Employee stock option plans (ESOPs) are by no means new. Growing numbers of companies have adopted equity incentives to attract talent and motivate employees. However, this comes with an ever-increasing amount of domestic and foreign ESOP disputes.
There are no marked differences between foreign and domestic ESOP disputes in terms of the legal relationships and their nature. However, approaches to defence can vary by jurisdiction.
This article discusses the key points in mounting a defence in a foreign ESOP dispute from the perspectives of procedural defence and substantive defence.
PROCEDURAL DEFENCE
Unqualified subject and jurisdictional objection. Usually, in a foreign options dispute, the actual domestic employer does not directly execute an option agreement with a labourer. Instead, the employer signs an employment contract with the labourer while a separate foreign option granting entity executes the option grant agreement. Accordingly, the option granter and the employer are not the same.
Partner
Jingtian & Gongcheng
In disputes of such arrangements, a domestic employer can claim that the domestic entity (the defendant) is not a qualified subject. Based on jurisdiction and governing law clauses under the option grant agreement, the foreign option granter can claim that the case is a foreign-related contract dispute. Foreign contract disputes should usually be resolved by foreign-related arbitration under the specified jurisdiction, thus raising a jurisdictional objection to the case.
In practice, debate remains as to whether an ESOP dispute is a labour or contract dispute. In Beijing, courts traditionally regard such cases to be contract disputes. However, the Beijing No. 1 Intermediate People’s Court’s recent tendency is towards holding ESOP disputes as labour disputes, deeming employee options to be essentially a type of benefit arising from an employment relationship.
Accordingly, a court hearing a foreign options dispute may reject the argument of unqualified subject and jurisdictional objection, but support precedents nonetheless exist. For example, in Wind & Lu v Wang (2019), the Chaoyang District Court held that the legal relationship arising from an equity incentive was independent from the employment relationship, and that the subject, object, rights and obligations in, and the legal basis of the parties’ legal relationships, were all different. It thus determined that a dispute arising from an equity incentive contract was a civil contract dispute. Under a civil contract dispute, a court may uphold a company’s procedural defence.
Governing law in arbitration agreement. If the dispute resolution clause of an option agreement points to foreign-related arbitration, where the court upholds the overseas company’s jurisdictional objection, the labourer may claim that the arbitration clause is invalid and that Chinese courts have jurisdiction. Under such circumstances, the law governing the validity of the foreign-related arbitration clause may be confirmed by ascertaining the relevant extraterritorial law and conducting a systematic analysis, adopting a perspective most favourable for the validity of the arbitration clause.
SUBSTANTIVE DEFENCE
Associate
Jingtian & Gongcheng
Procedure for, or specificities of, the granting of the foreign options are unlawful. Under the Measures for the Administration of the Equity Incentives of Listed Companies, any listed company’s share incentive plan must follow certain legal procedures, including:
- A draft equity incentive plan that is prepared by the company’s remuneration and assessment committee under its board of directors;
- The board voting to adopt the draft;
- Expression of opinions provided by the independent directors and supervisory board;
- An internal announcement of the beneficiaries of the incentive, before the convening of a shareholders’ general meeting;
- Engagement of a law firm to issue a legal opinion on the plan; and
- Voting on the plan at a shareholders’ general meeting.
Generally, an unlisted company’s equity incentive plan should also be approved at board and shareholders’ meetings. Where a plan’s details – such as grantor, exercise price, waiting period and exercise method – cannot be determined or specified, the plan is not viable and employees’ claims will likely go unsupported.
Foreign options not yet mature. Usually, the conditions for ESOP maturity will be set out in the option grant agreement – for example, whether an employee is required to achieve certain seniority or performance targets, or complete specific tasks – and the company is required to achieve a certain amount of turnover or financing, and that no event affecting its continuance as an ongoing concern, such as dissolution, has occurred.
Exercise conditions are not satisfied or exercise period has expired. An option agreement will usually specify the conditions that an employee is required to satisfy before exercising his or her options, or a specific exercise period. In a foreign ESOP dispute, the employee must provide evidence that the relevant exercise conditions have been satisfied, and that the exercise period has not expired. Failing this, his or her claims are unlikely to be upheld by the court.
Termination or cancellation triggering clause. An option agreement usually contains termination and cancellation clauses. Common causes of termination include the option holder’s disability or death, termination for cause or voluntary resignation. Common causes for cancellation include the complete invalidation of any unvested and unexercised portion of the options as a result of the employee’s conviction for a crime or alleged serious violation of a law, administrative regulation or company rule or regulation. Accordingly, even if options have matured, a company may request complete invalidation, cessation of vesting, complete buyback, total termination, or other method of handling pursuant to the option agreement.
Application for a stay of proceedings. The disposal of options often requires taking into account the employee’s performance and the provisions of the agreement to arrive at a specific determination. Ascertaining the establishment, performance and termination of the employment relationship between the labourer and the domestic company is the premise for hearing a dispute for the recognition of foreign options. Accordingly, under article 153 of the Civil Procedure Law, it is possible to claim that the trial of an options dispute case must be based on the outcome of the trial of an employment dispute, and an application may be made to the court to stay the proceedings.
Shaw Zhao is a partner and Mia Wang is an associate at Jingtian & Gongcheng
34/F, Tower 3, China Central Place
77 Jianguo Road, Beijing 100025, China
Tel: +86 10 5809 1026
Fax: +86 10 5809 1100
