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Stock option plans hit the courts

October 21, 2002
by Israel Foulon LLP

An employee may be terminated but rights to stock options can live on

Stock option plans have become a staple of employment compensation, especially for executives and employees in the technology field. Now options are finding their way into termination disputes and the legal system.

Canadian courts have made it clear that unless companies are extremely careful in the wording of stock option plans, these plans will be interpreted to allow employees dismissed without cause to accrue and exercise their options until the end of the reasonable notice period.

Stock options create an incentive for the employee that is directly tied to the success of the company.

Employees share in the profits their efforts have generated. Employers dislike the thought that terminated employees would continue to share in the successes of the company after the employee has been dismissed. Where the employee has a right to continue to exercise stock options after termination, the purpose of the plan is thwarted and it can be expensive when tallying compensation during the reasonable notice period.

Notice periods may be lengthy, especially for long-serving employees or those in the upper echelons of the company. The key for employers is to use wording in the stock option plan that limits an employee’s right to exercise options from a specified time after “actual notice” of dismissal is provided to the employee or to tie the trigger date for the expiry of the options to the last day that the employee performs “active services” for the company.

In the absence of careful wording, courts will interpret stock option plans against the employer and the trigger date for the termination of the options will not commence until the end of the reasonable notice period.

In Gryba v. Moneta Porcupine Mines Ltd., the plaintiff was the president of the defendant mining company for nine years. Gryba was dismissed without cause. He earned a salary of $60,000 per year plus stock options at the time of his termination. The key section of the option plan read: “…If an optionee ceases to be employed by the corporation otherwise than by reason of death or termination for cause,…any option or unexercised portion thereof held by such optionee at the effective date thereof may be exercised in whole or in part for a period of thirty (30) days thereafter.”

A majority of the Court of Appeal held that the stock option plan should be interpreted as implying a “lawful termination.” Lawful termination requires giving reasonable notice or pay in lieu of reasonable notice. The court concluded the stock options could be exercised up to 30 days after the expiry of the reasonable notice period as opposed to 30 days from the actual date of dismissal.

Such a decision can be costly to the employer. The calculation of damages in these matters is based on the loss between the option price and the actual trading price at the time the court determines the stock would have been sold had the option been available to the employee.

The judicial trend as shown in Gryba emphasizes the need for good legal advice in obtaining precision when drafting a stock option plan. Gryba also suggests that no matter how a stock option plan is written, it may be interpreted by the court as meaning something entirely different. Employer beware.

Protecting your firm

Recent stock option plan decisions indicate that creating a stock option plan that avoids providing employees with benefits after termination will be difficult. But, there is some hope.

The Ontario Court of Appeal’s decision in Brock v. Matthews Group Ltd. is one of the few reported decisions that has found a stock option plan to be correctly written so as to disallow the exercising of stock options after dismissal.

The key in Brock was the use of the phrase “notice of dismissal,” rather than just “dismissal” or “termination,” in reference to the time limit placed on the employee’s right to exercise stock options.

Despite the uncertainty surrounding this developing area of the law, the following steps that can be taken to protect your company from compensatory damages regarding stock option plans claimed by former employees:

  1. Determine if the existing or proposed language might lead to unintended results upon an employee’s termination.
  2. The language in the stock option plan or agreement should be clear, precise and unequivocal. If the wording is ambiguous the courts will interpret the stock option plan or agreement in favour of the dismissed employee. The plan should use specific language that limits the employee’s ability to exercise stock options subsequent to notice of dismissal being given to the employee.
  3. The phrase “actual notice of dismissal” is the preferred wording for limiting an employee’s stock option entitlement plans. Words such as “dismissal” or “termination” will be interpreted by the courts as meaning “lawful termination,” and the employee may be awarded compensatory damages for the loss of the right to sell stock options during a reasonable notice period.
  4. Another strategy is to expressly state that the trigger date for the termination of the option is the last day the employee performed “active services” for the company.

For more information see Gryba v. Moneta Porcupine Mines Ltd. [2000] O.J. No. 4775 (C.A.) and Brock v. Matthews Group Ltd. [1991] O.J. No. 83 (C.A.).

In the courts…

  • In Veer v. Dover Corp. ( Canada) Ltd., the Ontario Court of Appeal dealt with the issue of stock option rights after termination of employment. The plaintiff employee was a senior executive who was terminated by the employer on account of “persistent disobedience.” The court held that the employer did not have just cause to terminate Veer and therefore he was entitled to reasonable notice of termination (or payment in lieu of reasonable notice). The terminated employee took the position that he had the right to exercise his options during the reasonable notice period, despite the wording of the stock option agreement. The company maintained that the terminated employee’s options could only be exercised prior to his actual dismissal. The stock option agreement provided that the rights under the agreement ended as of the date of termination.

    The court held that the termination referred to in the agreement, in the absence of special language, must mean lawful termination. (Lawful termination entails termination with notice or compensation in lieu of notice.) The court further held that without express language, it could not be concluded that the parties intended that an unlawful termination would trigger the end of the employee’s option rights.

    Veer v. Dover Corp. ( Canada) Ltd. (1999) 120 O.A.C. 394 ( C.A.).

  • In Iaccobucci v. WIC Radio Ltd., the British Columbia Court of Appeal dealt with a similar issue. The employee’s termination took effect in May 1997. He was placed on salary and benefit continuation until November 1998. The former employee was advised that he had fewer shares to exercise than he had calculated. The employer asserted that the difference had been cancelled as a result of the termination. The former employee argued he was entitled to damages for the value of stock options which would have come due during the period between the dismissal and the expiry of the period of reasonable notice.

    The Court of Appeal upheld the trial judge’s decision that the phrases “terminating your employment” and “the date of his or her termination” as contained in the option plan meant lawful termination. This means if the employee had been provided with working notice, he would have remained employed until November 1998. During that time he would have become entitled to exercise the accelerated options. As a result, the employee was awarded substantial damages.

    Iaccobucci v. WIC Radio Ltd. [1999] B.C..J. No. 2890 ( C.A.).

Peter Israel and Chris Foulon are partners in the Toronto law firm of Israel Foulon LLP – Employment and Labour Lawyers. They can be reached at 416-640-1550 or pi@qtw38575.mywhc.ca. or cf@qtw38575.mywhc.ca. The authors would like to thank Douglas Hood for his assistance with this article. A version of this article originally appeared in the Carswell publication, Canadian HR Reporter.


Legal Disclaimer

This article is for informational purposes only and is not intended to provide legal advice, which in all circumstances must be tailored to the specific facts of any problem. You should obtain a proper legal consultation in order to determine how this article applies to your specific situation. Please feel free to contact Israel Foulon LLP to learn more at 416-640-1550.