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Tricky business

Labour & Employment
|Written By Henry Dinsdale and Jeff Goodman
Tricky business

Stock options are a common component of employee compensation packages, but they bring some tricky issues when it comes to termination of employment. Employers are increasingly being challenged by allegations that wrongfully dismissed employees are entitled to damages on account of unexercised stock options. The value of stock-option liability often dwarfs the damages that flow from lack of notice of termination.

In a series of rulings, dismissed employees have been granted the right to exercise vested stock options during the termination notice period. This, despite not working during the notice period and even where the stock-option agreement contains specific provisions that seek to end an employee’s exercise rights on the date of termination.

An option agreement of this type was considered by the Ontario Court of Appeal in the 1999 case Veer v. Dover Corp. (Canada). The termination provision of the option agreement stipulated that where an employee is “terminated for any reason,” whether the termination was “voluntary or involuntary,” stock options could not be exercised after the date of termination. The court engaged in close analysis of the option agreement and concluded because the employee was wrongfully dismissed, the employer’s immediate discontinuance of option rights was wrong.

In the court’s view, the use of the terms “voluntary termination” and “involuntary termination” presupposed that termination was lawful; termination as a result of an employee resignation or dismissal for cause or with reasonable notice. The court pointed out the option agreement did not contain “express language” stipulating the provisions also applied to “unlawful” terminations.

Consequently, the court held the plaintiff in Veer was wrongfully — and therefore unlawfully — dismissed and the termination restrictions in the option agreement did not apply. The plaintiff should have been entitled to exercise his stock options for the duration of his notice period, which the court assessed to be 24 months from his final day of employment.

Shortly after the decision in Veer, the Court of Appeal considered a differently worded stock-option agreement in Gryba v. Moneta Porcupine Mines Ltd. In Gryba, the court determined even though the option agreement discontinued exercise rights upon “ceasing to be employed,” a separate reference to the employee’s “effective date” of termination contemplated the incorporation of a notice period into the notional period of the individual’s employment. As in Veer, the court highlighted that the termination provision in the option agreement was not sufficiently clear and unambiguous to apply in a case of wrongful or unlawful dismissal.

The message? Courts will bend over backwards to interpret an option agreement in a manner that allows the options to continue to vest and be exercised throughout the period of notice.

The impact of the Veer line of cases is amplified by the judicial approach to calculating damages for lost stock-option rights. The standard applied is a “reasonably prudent investor” and how that investor would have exercised the options during the notice period. In Nurun Inc. c. Deschênes, the Quebec Court of Appeal applied this standard looking at the market’s performance during the entire notice period to determine when it would have been profitable for the employee to exercise his option rights. While the court also considered the average value of the employer’s share price, the retrospective nature of the analysis has the effect of calculating damages in a vacuum, away from the influence of risk and external market factors, with the benefit of hindsight. In the end, the result may be damages calculations that are very favourable to the dismissed employee.

Changes made to stock-option granting and vesting policies during termination notice periods can also be caught up in this line of cases. In the British Columbia Court of Appeal’s decision in Iacobucci v. WIC Radio Ltd., John Iacobucci was terminated and placed on an 18-month salary continuance during which time only a portion of his stock options were scheduled to vest. During the notice period, for reasons completely unrelated to the dismissed employee, WIC Radio accelerated vesting under the option plan to allow all outstanding employee stock options to vest immediately. When Iacobucci learned of this policy change, he sought to exercise all of his options in accordance with the terms of the revised plan. WIC Radio refused to allow this, taking the position that the plan in place at the time of his termination governed his rights.

The B.C. Court of Appeal did not accept WIC Radio’s argument and found Iacobucci was entitled to damages based on the value of the new options plan consistent with the approach that the terminated employee’s option rights continue to live during the reasonable notice period absent the very clearest contracted language to the contrary.

These are consequences to consider the next time you read your stock-option plan.

Henry Dinsdale and Jeff Goodman are labour and employment law partners with Heenan Blaikie LLP in Toronto.