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Introduction
Employee stock ownership plans (ESOPs) are a popular tool for retaining talent and boosting motivation by giving employees a direct stake in the company’s success. While the focus often lies on the tax advantages of such plans, the legal aspects related to employment law must not be overlooked. One particularly crucial issue is whether an employee stock plan qualifies as part of an employee’s salary. The legal implications in such cases can be significant.
Scope of an ESOP
In general, an employee stock ownership plan is not considered salary if both the decision to grant shares and the amount awarded are entirely at the employer’s discretion. The company has the flexibility to decide whether to issue shares or options and in what quantity.
However, exceptions can arise if a long-standing and undisputed practice of granting stock exists. If such a practice is perceived as a regular, planned benefit rather than a one-time discretionary bonus, the plan could be legally classified as part of the salary. This brings significant risks for companies, as employee stock options may then be treated as part of wages under employment law.
What happens if ESOPs are considered salary?
If employee stock ownership plans are classified as part of salary, several legal consequences arise that are significant for both employers and employees. Below are the key issues:
Impossibility of salary reduction
If the stock options are treated as salary, the employer loses the right to unilaterally reduce the allocation. Poor business results, which could justify a lower stock award, would not be enough to legally reduce the shares granted. Additionally, "claw-back" provisions, which allow for the recovery of already granted stock in certain situations, may be invalid. As a result, companies could be obligated to provide the full stock allocation even in difficult financial times or when the company’s value decreases.
Truck prohibition (Art. 323b Abs. 3 CO)
The truck prohibition states that agreements requiring employees to use their salary to purchase stock options can be invalid. This means that any contractual obligation forcing employees to buy shares with their salary could be seen as an unlawful restriction of employee rights. Therefore, companies must design such agreements carefully to avoid legal challenges.
Payment conditions
Another hurdle is the structuring of the conditions under which stock options are paid out. If the options are considered part of salary, the payout cannot be conditional on an employee remaining with the company. This means that vesting clauses or agreements requiring employees to stay with the company for a certain period to receive their shares could be legally challenged. Such conditions are generally not allowed for components of salary, which could significantly impact how many employee stock programs are designed.
Practical Tips: How to Design ESOPs
To ensure that employee stock ownership plans are not mistakenly classified as salary, companies must follow some important guidelines.
It is crucial that employee stock plans are clearly and explicitly defined as voluntary bonus payments, not as a component of salary. It should be stated that both the size and allocation of stock are discretionary. Additionally, it’s advisable to consult legal experts early to avoid future legal complications, especially for long-term plans and specific cases.
A close alignment between tax and employment law considerations is essential. Many companies focus primarily on optimizing their stock ownership models for tax purposes. However, without considering the employment law implications, they may face unforeseen problems.
Conclusion: Tax advantages alone aren’t enough
Employee stock ownership plans offer a great opportunity to bind employees to the company long-term and reward them for their contributions. However, to avoid legal pitfalls, it’s essential to consider not only tax implications but also employment law issues. Proper planning and clear legal distinctions are key to successfully implementing stock ownership models without incurring future legal or financial risks.
