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.

Written by Rajah. Rajah Lehal is Founder and CEO of Rajah is a legal technologist and technology lawyer who is, together with the Clausehound team, capturing and sharing lawyer expertise, building deal negotiation libraries, teaching negotiation in classrooms, and automating negotiation with software.