Compensation Used to Purchase Forfeited Restricted Stock not Deemed Earned Unpaid Wages

A November, 2009 California Supreme Court ruling affirmed that an incentive stock option plan which had not fully vested upon plaintiff employee’s resignation did not constitute earned but unpaid wages and the employer could lawfully require the employee to forfeit the stock and the salary used to purchase the stock.  Schachter v. Citigroup, Inc. (2009) 47 California Reports 4th 610.

Plaintiff David Schachter worked as a stockbroker for Citigroup from April 28, 1992 to March 29, 1996.  He voluntarily chose to participate in a company-offered incentive compensation plan which provided employees with shares of restricted stock options at a reduced price in lieu of a portion of that employee’s annual cash compensation.  Per this compensation policy, employees could elect to receive anywhere from 5% up to 25% of their total compensation in the form of restricted stock.

Restricted stock could not be sold, transferred, pledged or assigned for a two-year period; however, participating employees had the right to vote and receive regular dividends on such shares during the restricted period.

If an employee remained with the company for the two years following the purchase of the restricted stock, the title to the shares vested fully without restriction.  However, if an employee quit or was terminated for cause before the end of the two-year period, the employee was forced to forfeit his or her restricted stock as well as the percentage of annual income allocated for purchase of the restricted stock.  If an employee was involuntarily terminated without cause, the employee forfeited his or her restricted stock, but received a cash payment equivalent to the portion of annual compensation which had been paid in the form of such forfeited restricted stock.

Schachter elected to receive 5% of his total compensation in restricted stock during 1995 and early 1996.  He then resigned from Citigroup in March, 1996.  Because his resignation occurred within the two-year vesting period, he forfeited all his shares of stock and did not receive a cash payment equal to the 5% compensation used to purchase those shares.

In May, 1998, Schachter filed a class action lawsuit against Citigroup alleging that the restricted stock purchase plan (the Plan) violated California Labor Code sections 201 and 202 which require the employer to promptly pay all earned wages upon termination or resignation.  He also alleged the Plan’s forfeiture provision violated Labor Code section 221, which prohibits an employee from returning wages to an employer.

After eleven years of protracted litigation, the California Supreme Court (the Court) ruled that the Plan’s forfeiture provision did not violate California labor law.

First, the Court discussed the term “wages,” which it  broadly construed to include not only monetary compensation but also other benefits to which an employee is entitled as part of his or her overall compensation.  This can include accrued vacation pay which “vests” throughout a given year as well as bonuses and profit-sharing plans.

The Court then concluded the restricted stock constituted a “wage” under California law.  However, when Schachter voluntarily signed the Plan election forms he understood that the restricted stock would not fully vest for two years.  He chose not to remain with the company for the two year period and thus the Court ruled he did not earn and had no right to receive either the restricted stock or the compensation used to acquire it. According to the terms of the Plan, no earned, unpaid wages remain outstanding upon voluntary resignation.  In other words, the only thing the company hadn’t paid to Schacter was something he never earned, i.e. fully vested company stock.

The Court quoted the colorful truism, “He who shakes the tree is the one to gather the fruit” and concluded Schachter was not entitled to “gather the fruit” since he failed to perform the condition necessary to do so – i.e. remain employed with the company for two years after the stock purchase.

Further recommendations:  Companies that offer their employees incentives such as incentive stock options, commissions and bonuses should consult legal counsel to ensure these plans are properly structured and documented.

If you have any questions on these or any other employment laws, please contact me or any of our other employment law attorneys.  Best, Cindy Bamforth