California Supreme Court Upholds Forfeiture Provision In Incentive Compensation Plan
There are a significant number of our clients that have quarterly and annual bonus programs (such as Christmas Bonuses) that require an employee to be employed at the end of the quarter or the end of the year to qualify for the bonus. The California Supreme Court has issued a decision in Schachter v. Citigroup, Inc., upholding the legality of an incentive compensation plan provision providing for forfeiture upon an employee’s resignation or termination for cause. The plan at issue allowed employees to elect to receive shares of restricted stock at a reduced price in lieu of a portion of their annual compensation. Title to the shares vested two years after the purchase date. However, the plan provided that if the employee voluntarily resigned or was terminated for cause prior to the two-year vesting date, the employee forfeited his or her stock as well as the portion of annual income designated by the employee to be paid as shares of stock. (If an employee was involuntarily terminated without cause prior to vesting, the employee still forfeited the stock but was paid for the percentage of annual income the employee had directed be used to purchase stock.)
The Court also rejected Schachter’s argument that at least a portion of his incentive compensation should have vested on a pro rata basis, much like vacation wages. The Court explained that unlike vacation, which is compensation for past services, an incentive compensation plan is inducement for continuing future service. As a result, the Court held that rules prohibiting forfeiture of accrued vacation do not apply to incentive compensation plans.
Although the Schachter case is an employer-friendly decision that allows employers more control and flexibility in structuring incentive compensation plan, employers should note that the California Supreme Court placed some emphasis on the fact that Schachter had voluntarily resigned and, therefore, it was Schachter’s own actions that caused him to lose his contingent incentive compensation. Although the Court did not say that a forfeiture provision tied to involuntary terminations would per se violate California law, employers should be mindful that forfeitures in the case of involuntary terminations frequently give rise to a claim that the employer terminated the employee as a pretext to avoid payment of the incentive compensation. Therefore, particular care should be taken in drafting forfeiture provisions tied to involuntary terminations.
The case noted above has favorable overtones but please be extremely careful when it comes to such programs. As a reminder, employers can also structure commission plans that state an employee does not receive any commissions once they leave the company. It needs to be clearly stated, and signed off by the employee. Remember, we are still doing business in California. ANY such commission plans should be reviewed prior to enactment.