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A Start-Up Hypothetical Time passes, and Buddy is doing real well-- both financially (his company goes public - Before the Dot Bomb), and socially (please don't laugh). Soon he 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. Question – During settlement talks, the stock options issue come up. Everybody ponders the question: How much of the stocks and options belong to Bella? California the Land of Equality – at Least for Divorce 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. Half the Pie or Just a Few Slices? 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 [FN1] formula and the Nelson [FN2] 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 = Date of Hire; DOS = Date of Separation; DOE = 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 = Date of Grant; DOS = Date of Separation; DOE=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. If You Receive Options, You Usually Have to Pay More Support Too Under California law a divorcing spouse may be required to pay support to the other party. There are two distinct types of support, child support and spousal support. Child support is based on a statutory guideline formula. (e.g. - see Xspouse). Spousal support can be either temporary or permanent. Temporary spousal support (support that one party can request before a divorce is finalized) is also usually based on a local formula. Permanent spousal support (support received after final judgment of divorce) which is not just based on a set formula and is dependant on numerous factors, including the parties' standard of living during the marriage and immediately prior to separation (see my other article). How do the options factor into the child or spousal support payments? Buddy's income used to calculate child or spousal support may also include the amount of vested options received by Buddy (at least those vested options that he has actually exercised) [FN3]. Buddy may even have to pay a percentage of these options to Bella as either child or spousal support as well. [FN4] But, what if Buddy decides not to exercise the options as they vest? This issue is a what may be referred to as gray area. At least one other state court has decided that unexercised vested options may be considered as income in calculation of support [FN5]. However, the California courts have not specifically dealt with this issue. The main cases dealing with options in California have only dealt with the exercised options. Unfortunately for Buddy, depending on the amount of money at stake, a creative attorney may be able to convince a court to consider these unvested options in calculating support as well. But what about taxes on the sale of stocks after the options have been exercised – e.g. alternative minimum taxes? Fortunately for Buddy, a court will allow deductions of unavoidable expenses (Federal and State taxes) from exercising the options and consider the net amount in calculating support [FN5]. Conclusion – Don't Get Married and Remain the Silicon Valley Swinger? Not really, the wisest move for Buddy would have been to enter into a premarital agreement. I know what's the point of marrying if you can't trust your significant other? However, it is always better to anticipate that problems, especially financial ones that may occur and plan for them accordingly. Premarital agreements are generally accepted in California, however certain procedural requirements must be met or such an agreement will be unenforceable [FN6]. Pursuant to a premarital agreement parties can agree to any division of community properties, including stock options, and at least with spousal support they can also agree to waive or limit them. However, parties cannot seek to limit child support obligations with a premarital agreement. [1] Marriage of Hug, 154 Cal.App.3d 780 (1984) [2] Marriage of Nelson, 177 Cal.App.3d 150 (1986) [3] Marriage of Cheriton, 92 Cal. App. 4th 269 (2001) [4] Marriage of Kerr, 77 Cal.App.4th 87 (1999) [5] Murray v. Murray, 716 N.E.2d 288 (Ohio Ct. App. 1999) [6] Cal. Fam. Code Sec. 1615; Marriage of Bonds, 71 Cal App 4th 290 (1999) - - Law Offices of Rod Firoozye |