Restricted stock agreements and restricted stock units (RSUs) are becoming more common in divorce proceedings. The recent increase in these equity compensation plans stems out of a law created by the Financial Accounting Standards Board (FASB). This law, revised in late 2004, requires companies to expense their employee stock options.
In light of this, many companies have started using restricted stock instead of stock options. With that in mind, employers are favoring restricted stock over stock options to provide employees a greater sense of security. This is causing more couples to ask, who gets the restricted stock in the divorce? How are restricted stock units divided? What if the restricted stock have vesting schedules? What if a portion is for future employment after the divorce is over?
Generally, a court must divide the assets and compensation each party acquired for services performed during the marriage and must exclude compensation for services that will be performed afterwards. This blog describes some basics for determining whether a restricted stock will be classified as a marital asset or excluded as a separate asset.
Types of Restricted Stock Awards
There are two basic types of agreements that allocate restricted stock: (1) a restricted stock award, and (2) a restricted stock unit award. Under the first type of agreement, the employee receives, in his own personal account, the number of shares outlined in the restricted stock agreement. The second type of restricted stock agreement uses restricted stock units.
A restricted stock unit is simply a promise to deliver stock at a later date. The amount of stock that each unit represents will typically be outlined in the restricted stock agreement. For example, one unit may be equal to one, five, or ten shares of stock. The key distinction between the two types of agreements is that in the first type of agreement, the party owns the stock, and in the second type of agreement, the party owns a promise to deliver stock.
The Substantial Risk of Forfeiture: What Defines a Restricted Share of Stock?
Restricted stock is distinguishable from normal stock because it carries a substantial risk of forfeiture. A substantial risk of forfeiture is created when the restricted stock is conditioned on uncertain future events occurring. Generally, restricted stock agreements use time or performance-related conditions. A time-based condition is one that forces an employee to work for a certain period of time before they will receive the stock. An example of this may be restricted stock that vests on the first day of January each year. Performance-related conditions relate to factors such as revenue growth, increased customer satisfaction, or other types of goals. An example would be a restricted stock agreement which states that the stock will vest if revenue increases by 5 percent.
A substantial risk of forfeiture exists when the chance the employee will receive the restricted stock diminishes. For example, if an employee needs to increase revenue by 5 percent in a year and the country falls into a recession, there may be a substantial risk of forfeiture. In a divorce proceeding, it is difficult to determine how substantial the risk of forfeiture may be. Courts cannot just assume that restricted compensation will actually be received and therefore they have discretion and might not include the restricted stock as a marital asset.
Deciphering the Agreement
- Was the Restricted Stock award given for Past or Future Services? In general, restricted stock is a marital asset if it is granted for services performed during the marriage. In contrast, if restricted stock is granted for future services which do not occur during the marriage, it will not be marital property. A variety of issues occur when a single contract outlines several different conditions, some past and some future, which must be completed in order for the restricted stock to vest. In cases where this occurs, a court will analyze which portion of the restricted stock is a marital asset and which is separate. A court determines this by analyzing what compensation relates to past services and what compensation relates to future services.
- Are There Ownership Rights in the Stock? Although the recipient of a restricted stock award cannot sell his or her stock, they may be able to collect dividends or exercise voting rights. An example occurs when companies issue their CEO or top-level executives restricted shares of stock. The company wants the executive to be able to vote and receive dividends; however, the company restricts the employee from liquidating his or her interest. These ownership rights lower the risk of forfeiture and therefore provide the employee with a greater chance of receiving future compensation. The Colorado Supreme Court has found that such ownership rights diminished the risk of forfeiture so much that the “employer could not unilaterally repudiate husband’s right to retain stock.” In one case, the court found that the restricted stock agreement had both a past and future component. That being said, the court found that the ownership rights diminished the risk of forfeiture and therefore increased the chance the employee would receive the future benefits.
- Does the Employee have an Enforceable Right in the Stock or a Mere Expectancy? An important determination is whether the recipient of the stock has an enforceable right in the stock or a mere expectancy. The Colorado Supreme Court has stated that “[i]n determining whether one has an enforceable right to employee stock options, a court must look to the terms of the contract granting such options. If an employee has a presently enforceable right under the contract, regardless of whether the options are presently exercisable, such a right constitutes a property interest rather than a mere expectancy.”The Court held that if an employee has a presently enforceable right under the contract, regardless of whether the options are presently exercisable, such a right constitutes a property interest rather than a mere expectancy. Similar principles apply to restricted stock agreements. The court will analyze whether the stock has any enforceable rights or whether it can be unilaterally confiscated by the company. If the stock rights are a mere expectancy or are in consideration for services not yet performed during the marriage, then they are typically not marital property.
The Court’s Equitable Power to Divide the Restricted Stock
Once the Court has determined whether a restricted stock is marital or separate property, it is important to understand how a court will divide such an asset. Under Colorado law, the court “shall divide the marital property, without regard to marital misconduct, in such proportions as the court deems just after considering all relevant factors….” Some examples of this include the following:
- The contribution of each spouse to the acquisition of the marital property, including the contribution of a spouse as a homemaker
- The value of the property set apart to each spouse
- The economic circumstances of each spouse at the time the division of property is to become effective, including the desirability of awarding the family home or the right to live therein for reasonable periods to the spouse with whom any children reside the majority of the time.
In essence, the court has the ability to allocate any amount of marital property as it deems necessary and proper. That being said, the restricted stock could be allocated to the employee, the employee spouse, or divided between the two.
A further complication in restricted stock agreements is that most agreements disable the recipient from transferring the restricted shares. Because of these challenges, divorce courts can potentially appoint the employee/recipient of the stock to act as a fiduciary until the stock vests. Once the shares vest, they can be divided between the parties, subject to the court’s orders.
Suzanne Griffiths is the Managing Shareholder, President, and co-founder of Griffiths Law PC. She was recognized by the Best Lawyers in America© in 2019 for family law and was selected to Colorado Superlawyers from 2005-2018. She was also recognized in 5280 magazines for Top Lawyer in Family Law in Denver from 2016-2018.
Christopher Griffiths is a Shareholder at Griffiths Law PC and focuses his practice on complex civil litigation and family law matters. His civil litigation practice focuses on construction, insurance, real estate, commercial, and business disputes. His family law practice focuses on divorce and related domestic relations matters. Chris has assisted in the recovery of millions of dollars on behalf of his and his firm’s clients in Colorado and Texas.