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What legal rights do I have where an employer promised shares but did not deliver?

Trust is a big part of any deal, and  a situation where you’ve been hired and promised shares but never received any is a major breach of that trust. But does that trust translate into something legally binding, that when broken, gives you options for legal action?

 

The answer is in the details. When you say an employer has “promised” an employee shares, that can mean a few different things. If a verbal or oral agreement was made, it can be difficult to prove, even if it would otherwise be legally binding. If the shares were promised in a written agreement but never delivered, it can be much easier to force the employer to make good on the promise.


 

Verbal promises

Whether or not a verbal agreement is legally binding and enforceable depends on a number of important facts.

 

First and foremost is an employee’s ability to prove that a verbal agreement took place. This will require trustworthy testimony, and a clear reference to it in emails, messages, documents, journals, and so forth can be especially helpful. In cases like Druet v. Girouard (2012) (NBCA), email strings were accepted as verification of consent even when the electronic signatures themselves were disputed for not being totally accurate reflections of a person’s written signature. Supporting evidence lends weight, so don’t underestimate the importance of sifting through those emails!

 

Once the verbal exchange is proven to have taken place, the question becomes whether the elements of a binding agreement are present: an offer, acceptance, and consideration. That means there should be an identifiable exchange of something for the promise made, like money, or agreeing to accept a job in exchange for the promise of shares, to make the promise legally enforceable.

 

In the case of Fedel v. Tan (2010) (ONCA), Tan and Fedel started a new business together. They verbally agreed that Fedel would retain 60% ownership for organizing and administering the business, while Tan would retain 40% ownership for his financial involvement. Upon incorporation, Fedel received 100% of the shares issued, and Tan received none.Tan sued, and the judge looked at Tan and Fedel’s shared business history to determine that Tan had been entitled to 40% of the company. However, the judge decided against issuing shares to Tan. Because the business relationship between Tan and Fedel had been irreparably harmed by the dispute, ownership of shares in a closely held corporation would no longer have been a satisfactory result. The remedy instead was compensation.

 

So if you are entitled to shares, and can prove it, a court will still look at the particular circumstances to decide what the appropriate remedy will be, and this may not be the promised shares.

 

Written promises

If your employment agreement contains a provision entitling you to a particular number of shares at a particular point in time and you do not receive those shares, you may be able to bring an application in court to compel the employer to transfer the shares to you according to the terms of the employment contract.

Of course, this will not enhance the quality of your relationship with your employer! You are better off trying to use friendly channels to obtain the shares.

 

Stock Restriction Agreements

Before doing so however, you will need to look into the details of the contract. Often, employees or contractors will sign a stock restriction agreement. This contract usually provides that you are entitled to a certain number of shares that will vest over a period of time, for example X number of shares on July 20 each year, or X number of shares on the last day of each month. Until the shares have vested they are ‘restricted.’ Restricted shares can usually be redeemed (bought back) by the company at a very low price if your contract with the company is terminated, or if other trigger events take place (e.g., you are convicted of certain types of crimes). Often you are not entitled to vote restricted shares, and you may not be entitled to any dividends that have been declared. If you are terminated, you will not have a right to the promised shares if they have not yet vested.

 

 

Employee Stock Option Plans

Another common way for employees to believe they have been promised shares is under an Employee Stock Option Plan (ESOP). Your contract may entitle you to a certain number of options per year, or you may only be eligible to receive options if the directors use their discretion to grant options to you in any given year. It is important to check the fine print of the plan to determine what you are entitled to.

 

Once you have been granted options you will be able to exercise them to purchase shares at a set price. You will likely only exercise this option if the share value is at or above the purchase price. Note that the options will have an expiry date and many plans will specify that the company has the right, but not the obligation, to buy back any shares purchased under an ESOP if the employee’s contract is terminated for any reason.

 

To see standard versions of the agreements discussed in this article, visit our Small Business Law Library!

This blog was co-written by Alina Butt.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Issuing dates of employee stock option plans

To avoid confusion, stipulate the date the agreement is to take effect into the agreement. It should also be indicated that this is the date that will be used to determine the price of the stock option.

In McAnulty v. The Queen, 2001 CanLII 909 (TCC), the Tax Court of Canada was grappling with the date of the issuance of an employee stock option plan. In this case, McAnulty (the appellant) was arguing that the relevant date was the date of the oral agreement when the President of the company told McAnulty that she would be receiving options to purchase 45,000 shares.

The respondent’s position is that the relevant date was later i.e., at the time the director’s resolution and the written agreement was signed by the appellant and the President of the company. It was important to determine the relevant date for tax purposes. Section 7 of the Income Tax Act (ITA) deals with the taxation of employee stock option plans. The ITA allows for a deduction of a portion of the amount of shares taxed. However, if the fair market value of the stock at the time the option is granted is greater than the option price, the deduction is taken away.

Therefore, if the relevant date was the date of the oral agreement, McAnulty would have been entitled to the tax deduction.

