Knock of Death for Incentive Stock Options

A federal court in Florida has just ruled that restricted stock (on which most incentive stock options are based) cannot have any value simply because it is constrained. (Visit the site below for the court’s opinion.) Williamson v. Moltech Corporation started in New York in 1995. Although it is now in bankruptcy court, New York law applies in this case, not bankruptcy law.

Stock restriction is often used by early-stage companies that want to reward employees and/or attract needed employees. The shares are restricted because when the company does an initial public offering (IPO), the underwriters of the offering do not want the directors of the company to sell their shares in the IPO, as this would undermine confidence in the company. Usually, the restriction is lifted after a period of time after the initial public offering.

This new ruling would mean that any company can grant incentive stock options based on restricted shares and then rescind their agreement, leaving their employee with no recourse. This would be the case even if the company’s value had risen astronomically. Clearly, this fails the test of reason.

This ruling destroys as impractical the use of incentive stock options and the restricted shares underlying them for compensation purposes. Companies that want quality technologists and managers, but with little cash to compensate them, will now find that the previously valuable technique of granting incentive stock options is rejected by informed employees, who realize that the company may renege on its contract agreement. incentive stock options. with your employee at any time with impunity. Therefore, at any time after helping build the company, the employee could be left with nothing for his sweat efforts. Since companies will no longer be able to compensate their employees with stock options, more cash will be required, leading to a depletion of technological advancement.

In addition, the court failed to comply with the earlier ruling by the New York courts that denied Moltech summary judgment in the incentive stock option damages claim, even though the court is required to award commission to the ruling. of New York under res judicata. (Visit the site below to view New York’s summary judgment denial.) The court gives no apparent reason for its complete disregard of the earlier New York ruling.

New York law requires that damages be measured at the time of the breach. Oscar Gruss & Son, Inc. c. Hollander, 337 F.3d 186 (2d Cir. 2003). Also, when there is no market for shares, as is the case for restricted shares, a hypothetical market model is used to establish value between a buyer and a seller. Boyce v. Soundview Technology Group, Inc. 2004 WL 2334081 (SDNY 2004) set aside and remanded as to damages for Boyce v. Soundview Technology Group, Inc. 464 F.3d 376 (2d Cir. 2006); Boyce is equally a bankruptcy case. Thus, although Williamson v. The Moltech matter was in bankruptcy court, bankruptcy ten years later cannot have any effect on the value at the time of default. The court seems to have taken issue with this, acknowledging that the valuation must take place at the time of default under New York law, but also incorporating language related to the cancellation of shares through the approval of the bankruptcy plan, which is clearly inapplicable. .

Of greatest interest is the earlier court hearing. (Visit the site below to view the transcript of the hearing.) The reader will find the court’s comments at the top of page 31 very interesting, as this hearing was prior to the court receiving evidence on Williamson’s valuation. In fact, Williamson presented to the court evidence of the value of the restricted shares in the form of uncontested valuations, made among others by Moltech’s own analysts/auditors, including Price-Waterhouse and sales of shares by Moltech (directly sales of shares and preferred instruments convertible into ordinary shares).

Therefore, if the judgment in this case were upheld, it would result in a loss of stock options by the employees who owned them if your company chose to default on its incentive stock option agreements. Companies could default on such agreements before the IPO, leaving the employee in the lurch without high-value post-IPO stock. Naturally, incentive stock options would lose their attractiveness as compensation. New high-tech companies would suffer.

The case is currently on appeal in the US District Court for the Northern District of Florida, Gainesville Division, Case No. 1:07-cv-00016.

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