Client Alert

Update on Viscaino v. Microsoft: Temps, Stocks, and the Latest Round in the Ninth Circuit

6/1/1998
As first reported in Morrison & Foerster’s October 1998 Employment Law Commentary ("Are Your Independent Contractors Really Independent Contractors?"), Vizcaino v. Microsoft Corp. -- now in its 7th year in federal court -- illustrates the importance of properly classifying employees. Recently, the parties finished their third trip to the Ninth Circuit (99 C.D.O.S. 3474 -- May 12, 1999). As described in our October 1998 commentary, Microsoft’s first trip to the Ninth Circuit Court of Appeals in Vizcaino resulted in a finding that the company had improperly labeled as "independent contractors" or "temporary employees" workers who were in fact common law employees of Microsoft under the multi-factor analysis of Nationwide Mutual Ins. Co. v. Darden, 503 U.S. 318 (1992). See Vizcaino v. Microsoft Corp., 97 F.3d 1187 (9th Cir. 1996) (Vizcaino I). In Microsoft’s second trip to the Ninth Circuit, the court, en banc, largely affirmed its decision in Vizcaino I. See Vizcaino v. Microsoft Corp., 120 F.3d 1006 (9th Cir. 1997) (en banc) (Vizcaino II).

Although at its inception the Vizcaino class sought the panoply of benefits offered to Microsoft’s regular employees, the latest Ninth Circuit opinion is focused on whether workers classified as temporary employees are entitled to participate in the software giant’s Employee Stock Purchase Plan ("ESPP"). Following the Ninth Circuit’s May 12, 1999 decision, Microsoft may owe a class of up to 10,000 temporary employees between $15-20 million in Microsoft stock that they could have purchased had they been permitted to participate in the ESPP.

The Latest Ninth Circuit Opinion

In this increasingly bitter and costly litigation, the parties in Vizcaino have appeared before the Ninth Circuit several times. Most recently, the court’s May 12, 1999 decision clarified the scope of the Vizcaino class following the district court’s October 1998 order limiting the class to former independent contractors reclassified by Microsoft as temporary employees following a 1990 IRS audit. A three-judge panel of the Ninth Circuit disagreed with the district court’s narrowing of the subject class, and broadened it to include all temporary employees occupying an IRS-reclassified position, regardless of whether they were formerly classified as independent contractors. This distinction is significant, because it greatly expands the potential class – from about 500 workers to up to 10,000 workers. Moreover, on remand, the Ninth Circuit placed the burden on Microsoft to "show why any particular worker serving in a reclassified position who meets the ESPP service requirements is not entitled to participate" in the stock program.

The Ninth Circuit has agreed to reconsider its May 12, 1999 decision en banc upon Microsoft’s petition for rehearing.

Lessons from Vizcaino -- Stock Incentive Programs

With stock becoming more valuable than salary in an employee’s total compensation package, it is no surprise that the parties in Vizcaino are heavily litigating whether temporary workers are entitled to participate in a stock incentive program that has only been made available to Microsoft’s regular employees. Given the potentially high cost of providing stock to employees, employers may seek ways to prevent temporary employees or independent contractors from suing to obtain the benefits of a stock program intended only for regular employees. Vizcaino provides employers with some guidance in drafting and implementing stock incentive programs that apply only to regular employees. By learning from Microsoft’s mistakes, employers can take steps to restrict the types of employees eligible to participate in stock purchase programs.

Draft Stock Incentive Programs Carefully. Under Microsoft’s ESPP plan, eligible employees are given the opportunity to purchase Microsoft stock at 85% of the lower of the fair market value on the first or last day of each six-month offering period, through payroll deductions of 2 to 10 percent. In both Vizcaino I and II, the Ninth Circuit found that based largely on the language of the ESPP, participation in the program was available to all common law employees, regardless of their classification. The ESPP itself is set up under, and expressly incorporates, Section 423 of the Internal Revenue Code. It provides that Microsoft intended "to have the plan qualify" under Section 423 and that its provisions "shall accordingly, be construed to extend and limit participation in a manner consistent with [Section 423]." When first established in 1986, Microsoft’s plan stated that the ESPP was available to "any employee of the Company," but this language was later changed to "permanent employee" (in 1987) and then "regular employee" (in 1989).

Section 423 provides that "options are to be granted to all employees of any corporation whose employees are granted any of such options by reason of their employment by such corporation." The IRS has interpreted the phrase "all employees" to refer to common law employees. Section 423, however, allows employers to exclude four employee classifications: (a) employees employed less than 2 years; (b) part-time (20 or fewer hours per week) employees; (c) employees customarily employed for no longer than 5 months in any calendar year; and (d) highly compensated employees. Microsoft’s ESPP refers only to exceptions (b) and (c). In Vizcaino I and II, the Ninth Circuit found that by Microsoft’s express incorporation of Section 423 in the ESPP, the Vizcaino class members were eligible to participate in the ESPP and had been improperly denied the opportunity to do so. Although analyzed in the lower court, the Ninth Circuit did not discuss and apparently found unpersuasive Microsoft’s use of the phrases "permanent" and "regular" employee in the ESPP, resting its opinion on Microsoft’s incorporation of Section 423 into the plan.

With this in mind, employers should examine their existing stock purchase programs to determine which employees are covered under the express language of the program. Employers with Section 423 stock purchase programs will be unable to include language in their plan that categorically excludes temporary employees from participation. Nevertheless, where a stock incentive program is governed by Section 423, employers should be sure to take full advantage of the four specified exclusions discussed above. Such language is helpful to courts which may be called upon to interpret the plan. For example, in their latest Vizcaino opinion, the Ninth Circuit limited class members, in part, to those who are "qualified under the ESPP" to participate in the program, noting that the plan "by its terms, excludes short-term workers who work less than five months per year or less than half-time." Whether drafting a new stock incentive program or revising an existing one, employers should include clear language that expressly excludes particular classifications of employees (within the confines of the type of stock purchase program at issue) and bona fide independent contractors from participation in the company’s stock purchase program.

Explicitly Exclude Stock Program Participation in Employee-Signed Documents. In finding that class members were eligible to participate in the ESPP, the Ninth Circuit (in VizcainoI and II) also rejected Microsoft’s argument that statements made in the company’s non-disclosure agreements and other information documents signed by class members rendered them ineligible to participate. These employment documents included statements that the employee is "responsible for . . . other benefits" or "responsible to pay all [his] own insurance and benefits." The court found that these statements referred to health and welfare benefits or similar employee protection policies paid for by the employee himself if his employer does not provide the benefit. Under this rationale, the court reasoned that such statements were consistent with permitting class members to participate in the ESPP because under the plan, the employee himself, not Microsoft, makes the actual payment for the benefit (i.e., the stock).

With this in mind, employers should take steps, within the confines of their company’s stock purchase program (i.e., Section 423’s limitations), to explicitly reference and exclude participation in stock incentive programs in any documents that describe or refer to the benefits available to temporary workers or bona fide independent contractors. In particular, employers should make such exclusions clear in any document that will be signed by the temporary worker or independent contractor, including, for example, proprietary information and non-disclosure agreements, employment agreements or independent contractor agreements, and employee handbook provisions describing or relating to employee benefits.

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