Do your award agreements include the phrase “vesting commencement date” or a similar phrase? A recent lawsuit against Tesla hinges on what it means for vesting to “commence.”
The Lawsuit Against Tesla
A group of former Tesla employees have brought a lawsuit against Tesla, claiming that they should have been able to exercise their options at the time of their termination of employment, even though they had not yet fulfilled the one year of service required for the grants to begin vesting. At the heart of the lawsuit is the language in Tesla’s employment agreement, which states that vesting commences on the first day of employment. The employees have interpreted this to mean that the options were immediately vested at grant.
What Part of “One Year After” Don’t You Understand?
The whole claim seems rather disingenuous to me. As explained in The Recorder (“Trial Opens Over Tesla Options,” March 1, 2016):
The entire dispute turns on a single sentence in Tesla’s employment agreement letter, stating that employee stock options “will vest commencing upon your first day of employment.” But parenthetically added in the employment agreement is the following: “1/4th of the shares vest one year after the vesting commencement date, and 1/48th of the shares vest monthly thereafter over the next three years.”
Given the parenthetical, it seems hard to believe that anyone was really confused about when the options vested.
Key Takeaways
The problem with a lawsuit like this, however, is that no matter how disingenuous it might seem, it won’t go away by itself. Responding to a lawsuit often involves a lot of time, resources, and legal fees. It’s worthwhile to take some precautions to mitigate the company’s risk:
Make sure the language in your employment and grant agreements is clear. Avoid terms that are ambiguous, if possible. If you can’t avoid them, make sure they are clearly defined.
Take off your equity compensation hat once in a while. While a term like “vesting commencement date” might seem obvious to you, it might not be so clear to someone who doesn’t have a background in equity compensation. Plaintiffs’ attorneys are great at exploiting ambiguities.
Keep a record of all information communicated to employees about their awards. In a case like this, educational materials that further clarify how awards vest, possibly with examples, can help bolster the company’s defense.
Today I look at recent litigation relating to the use of non-compete provisions in award agreements. The case (Newell Rubbermaid v. Storm) involves an employee, Sandy Storm (yes, that’s her real name), of Newell Rubbermaid. Storm was responsible for the sale of infant and juvenile products (sold under the Graco brand) by Newell Rubbermaid to Target. In 2013, Storm signed an RSU agreement that included a number of post-employment restrictive covenants (e.g., relating to confidentiality, use of trade secrets, and non-solicitation) that effectively prohibited her from competing with Newell Rubbermaid. In 2014–you guessed it–she resigned from Newell Rubbermaid to work for one of their competitors (Artsana) selling infant and juvenile products (including to Target).
What is interesting here is that the Delaware Chancery Court agreed that the restrictive covenants are enforceable and issued a temporary restraining order against Storm. In today’s entry, I discuss some other aspects of the case that I think are interesting.
An Online Agreement and Acceptance
The agreement was distributed online and Storm consented to it with an electronic signature. The court did not seem to view this any differently than if the agreements had been in paper format and she had manually signed them, saying “Agreements may, of course, be made online.”
You Really Should Read All Those Online Agreements
Storm had not read the agreement, so she didn’t know about the restrictions. She knew that other employees had been asked to sign separate non-compete agreements, so, before resigning, she checked several other sources for prohibitions against working for a competitor (including her personnel file and the company intranet) and didn’t find anything. But she didn’t think to check her RSU agreement. And who can blame her–she thought that agreement related solely to her RSU award, which she was going to forfeit anyway because it wasn’t vested, and she’d signed RSU agreements in 2011 and 2012 that didn’t contain these provisions.
The court didn’t care, saying “Storm is understandably unhappy that she did not read the 2013 Agreements…She altered her post-employment rights in a manner she appears to regret now, but it was her choice to modify her rights without fully investigating the terms to which she agreed.” Harsh! Something to keep in mind the next time you accept an online service agreement without reading it.
Enforcement Went Beyond Forfeiture of the Award
What we typically see with non-compete provisions in awards is that the award is forfeited (or, if vested, clawed back) if the employee violates the provision. The employee essentially has a choice of (A) keeping the award or (B) competing. That wasn’t the case here. The restrictive covenants apply regardless of whether the award is forfeited. In fact, the award had not yet vested by the time Storm terminated, so she forfeited it regardless of where she went to work after leaving Newell Rubbermaid. The question is not whether she gets to keep the award but whether she can work for Newell Rubbermaid’s competitor at all. It’s a lose-lose situation for her; she already forfeited the award and now she’s out of work.
New Possibilities and Challenges
This certainly opens up some new possibilities for award agreements. Mike Melbinger of Winston & Strawn and blogger at CompensationStandards.com thinks, given Storm’s level in the organization and access to sensitive information, this particular scenario might even withstand a challenge in California.
