California Supreme Court Upholds Forfeiture Provision In Employee Incentive Plan
Time 4 Minute Read

A recent decision from the California Supreme Court has provided a rare victory for companies with employees in that state.  In Schachter v. Citigroup, Inc., the Court ruled that a forfeiture provision in an employee incentive compensation plan did not violate California wage laws.

Facts Of The Case

The incentive plan at issue in Schachter provided officers and other key employees of Smith Barney (now a subsidiary of Citigroup) the opportunity to elect to receive as much as 25% of their total compensation in the following year as restricted stock.  A participating employee could not sell, transfer, pledge, or assign the restricted shares for two years following the date of the award, and the restricted shares would not be reflected in his or her taxable income until after the expiration of the two-year vesting period.

The provision of the plan that led to the lawsuit was its forfeiture provision.  If a participating employee resigned or was terminated prior to the expiration of the two-year vesting period, he or she would forfeit the shares.  If the employee was terminated without cause, however, he or she would receive a cash payment equal to the portion of his or her annual compensation that had been paid in restricted shares.

The plaintiff, David Schachter, enrolled in the incentive compensation plan and elected to receive a percentage of his total compensation in restricted stock for the years 1995 and 1996.  Schachter later resigned in March 1996, before his shares were vested.  Accordingly, under the terms of the incentive plan, Schachter forfeited his stock and the portion of his income that had been allocated to purchase the shares.

In 1998, Schachter brought a class action against his former employer, alleging that the plan’s forfeiture provision violated Labor Code Sections 201 and 202, which require the prompt payment of wages upon the employee’s separation from employment, and Labor Code Section 219, which provides that the wage payment statutes cannot be contravened or set aside by private agreement.  After years of litigation, the trial court ultimately granted the company’s motion for summary judgment and the Court of Appeal affirmed.

The Court’s Decision And Reasoning

In a unanimous decision, the California Supreme Court upheld the plan’s forfeiture provision, rejecting Schachter’s argument that the portion of compensation he directed be paid to him in the form of restricted stock constituted a wage that remained earned but unpaid following his resignation.  (Schachter conceded that the forfeiture of the stock as a result of his resignation during the stock’s restricted period was lawful.)

The Court observed that “employers and employees are free to prospectively and bilaterally alter the terms of employment.”  Therefore, when Schachter enrolled in the plan, he agreed to a restructured compensation package that included a lower annual salary and payment in the form of restricted stock, subject to the terms and conditions of the plan.  The Court cited the well established rule that “[o]nly when an employee satisfies the condition(s) precedent to receiving incentive compensation, which often includes remaining employed for a particular period of time, can that employee be said to have earned the incentive compensation.”  Because Schachter elected not to remain employed for the duration of the vesting period, he “‘did not earn -- and thus had no right to receive -- either the restricted stock or the funds used to purchase it.’”

Given that no earned wages remained unpaid upon termination for cause or resignation, the Court held that the plan’s forfeiture provision did not violate California Labor Code Sections 201, 202, or 219.

What The Decision Means For California Employers  

The decision in Schachter v. Citigroup, Inc. is a reassuring sign that California courts will enforce contracts related to employment even when they are deemed to benefit the employer rather than the employee.  To be sure, the overwhelming tilt of laws in California is in favor of the employee.  The California Labor Code imposes numerous burdens on employers above and beyond those faced by employers in other states, with onerous penalties and damages obtainable against employers for infractions.

The Schachter decision demonstrates that California courts will not blindly negate any employment agreement under Labor Code Section 219 simply because it turns out to be unfavorable to an employee.  Even in employee-friendly California, employers can accomplish the results they need with careful drafting of compensation plans and contracts.  That said, the need for experienced and creative counsel is crucial for employers operating in California.

While the benefits of doing business in California abound, there are many challenges, including legal ones, that must be navigated.  With a growing presence in California, Hunton & Williams LLP is helping more and more clients make the most of their business opportunities on the West Coast.



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