Employee stock option plans have long served as a tool to strengthen the connection between employer and employees while allowing the employees to benefit from the company's success. The employer typically grants stock options directly to the employees; however, options may also be granted by an affiliated company (in particular, the parent corporation). Which entity is ultimately responsible for performing the obligations associated with the stock options vis-ŕ-vis the employee depends on which entity granted the options.
2003 Federal Labor Court Decision Serves as Precedent
The Federal Labor Court held in 2003 that stock options do not constitute a facet of the employment relationship if the parent corporation rather than the direct employer granted the options. If the parent company of the employer granted the stock options, then the employee can make claims arising from those options only against the parent corporation.
Also in 2003, the Federal Labor Court opined as to what happens to stock options granted by the parent corporation if the nongranting employer is involved in a "transfer of undertaking" (e.g. , the acquisition of a business by way of an asset deal). Jones Day represented the buyer in that case, not only with respect to the acquisition itself, but also in the ensuing litigation concerning the stock options. Specifically, the German subsidiary of a Finnish corporation had been acquired. An employee whose employment relationship had transferred to the acquiring entity subsequently filed an action against his new employer, arguing that the stock options granted by the Finnish parent corporation must now be granted by his present employer or, at the very least, that he should be compensated for the loss of his options. The plaintiff employee lost his case at the trial-court level, as well as in the court of appeals and the Federal Labor Court. Both the court of appeals and the Federal Labor Court held that the stock options, as granted by the parent corporation, were separate and distinct from the employment relationship. Accordingly, the stock options were not subject to the "transfer of undertaking" rules, which state that all aspects of an employment relationship are automatically transferred from the seller (the former employer) to the buyer (the new employer). Stock options granted by an affiliated company are not deemed to be an aspect of the employment relationship.
Two 2008 Federal Labor Court Decisions
The Federal Labor Court specifically confirmed this 2003 decision in a January 2008 decision. The court added, however, that even when an affiliated company grants the stock options, there are certain circumstances under which an employee may make a claim against the (nongranting) employer. If the employer and employee enter into an agreement whereby the employer is involved with the affiliated company's stock option program, the employer is also obligated to ensure that the employee's rights are observed. It may be that the employer's obligations are expressly set forth in a written agreement; it may also be that the employer's obligations arise as a result of the employer's actions. Because the latter was a distinct possibility in the January 2008 case, the Federal Labor Court remanded the matter to the court of appeals. There was some evidence that the (nongranting) employer, on several occasions, had discussed the parent corporation's stock options with the employee during the hiring process and had described the stock options as an additional aspect of the employee's compensation. As a result, it was quite possible that both the parent corporation and the employer had become responsible for ensuring that the employee could participate in the stock option program. Whether the court of appeals will reach this conclusion remains to be seen. One point, however, can already be made with certainty: Employers need to be cautious about discussing an affiliated corporation's stock option plan with employees, during both the hiring process and the employment relationship. If it is subsequently determined that the (nongranting) employer also promised the employee that he could participate in the stock option program, and the terms of the stock option are not satisfied, the employee may be able to make a claim against the employer that includes monetary damages.
In the Federal Labor Court's decision of May 28, 2008, there was no dispute that the employer—without the parent corporation's involvement—had promised to obtain the stock options for the employee for a certain price, even though the options concerned stock in the parent corporation. The dispute before the court was not whether the employer had agreed to become involved with the parent corporation's stock option program but whether this obligation ceased to exist once the employment relationship ended.
Stock Options as a Financial Risk
Stock option plans often include a clause that requires a certain connection by the employee to the employer through a specific date. If this condition is not satisfied— e.g., if the employer terminates the employee—the employee may not exercise the stock options. The Federal Labor Court has explicitly held that case law concerning benefits, as it has evolved over the years, particularly in relation to bonus payments, is not to be applied on its face to stock option plans. This is because stock options differ fundamentally from conventional benefits, primarily with respect to the risks involved.
As has become abundantly clear over the last few months, an employee cannot assume that stock options will retain their value over time, even when both the employee and the company perform well. Factors that neither the employee nor the company can influence may also play a role, e.g., the state of the economy and interest-rate policies. In extreme cases, as mentioned by the Federal Labor Court, "the stock options may lose their entire value within the course of one day." A mere possibility of financial gain should not be compared to more conventional and less risky employee benefits, at least from an employment-law perspective. It is for this reason that the Federal Labor Court has permitted relatively long vesting periods before an employee may exercise his stock options. A two-year vesting period for the initial vesting of stock options is expressly required under Germany's Stock Corporation Act as long as it concerns purely the granting of stock options to employees or management. Conversely, German law does not prescribe a maximum vesting period. Without taking a formal stance on this issue, the Federal Labor Court did say, however, that a vesting period of up to five years is reasonable.
Because of the inherent financial risks associated with stock options, the Federal Labor Court agreed that an employee's right to exercise his stock options may lapse once the employment relationship ends. This is the case not only if the employment relationship ends during the vesting period, but also if the vesting period has already expired. The Federal Labor Court added that it recognizes that this may lead to a financial burden on employees. Regardless, it is not an unreasonable burden, because the employee merely lost an opportunity to reap a financial windfall; he did not take a direct financial hit.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.