The truth behind the oft-misunderstood equity compensation plan

Increasingly, executives and professionals are paid not only through salary and bonuses, but through an ownership stake in their employer as well. Photo by UNSPLASH

Article content

George Gershwin’s It Ain’t Necessarily So, with lyrics by Ira Gershwin, debuted in Porgy and Bess in 1935. The song playfully questioned whether accepted truths were, in fact, true at all.

Article content

Regular column readers know that we often say the same thing about employment contracts. What appears to be clear on paper frequently turns out to be legally unenforceable.

Article content

Article content

Article content

The same is also true of another document employees often overlook entirely: the equity compensation plan.

Article content

Article content

Increasingly, executives and professionals are paid not only through salary and bonuses, but through an ownership stake in their employer as well. That equity may take the form of restricted share units (RSUs), stock options, deferred share units, performance share units or outright shares. In many cases, it represents the most valuable part of the employee’s compensation package.

Article content

Yet remarkably, some employees have never even seen the document that governs it. And of those that have, few have thoroughly read it.

Article content

The details are usually buried in a separate “plan” rather than in the employment agreement itself. That plan determines when awards vest, when they may be exercised and, most importantly, what happens if employment ends.

Article content

Almost invariably, the employer points to a clause stating that all unvested awards are forfeited immediately upon termination.

Article content

Case closed?

Article content

It ain’t necessarily so.

Article content

The starting point in every wrongful dismissal case is simple: An employee wrongfully dismissed is entitled to the financial position they would have occupied had they continued working throughout their reasonable notice period. That includes every component of compensation they would have received — salary, bonuses, benefits and, unless validly excluded, equity compensation.

Article content

Article content

This is where many employers — and surprisingly, many employees — misunderstand the law.

Article content

Article content

When an employee sues after a wrongful dismissal, they are generally not claiming the equity itself. They are claiming damages equal to the value of the equity they would have earned had they remained employed during the notice period.

Article content

That distinction has profound legal consequences.

Article content

Canadian courts have repeatedly held that an employer cannot simply rely on forfeiture language in an equity plan. If the employer intends to deprive an employee of compensation that would otherwise accrue during the notice period, the plan must do so with unmistakable clarity.

Article content

The language must clearly inform the employee that they are surrendering their common law right to damages for lost equity during the notice period. The Supreme Court of Canada made this very clear in the Matthews v. Ocean Nutrition case in which we acted.

Article content

And yet, very few plans do so sufficiently to be legally effective.

Article content

This is especially true of plans drafted in the United States, where employment law differs dramatically from Canada’s. In the U.S., the law often permits employment to be terminated at will without compensation and therefore plans contain language that is wholly inadequate to displace Canadian common law rights.