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Unexpected risks of stock option plans

Stock options and stock grants have become normal and expected elements of executive compensation in Canada. Stock options are generally granted to executive employees as a means of creating a common purpose or goal between senior employees and the company. Stock options will have a grant date, being the date on which they are issued to the employee. They will then have a vesting date, being the date on which title to the option will devolve to the employee. Finally, there will be an expiration date to the option, being the last date on which the option may be exercised. The Stock Option Plan normally provides that the option can only be exercised if the employee continues to be employed on the vesting date or the expiration date. The valuation of these options, and the employee’s entitlement to exercise them, has been an issue in many wrongful dismissal actions. I have written on this blog previously on the complexity in resolving the issues arising out of such options.

However, a grant of stock options also carries other implications for the granting company. In particular, an employee who is granted such stock options, and subsequently exercises the options, becomes a shareholder in the company. That status carries with it various rights and obligations under the Securities Acts of the various provinces.

An issue which has recently arisen involves the question of whether unvested stock options will continue to vest during the period of reasonable notice. As most human resources professionals are aware, the concept of notice of termination is intended to provide the employee with advance warning of her or his pending termination. During the period of notice, the employee is entitled to all of the benefits that would normally flow in the course of employment. This would normally include continued vesting of stock options.

While the entitlement of the employee to the options is generally governed by the employer’s stock option plan itself, it has recently been held that, where the provisions of the plan provide that the options cease to vest during notice, any ambiguity in the terms of the plan will be interpreted against the interests of the employer. This will often result in the employee receiving the benefit of the options that would have vested during the period of notice. Similarly, the courts have held that, in the absence of clear provisions of an option plan to the contrary, cancellation of the options on termination, must be read as meaning a “lawful termination”.  Such a lawful termination includes the period of reasonable notice. Companies seeking to prevent such options from vesting during the notice period must use very clear language to do so.

An example of such language was found in a 2007 decision of the Alberta Court of Appeal. The Court considered a clause that provided the employee could be terminated without cause on payment of a lump sum equal to two times his annual salary. Annual salary was defined in the employment contract as a total of all compensation which the employee would receive, including “any profit sharing, officer or employee incentive, compensation or bonus program or otherwise”. The employee argued that the value of the stock options was included in that clause.

In rejecting the employee’s claim, the Court referred to the definition section of the contract which specifically made reference to stock options in certain areas, but not in the area of salary or benefits. The Court therefore found that the parties had not intended to include such options in the ambit of compensation. This case highlights the importance of careful drafting when including stocks option or stock grants in the employment contract.

While the valuation of options will most likely be the issue to cause a dispute upon dismissal, employers must also be wary of the rights of employees as shareholders to demand information from the company that might otherwise not be disclosed. This information is often used by dismissed employees to increase their claims to damages.

In a recent decision of the Alberta Court of Appeal, released on October 6, 2011, the Court considered a request by an employee who had been granted 10 shares as part of her employment compensation. At one point, the company sought to purchase the employee’s shares, but the parties were unable to agree on a share value. The employee therefore commenced an oppression action, being a specific remedy provided by the Corporations Act of most provinces. The basis of an oppression action is that the minority shareholder is being unfairly treated. As part of that action, the employee sought production of the company’s audited financial statements in an effort to assess the value of her shareholdings.

In overturning the lower court, the Court of Appeal ordered that the employee was entitled to such information. The Court relied on a section in the Alberta Corporations Act that requires financial statements and the auditor’s report be provided to the annual meeting of shareholders.  The employee was not required to prove that they were relevant to the issues in her lawsuit. The Court held that she was entitled to the documents flowing solely from her status as a shareholder.

While Stock Option Plans may have lost some of their popularity in favour of stock grants, the issues surrounding the distribution of the equity of the company to employees is one fraught with difficulties for employers. Caution is the watch‑word in implementing such plans.

Earl Altman
Garfinkle Biderman LLP

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Earl Altman

Legal consultant at EA Consulting
Earl Altman was a partner at Garfinkle, Biderman and now heads his own consulting firm. Earl has practiced commercial and employment litigation. Earl’s practice focuses on employment disputes, including acting for employees and employers in wrongful dismissal claims, and in breach of contract and breach of fiduciary duty claims. Read more
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