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Tech Layoffs Give Employers and Employees Important Reminder to Review Equity Compensation Terms



The end of 2022 and the beginning of 2023 have been filled with news of tech layoffs, including the notable FAANG companies (Meta, Apple, Amazon, Netflix, Alphabet) and smaller, privately held companies. The cause of these layoffs is multifaceted, including increased cost of capital through higher interest rates, inflation, less optimistic economic forecasts, and over-hiring during prosperous times. Tech industry workers often receive some form of equity compensation, and this equity compensation can often be a significant portion of an individual’s total compensation package. These recent tech layoffs are a reminder that both employers and employees should review the provisions of their equity inventive plans and award agreements from time to time. This article will describe the common terms in an equity incentive plan or award agreement that may be implicated by the termination of an employee or service provider who received an equity compensation award (each an “award recipient”) and how specific types of equity compensation may be impacted by a termination.

Plan and Award Agreement Provisions Commonly Implicated by Termination

The only way to know for sure how a termination will impact an award recipient’s equity compensation award is to read the applicable document containing the terms and conditions of the award, typically this is a plan document and associated award agreement, but in some cases the equity compensation award may be granted through an employment agreement or other standalone document. Some award recipients may have received more than one equity compensation grant and, in this case, the terms of each award may or may not differ. Common provisions that may come into play in the event of termination include:

  1. Plan Interpretation: The plan administrator—usually the board of directors or a committee of the board—typically has the sole and absolute discretion to interpret both the plan document and the award agreement. This provision could potentially come into play if there is a dispute over (i) the meaning of certain language in the plan document or an award agreement, (ii) the calculation of certain formulas (including the values of any inputs used in a calculation), (iii) the determination of certain dates such as the date of termination or date of settlement, or (iv) the status of vesting.
  2. No Right to Further Employment or Additional Awards: Most equity incentive plans provide that the receipt of an equity compensation award does not confer to an award recipient the right to continued employment or service provider relationship with the company, nor does the receipt of an award give an award recipient the right to future equity compensation awards under the plan.
  3. Claims Procedures: Depending on whether the equity incentive plan is treated as a “Top Hat Plan,” any disputes related to the plan or award agreement may be subject to ERISA’s claims procedures. Equity incentive plans that are not considered Top Hat Plans may not include any claims procedure language or may provide for alternative language such as dispute resolution through mediation or arbitration.

Typical Impact of Termination on Equity Compensation Awards

In the event an award recipient is terminated, equity compensation awards are typically handled as follows (though the terms of a specific plan or award may provide otherwise and, in such case, control):

  1. Nonqualified Stock Options and Incentive Stock Options:

    Nonqualified stock options (NQOs) and Incentive Stock Options (ISOs), typically vest over three to five years (though some award agreements may provide for shorter or longer vesting periods). Most often, an award recipient’s termination without cause will result in the forfeiture of any non-vested NSOs or ISOs, as of the date of such termination. Any NSOs or ISOs that vested prior to the termination date usually remain exercisable for a period of time after termination. This post-termination exercise period is referred to as the “PTE Window.” The PTE Window for NSOs is typically around 90 days but can be longer or shorter depending on what is provided in the plan document or award agreement. The PTE Window for ISOs is capped at 90 days by the Internal Revenue Code (Code). Some equity incentive plans will provide that if an award recipient is terminated for cause (as defined in an employment agreement or in the plan document) they will forfeit both vested and non-vested NSOs and ISOs as of the termination date (if vested NSOs and ISOs have not yet been exercised).

    If an award recipient exercises their NSO within the PTE Window, the difference between the fair market value as of the date of exercise and the exercise price will be taxed as ordinary income and included in the award recipient’s taxable income. ISOs exercised during the PTE Window will not be taxed on exercise and any tax on a future disposition will be determined based on the applicable holding period requirements under Code Section 422.

    If as part of a separation agreement or settlement agreement the company and award recipient agree to additional vesting of NSOs or ISOs beyond what the plan or award agreement ordinarily provides for, such agreement must be completed prior to termination as the reinstatement of forfeited NSOs or ISOs after termination will result in a new option being granted. The grant of a new option means that the exercise price used in the prior option needs to be updated to at least the current fair market value of the company’s stock, effectively eliminating the spread between the fair market value and the exercise price of those NSOs or ISOs that additional vesting was negotiated for.

  2. Restricted Stock Units (RSUs): RSUs typically vest over three to five years—though some award agreements may provide for a longer or shorter vesting period—and settle on vesting. In some situations, an involuntary termination of an award recipient may trigger an acceleration of unvested RSUs (and settlement), but other plans may provide for a forfeiture of unvested RSUs.
  3. Restricted Stock and Unrestricted Stock: Typically, restricted stock not yet vested will be forfeited upon an award recipient’s termination. Depending on the company, a shareholder agreement may also provide the company or other shareholders with the option to purchase any of the award recipient’s vested shares of restricted stock or unrestricted stock that have already been ascribed to the award recipient on the books and records of the company. In this situation, the shareholder agreement typically provides for the time period by which the company or other shareholder(s) must provide notice to the award recipient of their decision to purchase the shares and will also typically provide for how the purchase price and purchase terms are determined.
  4. Phantom Equity: It is especially important to read the terms of any phantom equity agreement regarding an award recipient’s rights after termination. Some phantom equity plans will provide that any unvested portion of an award is forfeited, and the award recipient retains the vested portion of the award, thus entitled to payment in the future even if they are not with the company. Other phantom equity plans will provide that both the vested and unvested portions of the award are forfeited if the award recipient is no longer providing services to the company on the date of a payment-triggering event.

This article is provided for informational purposes only—it does not constitute legal advice and does not create an attorney-client relationship between the firm and the reader. Readers should consult legal counsel before taking action relating to the subject matter of this article.

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