Stock options, restricted stock, stock appreciation rights, and other similar vehicles (collectively hereafter “stock awards”) are becoming an increasingly regular addition to employee compensation, especially in the Northern Virginia area. Dealing with stock awards in a divorce action requires knowledge of the type of award one is dealing with, along with existing law and knowledge of the areas that may not be entirely defined by existing law. Not only must one classify the marital and separate shares of these awards, but in many cases one must also deal with the logistics of how to divide them or value them in a division. While Virginia case law offers some guidance, many potential issues have not been resolved. The following is a review of several issues practitioners often face in dealing with stock awards in Virginia.
What are Stock Awards?
There are many different types of stock awards. The most common of these are stock options.
A stock option is a call option on the common stock of a company, granted by the company to an employee of that company. In simple terms, it is the right to purchase company stock at a set price (commonly called the “strike price”), regardless of what the company’s stock price happens to be trading for at the time of exercise. For example, if an employee is given 100 stock options for ABC Company with a strike price of $2.00 per share, and he exercises those options at a time when the market price of a company’s stock is $10.00 per share, he will receive net proceeds of $8.00 per share, or $800 — the difference between the strike price and the market price. If the strike price is above the current market price, the options have no value, and are commonly referred to as being “under water.”
Stock options are sometimes given to an employee fully vested, meaning the employee has the right to exercise the options immediately upon receipt. More commonly, stock options are given to an employee with a vesting period, where the right to exercise options becomes earned over time. An example of a common vesting schedule would be that an employee with ABC Company is granted 100 stock options that vest in equal 25% increments each year for the next four years. Options typically also expire within a certain timeframe.
Other forms of stock awards with vesting schedules similar to stock options can be present. Restricted stock is similar to stock options, the main difference between the two being that when fully vested, restricted stock units are simply shares of company stock. Stock appreciation rights, often referred to as “SAR” also may be awarded. SAR plans function similarly to stock options, with the main difference being that SAR plans simply pay employees based on the increase in price of the company stock, without requiring them to pay an exercise price to receive the increase.
Case Treatment of Stock Awards
There are several seminal cases regarding stock awards in Virginia, the earliest and most widely known of which is Dietz v. Dietz, 17 Va. App. 203 (1993). In Dietz, the husband had stock options granted to him before the parties separated. The options vested both before and after the parties’ separation. The trial court treated the stock options as deferred compensation under 20-107.3(G) and ordered husband to pay wife a percentage of the net proceeds of the marital share if and when husband exercised any of the stock options that were marital property. The Court of Appeals found that the stock options were indeed part of a deferred compensation plan as contemplated by the statute and upheld the trial court’s ruling of that aspect of the options.
Ranney v. Ranney, 45 Va. App. 17 (2005) was the next published Virginia case to address the issue of classification of stock options in detail. In Ranney, husband entered into an employment agreement with a company that granted him 20,000 company options that vested over the course of the ensuing four years and that were contingent only on his continued employment with the company. He entered into this agreement approximately one month before the parties’ marriage, so while the options were granted to him pre-marriage, they vested almost entirely over the course of the marriage. At the time of the final hearing all the options had been liquidated and used to purchase assets or to meet the parties’ expenses. The trial court found that that entirety of the award was husband’s separate property, as he “acquired” the options prior to the parties’ marriage. The Court of Appeals reversed, holding that because the condition necessary to the vesting of the stock options (husband’s continued employment) happened during the marriage, husband earned the right to the options during the marriage.
Shiembob v. Shiembob, dealt with restricted stock. 55 Va. App. 234 (2009). Husband was granted 12,264 shares of restricted stock with his employer in 2004, which vested in five equal portions. The first portion vested on January 30, 2005 and the remaining portions vested on January 30 of the four ensuing years thereafter. The parties separated on January 20, 2007. The trial court held that the all of the restricted stock was entirely marital, even the portions that did not vest until after the parties’ date of separation. The Court of Appeals reversed, holding that because the 2008 and 2009 portions of husband’s restricted stock did not vest until after the separation, and his right to receive them was contingent on his remaining in the company’s employ, the trial court erred in holding that the shares were marital property.
In Schuman v. Schuman, wife’s employer granted her a number of stock options, as well as an award of restricted stock and an award of preferred stock (collectively “stock awards”), during the marriage. 282 Va. 443 (2011). However, all of these stock awards were subject to a vesting schedule, and as such did not fully vest until after the date of the parties’ separation. The Court of Appeals held in an unpublished opinion that the various stock awards were entirely wife’s separate property because they did not fully vest until after the date of separation. The Supreme Court reversed, however, holding that the stock awards were a form of deferred compensation under section 20-107.3 of the Virginia Code. As such, they could be divided “whether vested or nonvested.” The Court went on to hold that the marital share of the stock awards should be calculated in the same manner as the marital share of pensions or other retirement benefits – i.e. by implementation of the coverture fraction. See e.g. Mann v. Mann, 22 Va. App. 459, 464-465 (1996).
Classification of Stock Awards
Dietz v. Dietz remains the standard for classification of marital vs. separate shares of stock options. In short, Dietz stands for the proposition that options are marital to the extent that they are earned during the marriage and prior to separation. This holding was reaffirmed by the Supreme Court in its Schuman holding.