However, if the relevant date is the latter date (the time of signing), McAnulty would not be entitled to the deduction because at this time, the fair market value of the shares was greater than the option price. The court held in favour of McAnulty; the agreement need not be in writing. The court stated that to require a written agreement would defeat the purpose of this tax section. Because the oral agreement was made by a person in a position of authority, it was sufficient. The relevant date was the date of the oral agreement.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Reporting Requirements of Employee Stock Option Plans for Banks

If a bank has an automatic exercise of options program, they may be able to evade the insider reporting requirements (section 91 of the Securities Act) in respect to the sale of common shares of the Bank to employees.

In Royal Bank of Canada (Re), 2008 BCSECCOM 297 (CanLII), the Royal Bank of Canada filed an application in every jurisdiction for exemptive relief from insider reporting requirements in respect of the sale of common shares of the Royal Bank of Canada by certain insiders. This included officers of the Bank who hold or are, in the future, granted options under the Employee Stock Option Plan. The dispositions of the underlying shares were automatic and occurred at pre-determined regular intervals. The case was held for the Royal Bank of Canada. The insider reporting requirements would not apply to eligible employees so long as (1) the person receiving the options filed a report disclosing all transactions in the form prescribed by the Insider Reporting Requirements; and (2) the person receiving the options does not hold more than 10% of the voting rights attached to the Royal Bank of Canada.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Stipulating classes of shares under Employee Stock Option Plans

In the company’s articles, explicitly provide which class of shares is to be issued under the Employee Stock Option Plan (ESOP). Also, ensure that redemption rules for all classes of shares are clearly stipulated.

In Smith v. Centra Windows Ltd., 2009 BCSC 606 (CanLII) (Smith v. Centra) the unclear stipulation of the above issues caused Centra Windows Ltd. (Centra) a law suit.

Although the case was held in favor of Centra, the matter may have been avoided with clear stipulations in their company articles.

In Smith v. Centra, Mr. Smith, who used to work for Centra, was issued 67,200 common shares (30,200 Class A shares and 37,000 Class B shares). After Mr. Smith’s termination, an issue arose regarding the redemption of Class A shares. Although the ESOP contained redemption provisions which permitted the employee to sell the shares to a third party or seek redemption from the company, there was no provision requiring a shareholder to tender shares upon termination.

However, in the Centra’s articles, it was stated that Class B shares issued under the ESOP were to be redeemed by the company if the worker was no longer an employee with Centra.

The articles did not address Class A shares at the time of Mr. Smith’s termination. Amendments were made to the articles after Mr. Smith’s termination. The court held that this amendment was not done in bad faith. Rather, the operating assumption was to treat Class A and Class B shares similarly. The difference was not noticed until Mr. Smith’s termination. At this time, the company rightly amended its articles.

Furthermore, it was apparent that Class A and Class B shares were treated similarly when other employees left Centra. Mr. Smith would have been aware of this because he was a part of the inner management team at Centra.

Therefore, he should have known that all of his shares were subject to redemption like in the manner set out for Class B shares.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Required consideration for an ESOP

When issuing an ESOP, ensure that the proper consideration (money, property, or past services) is received and recorded. Even if the ESOP is issued on the basis of a loan provision, consideration must be received from the registered owner of the ESOP.

In Pearson Financial Group Ltd. v Takla Star Resources Ltd., 2001 ABQB 588 (CanLII), an application was made by Pearson Financial Group Ltd.

(Pearson) to cancel shares or to lose the voting power associated with the shares held by a Director of Takla. Pearson is a wholly owned subsidiary of a company that began acquiring Takla shares.

Once Pearson was fully incorporated, all Takla shares were transferred to Pearson. Soon after, Pearson challenged the validity of an ESOP on the basis that one of Takla’s directors did not pay any money for the shares and took advantage of the loan provision in the ESOP. The loan provision allowed up to five years of a loan for the payment of the ESOP. The directors granted an extension of the loan for a further five years. Pearson argued that this extension could not be granted.

The court held that because the company articles gave the directors power to amend or revise the ESOP, there was nothing prohibiting them from extending the loan term.

Furthermore, the court said that the law is clear that a share shall not be issued until consideration for the share is fully paid in money, property, or past services.

However, the court argued that the cancelation of the shares were too harsh of a penalty, in this case. The Talka director should have received a cheque for the loan and then that money should have been used to write a cheque to the company for the shares. Because this technicality was missed, the court directed that the exchanging of cheques happen forthwith.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Mandatory ESOPs

Ensure employees have sufficient knowledge about a mandatory Employee Stock Option Plans (ESOP). If the ESOP becomes mandatory, ensure that employees are given sufficient notice and are well aware of this change.

In Carabine v. Daam Galvanizing Inc., 2000 ABPC 56 (CanLII), employees had been subject to a bonus plan during their employment in addition to their wages.

