Equity incentive schemes, a key tool in corporate management, have recently sparked a significant increase in legal disputes. The determination of such disputes carries substantial procedural consequences: labour disputes follow a one-arbitration, two-level appeal system, while non-labour disputes adhere to a two-tier trial system or contractual arbitration arrangements.
This determination also shapes judicial philosophy, forcing courts to balance worker protection against respect for contractual autonomy. As such, whether equity incentive disputes should be treated as labour disputes has become a contentious issue in judicial practice.
Amid significant controversy, article 1 of the Supreme People's Court's Draft Interpretation (II) on Several Issues Concerning the Application of Law in Labour Dispute Cases stipulates: "Disputes arising from employers granting equity incentives as labour remuneration under employment relationships – where employees claim the equity incentives or compensation for related losses – shall constitute labour disputes, excluding those arising solely from exercising share rights."
However, this judicial interpretation remains in draft form, without legal effect so far. In judicial practice, the determination of equity incentive disputes as either labour or civil and commercial disputes remains unresolved. Drawing on practical experience, the authors analysed nearly 800 judgments from Beijing, Shanghai, Guangzhou and Shenzhen courts between 2022 and 2024 to identify three factors that courts consider when determining the nature of these disputes.
Incentive recipient v provider
The current law confines labour disputes to those arising from an employment relationship. Thus, the legal relationship between the incentive recipient and the incentive provider is key in determining whether an equity incentive dispute qualifies as a labour dispute. In practice, courts typically focus on the following dimensions.
Independence of rights and obligations. This refers to whether the equity incentive agreement operates independently of the employment contract and avoids establishing a subordinate employment relationship. If the agreement stipulates that the conditions for exercising equity rights are solely tied to market indicators and bear no direct link to performance assessments or employment status, it is more likely to be regarded as a commercial agreement.
If the exercise conditions are integrally linked to job grade or an attendance system, this may prompt examination of the inherent subordinate employment relationship.
Symmetry of risk allocation. This criterion examines whether incentive recipients bear market risks (share price volatility, vesting failure) and derive returns tied to enterprise performance, rather than receiving fixed compensation for labour.
Where equity rewards require secondary market liquidation, feature valuation-adjusted exercise prices or incorporate exit-related contingency clauses, the remuneration structure demonstrably shifts from employment-based certainty to investment risk exposure. Such arrangements typically warrant classification as commercial transactions under judicial scrutiny.
Autonomy of contractual intent. The determinative factor is whether employees enjoy genuine freedom to accept or decline equity incentives without adverse employment consequences.
Where such voluntary participation exists, the arrangement demonstrates the arm's-length negotiation characteristic of commercial contracts, distinct from the inherent power imbalance in employment relationships. Incentive schemes executed concurrently with employment contracts and contingent on continued service typically fall within the labour law's protective remit.
Equity incentive v remuneration
Article 2.5 of the Labour Dispute Mediation and Arbitration Law stipulates that disputes concerning labour remuneration fall within the scope of labour laws and regulations. Where equity incentive instruments are recognised as elements of remuneration, such disputes shall be adjudicated as labour cases. In practice, two principal interpretations have emerged regarding this provision.
Rigid requirements on statutory payment forms. A prevailing interpretation holds that equity incentives cannot constitute labour remuneration due to rigid statutory payment requirements. Unlike relatively stable wage payments, share-derived returns are inherently subject to market volatility. This characteristic of variable returns fails to satisfy the legal criteria for remuneration payments.
Functional interpretation of labour consideration. A countervailing view maintains that equity incentives may properly constitute labour remuneration under a functional analysis. Remuneration encompasses not only monetary payments but all valuable consideration employees receive in exchange for their services.
Labour legislation contains no statutory exclusion of restricted stock awards from permissible benefits. Provided such arrangements comply with mandatory legal requirements and contractual terms, they retain valid status as remuneration components.
Equity incentive v employment relationship
It is generally believed that equity incentives help employees recognise that their performance can impact share value, directly aligning with their own interests. Companies offer such incentives to boost employee motivation. From this perspective, some contend that if the acquisition and exercise of equity incentives are closely tied to the employment relationship, then their grant is rooted in labour relations and falls within the realm of labour disputes.
If equity incentives constitute a significant portion of an employee's total income and the exercise conditions are directly linked to work performance – for example, performance bonuses being converted into stock awards – they may be seen as a disguised wage payment.
Similarly, when companies use equity incentives to conduct performance assessments, such as linking exercises to KPIs, the benefits effectively become an extension of labour management and are thus subject to labour dispute resolution.
Judicial assessments of equity incentive disputes adopt a scenario-based approach, requiring a comprehensive evaluation of factors such as the agreement process, contractual form, clause wording and conditions.
Striking the right balance between contractual autonomy and employee protection still needs further exploration. Companies should therefore seek a dynamic equilibrium between governance innovation and legal compliance, while rigorously scrutinising the systemic risks inherent in both the design and implementation of their equity incentive schemes.
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.
