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October 26, 2010
Are Stock Options Wages?

A salesman for a Maryland company left employment just before his stock options vested. Was he entitled to them as wages?

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What happened. Catalyst Health Solutions hired “Mark” as vice president of sales in February 2004. His compensation included an annual base salary of $135,000, a monthly car allowance, and 40,000 options to acquire company stock at a set price. According to the letter of employment, 25 percent of the option award would vest 12 months after the initial vesting date, and the remaining 75 percent would vest in three equal annual installments each year thereafter. Installments would not be exercisable if Mark terminated his employment before the vesting date.

Several weeks later, Mark’s compensation package was revised to give him a $200,000 loan to help him move and an additional 35,000 stock options. Five months later, Mark’s compensation was revised again to increase his salary, give him a larger loan, and grant him another 40,000 stock options if the company reached its sales objectives called “stretch goals.” He was soon granted these options.

In November 2005, Mark and the company agreed to a revision of the vesting schedule of his 115,000 stock options so that he could pay off his relocation loan to Catalyst. The company agreed to accelerate the vesting of his options so that he could exercise 55,000 options by December 28. After this transaction took place, Mark had enough money to pay off the outstanding $266,000 on his relocation loan, netted another $100,000 after taxes, and kept 60,000 stock options that were now set to vest on April 16, 2006.

In February 2006, Mark accepted a job with one of Catalyst’s competitors and tendered his resignation. He terminated his employment with Catalyst on April 5. Two weeks later he attempted to exercise his remaining 60,000 stock options, but he was unable to do so because Catalyst had put a block on his brokerage account. Catalyst filed a complaint in the Montgomery Circuit Court asking it to find that Mark had no claim for the stock options that vested when he ended his employment. The trial court found that Mark’s options should have been considered as wages earned during employment. It awarded Mark nearly $850,000, the value of the options if they had been exercised. Catalyst appealed.

What the court said. The question before the Court of Appeals was whether unvested stock options can be considered “wages” under Maryland law. The Maryland Wage Payment and Collection Law, Sections 3-501 to 3-509 of the Labor Employment Article, states that “each employer shall pay an employee … all wages due for work that the employee performed before the termination of employment, on or before the day on which the employee would have been paid the wages if the employment had not been terminated.” “Wages” include all compensation due to an employee, including bonuses, commissions, fringe benefits, or other remuneration promised for services.

Employees, however, must fulfill all conditions they have agreed to with their employers in order to be eligible for compensation. For example, in Whiting-Turner v. Fitzpatrick (2001), a Maryland court found that a profit-sharing bonus was not part of an employee’s compensation because he had not met the required condition of 2 years of employment and therefore had not earned the bonus at the time of his termination. Catalyst argued that Mark had not met the terms of his agreement because he was not still employed at the time his options would have vested.

The trial court had determined that the options were granted for goals already achieved, but the Court of Appeals disagreed. The options were not wages due to Mark for work he had already performed. Mark had been promised the right to exercise stock option grants upon meeting the condition of being employed on the vesting date. Because he was not employed on that date, he did not meet the conditions necessary for his stock options to vest. The court reversed the earlier decision and found that Mark was not entitled to exercise those options. Catalyst Health Solutions v. Magill, Court of Appeals of Maryland, No. 80, September Term 2009 (6/2/10).

Point to remember: Stock options are not wages, and clearly written contracts always help resolve situations like this.

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