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Compensation Plan in Which Stock Can Be Forfeited Is Upheld by California Court
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February 25, 2008
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By Stephanie A. Henderson
Thelen Reid Brown Raysman & Steiner LLP
A California Court of Appeal has upheld a compensation plan even though participants forfeited the stock and the money used to buy it if they were discharged or voluntarily terminated within two years. Schachter v. Citigroup, Inc., -- Cal.App.4th -- , 2008 WL 162244 (2008).
The plan was designed to encourage the retention of high-level employees. Under it, employees directed that a portion of their cash compensation be used to purchase company stock at 25 percent below market price. For two years afterward, the stock was restricted and could not be sold or transferred. During this time, participating employees retained the right to receive dividends and to direct votes of the shares. If employees voluntarily terminated their employment or were terminated for cause during the two years, they forfeited the shares of stock and the money used to purchase them. After two years, the shares of stock became fully vested with the employees, free of all restrictions.
In 1994, the plaintiff signed an agreement directing his employer to pay him 5 percent of his total compensation "in the form of restricted stock.” He received shares of restricted stock in 1995 and 1996. Then on March 31, 1996, plaintiff voluntarily terminated his employment, forfeiting all shares of stock and the money used to purchase them.
On summary judgment, the employee argued that the plan, in effect, deferred employee wages. Labor Code §§201 and 202 provide that when an employee is discharged or when an employee quits, "wages earned and unpaid at the time of the discharge are due and payable immediately." Because the plan deferred payment of earned wages, the employee argued, then the failure to pay these wages upon termination violated §§201 and 202. The employee sought restitution of the purchase price of the forfeited stock under Business and Professions Code §§17200 (unfair business practices), damages for conversion and "waiting time" penalties under Labor Code §203.
The Court of Appeal held that the Labor Code sections were inapplicable because the "economic reality" was that the employee had been paid all cash wages due to him. Plaintiff chose to use some of his cash compensation to buy stock through the stock purchase plan.
At most, the court held, the cash taken from the employee's paycheck for stock purchases was a permissible wage deduction. Thus, there was no violation for the withholding because Labor Code §224 permits deductions that are expressly authorized by the employee in writing, which the employee did here.
Moreover, the forfeiture provision did not violate the Labor Code. The employee "received the full benefit of his bargain." "As part of his negotiated compensation package, [employee] requested and received... both a present and conditional interest in the form of shares of restricted stock." Plaintiff received all bargained for compensation. The "[r]ealization of any additional benefit (including avoiding a loss on his investment purchase) was part of the risk, not a guarantee, of his chosen compensation bargain."
Employee argued that the compensation was the stock and not the cash used to purchase it. Therefore, the employee asserted that he had not been paid wages earned because there was no ascertainable value to the restricted stock. In rejecting this argument, the court concluded that the Labor Code "does not prescribe how the value is to be determined or otherwise prohibit employees from negotiating a compensation package that includes as a part of their wages a conditional future interest in a valuable asset." Employee's bargain had real value, the "present right to receive dividends (and vote the shares) and a contingent future interest in freely marketable shares with a significant potential for a return greater than the cost of the stock." Therefore, the court held, that the restricted shares of stock could constitute wages under the Labor Code.
Moreover, the court rejected plaintiff's argument that the plan violated Labor Code §212, which provides that payment in checks or other "acknowledgement of indebtedness" must be "payable in cash, on demand, without discount." The court held that even if the shares of stock were paid in lieu of a cash payment, "those shares were not given as instruments of indebtedness of compensation; to the contrary, they were the compensation."
The court also concluded that the employer would not have violated the Labor Code even if the court took the view that the employee never was paid the compensation through any means. The court reasoned that a wage is not earned until certain agreed upon preconditions are met. Wages "may be contingent on future events, including the employee's continued employment as of a specific target date, without running afoul the Labor Code's prohibitions against the forfeiture of wages."
Therefore, there could be no violation when plaintiff agreed that his compensation would consist of cash payments and a retention-based conditional interest in stock, with the latter being earned only if he remained with the employer for two years. When the plaintiff left his employer, he had not perfected his right to payment and thus had no right to receive either the restricted stock or the funds used to purchase it.
As a practical matter, the decision provides employers with greater flexibility in implementing non-traditional compensation plans and assurance that restricted stock shares or conditional compensation plans, as part of a overall compensation scheme, will be favorably viewed by the courts
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For more information about the issues covered in this report, please contact Stephanie A. Henderson in our Los Angeles office at 213-576-8049 or at shenderson@thelen.com or contact your Thelen attorney. For more information about Thelen’s Construction and Government Contracts Department, click here.
©2008 Thelen Reid Brown Raysman & Steiner LLP
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