Los Angeles Divorce Attorney
Property Division in California


DIVORCE AND STOCK OPTIONS

Terminology

An employee stock option is the right of the employee to buy a specified number of shares in the
employer corporation at a specified price (
the strike price, grant price or exercise price) at a specified
time in the future not earlier than
the maturity date and not later than the expiration date.  The option
will not usually
vest for a number of years after the grant and to encourage the employee to stay with
the company. Portions of the options may vest in stages (
flights). Usually the maturity date is the same
as
the vesting date. Most options lapse after a certain number of years from the grant date.  The
employer may set the exercise price at the market value at the time the option is granted (
at the
money
) or below market value (in the money). If the stock appreciates the employee can acquire stock
at below market value and realize a gain when he or she sells the stock.


Community Property in Stock Options

In California the courts have held that the community has an interest in stock options granted during
the marriage and exercisable after the date of separation to the extent their grant is attributable to
community efforts during the marriage. In determining whether stock options are deferred
compensation for past community efforts, compensation for present efforts or incentives for future
services and retention, the court has extremely broad discretion to select an equitable method for
allocating the community and separate property interest. FN1. Cases have held that stock options
granted and exercisable during marriage are wholly community and those granted after the date of
separation are separate property. FN 2.

In cases where the stock options were granted during marriage but do not vest or become exercisable
until after the date of separation, the Courts have developed the following time rules to determine the
marital interest. However, these are not rigid rules and the Courts have indicated that they are willing
to apply any formula that is equitable in the circumstances.

A.        
In Re Marriage of Hug (1984) 154 Cal. App. 3d 780, 782.

Months between start of employment and date of separation
Months between start of employment and date when options first exercisable  

x    number of shares which can be purchased when the option is first exercisable

The court was influenced by a number of factors: employee induced to join company by promise of
stock options; employee anticipated that he would be granted options when he joined the company;
employee granted stock options in lieu of other compensation during initial start up period; nothing in
plan indicated that were solely for future services.

B.        
In Re Marriage of Nelson (1986) Cal App. 3d 150.

Months between date of grant and date of separation
Months between date of grant and date when options first exercisable

X         number of shares which can be purchased when the option is first exercisable

The court distinguished
Hug and focused on the date of grant since the options were granted to
secure future performance evidenced by the fact that grant price was the fair market value at the date
of grant (
at the money) and for the employee had to stay on at the company while the market value of
the shares increased in order to make a profit. The court also held the trial court did not abuse its
discretion when it credited the employee with his estimated tax liability for future gains in spite of the
rule that liabilities that are not “immediate and specific” should be disregarded.

C.        
In Re Marriage of Harrison (1986) 179 Cal. App. 3d 1216 and In Re Marriage of Walker (1989)
Cal .App, 3d 644.

Months between date of grant and date of separation
Months between date of grant and date that the stock fully vested and not subject to disinvestment

X     gain on the stock option on the date of exercise (after cost of purchasing option and taxes paid on
gain).

In
Harrison, the stock options did not unconditionally vest until after the date of separation and were
therefore deemed primarily an incentive for future services.
Walker held that it was an abuse of
discretion for the Court to apply the
Hug formula and to disregard the date when the stock vested.

The
Walker court also explained in calculating the community interest the “time rule” fraction could be
multiplied any of the following:

    1.        If at the time of trial the option has been exercised and the stock sold, the difference
    between the option price and the sales price.

    2.        If the option has been exercised but the stock has not been sold the court has the
    discretion to either order the stock divided in accordance with the community interest or order
    the employee spouse to buy out the other’s community interest which would be the difference
    between the value of the stock on the date of trial and the option price.

    3.        Determine the community interest in the unexercised options and order the employee to
    deliver up to one half of the community interest share. Each of these solutions presents
    problems. If the options are not yet exercisable valuation is difficult and may require an expert to
    use a valuation model e.g. Black/Scholes pricing model. Also stock options are rarely
    assignable due to company restrictions and potential adverse tax consequences. Therefore, a
    preferable alternative is to negotiate a deferred distribution approach where the employee
    spouse retains the options but the other spouse shares the after tax gain when the options are
    exercised and the shares are sold. Any such negotiated settlement should contain notification
    provisions if the options are reloaded or repriced or exercised, provisions that confer on the
    non-employee spouse the right to direct the employee spouse to exercise options on his or her
    behalf, and how taxes will be calculated.

In determining the correct “time rule” formula some factors to consider in assessing whether the
options are for past, present or future performance are:

  •        Review the option plan terms and any documentation relating to the grant
  •        Options for a specific purpose or a bonus (past performance)
  •        A reward for long term employment or under compensation in the past (past performance)
  •        Part of a compensation package (present performance)
  •        A form of signing bonus for a new employee (present performance)
  •        In lieu of current compensation or in addition to salary especially where options are   
    granted on a regular basis and the company is a start up (present performance)
  •        Employee took a lower salary for higher stock options (present performance)
  •        Options anticipated by employee (present performance)
  •        Long vesting period (future performance)
  •        “Golden handcuffs” intended to retain an employee (future employee)
  •        Other factors include the size of the company and the strike price (possible future
    performance.)


FN1.     In Re Marriage of Hug (1984) 154 Cal. App. 3d 780, 782.
FN 2.    In Re Marriage of Nelson ( 1986) Cal App. 3d 150.


Contact a Los Angeles Divorce Attorney at Law Offices of Warren R. Shiell to discuss your
property division issues.
Call for a free consultation now 310.247.9913.


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