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MD Court of Appeals Holds That Conditionally Granted Unvested Stock Options Are Not "Wages"

A recent decision by the Maryland Court of Appeals in Catalyst Health v. Magill brought a welcome sigh of relief from employers. There, the Court of Appeals held that conditionally granted unvested stock options were not “wages” under Maryland’s Wage Payment and Collection Law (“Wage Payment Act”).

At issue in Catalyst Health was the compensation of an employee, Magill. At the outset of his employment, Magill received a significant base salary plus thousands of options to acquire the employer’s common stock. The terms of the options were described in the company’s stock option plan. The stock option award agreement that the employee received contained a vesting schedule providing that 25% of the stock option award would vest twelve months after the date of the grant, and that the remaining 75% would vest in three equal annual installments beginning on the first anniversary of the initial vesting date. The employee subsequently resigned and accepted employment with a competitor of the company. His resignation date was eleven days before several thousand stock options were scheduled to vest. Following the termination, the employee attempted to exercise his unvested stock options, but the company placed a block on the brokerage account.

The Court’s Explanation of Wages

The employee sued, alleging that under the Court of Appeals’ seminal decision in Medex v. McCabe, the stock options were “wages” under the Wage Payment Act. The trial court ruled in favor of the employee. However, on appeal, the Court of Appeals held that the unvested stock options were not wages. Specifically, the Court of Appeals explained that in Medex the incentive fees at issue qualified as wages under the Wage Payment Act because the employee had done everything that he was required to do to earn those fees, and simply because the employee was not employed on the date that the employer had unilaterally decided to pay commissions was not a justification for failing to pay them. The Court of Appeals held in Medex that to hold otherwise would place the employee’s wages at the whim of the employer to determine whether to pay them. 

In Catalyst Health, the Court of Appeals concluded that the employee had not satisfied all of the agreed upon conditions for exercising the stock options - - specifically, the service requirement that was set forth in the applicable Stock Option Grant Agreement. In language relevant to employers who use stock options as part of a compensation package, the Court of Appeals explained “that the trial court erred as a matter of law because the options were granted for services, but their exercise is conditioned upon an employee’s employment for a specific period of time which he did not meet.”

The significance of the decision should not be lost on Maryland employers. As employers in Maryland are or should be aware, employees who establish violations of the Wage Payment Act may be entitled to triple damages as well as attorney’s fees.

Lessons Learned

Although the Court of Appeals’ decision in Catalyst Health was certainly a welcome one from the perspective of employers, it underscores the importance of the care employers must exert in drafting offer letters, employment agreements, and other documents that set forth the terms of employee compensation or possible compensation. In particular, it is extremely important for employers to be careful in defining exactly when it is that a wage, benefit, commission, stock option, etc. is actually earned. Interestingly, in explaining its decision, the Court of Appeals in Catalyst Health distinguished a decision by the United States Court of Appeals for the Third Circuit, which held that employee stock options granted under a two year oral agreement were within the Pennsylvania Wage Payment and Collection Law because the employee had rendered all services necessary for the options to vest, and the employer had wrongfully terminated the employee. The significance of drafting these provisions carefully is particularly heightened in this economic environment where employers are increasingly using compensation arrangements that have a relatively lower base salary component, yet provide for some incentive based compensation linked to performance.

It is important that employers work with experienced counsel to review or, as the case may be, draft their compensation documents.

This article is not intended to provide legal advice as to any specific matter.

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