Stock Option Issues and Divorce
Parties contemplating divorce frequently can agree to sell a car or a home and divide up the receipts. However with assets that cannot be sold or do not have any real value, parties sometimes agree to just give up their rights to that asset in exchange for some other asset. This exchange sometimes occurs with private company stock options granted to one party. Therefore since an exact value of the options cannot be determined, one Party may agree to some type of exchange.
A Start-Up Hypothetical
Here’s a typical Silicon Valley scenario: Husband has a job working for start-up company. As part of his compensation package, he has received stock options subject to a four year vesting schedule. The Party’s are unsure if the start up will continue on and later be acquired, or will fold up as many other companies’ have in the Valley.
Question – During their discussion about the division of their assets pursuant to a divorce, the stock options issue come up. The parties try to figure out what to do with the options and whether Husband should just get to keep them in exchange for his gratitude and agreement to not to speak to Wife again.
California the Land of Equality – at Least for Divorce
Under California Law, there is a presumption that any assets acquired from the date of marriage until the date the parties separate (referred to as “date of separation”) is considered community property (This presumption is referred to as a “general community property presumption.”). Community property would then be subject to equal division (50 – 50).
The date of separation is a very important date as it establishes different characterization in property rights. The date of separation is generally the date when one of the parties subjectively decided that the marriage was over and then objectively did something, such as moving out. Parties sometimes later end up arguing about when exactly the date of separation was as it can make a major impact on what assets where community property subject to equal division or separate property (since they were acquired after the date of separation). For example, bonuses received before the date of separation would be subject to equal division, but bonuses received after that date would be considered separate property.
In our hypothetical, let’s assume there is no problem on the date of separation and the parties agree that it was the date that Husband moved out the home.
Some of Husband’s options vested during marriage and before the date of separation. Based on the “general community property presumption,” these vested options would be subject to equal division.
But what about those options that were granted during marriage but had not vested before the date of separation?
Some people may think that the options that were not vested do not have any present value and if Husband were to quit or be fired, they would not be worth anything anyway.
However, the courts in California disagree with this view, and believe that even though these options may not have a present value, they you are subject to division.
Half the Pie or Just a Few Slices?
So how does the court determine what portion of the options belong to Wife?
Generally, courts use one of several formulas (commonly referred to as “time rules.”). Before deciding which formula to use, a court may first want to determine why the options were granted to the employee (e.g. – as an incentive to stay, or to attract the employee to the job).
Two of the main time rule formulas used are the Hug formula and the Nelson formula.
The Hug formula is used in cases where the options were primarily intended to reward past services, and to attract the employee to the job. The formulas used in Hug would be:
DOH – DOS
—————– x No. of shares exercisable = Community Property Shares
DOH – DOE
(DOH = Date of Hire; DOS = Date of Separation; DOE = Date of Exercisability)
The Nelson formula is used in circumstances where the options were primarily intended more as compensation for future performances, and as an incentive to stay with the company. The formula used in Nelson is:
DOG – DOS
—————– x No. of shares exercisable = Community Property Shares
DOG – DOE
(DOG = Date of Grant; DOS = Date of Separation; DOE=Date of Exercisability)
There are several other Time rules formulas for other types of options, and the courts have quite a lot of discretion to decide which formula (if any) to use, and how to equitably divide the pie.
Generally speaking though, the longer the time between the date of separation and the date the options vests, the smaller the overall percentage of the amount of the options that would be considered community property. For example if a specific number of options vested one month after separation, then a significant portion of those shares would be considered community property subject to equal division (50 – 50), however if the options vested several years after the date of separation, then a much smaller percentage would be considered community property.
After application of either time rule, the parties could then agree that the employee spouse would retain the agreed upon number of shares in trust for the other person. When the shares vest and if they can be sold, then non-employee spouse could then request that her portion of the shares be sold on her behalf.
Conclusion
Before Parties agree to just give up their rights to the other person’s stock options, they may want to consider applying a time rule formula to such options, even though presently they may not be worth anything. Accordingly, should the shares later become valuable due to an acquisition or other circumstances, the non-employee spouse could still retain their interest in such shares, and their potential profits.
