How Do Courts Handle Unvested Stock Options

By January 28, 2014Divorce, Stock Options

On behalf of The Marks Law Firm, L.L.C. posted in Stock Options and Divorce on Tuesday, January 28, 2014

Often individuals obtain as a benefit of their employment stock options with their employer.  Sometimes, these options have a variety of requirements regarding when they vest  (become the actual rather than potential property of the employer).  At other times, these options may vest upon issue but have a long window to exercise.

Handling stock options during a dissolution of marriage can present some complicated issues.  First, when do the options become marital property – at the time the employee receives the options, at the time the employee becomes vested in the options, or at the time the employee exercises the options?  Second, how does one value the options at the time of dissolution if they have not vested or been exercised?

A stock option is a benefit received in conjunction with employment.  In that sense, a stock option is no different than employment income, employer contributions to a retirement or pension fund, or an employee bonus.  Any benefit received during the time the parties were married is in fact marital property.

Of course, stock options differ from regular income in that they may not automatically vest in the employee and have a value that could fluctuate from the time of issuance to the time of exercise based on the price of the stock.  If the option increases significantly in value, a spouse would lose out on that increase if the valuation is taken at the time of dissolution.  Conversely, if the option decreases significantly in value, a spouse would lose out on the value if valuation is taken at the time of exercise.

If the option vested and has been exercised during the marriage, the value is easily known at the time of exercise.  If the option vested but has not been exercised at the time of dissolution, it is valued at the time of dissolution.  If the option has not vested and has not been exercised at the time of dissolution, courts can choose to value the option as of the time of dissolution or avoid the risk of undervaluing or overvaluing the option by dividing it as a percentage rather than a dollar value.

How do courts compute the marital portion of an option?  Unlike with a retirement or pension account, which accrues with years of service or contribution and can be easily measured as marital and separate from the date of marriage and date of dissolution, options do not always meet such a neat formula.  For example, some options may not issue until after a long term of service, only some of which may have been marital.  Generally, if the option vested during the marriage, it became a marital asset at that time, whether the employee cashed out the option or not.  A more complicated question involves an option that vests after the end of the marriage.  Often these options do not vest until the employee meets certain conditions or they represent a performance accomplishment.  In these situations, the employee has the burden of demonstrating none of the future option has anything to do with past employment.  As recently discussed in Beecher v. Beecher, a case from the Southern District of the Missouri Court of Appeals, the employee has a very high burden to meet, as courts will assume that the award of the option during the marriage renders the option marital property subject to division.  When the employee fails to meet the burden, as he did in Beecher, the option may be treated as funds received in their entirety during the marriage, which entitles the spouse to a half share – a different outcome than the formula used for measuring retirement and pension accounts where the percentage is based on the number of years of employment during marriage divided by the total years of employment.  In this sense, stock options look more like a one time bonus and a spouse should share in the windfall.

Is it fair to the employee to have so much of the option inure to the benefit of the spouse, particularly if the marriage was of a short duration?  As with any marital asset, an individual may argue to the court that it has a mixed character of separate and marital funds and should be divided accordingly.  So, in the case where a spouse would gain a windfall after two years of marriage for what had been 25 years of employment, the court would likely award only a small percentage of the option.  But note – it is the duty of the employee to make the case that a marital asset should be “sourced” in this fashion, otherwise the court will make an equal division.

So, stock options earned during the marriage, even if not vested or exercised, are marital property subject to division, valued at the time of exercise or the time of dissolution if not exercised.  An employee may seek to show that the options were earned outside of the marriage to overcome the presumption of equal division, but that burden is on the employee and the court may reject that argument.

If you have questions about division of stock options in divorce, contact our St. Louis divorce attorneys – we can help.