Does a spouse have the right to a portion of unexercised stock options when splitting assets?
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The following comes from an article written by the Law Offices of Rod Firoozye. This article was published on July 17, 2004, and can be found at: http://www.divorcenet.com/states/california/ca_art32
California law defines community property as any asset acquired or income earned by a married person while living with his or her spouse. Separate property is defined as anything acquired by a spouse before the marriage, or during the marriage by gift, devise or bequest. The law requires that the community estate be divided equally if there is no written agreement to the contrary. This means that from the total fair market value of the community assets, the joint obligations of the parties are subtracted, yielding the net community estate. Unless agreed otherwise, each spouse must receive 50% of the net community estate. It should be understood that the law does not require an "in kind" division of the community property. All that the law requires is that the net value of the assets received by each spouse must be equal. Thus, it is not uncommon for one spouse to be awarded the family residence, with the other spouse receiving the family business and investment real estate. Since the total net value of the assets being received by each spouse is equal, such a division is proper.
Ordinarily, it is not difficult to determine whether a particular asset is community or separate property. However, certain types of assets can pose unique problems in this regard. Here's a typical Silicon Valley scenario: Buddy is a Linux specialist who gets a job working for PaperMoney, a start-up company. As part of his compensation package, he receives stock options subject to a four year vesting schedule. Time passes, and Buddy meets Bella. They start dating and shortly thereafter, get married. After a year Buddy and Bella have a child, Bel-Bud. However, right after Bel-Bud's birth, Buddy and Bella's marriage falls apart, and they decide to separate and file for divorce. During settlement talks, the stock options issue come up. Everybody ponders the question: How much of the stocks and options belong to Bella?
Under California Law, property acquired during marriage is presumed to be community property and is subject to equal division. In this scenario, some of the PaperMoney options were acquired by Buddy during the marriage and may be considered community property. What about those options that had not vested yet?
Some people may think that the options that were not vested do not have any present value and if Buddy were to quit or be fired, they would not be worth anything anyway. However, the courts in California disagree with this view. So how does the court determine what portion of the options belong to Bella?
Generally, the courts use one of several time-rule formulas. Before deciding which formula to use, a court would first need to determine why the options were granted (e.g. as an incentive to stay, or to attract the employee to the job).
Two of the main formulas used are the Hug formula and the Nelson formula.
The Hug formula is used in cases where the options were primarily intended to reward past services, and to attract the employee to the job. The formulas used in Hug would be:
DOH & DOS/DOH & DOE x No. of shares exercisable = Community Property Shares.
DOH stands for Date of Hire. DOS stands for Date of Separation. DOE stands for Date of Excercisablity.
The Nelson formula would be used in circumstances where the options were intended more as compensation for future performances, and as an incentive to stay with the company. The formula used in Nelson is:
DOG % DOS/DOG & DOE x No. of shares exercisable = Community Property Shares.
DOG stands for Date of Grant. DOS stands for Date of Separation. DOE stands for Date of Excercisability).There are several other Time rules formulas for other types of options, and the courts may use their discretion to decide which formula to use, and how to equitably divide the pie. Generally speaking though, the longer the time between the date of separation and the date the options vests, the smaller the amount of each option that would be considered community property. For example, suppose Buddy received options that were vesting on a monthly schedule at a rate of 100 options each month. One month after the date of separation, maybe 98 options maybe considered community property, after the second month 96 options. After one year 50 options out of 100 would be considered community in nature.
To the extent that a married person accumulates an interest in a pension, retirement, profit sharing or other employee benefit plan during the marriage, it is community and subject to division in the Dissolution of Marriage. The law gives the judge the power to award a spouse his or her pension plan, based on its "present value," or to "reserve jurisdiction" to award each spouse a proportionate share of the benefits when they are paid.
Generally, Pension Plans are divided in one of two ways: a "reservation of jurisdiction," a "cash-out." The most common way in which Pension Plans are handled is by reservation of jurisdiction. Under reservation of jurisdiction, the court orders that when the employed spouse retire the other spouse will receive a percentage of each pension check. This percentage is calculated by dividing the years when the spouses lived together as husband and wife by the total number of years that the employed spouse has been participating in the Pension Plan. The result of that division is the community property percentage of the Pension Plan. For example, if the husband had 20 years of contributions into a Pension Plan, with 10 of those years coinciding with the years he lived with his wife, the community property share of his Pension Plan would be 50% (10 divided by 20). Thus, the wife would be entitled to 25% of the husband's pension
checks (1/2 of 50%).
Under a reservation of jurisdiction, the spouse can elect to receive his or her share of the employed spouse's pension benefits at the earliest time that the employed spouse could retire. This means that even if the employed spouse chooses not to retire, he or she still has to pay to the other spouse what that spouse would have received if the employed spouse had retired.
For example, if the husband is eligible for "early retirement" at age 55, but he chooses not to retire at that time, his ex-wife can demand that he pay her the amount of money that she would get if he actually retired. However, if the wife makes such an election, she does not receive any cost of living increases after that date.
The Federal Retirement Equity Act of 1984 created what is known as the "Qualified Domestic Relations Order," or "Q.D.R.O." (pronounced "quadro"). Where the Court makes orders concerning a spouse's retirement plan and the order is prepared in the correct form, the
Federal law requires the employer to comply with the terms of the order. The preparation of a Q.D.R.O. can be time consuming and complicated, and, consequently, expensive. However, it is a necessary step in the dissolution process.
Several companies have been formed for the sole purpose of preparing Q.D.R.O.s. For a fee, these companies prepare the O.D.R.O.'s and submit them to the pension plan administrators.
The other method of dealing with Pension Plans involves obtaining "actuarial evaluation" of a Pension Plan. An actuary is an expert who deals with statistical and financial evaluations of insurance policies, annuities and Pension Plans. By reviewing the Plan description as well as the accumulations on the account of the employed spouse, the actuary can determine
the "present value" of the Pension Plan. For example, if the husband's Pension Plan provides that he will receive $1,000 per month upon his retirement at age 65, and the husband is
presently 45 years old, the actuary estimates how much money would have to be deposited in an interest-bearing account now to yield interest income in 20 years of $1,000 per month. This process includes an estimation of the long-range interest rates that would be in effect over that period of time. With a cash-out, the employed spouse receives his or her Pension Plan, with
other community property assets being awarded to his or her spouse to result in equal division of community property.