Typically stock awards are considered to be earned as they vest, but this may not always be the case. There are circumstances in which awards may be earned at other times, regardless of the vesting schedule. For example, if awards are granted specifically to reward past performance that took place entirely prior to separation, it may well be that despite awards vesting or even just granted after the date of separation should be treated in whole or in part as marital. See Ott v. Ott, 2001 Va. App. LEXIS 10 (unpublished). In most cases, however, stock awards are granted for no specified reason – their primary function is to operate as “golden handcuffs,” to entice employees to remain with their employers. In this typical scenario, stock awards are simply granted to an employee with no explanation for the purpose of the grant, after which they vest over a certain period of time. Awards may be exercised only after they vest, and if an employee ceases his or her employment, his or her awards typically become null and void. In this typical situation — where no specific reason is given for an award — stock awards are generally held to be earned as they vest.
Implementation of the Coverture Fraction
Where stock awards are granted during the marriage, earned as they vest, and some vest after the date of separation, one must implement a coverture fraction to determine the marital and separate shares of those awards. This also holds true where awards are granted prior to a marriage and vest in part during the marriage. Implementing this coverture fraction can pose problems, however, as described below.
In situations where a block of stock awards is granted and all the awards vest over the same time continuum, implementing the coverture fraction is rather simple. For example, assume that parties are married on January 1, 2005 and husband is granted 100 stock options on January 1, 2008. All 100 options vest on January 1, 2012, and the parties separated on January 1, 2010. In that scenario, half the options would be marital and half would be separate, because they vested over a four-year time continuum with exactly two of the years coming before the separation, and two of the years coming after.
The more vexing question, and one which Dietz did not answer, is how to implement the coverture fraction in situations where one block of stock awards is granted, yet separate portions of that award vest over different time frames.
It has become relatively common for companies to issue one grant of stock awards with separate portions of the overall grant vesting over different time continuums. When this happens in a divorce context, the method with which the coverture fraction is calculated can have a significant impact on the classification of the options. This concept is perhaps best explained by a hypothetical:
Return to the couple in the previous example who married on January 1, 2005 and separated on January 1, 2010. Assume again that husband was granted 100 options on January 1, 2008. Now, instead of all options vesting at the same time, four years after the January 1, 2008 grant date, assume the options vest on the following time continuum: 25 on January 1, 2009, 25 on January 1, 2010, 25 on January 1, 2011, and 25 on January 1, 2012. There are two ways of calculating the marital and separate portions of these options.
The first method is to run the coverture fraction on each individual portion of the grant. Applying this method, the first two portions of the grant would be entirely marital, as they vest before the date of separation. However, basing the coverture fraction on each individual portion of the grant means the third portion began vesting on January 1, 2008 and finished on January 1, 2011. Therefore, it would be 66% marital and 33% separate. The fourth portion of the grant – the one that vested on January 1, 2012 – would therefore be 50% marital and 50% separate. All told, this method would result in 70.75 of the 100 options being marital and the remaining 29.25 being separate. On a graph, it would look something like this:
The second method is to run the coverture fraction exactly the same as you would have if the options were not divided into four separate portions. As in the example on the prior page, this would result in exactly half (50) of the shares being marital and half (50) being separate. On a graph, it would look something like this:
There is obviously a substantial difference between the results yielded by the two methods, and there are logical arguments for why each method is correct. For ease of reference, I’ll refer to running the coverture fraction on each individual portion of one overall grant as “Method 1,” and running the coverture fraction on the grant as a whole as “Method 2.”
Method 1 can be logically defended because the different vesting schedules result in the stock award being vested earlier than if all options vested over the same schedule. For example, if the 100 options simply vested over a 4 year continuum and husband lost his job at some point in year 3, he would lose all 100 of the options, because technically none of them would be fully vested until year 4, at which point they all would be. Under the same scenario, however, where the options vest in 25 option blocks in four successive years, when husband lost his job in year 3, 75 of the options would have already vested and be fully exercisable.
Method 2 can be logically defended because it results in all the components of the stock award vesting at the same rate of speed, which appears to be what is intended by the overall grant. Each year the same number of options vest, which suggests that all are vesting at the same rate of speed. By contrast, Method 1 assumes the options vest at different speeds, with the options in year 2 vesting at half the speed as those in year 1, the options in year 3 vesting at one third the speed, etc. Using Method 2 also avoids the seemingly absurd results one would encounter by varying the vesting schedules of the underlying portions of the grant, while all the while having the end result remain the same. To illustrate this, assume that 100 options are granted on January 1, 2008. If the options vest in 25 block increments each year for four years, Method 1 results in 70.75 of the options being marital and Method 2 results in 50 of the options being marital. Now assume that a different vesting schedule is used. Of those 100 shares granted there are only two vesting dates — 75 of the options vest on January 1, 2011, and 25 of the options vest on January 1, 2012. The options vest on essentially the same time continuum, just with different vesting dates. Use of Method 1 would result in 62 of the options being marital. Use of Method 2 continues to yield the same result, with 50 of the shares being marital. Method 2 also appears to be the method used by the Court of Appeals in the Shiembob decision, described above.
Although existing case law in Virginia provides a reasonable framework for classifying and distributing stock awards, questions remain outstanding. A good practitioner will be able to spot the issues associated with stock awards and ask the questions necessary to ensure that he or she is classifying the award properly.