Getting a fair share

by Susana Ng, senior associate

Article contributed by Allen & Overy

The underlying objective of companies offering their executives stock options is to align their interests more closely with those of the shareholders by giving them the opportunity to share ownership of the business. The theory is that this will encourage company leaders to take a longer-term view of performance.

Share option plans generally give eligible employees the right to buy a fixed number of the company's shares at a fixed price for a fixed period of time, subject to specified terms and conditions. Plans usually contain provisions regarding the vesting of share options and the treatment of the options granted in case of termination of employment "for cause", for example, if the company ends the employment for a substantial reason, such as chronic performance problems not corrected after warning.

The High Court recently considered an employee's share option entitlement following wrongful dismissal in the case of Lee Hung Chiu Philip vs Becton Dickinson Asia Limited (2009).

In this case, Mr Lee, the plaintiff, was the country manager of the defendant company's China operation. His remuneration package included stock options under an executive incentive compensation plan. The stock option plan contained a vesting rule, stating that half of the options would vest at the end of the second year after they were granted and the remainder would vest at the end of the third year.

Mr Lee was suspended from duty on 9 June 1999 and was summarily dismissed on 21 July 1999. The company alleged that he had breached its business conduct rules and had wilfully disobeyed lawful and reasonable orders by his superiors. Mr Lee then lodged a claim against the company, seeking, among other relief, damages for his loss of stock options granted by the company.

Stock options

First of all, the court found that the company had no grounds to summarily dismiss Mr Lee, after examining the evidence.

Another key issue was the date to be used to determine a fair market value of the shares in order to calculate the damages payable to Mr Lee. There had been a significant drop in the share price from the date of Mr Lee's suspension to the date of his summary dismissal. The price of the shares dropped even further thereafter.

The court considered the most appropriate share price for calculating the amount of damages to have been the price on 21 July 1999, the date of Mr Lee's wrongful dismissal.

Mr Lee also received a number of special stock options during his employment. He was informed in an internal memorandum that the special options could be vested in one instalment three years after the grant date.

The timing for the vesting of these special stock options was crucial, since they were granted slightly less than three years before the date of Mr Lee's dismissal. Mr Lee tried to argue that the vesting rule should prevail in this case, since under this rule he would be able to recover damages in respect of half the special stock options that had been granted more than two years before the date of dismissal.

The court ruled against this, however, since it was clear from the internal memorandum that a different vesting formula applied to the special stock options. Given that the options were not vested at the time of the summary dismissal, Mr Lee could therefore not recover any damages in relation to the special grants.

Forfeiture of unexercised grants

The stock option plan contained a provision relating to the forfeiture of unexercised grants, stating that they expired immediately if an employee was terminated "for cause" and three months after a voluntary or involuntary termination "without cause".

In its dismissal letter, the company had tried to deprive Mr Lee of his right to the stock options on the basis of his summary dismissal. However, given the court's finding that there had been no legal basis for his dismissal, the company argued that Mr Lee had failed to notify the company of his wish to exercise the stock options and that it was therefore entitled to forfeit all the outstanding stock options, vested or unvested.

The court ruled that the company had in effect deprived the plaintiff of the stock options that had already vested on 21 July 1999, and the judge said it was disingenuous for the company to argue that Mr Lee could still somehow have "exercised" the options at some time during the period that he had been wrongfully deprived of them.

Q & A on Share option entitlements in case of wrongful dismissal
Q1 What protection does the Employment Ordinance offer with regard to stock option benefits?
A1 The Employment Ordinance does not contain any provisions regulating the granting or entitlement of stock option benefits. These are matters of agreement between the parties and are subject to the terms and conditions of the relevant plans.

Q2 When do stock options become taxable?
A2 Under Section 9(1)(d) of the Inland Revenue Ordinance, a gain derived by an employee from the exercising of share options is calculated based on the date when the option is exercised (not the date of the grant), on the difference between what the employee paid for the option and its market value.

Taken from Career Times 25 December 2009, p. A8

(Last review date: 23 August 2013)

The opinions expressed in this article are those of the contributor

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