It Is Time for Hug/nelson's Hegemony Over the Division of Stock Options to End?

• Publication year: 2018
• Author: James M. Crawford, Jr.

It is time for Hug/Nelson's Hegemony Over the Division of Stock Options to End?

James M. Crawford, Jr.

Jim Crawford is an employee benefits/ ERISA attorney who, for more than 30 years, has been serving as a consultant and expert witness for California family law practitioners regarding the characterization, apportionment and division of retirement plans and other forms of deferred compensation. He may be reached at jcrawford@ ERISAsite.com.

In In re Marriage of Hug, 154 Cal. App. 3d 780 (1984) (hereafter, "Hug"), the First District was asked to address what it referred to as an issue of "first impression," i.e., how to apportion unvested stock options that are granted during marriage before separation and that vest after separation.¹ The case arose because while the parties agreed the options should be apportioned according to "a time rule," ² they disagreed as to how the rule should be applied.

As background, the time rule was originally developed as a means of apportioning retirement benefits to which a right is acquired over time.³ It basically holds that where there is a "substantial relationship" between the number of years of service and the amount of an employee benefit, the relative contributions of the community and separate estate to acquiring a right to that benefit can reasonably be determined based upon the amount of credited service contributed by each.⁴

The Hug court's charge was unusually challenging for two reasons. First, when an option is granted subject to vesting, service after the grant date can reduce the risk of owning that unvested property, but it cannot alter, add to, or earn the rights acquired in any part. When an option vests, the rights that vest are the rights that were acquired on the grant date. Because such rights are not accrued or earned over time, using the time rule to apportion them is like trying to put a square peg in a round hole.⁵ Worse, the value of a right to purchase employer stock in the future at its price on the date of grant is a function of the market for that stock, not the amount of vesting service, since vesting determines only whether the rights granted and owned are subject to forfeiture on termination of employment.

Second, In re Marriage of Brown, 15 Cal. 3d 838 (1976) had established that because the time of accrual alone determines whether a right is owned as separate or community property, apportionment is allowed only when the rights in issue, vested or not, ⁶ are partly acquired by the community estate and partly by the separate estate. As the California Supreme Court was later to confirm in the context of retirement benefits:

As we held in Brown, what is determinative is the single concrete fact of time. To the extent-and only to the extent-that an employee spouse accrues a right to property during marriage before separation, the property in question is a community asset. "Throughout our decisions we have always recognized that the community owns all [such] rights attributable to employment during marriage" before separation.
...
Under the leading case of [Brown] and its progeny, such property may include the right to retirement benefits accrued by the employee spouse as deferred compensation for services rendered. This is the case whether or not the right to retirement benefits is "vested" in the sense of 'surviv[ing] ... discharge or voluntary termination....'"⁷

This concept can be distilled down to a simple rule:

"An employment benefit ...is community property to the extent a right to it accrues during marriage" before separation."⁸

In Hug, the options in issue were all granted during the marriage and owned as unvested community property on the date of separation. Because the options that later vested were therefor 100% community property under Brown's simple rule, the case should have been decided as the "no brainer" that it was. Because the First District panel instead approached the matter as calling for an apportionment of that which was not subject to apportionment, it is not surprising that it perceived the issue before it as one of first impression.

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The irony here is that although the disposition of the stock options should not have been apportioned, had the time rule been used to do so, the result would have been the same: 100% community property (the number of years during the marriage divided by the time over which the unvested rights were...