Divorce: Equitable Distribution Of Equity Compensation

Appellate Division Provides Guidance On Equitable Distribution Of  Equity Compensation That Vests Post-Complaint

By: Barbara Ulrichsen, Esq.

Equity compensation is a common component of the overall compensation package of executives employed by major corporations and, to some extent, smaller business entities. Equity compensation is paid in a number of forms, including Restricted Stock Units (RSUs) that entitle an employee to receive a shares of company stock or a payment equivalent to the value of the stock; stock options or warrants that permit an employee to purchase stock at a fixed price on a future date; and performance share units (PSUs) that are comparable to RSUs but have additional performance related conditions on the receipt of the shares. An employee’s receipt of equity compensation is typically conditioned upon a vesting schedule that requires the employee to continue working for the company to receive the benefit on a future date. The employee may become eligible to receive the compensation at a specific rate (such as 20% or 25% per year) over a certain number of years or may provide that 100% of the award is given after employment for a fixed term of years with no intermediate payment of the award.

A significant issue arises with respect to the equitable distribution of equity compensation that was awarded during the marriage but is unvested at the time of the complaint. The treatment afforded to unvested equity compensation becomes an issue because the purpose of equitable distribution is to distribute the fruits of the joint marital enterprise. Rothman v. Rothman, 65 N.J. 219, 229 (1974)It is well-established that value created by a party after the termination of the marital enterprise that typically occurs upon the filing of a complaint for divorce belongs to the party whose efforts created an asset or enhanced the value of an existing asset. Applying these principles to unvested equity compensation plans, it must be determined whether the requirement that the employee continue working at his or her job results in the unvested equity compensation being excluded from equitable distribution because of its relationship to the employees’ post- marital efforts.

This issue was addressed by the Appellate Division in M.G. v. S. M. a published decision by Judge Mawla decided December 26, 2018. In this case, the trial court  included the Husband’s unvested stock awards, even an award granted 33 days after the complaint, as marital assets and distributed 50% of such awards to the wife with the understanding that the husband would hold the wife share of the awards in trust until vesting occurred. The husband had testified that the awards were granted to retain him as an employee and to make sure that he consistently performed better. The husband had also submitted the plan documents in evidence that indicated that the company believed “that employees who become shareholders maintain a long-term, vested interest in sustained individual excellence in the overall success of the company.” In connection with a post judgment reconsideration application, the husband provided additional documentation which indicated that the Award Agreement and Plan required the employee to be “continuously employed” through the vesting dates.

The Appellate Division reversed the decision including 100% of the equity compensation awards as an asset subject to equitable distribution. In doing so, the Court rejected the use of the coverture fraction that many practitioners have relied upon in handling unvested equity compensation awards. Under this approach, a fraction is developed with the numerator consisting of the number of months from the award date to the complaint date and the denominator consisting of the total number of months required for the vesting of the award or, if partial vesting is involved, a tranche of the award. A similar approach had been approved in handling the distribution of pensions that were not fully vested as of a complaint date but which became vested and payable in the future. Marx v. Marx, 265 N.J. Super. 418 (Ch. Div. 1993).

In M.G. v. S. M., the Appellate Division held that the purpose of the award was a critical determining factor with respect to the treatment of unvested equity compensation in divorce situations. This was in keeping with the N.J. Supreme Court decision in Pascale v. Pascale, 140 N.J. 583 (1995).  Awards given as a bonus for employment efforts during the marriage were found to be entirely marital, regardless of whether such awards were subject to a vesting schedule. In contrast, awards that were given to procure future services may be partially or entirely exempt from distribution. The Court promulgated the following rules to be applied in the consideration of this issue:

  • Stock awards granted during the marriage and vesting prior to the complaint date are entirely subject to equitable distribution;
  • If a stock award is made during the marriage for work performed during the marriage (such as bonuses consisting of equity compensation), it is entirely subject to equitable distribution;
  • There is a rebuttable presumption that stock awards made during the marriage, but vesting after the date of complaint are subject to equitable distribution unless there is a “material dispute whether the stock, either in whole or in part, is for future performance”. If a party seeks to exclude the award from equitable distribution, that party must prove by the preponderance of the evidence that the “award was made for services performed outside of the marriage”; e.g. after the complaint. The Court outlined the probative evidence on this issue to include, without limitation, the following: testimony from the employed spouse; testimony of the employer’s representative; stock plan; any correspondence that accompanied the stock award; stock plan statements from the commencement of the award to the date nearest the complaint; and the vesting schedule.

Applying these principles to the facts in M.G. v. S. M., the Appellate Division held that the husband would have rebutted the presumption that all stock awards were marital and that the evidence “strongly suggest[ed] that the unvested awards were either in whole or in part on unattributable to the marriage”. The court went on to stress that the stock received from such unvested awards would not be subject to equitable distribution.

From a practice perspective, it would appear that the presumption of inclusion would be readily rebutted in circumstances involving unvested equity compensation awarded as part of a “retention award” or PSUs that require the achievement of explicit future performance goals. In the less definite circumstances involving more generic option and RSU awards that are typically given with cash bonuses, the exclusion of the unvested portions may be more difficult.

Besides providing guidance with respect to unvested equity compensation, the M.G. v. S. M. decision reiterates that the equitable distribution of marital assets is not an automatic process in which the assets determined to be marital in nature are simply equally divided. The Court stressed that to achieve a fair and equitable distribution, each individual asset should be handled separately and evaluate the facts and evidence associated with each asset. In light of this principle, circumstances where the equity compensation award is marital, but will require post complaint efforts, a disproportionate distribution in favor of the spouse who must perform the post complaint work might be considered.