee is considered a bad leaver, if:
- the employee terminates the employment in accordance with the agreed notice period in the employment agreement; or
- the employer terminates the employment due to the employee’s breach of the employment agreement.
If the employee is considered a good leaver, the employee retains the right to exercise granted Shares when the employment lapses. If the employee is considered a bad leaver, the employee’s rights to exercise the granted Shares lapses, unless the parties have stipulated otherwise in an agreement.
For Incentive Plans entered into after 31 December 2018, the good leaver/bad leaver assessment no longer applies and the employer/employee consequently have a wide contractual discretion to decide on rights to compensation.
After 31 December 2018, the employer and the employee are considered “equals” and the protection of the employee is, consequently, reduced. The parties can, for example, agree that the employer can repurchase Shares, purchased by the employee under an agreement with the employer at market value, when the employment lapses.
If an agreement is deemed unreasonable by the courts, it can be set aside as invalid under the general clause in section 36 of the Danish Contracts Act.
The Danish Salaried Employees Act
Under section 17a in the Danish Salaried Employees Act, a salaried employee is entitled to a pro rated bonus, if the employment is terminated during the period under which the bonus is accrued.
Bonus payment not subject to the Danish Salaried Employees Act or the Danish Stock Option Act
If an employee is not subject to the Danish Salaried Employees Act and the bonus payment is not subject to the Danish Stock Option Act, the employee’s rights, in connection with the employment being terminated, depend on the wording/understanding of the employment agreement, including the bonus agreement.
Because incentive plans are not regulated in Ecuador, the conditions for granting or eliminating them can be established by the company or agreed on by the parties. According to Ecuadorian jurisdiction, however, cash payments made regularly to workers could be presumed to be a permanent employment benefit; for example, if an employee receives a bonus in the same amount for several successive months, then in the case of any dismissal dispute, the authorities would take the worker’s salary, plus payment of cash-based incentives made on a regular basis, into account when calculating severance pay.
It depends on the company’s option incentive plan and the agreement signed between the company and the vestees The companies may have option repurchase arrangements for the participants when their employment terminates and they haven’t fully exercised their options or the vested Restricted Shares, but such arrangements would differentiate depending on the stage of the option (whether granted, attributed, exercised etc.) and on the reason for the termination (voluntary, involuntary, grave misconduct etc.). And when the court finds the conduct of the company is in violation of the Law on Employment Contracts or obviously lack of rationality, then the court may rule for the compensation to the participant. While it is difficult for the participants to receive such compensation if the options/ shares under incentive plan are deemed as independent from the employment package.
Yes, (1) if such employment is terminated due to fault or incompetence of the participants, then the participants don’t have the right to compensation for loss of their awards; (2) if such employment is terminated due to resignation, adverse change of the objective conditions, expiration of the medical treatment, lay-off, the compensation may be made in accordance with the agreement or the court decisions. When disputes arise between the vestee and the company for the matter of incentive option indemnification, such as when the parties at dispute do not reach an agreement on whether the vestee could receive the incentive equity shares or the indemnification fee, then such dispute may lead to overlapping application of labor laws or business laws and regulations such as the contract law or the company law, and the subject matter and the judicial institution may also vary. In practice, some cases are adjudicated as termination of labor relation and indemnification dispute case by the labor arbitration commission and the competent court; while some cases are adjudicated as equity dispute cases by the business arbitration commission or the competent court, depending on the dispute resolution provisions in the equity incentive agreement. Such variation makes the final judicial decisions of cases complicated and different from one another, so the dispute resolution strategy the disputing parties adopt is very important.
In principle, participants do not have a right to compensation for loss of their awards when their employment agreement terminates. As set out above, this is only different (i) in certain (limited) circumstances when the forfeiture of awards is contrary to the principle of reasonableness and fairness (redelijkheid & billijkheid) , or (ii) in case of – in short – unfair dismissal as in such case an employee can claim a fair compensation and the (potential) value and/or vesting of awards may be taken into account by a court when determining the amount of fair compensation.
The calculation of the fair compensation could for example be as follows. If the employment agreement is terminated without a reasonable ground (e.g. there is not sufficient file for underperformance) a court may grant a fair compensation. The court will in such case calculate the fair compensation by determining the missed income of the employee until the date the employer could have terminated the employment agreement with a reasonable ground. Building up an underperformance case could – depending on the specific situation – take for example 3 to 6 months. If awards would vest during this period, the court will add the value of the awards to the fair compensation amount.
The employment law does not have specific provisions on the right to compensation for a loss in the event of employment termination. Also, the payment of awards will depend on the type of incentive plan, and the terms and conditions of such plan. As a rule, if the plan is characterised as compensation and the participant is an employee, the case law considers the payment of a prorated portion of the incentive of the respective year of termination that the employee should be entitled for in the event of termination without cause or resignation. Other situations involving an employment termination and payment of compensation/award should be analysed on a case-by-case basis.
Participants in incentive plans do not have any right to compensation for loss of their awards when their employment is terminated. Far from it, companies may stipulate that employment termination is a condition of forfeiture of the incentive plan’s rights. In this sense, it is difficult to see a right of employees in a common incentive plan as a definite legal right in Japan since right in a common incentive plan involves conditions to vest and/or exercise and rely upon the discretion of the company.
Whether the participants have a right to claim compensation depends on the legal basis of their claim.
Where the incentive plan is based on a mutual agreement, the employee’s right to compensation must be interpreted on the basis of the agreement and in accordance with the common intentions of the parties at the time of the agreement.
