Valuation and Division of Employee Stock Options in Divorce

• Publication year: 2000
• Pages: 61
• Citation: Vol. 29 No. 5 Pg. 61

29 Colo.Law. 61 Colorado Lawyer 2000.

2000, May, Pg. 61. Valuation and Division of Employee Stock Options in Divorce

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61

Vol. 29, No. 5, Pg. 61

The Colorado Lawyer
May 2000
Vol. 29, No. 5 [Page 61]

Specialty Law Columns
Family Law Newsletter
Valuation and Division of Employee Stock Options in Divorce
by Andrew C. Littman

An employee stock option is a contractual right to purchase stock during a specified period at a predetermined price.1 Increasingly, corporations are granting stock options to employees as compensation for services that have been or will be performed. The increasing use of employee stock options has translated into expanding litigation concerning whether stock options are marital property and, if so, how they should be valued and divided.2

Retirement benefits provided fertile controversy in the 1990s, and stock options are destined to become a primary focus in the new millennium. This article discusses stock options as marital property, describes how courts divide and value stock options, provides examples of distribution and valuation alternatives, and compares incentive options with non-qualified stock options

Stock Options as Marital Property

Marital property generally includes all property acquired by either spouse during the marriage.3 In evaluating whether an employee stock option constitutes a "property" interest, as opposed to a mere expectancy, the first determination that needs to be made is whether the stock option is "vested."4 A non-vested stock option is treated as a mere expectancy because the holder has no enforceable rights. Therefore, non-vested stock options are not property and are not subject to division.5

The definition of "vesting," for the purpose of determining whether the options are property under dissolution of marriage laws, is not the same as the concept of "vesting" used in the tax code or under the option itself.6 Under Colorado dissolution of marriage law stock options can be vested and, therefore, property, even though the ability to exercise those options is contingent on the passage of time or continued employment.7 In divorce law as long as the employer cannot repudiate the option unilaterally, the option should be deemed vested and, therefore, property.8 When the option-holder has the absolute right to exercise the option at any time by paying the option price, the option is said to be both vested and "matured."

Once an option is determined to be vested and, therefore, a property interest, the next step is to classify that interest as either marital or separate property. The Colorado Supreme Court determined the test for making this classification:

[T]o the extent an employee stock option is granted in consideration of past services, the option may constitute marital property when granted. . . . On the other hand, an employee stock option granted in consideration of future services does not constitute marital property until the employee has performed those future services. . . .9

Whether an employee stock option is characterized as being granted in consideration of past or future services depends on the circumstances surrounding the grant and the effect of the option agreement. The determination may depend on factors such as the flexibility and variety of option plans, as well as the size of the company and its need to offer incentives to employees to remain at the company.10

Options are an effective tool in providing incentives to employees in the competitive high-technology industry. Options also may be awarded as an inducement to lure an executive to a company. Options granted during a term of employment may be a reward or bonus for work done well (past services) or "golden handcuffs" to keep an employee from accepting a more lucrative offer elsewhere (future services).

At a minimum, the following questions should be considered when determining whether options are granted for past or future services:

1. Were the options granted at inception of employment or during a continuing term of employment?

2. Were the options a reward for a specific past service?

3. Are the options a substitute for salary?

4. Are the options a bonus or a profit-sharing reward?

5. Were the options an inducement to accept employment?

6. Were the options spread uniformly over time or were they front-end options?

7. Has the employer provided testimony explaining the purpose of granting the options?11

Even if a stock option initially was granted for future services, it may become marital property if the employee already has performed the services at the time of the marriage dissolution.12

How Courts Divide and Value Stock Options

Once vested stock options have been classified as marital property, the court has discretion to determine the appropriate method for valuation and distribution.13 The three approaches to valuation and division are: (1) net present value, (2) deferred distribution, and (3) reserve jurisdiction.14

Net Present Value Method

The net present value approach results in immediate distribution to the non-employee spouse. A lump sum that represents the net present value of the future benefit is determined and may be offset by the value of other property in the marital estate.15 If using this method, the trial court, guided by actuarial data, values the future benefit considers a number of different factors, including...