Article by Capehart Scatchard

Employee stock options are considered marital assets that are subject to equitable distribution. These include both vested and unvested stock options. Even stock options awarded shortly after the divorce complaint was filed are considered subject to equitable distribution if they were awarded as a result of efforts expended during the marriage. On the other hand, if the options were awarded shortly after the marriage ended but are incentives for future performance (i.e. to keep the employee spouse at the company) then they are not eligible for equitable distribution.

The issue as to whether stock options obtained after the divorce complaint was filed were awarded for past performance or for future performance is often an issue in divorce cases. Usually the documents granting the options do not spell out the reason(s) for the award, which must then be inferred from the nature of the employment and the other facts of the case.

The speculative nature of a stock option’s value makes it one of the most difficult assets to value at the time of the divorce. This is because it is impossible to predict the exact future value of the stock at the time the option will be exercised, which may be years later; in fact, there is no guarantee that the option will be worth anything at all at the time that it becomes exercisable.

There are two methods for equitably distributing stock options. The first, and by far less common, method is the Present Value Method which utilizes a mathematical formula to try to calculate the present value of the stock options. The most widely accepted present value formula is the Black-Scholes formula which combines a variety of factors, such as the exercise price of the stock, the share price on the valuation date, the length of time until maturity, interest rates and a standard deviation formula to account for the volatility of the share price.

The Present Value Method allows the parties to divide the value of the stock option(s) at the time of the divorce, with the non-employee spouse receiving monetary compensation (or an equivalent offset of assets) for his/her share of the other party’s stock options. The benefit of using the Present Value Method is the finality of the distribution of the stock options at the time of the divorce. The downside is the cost of having the options valued as well as the speculative nature of the Present Value Method as it applies to stock options. In fact, some state courts have held that the speculative nature of stock options makes them unsuitable for present value calculations.

The more common approach to dividing stock options is the Deferred Distribution Method. Using this method, the parties’ Marital Settlement Agreement or the Final Judgment of Divorce contains language which imposes a “Constructive Trust” over the non-employee spouse’s share of the stock options. The Constructive Trust requires the employee spouse to hold the options for the benefit of the non-employee spouse. The employee spouse holds on to the options until they vest, are exercisable (if unvested and/or non-exercisable at the time of the divorce) and non-employee spouse directs the employee spouse to exercise them. It is important that there be language in the Agreement requiring the employee spouse to notify the non-employee spouse prior to the options lapsing. Once the options are exercised, the employee spouse sells the stock and gives the sale proceeds to the non-employee spouse after the payment of taxes at the employee spouse’s tax rate.