For many workers, stock options are the promise and the path to instant wealth. In fact, last year, more than 160,000 employees became millionaires through their stock options. Through an employee stock option plan, an employee receives an option to purchase stock in his or her employer. The stock is offered to the employee at a price generally far below the price at which shares of stock of the company are offered to consumers on the open market, and the amount of stock the employee can purchase typically increases in proportion to the employee's duration of employment. Thus, when a private company "goes public" (or is purchased by a publicly-traded company) or the share price of a public company's stock increases, the employees of these companies can benefit greatly.

It is often overlooked that the widespread use of employee stock option plans is a relatively recent phenomenon. For example, in 1993, approximately 17% of the major companies in America had employee stock option plans. Six years later, this figure more than doubled to 39%. Earlier this year, Fortune Magazine reported that 36 of the 58 public companies on its "100 Best Companies to Work For" list offered stock options to employees. Though stock options began as an executive perk, they now have spread through the ranks. In this regard, a 1998 study found that of the 389 companies questioned, 34% made grants to non-exempt employees. Stock options truly have become "the preferred currency for compensation programs in the U.S."

The proliferation of employee stock options has raised an array of legal issues for employers and labor and employment law practitioners alike. There is a growing conflict between the growth of stock options that has accompanied the Internet explosion on the one hand, and traditional labor and employment laws, many of which were promulgated long before the advent of the computer, and were not drafted to account for stock options and the "dot com" workplace. Some of the legislative and judicial challenges presented by employee stock options are noted below.

• Stock options and overtime. A recent example of the discordant fit between established labor and employment laws and stock options involved the application of the 62-year-old Fair Labor Standards Act ("FLSA") to the relatively new phenomenon of issuing stock options to large numbers of employees who are not exempt from the overtime provisions of the FLSA. In February 1999, the Wage/Hour Division of the Department of Labor ("DOL") issued an advisory letter that concluded that employers were required to include the value of stock option profits in the regular rate of pay of employees who are non-exempt under the FLSA for overtime calculation purposes. Although the DOL advisory letter probably was based upon a technically correct interpretation of the FLSA, it triggered an avalanche of criticism. (See sidebar on page 2.) This criticism, in turn, produced a swift legislative response in mid-May 2000 with the enactment of an amendment to the FLSA entitled the "Worker Economic Opportunity Act." In effect, this statute provides that income earned from most stock option plans will be exempt from inclusion in the regular rate of pay for purposes of calculating overtime.
  

  This is not to say that California, or any other state, could not endorse a different interpretation that compels employers to include stock option profits in making base rate calculations of overtime payments due non-exempt employees under state law. Thus far, however, the Division of Labor Standards Enforcement ("DLSE"), the state agency that administers wage and hour law in California, has stood silent on this issue. The DLSE has not issued any enforcement actions, and since many DLSE policies are derived from and supported by FLSA rules and regulations, we believe that the DLSE is unlikely to deviate from the position taken in the Worker Economic Opportunity Act amendment to the FLSA.
  

• Stock option vesting and leaves of absence. Another tangled area, potentially implicating federal and state leaves of absence laws, involves an employer's ability to suspend stock option vesting during an employee's leave of absence. For example, in California, would an employer who temporarily ceased vesting of stock options during an employee's leave of absence for a workers' compensation injury be liable for a Labor Code § 132a retaliation claim? (Labor Code § 132a prohibits employers from discriminating against employees for exercising their rights under workers' compensation law.)
  
• Lost stock option profits as damages. Another constellation of unresolved questions are raised with respect to the proper method of calculating damages arising from a terminated employee's loss of unvested options. Inevitably, these questions focus upon determining the valuation of the stock based upon a fictional date of sale. Remembering that "hindsight is 20/20", should a court rely on the testimony of a plaintiff as to when he or she would have sold the stock? Should a court use the value of the stock on the date of termination? Date of trial? Should the price be the average from the date of termination to trial? Trial courts grapple with these questions every day.
  
• Stock options and claims for breach of the implied covenant. One of the most potentially explosive (and expensive) areas in wrongful termination law is the extent to which an indisputably at-will employee can nonetheless seek damages for loss of stock options under a claim for breach of the implied covenant of good faith and fair dealing. A recent unpublished California appellate decision, Eysie v. Zacson, was touted by the plaintiffs' bar as supporting the claim that a terminated employee whose employment was otherwise at will could nonetheless still sue for breach of the implied covenant for denial of an economic benefit. Although the compensation at issue in Eysie was unpaid commissions, not stock options, the legal theory endorsed by the appellate court can easily be applied to options.
  