The company had discussions to change the bonus plan from a cash payment plan to a share issuance plan (an ESOP).

However, there was reluctance from the employees about this change. The employer distributed documents to the employees about these changes. The first guideline document made reference to the mandatory participation in the ESOP. But, the second guideline document, distributed later, did not make this reference. The court said that this left employees under the impression that the cash plan would or could still be in effect.

It was not until seven months later did the company clearly communicate to all employees that the ESOP was now mandatory.

Subsequently, many employees left the company. The change was considered a material change in the employment contract and required sufficient notice. The court stated that although the employees had reason to believe that the bonus cash plan was being changed, this did not constitute notice to the employees. Therefore, the company was liable to pay the employees their shares of profits and damages.

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Drag-along Provisions Allow for Future Flexibility

Links from this article:
Read the article here.
here!

If there is a bona fide takeover bid from a third party, a majority of the shareholders can agree to the take-over on behalf of all shareholders due to the drag-along provisions. These provisions require the remaining shareholders to sell all of their shares to the third-party acquiror. Any remaining shareholder who fails to comply with the drag-along will be subject to the exercise of a power of attorney designed to allow the majority shareholders to complete the takeover bid.

Read the article here.

Take away:

  • A company needs to be prepared for all future scenarios including takeover scenarios, and drag-along provisions are part of that preparation.

 

Are you a Startup Company looking for discounted legal services? Check out our partnership with Black Letter Law lawyers here!

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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Paying with Shares: The Employee’s Perspective

Introduction

What makes a stock option plan or agreement attractive to an employee? The short answer is – the opportunity to make money!

 

There are three basic ways for an employee to make money on the shares: via dividends; by selling the shares for more than they paid for them; or by participating in the value of the company if it is liquidated.

 

Dividends

Frequently dividends are declared “at the discretion of the Board of Directors”, which means that the shareholders will get dividends if the Board decides to declare dividends. Often dividends are also not ‘cumulative’, which means that if the Board does not declare dividends in a year, there is no carryover of rights to dividends from that year’s profits in any following year. To make it more likely that employee shareholders will receive dividends, their dividend rights should be tied to the dividend rights of the shareholders who control the company.

This can be done in various ways. The ‘employee shares’ could have the right to dividends if any dividends are declared on the shares of the controlling shareholders. Another possibility is to make dividends on the shares of the controlling shareholders payable only after dividends on the ‘employee shares’ have been declared and paid.

 

Sale of the Shares

For private companies, especially startups, the employee will likely only be able to sell their shares in one of two situations: to the company under a share repurchase agreement; or to a purchaser making a bid for the company. From the employee’s perspective, it is desireable to be able to require the company (at the employee’s discretion) to repurchase the shares for the price paid plus undeclared dividends (at a minimum). From the employer company’s perspective, it is desireable to be able to repurchase the shares (at their discretion) or if the employee leaves the company, or upon defined financing events.

 

If a purchaser is making a bid for the company, the employee will want to have the right to participate in the bid to be able to sell their shares for the same price offered to the controlling shareholders. The employee will also want to have an acceleration provision in the stock option plan which permits all the options to vest immediately upon an offer to purchase the shares of the company. This would enable the employee to purchase all the shares under the plan at the exercise price, and sell them into the bid.

 

Liquidation Value

The right to participate in the liquidation value of the company is an opportunity to participate in the growth in value of the company.

From the employee’s perspective, it is desireable to have shares that participate equally with (or in priority to) the common shares.

 

The Worst Case Scenario for the Employee

From the employee’s perspective, the worst combination of rights are shares that have only discretionary dividend rights without any preference over or ties to dividends on the owner’s shares; shares that can be repurchased at any time for the price paid by the employee (plus declared but unpaid dividends, if any were declared); and shares that do  not participate in any ‘liquidation event’. These shares will bring only the repayment of the purchase price, no guarantee of dividends, and no right to participate in the growth of the business. Worse yet are shares that the shareholder may never be able to sell or receive dividends on!

 

These types of shares are like an interest – free loan to the company, and will not likely create any incentive or loyalty to the company for employees who understand the risks – and potential rewards- of working for a startup.

 

Takeaways:

  • employees will want dividend rights that require dividends to be paid to them when dividends are paid to the controlling shareholders
  • employees will want to be able to require the company to repurchase their shares
  • employees will want to have the right to sell their shares at the same price as the controlling shareholders if a bid is made for the purchase of the company

 

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This article is provided for informational purposes only and does not create a lawyer-client relationship with the reader. It is not legal advice and should not be regarded as such. Any reliance on the information is solely at the reader’s own risk. Clausehound.com is a legal tool geared towards entrepreneurs, early-stage businesses and small businesses alike to help draft legal documents to make businesses more productive. Clausehound offers a $10 per month DIY Legal Library which hosts tens of thousands of legal clauses, contracts, articles, lawyer commentaries and instructional videos. Find Clausehound.com where you see this logo.

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