What are stock options?
A stock option is the right but not the obligation (i.e. the “option”) to purchase stock in the Employer Corporation at a particular price (“exercise price”) at a set time in the future. If the value of the stock is greater than the exercise price, then the employee will realize a profit on the sale of those shares (usually when the Company is sold). Stock option arrangements are popular because they serve as a performance motivator and do not require upfront cash payments to employees.
What happens when the stock options are granted?
Nothing. When the options are granted, the employee does not actually receive anything. Instead, the employee is entitled to purchase a set number of stocks under a vesting schedule. In order to become eligible to exercise the option at the exercise price, sell, and realize a profit, the stocks must “vest” in the employee. Stock Option Plans provide for vesting and exercise of the Options according to the achievement of certain milestones.
For example:
Nigel Co. (a private corporation manufacturing luxury mousepads) wants to incentivize Manolo Manager to perform well as a manager, but does not have sufficient cash on hand to pay him a higher salary or a bonus. Manolo could command a higher salary elsewhere. As of today, Nigel Co.’s stock is worth $2.00 according to a recent valuation. To entice him to perform well, Nigel Co. gives Manolo the option (but he doesn’t have to) to purchase 100,000 stocks in Nigel Co. over a five year period. Nigel Co. hopes that by offering this option, Manolo will assume a greater sense of ownership in Nigel Co. and, in turn, drive up the stock price. In year 6, due in part to Manolo’s excellent performance, Nigel Co.’s stock is now worth $3.00 at fair market value. If Manolo exercises his options, he can purchase 100,000 shares at $2.00 per share for $200,000. Manolo can then sell these shares and realize a taxable profit of $100,000.
What happens to my stock options if I am terminated?
Stock option plans usually address what occurs when the employee ceases to be employed. Depending on the circumstances surrounding the termination, the employee may have the choice of exercising vested options (and realizing a profit) for a short period of time. Typically, stock option plans set out what becomes of the vested and unvested options on termination in a variety of circumstances. For example:
- If the employee ceases to be an employee due to termination for just cause
- Then the vested and unvested Options granted will expire and be of no force or effect
- If the employee ceases to be an employee due to termination without cause
- Then the vested Options remain exercisable for 90 days following termination date; and
- Unvested Options expire and are of no force or effect
- If the employee ceases to be an employee due to resignation
- Then the vested Options remain exercisable for 90 days following date of resignation; and
- Unvested Options expire and are of no force or effect
In the context of wrongful dismissal, disputes often arise about when vesting ceases under the relevant stock option plans. If vesting continues through the period of reasonable notice, the profit implications regarding the underlying stock may quickly outstrip the value of the balance of the severance package or damages award. In order to avoid unwanted liability by allowing vesting through the notice period, the Stock Options Plan has to be unambiguous as to when vesting ceases. In the absence of such clear language, the vesting will be deemed to continue through to the end of the period of reasonable notice at common law. For example, if the period of reasonable notice is 24 months, absent express limiting language to the contrary, the employee will be able to exercise his options during the entirety of those 24 months. Depending on the value of the options award, the monetary stakes could be high.
This blog post was written by Nigel McKechnie, a member of our Employment Law team. Nigel can be reached at 613-369-0382 or at nigel.mckechnie@mannlawyers.com.
