Stock Options Lost In Job Termination: How One Fired Employee Won Big

Job termination is a major event not only for you but for any stock options you have. It's important to know your post-termination exercise period (PTEP), which is specified in your grant agreement. The PTEP dictates how much time you have to exercise vested stock options after job loss. Typically, you have just three months to exercise vested options, and you forfeit any unexercised options.

However, all bets are off if you’re fired “for cause,” i.e. the company ends your employment due to your bad behavior. In that case, usually your stock options, included vested options, expire immediately on your termination date. That can cause you to miss out on a big stock option payday.

Stock options are potentially very valuable, especially when they are granted in a startup company that later undergoes an initial public offering (IPO). Inevitably, with great potential wealth comes great litigation. Case law abounds with disputes between former employees and companies over valuable stock options. While companies often prevail in such litigation, a recent lawsuit over startup company stock options in California, Shah v. Skillz Inc., resulted in a lucrative win for the plaintiff (a fired employee) and a notable ruling about how damages involving options can be calculated.

Gaming Company Employee Does Not Play Games After Firing

Gautam Shah, the plaintiff, worked at Skillz Inc., a company that makes games for mobile phones. He joined Skillz in 2015, when it was a private company in San Francisco, and received a grant of stock options. Like many startup companies, which may have little cash, Skillz relied heavily on stock options and other equity awards to reward employees in lieu of cash compensation. As a private company’s stock lacks liquidity, a startup company’s employees with stock options hope that their options will become valuable after the company goes public or is acquired.

In 2018, Mr. Shah told the two founders of Skillz that unless he received a promotion and a raise, he would consider leaving the company. In the circumstances, the founders suspected he might have done something to undermine the company’s interests. A company forensic analysis revealed that Mr. Shah had forwarded a highly confidential business report to his personal email address, apparently for no legitimate business reason. He was fired “for cause” on the grounds of a breach of his employment contract via a purported violation of company policy about confidential information and theft.

Not surprisingly, at the time of his firing Mr. Shah tried to exercise some of his stock options. However, he was told the options were immediately void because of his “for cause” termination, as provided under his stock option agreement. Mr. Shah claimed he had forwarded the document to himself purely for convenience and was not in breach of contract, to no avail.

In late 2020, Skillz went public via an IPO. Several Skillz employees, both current and former, profited handsomely from shares they held in the company. In 2021, Mr. Shah sued Skillz for breach of contract, wrongful termination, and retaliation. He claimed that Skillz did not have cause to fire him and had therefore wrongfully prevented him from exercising the stock options he had earned as a Skillz employee.

In the trial, the jury awarded Mr. Shah more than $11.5 million in damages for his lost options, finding by implication that he had not been legitimately fired for cause. The jury was evidently unpersuaded that Mr. Shah’s forwarding of the email to his personal address was done in bad faith. In other words, it decided that the basis of the firing arrived at by the company was an unfounded miscalculation.

Company Miscalculation Leads To Big Calculation Of Damages

Crucially, the jury calculated the monetary value of Mr. Shah’s damages according to what his shares would have been worth after the IPO had he been allowed to exercise his options then. The figure they arrived at, over $11.5 million, made a fine payday for Mr. Shah. If the damages had been calculated on his options’ value at the time of his firing, they would have amounted to a paltry $41,032.

Skillz appealed, arguing that the monetary value of the damages should be assessed according to the option value at the time when Mr. Shah was fired. However, the California Court of Appeal held that, under both California and Delaware law, damages for lost stock options in a breach-of-contract action can in certain circumstances be assessed from a date other than the date of the breach.

Those circumstances include the availability of a market for the stock at the time of the contract breach. When Mr. Shah was fired in 2018, Skillz was still private, so its stock had no liquidity. On that reasoning, the court upheld the decision to calculate the damages for lost stock options using the shares’ value after the IPO, though it did reduce the damages to $6.7 million.

The court also ruled that stock options are not “wages” under the California Labor Code. This meant that, while his breach-of-contract claim was successful, Mr. Shah’s claims for retaliation and wrongful termination were dismissed. He therefore lost any right to pursue tort damages, which could have included punitive damages and attorney’s fees. Interestingly, the court noted that restricted stock would be considered “wages” because, unlike options, they have an “ascertainable value.”

Lessons For Companies And Employees

To avoid costly lawsuits, companies often consider future vesting dates when terminating employees. The actions they take may delay the termination date, extend it by using “paid time off” days, or accelerate the upcoming vesting to avoid appearing to terminate an employee merely to forfeit soon-to-be vested equity grants. If a company plans to terminate your employment for what you believe are unjustifiable reasons, you can also negotiate with it to take actions such as those so that you avoid losing valuable stock options or restricted stock units (RSUs).

Attorneys at the law firm Squire Patton Boggs cover additional employer implications of Shah v. Skillz in a commentary for the firm’s blog Employment Law Worldview. The attorneys conclude that in similar situations companies should “proceed with caution” when firing employees for cause.