The employee may in some cases claim compensation on the basis of fault or negligence (“culpa” liability). For this to occur, the employee must show that there is a basis for liability, financial loss and causation between the basis for liability and the financial loss.
An incentive plan may be a result of regular practice or policy of the company.
In such case, one must carefully view the type of plan, the purpose of the plan, company guidelines, how it has been implemented by the company as well as other relevant factors. Whether the incentive plan is discretionary and solely based on the company’s administrative authority may matter too.
The reason for termination is a relevant factor.
In the event the employee is unlawfully dismissed, the employee may claim compensation in accordance with the Norwegian Working Environment Act.
The compensation is normally based on what the court deems reasonable in view of the financial loss, circumstances relating to the employer and employee and other facts of the case.
The majority of incentive plans will be governed by leaver provisions either in the plans themselves or in the articles of association of the company. These provisions will set out the conditions under which an individual will be a good leaver or a bad leaver, and what will happen to their options/shares or what they will receive for their shares upon termination of their employment. Good leavers (commonly those that leave by reason of death, injury, disability, redundancy, retirement or the transfer of the company or business for which they work outside the issuer's group) are generally entitled to retain their awards whereas other leavers typically lose them. Some plans may permit the board to have a discretion to determine whether or not a participant's awards will lapse.
If a participant's options lapse on the termination of their employment then the rules of the plan will generally provide that they are not entitled to any compensation for the loss of their options even if this is as a result of the breach of their employment contract. However, in some circumstances, it is not possible to exclude liability under a statutory claim the participant may have (for example by reason of unfair dismissal or redundancy).
Generally, the employee is not entitled to compensation for loss of his or her awards if the employment relationship ends, unless a compensation for such an event (scenario) has been contractually agreed upon. The loss of options is not deemed disadvantageous at least as long as the options have not yet been vested. Other incentive plans not related to share options or securities, such as bonus agreements, lead to an entitlement to payment in the proportionate amount (pro rata temporis).
a. In principle, assuming that the plan does not state otherwise, employees have no right to compensation for loss of their awards when their employment terminates regardless of the reason for the termination.
Note that a clause depriving the employee from the benefit of the plan only in the event of dismissal for misconduct shall be deemed unwritten. Such a clause constitutes a pecuniary sanction, prohibited under French employment law.
b. However, as an exception, an employee has a right to compensation in the event of a dismissal ruled unfair by judges. In that case :
- for “cash bonuses”, the bonus would be due even if the employee does not meet the attendance condition;
- with regard to stock options and free shares, the employee may be awarded damages for loss of opportunity to exercise the option. Note that some judges have decided on the total allocation of the shares or their equivalent value in such a case.
Considerations from an employment point of view.
Under certain termination scenarios, employees may be entitled to receive their awards (at least on a pro-rata basis) as well as to continue vesting after their termination. This risk is specially high in case of unfair dismissal (i.e. dismissal without cause) and must be analysed in light to the particular circumstances of the case. To try to reduce (not to eliminate) the risk of claims and reinforce the position of the company in case of conflict, it is highly advisable to include in the plan specific provisions on the consequence of the termination of the employment relationship on the awards under each different scenario.
Considerations from a mercantile/regulatory point of view.
Spanish Corporate Law provides no specific rule on the right to compensation for loss of their awards when their employment terminates. In this sense, the provisions of the incentive plan and/or the contract with the employee or administrator shall apply. As explained in paragraph, 5 above, any severance grants, provided that the termination was not due to failure to perform the duties of director, must be provided for in the company´s Articles of Association.
Parties within an employment contract may agree on the terms and conditions in which incentive plans will be granted, hens, they may agree benefits will not be paid if the employment contract is terminated with cause, or if the employee does not fulfil an specific requirement such as being engaged to the company for a specific period of time.
As per awards, usually the stock option agreement establishes conditions regarding termination of the employment contract, and possible compensation.
In case of employment termination that implies the payment of compensation, for purposes of severance payments calculations, the only amounts that must be considered are the basic pay and the so-called seniority allowances. Moreover, from a Labour Law perspective, this kind of benefits is not equivalent to retribution. Thus, since the benefits emerging from the Plan do not have a retributive nature, they are not subject to the guarantee scheme granted by Labour Law regarding retribution. Also this kind of benefits is not regulated by Portuguese labour legislation and therefore any conditions related with the rights and obligations arising from the Plan can be established by the employer (provided that those conditions fulfil the general requirements of any contractual obligation, such as, the requirements related with the principle of non-discrimination).
However, if there is a dismissal deemed unfair by a court decision, the employee is entitled to receive the pay and benefits which he or she would otherwise have received from the date of the dismissal up to the date of the ruling. This may include the benefits related with incentive plans the employee would have been entitled to during that period. The employee may also be awarded damages for loss of opportunity to exercise stock options plans, although we are not aware of any case where this has happened.
These aspects may be regulated by agreement between the parties. As a general rule, in the absence of agreement, the loss of options does not trigger a right to compensation. Other incentive plans, such as bonus agreements, usually provide that the bonus is paid pro rata temporis. However, the regulations of the incentive plan may well provide limitations or forfeiture of the option in the event of termination of the employment relationship.
There is a risk of employees claiming that they are entitled to compensation for loss of rights under any plan when their employment is terminated. In this case the rules primarily agreed between the parties regulating the incentive and termination reason will determine the decision of the court.