But a provision like this would be a darn good reason for an employee to refuse to accept an award. Storm’s future employment opportunities were limited as soon as she accepted the award agreement (without even reading it!). Enforcing acceptance of award agreements is already a challenge (see the NASPP webcast “Is Silence the Answer? Acceptance of Grant Agreements“), giving employees a legitimate reason to decline them makes this process even harder.
Moreover, a key consideration for the court was that Storm checked a box labeled “I have read and agree to the terms of the Grant Agreement,” and clicked a button labeled “Accept.” The court reviewed screen shots of the page that Storm used to accept the agreement and emphasized this in its decision. I’m not sure that the court would have sided with Newell Rubbermaid if Storm hadn’t had to voluntarily take action to accept the award. And many companies don’t get serious about enforcing acceptance until awards are about to vest. Storm’s award hadn’t vested yet; if Newell Rubbermaid had taken that approach, Storm would probably be happily working at their competitor today.
Grant agreement distribution has become streamlined and simplified with the advances we’ve made in electronic processes. It seems we’ve got the distribution part covered. The part that seems a bit up in the air is the question of what happens if the grant agreement is not signed by the recipient? In today’s blog I’ll explore the issue and offer up my favorite solution.
Yes, Acceptance is Important
There’s a lot of investment that goes into creating grant agreements – some companies are investing thousands of dollars into customizing agreements to jurisdictional requirements, ensuring that agreements are relevant and comprehensive. Ultimately, the intent of the agreement is to inform that participant and protect the company. It seems most companies get this – 76% of respondents in our 2011 Stock Plan Administration Survey (co-sponsored by Deloitte) stated they require acceptance of grant agreements. Hopefully we’re all on the same page about the importance of these agreements, and the need to capture the recipient’s acceptance of the terms and conditions.
Simple for Options, Sticky for Awards
The collection of stock option agreement signatures should be fairly straightforward. Whatever policy your company adopts in this area, it’s relatively easy to enforce, because you have control over the participant’s ability to exercise their stock options. If the company wants to restrict the ability to exercise until the signed grant agreement is on hand, it can do so. The exercise of an option is not an automatic event – it must be initiated. If a participant initiates an exercise without a signed grant agreement on file, the company can simply block that transaction (often via predetermined settings with their third party vendor) from occurring until the agreement has been accepted.
Where things can get sticky is with award acceptances. The challenge is that the vesting of an award is automatic – either based on satisfaction of a service period or some type of performance condition. Unlike stock options, there’s nothing to initiate – the vesting event just happens, triggering income and taxes in many jurisdictions. If the agreement hasn’t been signed by the time the award vests, what should the company do?
We had a great webcast on this topic back in January 2013. If you’re a company muddling through this dilemma, it’s worth a look at the transcript or playback. That webcast offered up several options to the award acceptance conundrum. Today, in the interest of time and space, I’ll just pick my favorite to explore.
You Snooze, You Lose
First, let me just clarify that I haven’t seen an enforcement method for award agreements that is perfect. By perfect I mean without risk or some complexities. That said, I’m a fan of adopting a policy that requires acceptance within a specified period (e.g. 30-90 days) and then canceling the award if it hasn’t been accepted in the first place.
Canceling grants for non-acceptance was once viewed as an ultra-conservative penalty. However, in recent years, we’ve seen this emerge as an increasing trend, and I believe it will eventually emerge as a best practice. In a 2011 NASPP Quick Survey, 22% of companies reported using this approach.
I like this approach for many reasons. First, it’s pretty straightforward to administer. The grant is just canceled if not accepted within the proper time frame. It also eliminates 409A issues that are front and center in some of the alternatives (e.g. delay releasing shares until the agreement is signed). Since the award is canceled, there is no concern about the timing of share delivery – the shares no longer exist. There are no major accounting concerns – the expense under ASC 718 would be accrued just like any other RSU. The key accounting question with this approach is what to do if the award is canceled, and the answer depends on whether the company is using the board approval date as the “grant date” or deferring the grant date until the date the agreement is signed. In the latter scenario, the company might be able to argue that there was never a grant. In the former scenario, the company would accrue expense just like any other RSU, but note that it’s unlikely any of the already recognized expense would be reversed upon cancellation.
Companies who consider this approach do need to be aware of the impact this may have in jurisdictions outside the U.S. Some locations do tax awards at grant (either employee or employer), and those taxes may not be recoverable if the award is subsequently canceled. In addition, a robust communication and follow up plan is a must, because the last thing you’d want is an executive who realizes the “mistake” in canceling his grant and asks for a reversal of the cancelation. If the company doesn’t comply with the request, it’s possible that there may be litigation. As with any policy, there are other considerations as well – but these are the major pros and cons.
My guess is that with the threat of cancelation, most employees will pay attention and accept their agreement terms before the deadline. Companies who have adopted this method report few cancelations. It’s definitely worth considering if you are exploring ways to enforce your grant agreement acceptance requirements.