US companies have been granting various forms of share-based awards to employees around the globe for many years, and companies in other countries are increasingly following suit.
Because share-based awards are ubiquitous, and for many companies an important part of the total pay package, we are now also seeing an increasing number of lawsuits and other disputes involving such awards.
The Claims
Broadly, these disputes can be categorized as follows:
Entitlement Claims
These can arise if a company is eliminating or paring back a previously offered share program. In this case, employees who are no longer eligible for awards or receive less/reduced awards may claim that they have become entitled to the awards, such that the company cannot unilaterally eliminate/reduce the program without otherwise compensating the employee. Employees may also try to raise constructive dismissal claims.
A related issue in this situation is whether a company has to notify or consult with existing Works Council or other employee representative bodies regarding the changes to the share program. If Works Council is found to have a consultation right, implementing the change without such consultation can be very problematic and Works Council can take the company to court.
Increased Severance Pay
If an employee is involuntarily terminated, they are often entitled to statutory severance pay. Severance pay is typically calculated based on the employee’s salary paid during a certain period prior to termination. If share-based award income has to be included as salary for this purpose, this can increase (in some cases, significantly) the amount of severance pay due to the employee.
Continued Vesting
Most share-based awards vest over time, subject to the employee’s continued employment. If an employee terminates, any unvested awards usually forfeit at termination. Employees who are contesting a termination may argue that they should be permitted to continue to vest in the award after termination (since they could have vested, if not for the wrongful termination), or at least receive damages to compensate for the lost award.
A nuance to this issue is the question of whether an employee can claim to be entitled to vest through any notice period, even if the award documentation provides that vesting will cease when the employee no longer provides active service. Since notice periods/garden leaves can be lengthy depending on the country and the employee’s seniority, this can make a significant difference in the amount of shares the employee may receive.
| See the attached chart for a summary of the various claims raised and risk level for each in a select number of countries. |
Mitigation Strategies
Employment claims are extremely fact-specific, and often, claims related to share-based awards are part of a larger dispute between the employee and the employing company. And, of course, local employment rules and case law vary vastly between countries. Therefore, it is virtually impossible to effectively mitigate against all and any claims in relation to share-based awards. Notwithstanding, there are a number of measures companies can take both when operating the share-based program and when defending against a live claim.
Discretionary Parent Company Grant Separate from Local Compensation
Many of the claims described above hinge on whether the share-based awards are part of the employee’s compensation paid by the employer. For example, as described above, severance pay is calculated based on the employee’s salary. If share-based award income can be distinguished from salary, there is an argument it should not be factored into the calculation of severance pay. Similarly, in most countries, it is extremely difficult (if not impossible) to unilaterally reduce an employee’s salary, which could make it difficult to eliminate/reduce share programs if they are viewed as part of salary.
Therefore, at least for awards granted by a foreign parent company, it is advisable not to mention the awards in local employment documents, such as offer letters or employment agreements,[1] and to ensure that any communication regarding the awards is coming solely from the parent company. Further, in any documents that list the employee’s total compensation (such as Total Reward Statements), companies should refrain from referring to the awards as part of salary or other compensation paid by the employer, and include language to emphasize the discretionary nature of the awards.
The award documents provided to the employees when awards are granted should similarly include strong language providing that the awards are not part of local compensation but a special incentive provided by the parent and do not require the company to continue to grant awards in the future or impede its ability to terminate the program. Further, it is recommended that the award agreement clearly state that the grant of the award does not create any entitlement for the employee to remain in employment with the employer, and does not impact the employer’s ability to terminate the employee’s employment relationship. If correctly crafted, this language can be included in the body of the agreement that is used for grants in all countries. In some countries, it is advisable to include customized disclaimer language to mitigate against the country-specific risks. These provisions can be included in an appendix to the award agreement (i.e., it is generally not necessary to prepare country-specific agreements).
It is also helpful if awards are not granted and/or do not pay out on a regular/recurring basis, and if companies do in fact make changes to the program from year-to-year. This is difficult to achieve for plans like an Employee Stock Purchase Plan, under which participating employees purchase shares on predetermined/recurring purchase dates year after year. Consequently, the risk for such plans tend to be higher than for long-term incentive programs that often change over the years at least in some respects.
Governing Law / Venue Provisions
The plan and award documents should be governed by the law of the country in which the parent company is incorporated, and the award agreement should provide that any dispute related to the awards has to be adjudicated exclusively by a court in the parent company’s country and as preferred by the parent. (It may also be possible to include an arbitration provision.[2])
If included, the first defense against an employee claim related to share-based awards that is filed in the employee’s country should be that the local court lacks standing to hear the case, due to the venue provision in the award agreement. This argument will not always be successful,[3] as many labor courts will either decide that the award is at least indirectly tied to the employment relationship and/or there is a public policy reason to hear the case in the employee’s home country.
If a local court decides to adjudicate the claim related to the share-based award, as a second step, the company should point to the governing law provision in the award agreement to try to preempt the application of local employment laws that are often more employee-friendly than the governing law (at least for US issuers).
Other Tips
More broadly, companies should educate their local teams on the strategies described above and ensure that local employment counsel consults with the parent company’s employment counsel responsible for the share program. Unfortunately, we see quite frequently that local counsel simply assumes that the share awards are part of local compensation and fails to make the arguments described above, which then results in “bad” precedent that hampers the defense against future claims.
Conclusion
When granting share-based awards to employees globally, companies should not underestimate the potential for these awards to play a significant role in disputes with employees and prepare accordingly. While not always successful, companies can and should vigorously defend against such claims on the basis that share-based awards granted by a foreign parent company can be distinguished from locally-paid compensation and may therefore not be subject to the same entitlement and other claims that apply to such compensation.
Please talk to your Compensation attorney if you would like to evaluate your company’s mitigation strategies and do not hesitate to reach out to our local employment colleagues if you need assistance defending against a local claim.
[1] If companies want to communicate the share-based award to candidates/new employees, they should do so in a separate equity side letter provided by the parent company, as described in our earlier blog that can be found here.
[2] Please see our blog on the considerations for arbitration clauses in equity award agreements here.
[3] It has, however, been successful in a number of countries, most notably Germany.
