CALIFORNIA SUPREME COURT OK'S INCENTIVE PLAN FORFEITURE CLAUSES
The concept behind incentive compensation is to motivate employee behavior, such as employee retention.
Employers commonly design the incentive by providing that employees who
quit or are fired for misconduct before an established date forfeit the
incentive. In the past, California's Labor Commissioner and
some court cases have challenged these forfeiture provisions as being
contrary to California's pro-employee wage laws. However, the California Supreme Court issued a
recent decision which allows employers to design plans in this manner
without running afoul of California law. Here is what happened in the case of Schachter v. Citigroup, Inc., and what the Court's ruling means to you.
In the 1990s, Smith Barney, Inc. (now a subsidiary of
Citigroup, Inc.) devised a "Capital Accumulation Plan" that allowed key
employees and officers to receive as much as 25% of their pay in the
form of restricted company stock. Under the plan, this restricted stock
vested fully two years after the date of the award. During the
two-year vesting period, the stock could not be transferred, sold,
pledged or assigned. Participants could elect to pay taxes on the
restricted stock when it was purchased, but their restricted shares
were not included in their gross taxable income until the end of the
two-year vesting period. The plan also contained stipulations about
what would happen in the event an employee leaves the company. If the employee remained with the company for the
entire two-year period, title to the shares vested fully with the
employee, without restrictions. The employee could then dispose of
the shares as the employee saw fit. If the employee was terminated without cause, the
employee forfeited the shares, but received a cash payment equal to the
portion of annual compensation that had been paid in the form of
restricted stock. However, if the employee quit or was discharged for
cause before the stock fully vested (two years after purchase), the
employee had to return the stock and got nothing. One of the company's stockbrokers voluntarily quit
16 months after enrolling in the plan. Because he resigned before the
restricted stock vested, his employer took the position that Mr.
Schachter forfeited all of his shares and was to be paid nothing under
the incentive plan as a result. The employee was unhappy with this outcome and filed a class action lawsuit
against the company. He claimed that the plan's forfeiture provisions
violated several provisions of the California Labor Code relating to
the payment of earned wages to terminating employees.
The trial court ruled for Citigroup. So did the Court of Appeal and the Supreme Court.
The ruling is a big boost to employers wishing to craft incentives.
Here is what the Supreme Court had to say in upholding the forfeiture
provision. The Supreme Court first addressed whether the plan's
participants would have been owed any "wages" that were "earned but
unpaid" upon quitting or being terminated for cause. Not surprisingly,
the Court confirmed that the restricted stock was compensation that
legally qualified as a form of "wages". However, the Court concluded that no payment was due
in this instance because under the terms of the plan, the shares in
question were not "earned" at the time the employee had
quit. Therefore, the employee had no legal right to these "wages"
(i.e., the unvested shares or to a cash payment in lieu of the shares).
The court also confirmed that since Mr. Schachter was
an "at-will" employee, he and the company were free to agree to
restructure his compensation package at any time and for any reason. In
this case, the employee voluntarily agreed to accept a lower cash
salary along with restricted stock which was subject to the incentive
plan's restrictions and rules. Another helpful fact was that Mr.
Schachter specifically acknowledged his understanding in writing about
what would happen to the stock if he quit or was discharged for cause. The Supreme Court noted that while the employer
would have had legal problems if the company had fired Mr. Schachter
for the purpose of preventing his restricted stock from vesting, this
is not what happened here. Since Mr. Schachter voluntarily quit
before his shares vested, he was not entitled to anything on his claim.
The Supreme Court's seal of approval on this plan
gives California employers a "green light" to formulate bonus and other
incentive compensation plans with forfeiture provisions and which
condition payment on the occurrence of certain events, such as
employment for a specified period of time.
However, the plan must be carefully drafted to account for the pro-employee wage laws in California. For example, the plan should not enable employees to forfeit any incentives that already have been "earned".
Nor, should the plan allow the company to avoid the incentive
payment merely because the employee was fired. Rather, the
disallowance of the incentive should be restricted to terminations
where the employee engaged in serious misconduct. Otherwise, the
company will be inviting challenges suggesting that the discharge was a
ruse which enabled the company to get the benefit of the employee's
services without paying the agreed incentive.
Your contact at the Firm has experience drafting and
defending challenges to these plans. We are ready to assist you
if you have any questions about this topic, or wish to arrange for a
review of your existing or proposed compensation plans or policies.
For more information, call us today at (818) 508-3700,
or visit us on the web, at www.brgslaw.com.
Sincerely,
Richard S. Rosenberg
Partner
BRG&S, LLP
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