  However, in a recent landmark decision, Guz v. Bechtel National, Inc., the California Supreme Court appears to have cast doubt on the viability of breach of the implied covenant claims involving stock options. Guz (see below) holds that, where employment is at will, a breach of the implied covenant based on a breach of the same term upon which the breach of the underlying contract is alleged, is superfluous. Guz precludes an implied covenant claim based on the alleged breach of obligations beyond the contract's actual terms. Guz, therefore, would appear to limit the scope of implied covenant claims in the future. But upon closer scrutiny, Guz, in fact, may not completely foreclose the possibility of stock option claims. In a footnote, the Court states that,
  

  [t]he covenant might be violated if termination of an at-will employee was a mere pretext to cheat the worker out of another contract benefit to which the employee was clearly entitled, such as compensation already earned. We confront no such claim here.

  
  Thus, while Guz appears to make implied covenant claims less plausible, it cannot be said to completely rule out their possibility.
  
  Tips for Employers. The answers to the myriad wrongful discharge-related risks faced by employers in administration of stock option plans will be resolved in courtrooms and legislatures in the years to come. In the interim, however, employers can take steps to try to insulate themselves from stock option claims.
  
• Exercise care in terminating employees with stock options. Stock options certainly are not a protected category under EEO law, e.g., stock option eligibility is not an immutable characteristic like race. Nonetheless, employers would be well advised to apply the same level of scrutiny to a potential termination of an individual with stock options as they would an individual who is over the age of 40 or a member of another category protected by EEO law. This does not mean that an employer should be paralyzed into inaction. Rather, an employer simply needs to be certain that the termination decision is being made for a legitimate, nondiscriminatory reason, and that it can clearly articulate this reason, preferably with supporting documentation.
  
• Be aware of vesting dates. In particular, employers should be cognizant of vesting dates falling near the anticipated termination date. While the appropriate action to be taken by the employer and timing thereof ultimately depend on the facts of each case, employers should exercise utmost caution when terminating employees immediately before an annual vesting date.
  
• Draft stock option agreements that specifically address vesting on termination. Many stock option agreements have a provision stating that the grant of options does not alter the parties' at-will employment relationship. Now, however, employers may want to be even more explicit and anticipate any attempts to imply terms to the stock option agreement. For example, employers may want to consider language telling employees that they will not be entitled to any pro rata vesting upon termination for any reason, with or without cause. Likewise, a stock option agreement should include a specific representation to employees that they may be terminated prior to any vesting date, in which case they will lose all rights to such unvested options, and that they accept the grant with that understanding. While this language may appear to some employers as overkill, in light of recent events, it may be necessary.
  
• Construct and implement at-will notification system. Though under attack, perhaps the strongest defense to the breach of implied covenant claim is an express at-will employment standard. While the exact frequency of notifications may vary, the key is that employers must be consistent. The offer letter should indicate in clear terms that the employee is at will. For example,
  

  [ACME] is an "at-will" employer. That means that both employees and the Company have the right to terminate employment at any time, with or without advance notice, and with or without cause. Employees also may be demoted or disciplined and the terms of their employment may be altered at any time, with or without cause, at the discretion of the Company. No one other than an officer of the Company has the authority to alter this arrangement, to enter into an agreement for employment for a specified period of time, or to make any agreement contrary to this policy. Any such agreement to the contrary must be in writing and must be signed by an officer of the Company and by the affected employee.

  
  The stock option agreement should affirm the at-will nature of employment and confirm the disposition of stock in the event of such termination (as described above).
  
• Diligently apply performance improvement practices. Notwithstanding at-will employment, employers should carefully document performance or other problems that may result in disciplinary action, and regularly communicate with employees regarding such problems. If employers take these measures, they will significantly increase the ability to defend against breach of covenant claims. They also may decrease the risk of such claims being brought in the first place, as an employee will be less likely to bring such a claim when he or she has been apprised of the real reasons for his or her termination, and most importantly, that the employer can prove it.

Though by no means an absolute defense, the above methods will help employers in their defense to any potential stock option claims.

California Supreme Court Reaffirms an Employer's Right to Terminate At-Will Employees and Raises the Bar for Age Discrimination Claims

The California Supreme Court's recent decision in Guz v. Bechtel National, Inc. (00 C.D.O.S. 8230, October 5, 2000) is a victory for California employers. Guz, a 22-year employee, sued Bechtel for wrongful termination and age discrimination after he was laid off during a corporate reorganization. Guz claimed that Bechtel breached an implied agreement not to terminate him without good cause and that he was discriminated against because of his age. The trial court granted Bechtel's motion for summary judgment and dismissed Guz's claims. The Court of Appeal, however, reversed the trial court's ruling. The California Supreme Court resolved the dispute, and in doing so clarified the standards for litigating wrongful termination, breach of the implied covenant of good faith and fair dealing, and age discrimination claims in California.