Additional Resources

For more on job termination when you have stock options and RSUs, see a related blogpost, Job Loss: How To Protect Your Stock Options And RSUs. See also the Job Events section on myStockOptions.com, including a fun interactive quiz.

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SCOTUS Decision On Stock Options At Railroad Companies: Do The Justices Understand Stock Compensation?

Some interesting summer reading came our way in a recent Supreme Court decision that features stock options: Wisconsin Central Ltd. v. United States. The decision is an easy read that provides some insights into what the justices in our highest court know about equity compensation. While initially it appears that the application of the decision is narrow and applies only to employee stock options (also perhaps RSUs and other types of stock compensation) at railroad companies, the implications are broader.

In short, by a 5–4 margin, the Supreme Court ruled that options are not taxable compensation under the Railroad Retirement Tax Act (RRTA) because they are not "money remuneration" as meant by the term in the statute, which was written in 1937. Significantly, when Congress adopted the RRTA it also enacted the Federal Insurance Contributions Act (FICA), which taxes "all remuneration," including benefits "paid in any medium other than cash." Therefore, according to Justice Neil Gorsuch, who wrote the majority opinion, "the Congress that enacted both of these pension schemes knew well the difference between 'money' and 'all' forms of remuneration and its choice to use the narrower term in the context of railroad pensions alone requires respect, not disregard."

The RRTA, which few stock comp professionals are familiar with, provides funding for pension-like benefits to railroad employees instead of Social Security retirement benefits. The spread at exercise would still be subject to the standard income tax rules, as the NASPP recently confirmed in its blog. For railroad companies, a commentary from PwC provides some guidance on the decision. Of course, for those not working on the railroads, the spread at the exercise of nonqualified stock options (NQSOs) remains subject to Social Security and Medicare taxes.

Does The Supreme Court Understand Stock Options?

The vote on the court followed the conservative-versus-liberal pattern of many 5–4 decisions. Therefore, in our view, the majority opinion and the dissenting opinion (by Justice Breyer, joined by Ginsberg, Sotomayor, and Kagan), represent an argument over two points:

• the approach the Supreme Court should take in interpreting statutory language
• the ability of government agencies, such as the Treasury Department and the IRS, to issue regulations when terms of a statute are ambiguous

Like any well-written Supreme Court decision, this case can be analyzed on many different levels. At myStockOptions.com we were interested to see how well the Supreme Court justices understand and explain stock options and equity compensation. They seem to know how stock options work, they recognize the differences in the taxation of ISOs and NQSOs, and they comprehend the underlying purpose of equity compensation for employers. Justice Gorsuch succinctly states that the goal of options is "to encourage employee performance and align employee and corporate goals" and describes in his own way the various exercise methods. In his dissent, Justice Breyer discusses how companies use stock options to compensate employees—in part, "hoping that by doing so they will provide an incentive for their employees to work harder to increase the value of the company."

For Justice Gorsuch, the author of the majority opinion, it didn't seem to matter as much that stock options can be easily exercised and the shares sold for money. Yet in the minority opinion, Justice Breyer elucidates in detail the procedure for cashless exercises and provides data on how a large percentage of employees at railroad companies use this exercise method. He also notes that many of the country's "top executives are compensated in both cash and stock or stock options," with stock-based compensation often exceeding cash salary. The strongest argument in his dissenting opinion is that cashless exercise makes options almost identical to money remuneration. After reading a summary of the justices' questions during the oral argument and the lawyers' replies, we do wonder if the decision hinged on whether the justices who supported the majority opinion fully understood how cashless exercises really work. For stock plan professionals who lived through the intense debates as to whether stock options should be expensed on the income statement (they have been since 2006), it is odd that the decision does not mention the accounting rules, even in its discussion of whether options have a "readily discernible value."

More Lawsuits Involving Stock Compensation

Back in January, this blog looked at some recent lawsuits of interest involving stock compensation. In recent months, a few additional court decisions involving equity comp have caught our attention.

Online Grant Acceptance

Electronic distribution and acceptance have become common procedures for stock grants. Occasionally lawsuits challenge these, often when the agreement has a provision that restricts an employee who later contends that he or she did not see it or agree to it (e.g. a covenant not to compete). That's what happened in ADP v. Lynch, in which the US Court of Appeals for the Third Circuit upheld a lower court's decision enforcing restrictive covenants in electronically delivered grant agreements. In the company's online procedure, employees needed to check boxes confirming that they had reviewed the documents, which included the plan, the award agreement, and the noncompete. The first page of the grant agreement also specifically told employees that acceptance of the award depended on their agreeing to the noncompete. The court found that by checking the box affirming their reading of these documents, employees agreed to the provisions. It rejected as irrelevant the contention that the employee did not recall doing so and was not adequately informed about the consequences of accepting the grants.

