Application in Divorce
A popular form of deferred compensation in the 1990s, stock options lost popularity in corporate America in 2005 when the government made them more expensive for employers to award, but these incentives generously rewarded top management during the stock market boom.
Stock options give a person the right to purchase stock at below market prices and exercise them for cash.
Sometimes an option is granted with an immediate exercise date. Often, however, an option is granted with a deferred exercise date.
The option gives owner the right to purchase stock at what is called the
strike price, which is below the market value of the stock. When exercised, the stock is sold (usually at the same time), and the difference between the strike price and the market price is the employee’s profit. (The routine is not necessarily a shortcut to easy street: when the market price of a company dips below the strike price, the options are worthless.) Nevertheless, during runups in the stock market, options can become quite valuable, and stock options have become increasingly important in the distribution of property in divorce. Options carry a grant date, when the employe conveys the option to the employee; a vesting date, usually one to five years, after which the employee owns the option outright; and an exercise or maturity date, when it may be used.
Stock options are said to be at the money when the
strike price and market price are the same. They are said to be in the money when the strike price is below the market price and there is a potential for making money by exercising them. Options with a strike price is above the market price are called out of the money, or under water.
Like pensions, stock options are regulated by the federal government. There are a variety of option plans, but they fall into two broad categories: nonstatutory, which are also known as nonqualified (NQSO or NSO), and statutory. There are technical differences between nonstatutory and statutory options, but the most important one is that nonstatutory are taxed as ordinary income rather than
Options, particularly what are called "statutory stock options" given key employees, require an almost case-by-case analysis in a divorce because they are awarded for many reasons. One purpose is provide an incentive for hard work, and in this case, options can be seen as compensation for future services. In smaller companies that are starting up, the options can be seen as deferred compensation for present services. Another view is that options are a bonus for work already performed.
Compensation for future services, deferred compensation, or a bonus for work already performed -- all can and are argued when couples divorce.
In a divorce, it becomes important to distinguish between vested options, that is, those which an employee owns and may exercise even if he leaves the company, and those which are unvested, that is, one which the employee loses if he or she leaves the employment of the company. A vested option that is exercisable is said to be mature.
Vested mature stock options that are received during a marriage are marital property. They are subject to distribution even if they are not exercised until after the parties are divorced. Unvested options are harder to classify because they substitute for future rather than past compensation, and they may be considered
separate property. In a divorce dispute, the burden of proof is on the party asserting that options are separate property.
Many courts work on the assumption that because unvested or unmatured vested options lack a
present value, distribution must be deferred until they are exercised.
Stock options are not transferable. After a value is placed on them, the nonowning
spouse sometimes receives an offset as part of the distribution of marital property.
Unexercised stock options sometimes make for difficulties during settlement negotiations, because the court must decide if the options reward efforts made by the owning
spouse during his or her marriage (and are marital property) or a reward for future efforts (and hence separate property). In a divorce, couples battle about both the classification and distribution of unexercised (also unmatured) because the employee spouse contends that the options are his separate property "in part or in whole" because the value will not be received during the marriage, and the nonemployee spouse contends that they were earned during the marriage for past services. Thus, the courts must decide today about a reward that may be for Christmas past or future. Courts almost universally hold that vested or unvested, stock options earned during a marriage are martial.
Almost unanimously courts rule that matured options received during a marriage that have not been exercised by the
cutoff date are marital property. In this, the courts see the options are deferred compensation. Some courts hold that even unvested options are nonetheless marital property.
Thus, in the absence of
evidence otherwise, stock options exercised to acquire stock during a marriage are marital.
When some options have been awarded before a
party marries and some after he or she marries, courts sometimes apply a coverture fraction to classify the part that is separate and the part that is martial.
Valuation of the unexercised options can be equally difficult. In tackling this task, one Maryland intermediate court noted "an unassignable, unsalable option has no fair market value," but held that it is nonetheless an "economic resource."
Two models -- the Binominal or Lattice Model or the Black-Scholes Model -- can be used to place a value, but most courts dodge the valuation problem by some method of deferred distribution, whereby the courts retain
jurisdiction "until such time as the options are exercised or expired." These deferred distribution schemes involve sharing a percentage of the value with the former spouse when the options are exercised after the divorce is granted.
See also Binominal or Lattice Model; Black-Scholes Model.