What is the role of stock options in divorce? Many working spouses collect stock options during marriage (especially in Silicon Valley) as a form of compensation for employment. These options are Incentive Stock Options. They are not transferable and their exercise is contingent upon continued employment.
These options are considered community property if earned, vested, and exercised during marriage. Community property will normally be acquired from the date of marriage to the date of physical separation of the parties. Problems occur with regard to the allocation of stock options in divorce court, however, when the options are earned during marriage but their benefits are realized only after the couple separates. In this case, the community portion of the options must be allocated by the court. Three formulas have been utilized by the courts to determine the community portion of stock options depending on the circumstances of the case. (Multiply each formula below by the number of shares.)
1. Stock Options During Marriage And Exercisable After Separation
In In re Marriage of Hug (1984) 154 Cal.App.3d 780, the court created a formula (the “Time Rule”) to determine shares of stock characterized as community property as follows:
Number of Months between START OF EMPLOYMENT and DATE OF SEPARATION
Number of Months between START OF EMPLOYMENT and DATE OPTION IS EXERCISABLE
The Hug case involved stock options which were granted prior to the date of separation of the parties but became exercisable after the date of separation. In fashioning its formula, the court held that the trial court had broad discretion “to select an equitable method of allocating community and separate property interests in stock options.” The court in Hug did, however, noted that no one formula would dictate the conclusion of the court.
2. Incentive Stock Options
In another case, another approach, the Harrison approach (In re Marriage of Harrison (1986) 179 Cal.App.3d 1216) was used in order to determine the community property rights in stocks:
Number of days between DATE OF GRANT and DATE OF SEPARATION
Number of days between DATE OF GRANT and DATE OPTION BECAME VESTED
The Harrison case involved incentive stock options. These options were used as an incentive for a party to stay with the employer. Under one of the options, the husband had the right to buy his employer’s stock in increments of 25 percent on specified dates extending over a period of four years.
Under several other options, the husband could purchase all the stock covered by the option on the day the option was granted but restrictions applied. Stock issued once the options were exercised was to be forfeited to the employer if the employee was terminated for cause or left voluntarily without the employer’s consent.
3. Alternative Calculation: Options Granted Before Separation of the Parties
In a third case, In re Marriage of Nelson (1986) 177 Cal. App. 3rd 150, the court applied a third formula in order to apportion options between community and separate shares as follows:
Number of Months from DATE OF GRANT TO DATE OF SEPARATION
Number of Months from DATE OF GRANT TO DATE OPTION IS EXERCISABLE
In the Nelson case, the above formula was applied to options granted before the parties separated but were not exercisable until after they separated.
Distribution of Incentive Stock Options in Divorce
The value of the Incentive Stock Options using one of the above formulas must be distributed to each party equally as community property. This is done with a court order authorizing exercise of the options on the non-employee’s behalf and distribution to the non-employee.
Because the options are non-transferable, the court order should provide that the employee spouse must exercise the options for distribution to the non-employee spouse.
Transaction costs and income taxes, should be deducted from the proceeds that the non-employee spouse receives. The court should not award the actual options themselves to the non-employee spouse.
Thus, Incentive Stock Options are often the subject of family law litigation with the court attempting to fashion an equitable solution for their distribution. Differences in the community share are traced to the approach used above.