The marital stock exchange

Restricted stock agreements are becoming more and 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 begun to use restricted stock instead of stock options. Restricted stock agreements are generally less risky than stock options. With that in mind, employers are beginning to favor restricted stock over stock options to provide employees a greater sense of security.

Generally, a court must divide the assets and compensation each party acquired for services performed during the marriage and exclude compensation for services that will be performed after the marriage is dissolved. This column describes some of the 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 in that 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.

The substantial risk of forfeiture occurs 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

1. 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 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.

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2. 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.

3. Does the Employee have an Enforceable Right in the Stock or a Mere Expectancy?

An important determination is whether the recipient of stock has an enforceable right in the stock or a mere expectancy. The Colorado Supreme Court has stated that, "In 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.

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:

(a) The contribution of each spouse to the acquisition of the marital property, including the contribution of a spouse as a homemaker;
(b) The value of the property set apart to each spouse;
(c) 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 the 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.