In November, the California Supreme Court issued an unusually significant decision in the area employment compensation. Schachter v. CitiGroup, Inc. (PDF, 107KB) (S161385), Nov. 2, 2009, concerns Citigroup’s restricted stock incentive compensation plan, pursuant to which employees may elect to receive a portion of annual earned compensation in the form of restricted company stock that vests over time. The restricted stock plan provides, however, that if a participating employee resigns, he or she forfeits rights to any unvested restricted stock (as well as to the cash the employee would have received had he or she not opted for restricted shares instead).

Schachter had opted to receive restricted shares in lieu of cash during certain years. The restricted shares were awarded at a 25% discount below market price at the time of award. Schachter quit and therefore lost the value of not-yet-vested restricted stock. He claimed the restricted stock plan violated two sections of the California Labor Code, sec. 201 (which requires unpaid earned wages to be paid upon discharge), and sec. 221 (which prohibits an employer from “collecting or receiving from an employee any part of wages theretofore paid . . .”

The Court, in a ruling that has generated much laudatory comment by employment defense firms, found that Schachter had, in fact, received all of his earned compensation. He had simply voluntary agreed to exchange part of it for restricted stock that would have limited and conditional present value (the stock could be voted and would accrue dividends before vesting) and would not fully vest until two years after the date he received it. In other words, Schachter – who was not required by his employer to take any part of his compensation in restricted stock – made his own decision to gamble part of his compensation by purchasing discount restricted stock the value of which he would not obtain unless he chose to remain employed through the vesting period. The fact that stock did not vest was a function of his own decision to leave. Frankly, notwithstanding the excitement of the employment defense bar, the decision of the Supreme Court (which affirmed a decision of the Court of Appeal) was not particularly surprising. The restricted stock used in Schachter is not different in material respects from most other sorts of equity (or deferred) compensation subject to vesting requirements.

What the employment defense firms have not commented on – and what we see as the more significant aspect of the Supreme Court’s decision – is the first absolutely clear statement by that court that shares of restricted stock (and, implicitly – but necessarily – all equity compensation) are “wages” within the meaning of the California Labor Code. In 1999 the Ninth Circuit, in IBM v. Bajorek, 191 F.3d 1033, had held otherwise. Bajorek’s IBM equity compensation package was different from Schachter’s. Bajorek was permitted to exercise stock options after his termination – but only if he agreed not to compete against IBM post-termination. Bajorek exercised stock options worth over $900,000. His agreement provided that if he went to work for a competitor of IBM within six months of termination, he would forfeit the value of the options. The Ninth Circuit ruled for IBM. In so doing, it not only applied its own judicially created “narrow restraint” doctrine to hold IBM’s post-employment non-compete enforceable, despite the clear language of sec. 16600 of California’s Business & Professions Code, but it held that stock options are not “wages” within the meaning of the California Labor Code. Thus, Bajorek’s claim that the agreement constituted a violation of section 221 of the Labor Code (precluding an employer from compelling a kickback of earned “wages”) was not applicable.

Bajorek was an astounding result, and was roundly criticized for a decade. It was, however, an effective tool for defense counsel seeking to defend post-employment non-competes, particularly when designed to be self-enforcing by operation of equity compensation forfeiture provisions. In 2008, however, in Edwards v. Arthur Andersen LLP (2008) 44 Cal.4th 937, the California Supreme Court emphatically ruled that the Ninth Circuit’s “limited restraint” doctrine was not the law in California and that sec. 16600 invalidated all contractual restraints on competition – “limited” or otherwise – other than the (non-applicable) express statutory exceptions to 16600. For more detail on Edwards, see our article, Post-Employment Non-Competes Unenforceable in California.

But Edwards did not discuss the other widely criticized Bajorek holding; that equity compensation was not “wages” under the Labor Code’s definition. Schachter rectifies that omission. After discussing the Court of Appeal’s specific holding that restricted stock “constituted a wage” within the meaning of the Labor Code, the Court cited its own precedent, noting that “[w]e construe the term ‘wages’ broadly to ‘include not only the periodic monetary earnings of the employee but also the other benefits to which he is entitled as a part of his compensation.” The Court’s subsequent analysis (which determined that Schachter had received all of his earned “wages,” but that he had decided to contractually “gamble” cash – which he could have retained – for qualified and contingent rights to stock that may have been worth more had he not triggered the forfeiture provision by resigning) proceeded from the finding that the restricted stock did, in fact, comprise “wages.”

Schachter’s clear holding that restricted stock and other deferred equity compensation is a form of wages is extremely significant for California employees. First, a suit over rights to such deferred equity compensation is now a suit for unpaid wages – a statutory and public policy suit in California. Thus, a prevailing employee plaintiff will be awarded attorney’s fees, thereby making the litigation attractive to the plaintiffs’ bar, even if the amount at issue does not warrant what would otherwise be the litigation cost. Second, in the arbitration context, the employee plaintiff will be accorded the benefit of the Armendariz protections (the California Supreme Court’s attempt to mitigate the employer advantage in employer/employee pre-dispute arbitration agreement contexts); i.e., the employer will have to pay the arbitration costs, including hefty arbitrator fees which will often exceed the amount at issue for modestly compensated employees The Armendariz protections are only accorded to employee plaintiffs where they bring claims involving violation of specific statutes or fundamental public policy. Now that equity compensation has been authoritatively recognized to be “wages,” an employee can bring a $75,000 stock option compensation claim in arbitration without concern that his half of a $700 per hour arbitrator’s fee will exceed his likely award.