This case is a clear warning that you need to read and understand the provisions in your grants agreement and stock plan. Plus, don't assume that the provisions in new grants you receive are identical to the provisions of prior grants. For more on restrictive covenants in stock grants, including this case and others, see the myStockOptions article Watch For Noncompetes And Other Restrictive Covenants In Stock Grant Agreements.

Divorce

Like other assets and forms of compensation, stock comp sometimes gets dragged into divorce property settlements and alimony payments, though the issues can be more complex. In the case Ludwig v. Lamee-Ludwig, the Massachusetts Court of Appeals looked at the question of whether unvested shares are considered assets for the property settlement and/or income for child care/alimony. The court confirmed a lower court's decision that the calculation of an employee spouse's alimony obligation may include income received from unvested employee stock options that were not subject to equitable division as assets, under application of the "time rule" in Baccanti v. Morton (434 Mass. 787, 2001), for dividing unvested grants. This would not constitute "double counting" if the income were included in determining the husband's alimony or child support. At his blog, divorce attorney Jason Owens discusses the importance of this case, which in his view offers "precision" for treating unvested options not divided under the property settlement (Treating Stock Options And RSUs As Assets Vs. Income In A Divorce).

For more details on the treatment of restricted stock and stock options in an divorces, see the articles and FAQs in the Life Events: Divorce sections of myStockOptions.com.

Lawsuits And Court Cases Of Interest That Involve Stock Compensation

Here at myStockOptions.com, we keep an eye on major court cases and rulings that involve stock compensation or stock holdings, as these developments can influence both stock plans and the actions of stock plan participants. A few recent lawsuits and court decisions have drawn our interest.

Class-Action Lawsuit Claims Uber Made Unfair Changes In Stock Grants

Uber is facing a lawsuit related to changes it made in its stock grants, according to the complaint in a class action recently filed against the company. The acquisition centers around the technical ISO rule that only grants with an aggregate value of $100,000 can be exercisable in any one calendar year. Any grants that vest in a year with a value over that automatically become NQSOs, and income, Social Security, and Medicare taxes are withheld at exercise. According to the complaint, Uber recruited software engineers with whom it had employment agreements to grant ISOs with a vesting schedule of 25% after the first 12 months and then monthly vesting thereafter (see Exhibit 1). However, the company changed the provision to allow all of the shares to become exercisable after six months, forcing some ISOs to become NQSOs (see Exhibit 2). This situation raises the issue of whether "exercisable" means "vested" in the related tax-code provision, which was adopted before a distinction between exercisability and vesting existed in certain pre-IPO stock options with early-exercise provisions.

Various news publications picked up on this lawsuit, including TechCrunch and Courthouse News Service. TechCrunch reports a statement issued by Uber, which explains that the company gives employees a "real stake" in its success and that it is "proud to offer equity compensation in service of that goal."

State Supreme Court Confirms Nonresidents Cannot Escape Taxation On Options Earned In The State

You cannot escape state taxation of vested stock options by moving to a state without an income tax. In Allen v. Commissioner of Revenue Services, the Connecticut Supreme Court confirmed that Connecticut can tax income from option exercises by a nonresident if the options were granted as compensation for performing services within the state. Connecticut, like many states, has a provision that authorizes the taxation of income "derived from or connected with sources within this state of each nonresident." The court rejected the plaintiff's creative positions, including the argument that it is "unconstitutional" to impose a tax on income derived from the exercise of nonqualified stock options by someone who at exercise is a nonresident. For more about this case, see an article about it at the website of Forbes. The taxation of mobile employees in the US and in other countries shows the eagerness of governments to find tax revenue in stock compensation.

Supreme Court Issues A Major Decision On Insider Trading

Everyone working for or advising a public company needs to know the insider-trading rules. Even if you unintentionally violate the laws of insider trading, you can face a serious punishment. (For details, see the FAQs on insider trading at myStockOptions.com and the Think Twice video series for insider-trading prevention.) It is not hard to imagine a situation in which you casually tell a relative or a friend about upcoming important company news, and that this person then uses that information to make a stock-trading profit. Although the tipoff would probably be a violation of your company's confidentially rules, you might not have miscreant intentions or expect anything in return from the tipped-off person, and therefore might (wrongly) not view this act as insider trading.

The US Supreme Court has issued a major decision on insider trading that involves just that type of situation. In its ruling on Salman v. United States, the Supreme Court makes it very clear that whenever a friend or relative is tipped, insider trading has occurred, regardless of whether the tipster receives a benefit. Prosecutors do not need to show something of value was received for providing the valuable information. In the court's view, "the tipper personally benefits because giving a gift of trading information to a trading relative is the same thing as trading by the tipper followed by a gift of the proceeds." The tipper does not need to receive something of a "pecuniary or similarly valuable nature" in exchange for this gift to a trading relative.

The ruling is seen as a victory for the US government, as it strengthens the position of federal prosecutors and their will to bring insider-trading cases. The case prompted several commentaries, including articles from the law firms Morgan Lewis & Bockius and Goodwin Procter and an analysis in the blog of the Supreme Court itself.