With respect to wrongful termination claims, Guz confirms the strength of the at-will doctrine in California. It has long been the rule in California that employment is presumed to be at will absent evidence to the contrary. In 1988, however, the California Supreme Court recognized in Foley v. Interactive Data Corp. that this at-will presumption could be rebutted by an implied in fact agreement to terminate only for good cause. Since Foley, many wrongful termination suits have been brought alleging the violation of implied good cause contracts based on the "Foley factors" -- employer personnel policies and practices, employee longevity of service, employer actions or communications reflecting assurances of continued employment, and industry practices. The Guz Court, however, refined its ruling in Foley ("we did not suggest, however, that every vague combination of Foley factors shaken together in a bag, necessarily allows a finding that the employee had a right to be discharged only for good cause"). The Court ruled that the express at-will pronouncements in Bechtel's policies established that Guz was an at-will employee notwithstanding his prior years of satisfactory service to the Company.

The Guz Court also narrowed the scope of the breach of implied covenant of good faith and fair dealing in the employment context. The implied covenant generally provides that a party cannot act arbitrarily to frustrate another party's enjoyment of the benefits of the contract. Prior cases had suggested that the implied covenant could be breached by acts extraneous to the contract and if the employer terminated an employee on bad faith or without probable cause. The Guz Court, however, specifically disapproved of prior cases to the extent that they "suggest that the implied covenant may impose limits on an employer's termination rights beyond those either expressed or implied in fact in the employment contract itself." Therefore, "[w]here the employment contract itself allows the employer to terminate at will, its motive and lack of care in doing so are, in most cases at least, irrelevant."

Finally, Guz confirms that age discrimination plaintiffs must rely on more than circumstantial evidence and technical disputes of facts to prevail. Bechtel presented substantial evidence that its decision to lay off Guz had nothing to do with his age. Guz, however, failed to dispute the bulk of Bechtel's evidence, and his argument that some, but not all, of the workers preferred over him were considerably younger was based on a statistically irrelevant sample. At most, Guz's evidence may have put Bechtel's reasoning in question, but that was not sufficient. The Guz Court held that a plaintiff must present evidence that actually demonstrates that the employer's decision was based on a discriminatory animus.

Congress Approves Worker Economic Opportunity Act

The purpose of the Worker Economic Opportunity Act was simply to amend section 7(e) of the Fair Labor Standards Act of 1938 (the "FLSA"). Section 7(e) of the FLSA defines "regular rate" of pay for non-exempt employees. Last year, the Department of Labor's Wage and Hour Division issued an advisory opinion noting that a proposed stock option program did not fit within any of the FLSA's statutory exemptions to "regular rate," thus, the employer would need to include stock option profits as part of the calculations of a non-exempt employee's "regular rate" for overtime purposes. Because stock options typically vest over several years after they are issued, the DOL's interpretation would have effectively required employers to retroactively calculate overtime owed to non-exempt employees who received options. Given this administrative nightmare, many employers postponed or delayed new stock option programs for non-exempt employees.

Supported by the Clinton Administration (even the Wage and Hour Administrator asked Congress to amend the FLSA), in mid-May 2000 the Worker Economic Opportunity Act passed both the House and the Senate without a single vote cast in opposition to the statute.

Although the amendment exempts from overtime calculations income earned through most stock option plans, stock appreciation rights and employee stock purchase plans, it does not exempt all stock option programs. Consequently, employers should review each plan they are using or intend to implement on a case-by-case basis to confirm whether it is exempted.

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The authors would like to note their reliance on the following authorities for the references to the "popular press" and certain statistics cited in the article: Elise Ackerman, Optionaires, beware!, (March 6, 2000); Sharing The Wealth Through Stock Options Facts & Figures(Sept. 4, 2000) (citing Broad-based stock options-1999 Update, William M. Mercer, Inc., 1999); Robert Levering and Milton Moskowitz, "100 Best Companies to Work For," FORTUNE, January 10, 2000, p. 82; Testimony of Alan A. Nadel, Arthur Andersen LLP, Education and the Workforce Subcommittee on Workforce Protections Hearings, United States House of Representatives, Washington, D.C., March 2, 2000 (citations omitted); Samuel Greengard, Stock Options have their ups & downs, WORKFORCE, Dec. 1999, at 44 (quoting Heidi Toppel, Regional Practice Leader, Watson Wyatt Worldwide); Reynolds Holding, "All's Fair With ‘At Will' Workers," SAN FRANCISCO EXAMINER & CHRONICLE, July 23, 2000, p. Z1; and Peter Blumberg, "Dot-Com Layoffs Tied to Stock Option Payout, Attorneys Say," DAILY JOURNAL, July 11, 2000, p. 1.