Valuing and recovering lost equity as part of lost compensation damages in wrongful-termination cases
Some companies, particularly technology start-ups, provide employees with an ownership interest in the company to attract, retain, and compensate workers. This practice of providing some form of equity as part of an employee’s compensation has become increasingly common across tech and other industries, including in more established companies. An employee’s overall compensation package may include components such as base salary, bonus, and equity grants as well as other fringe benefits such as 401K matching.
Common forms of equity that employees may receive include stock, stock options, restricted stock, and restricted stock units. Often, equity is granted subject to vesting restrictions, based on time and/or performance metrics. Equity grants can make up a significant portion of the value of an employee’s compensation package, particularly in companies where valuation rapidly increases. In a sense, employees working at companies that provide equity are investing in the companies in the hope that they will be valuable, paying for a share of ownership with their labor.
Claims seeking equity as damages can arise in a variety of situations. For example, an employment agreement may specify certain payment to the employee, including acceleration of equity vesting, should certain conditions occur, such as an acquisition of the company. The employee may seek the equity that should have vested pursuant to the acceleration clause as breach of contract damages. This article focuses on equity as a form of lost compensation in wrongful termination cases, where an employee has been terminated in violation of a statute or the common law.
Courts have recognized that stock is a component of compensation for decades.1 In our experience litigating cases involving equity as a component of damages, most judges and arbitrators will allow evidence on lost equity, including testimony on the value of the equity from experts or other witnesses. However, the availability of equity damages as a matter of law is still frequently disputed and there is a dearth of authoritative case law on the topic. Additionally, defendants may challenge the valuation of equity as speculative, particularly where the company is privately held. Even with publicly traded companies where the stock price is a matter of public record, defendants may dispute what valuation should be applied to disputed shares.
Employment damages include future projected wage loss
In a wrongful termination action, such as a claim based on state or federal employment discrimination laws2 or statutes prohibiting retaliation for engaging in protected activity,3 the plaintiff-employee can seek compensatory damages.4 Courts are directed to fashion effective remedies “so as to make the individual whole” and compensate for the harm – both economic and emotional – caused by the employer’s unlawful actions.5
In many cases, calculating lost wages that the plaintiff-employee would have earned over time involves a degree of uncertainty because it requires determining the facts of an alternate reality: How long would the employee have remained employed absent the wrongful termination?
To determine the period that the plaintiff-employee’s employment was reasonably certain to have continued, the trier of fact should consider “(1) the employee’s future in the position from which she was terminated; (2) her work and life expectancy; (3) her obligation to mitigate her damages; (4) the availability of comparable employment opportunities and the time reasonably required to find substitute employment; (5) the discount tables to determine the present value of future damages; and (6) other factors that are pertinent in prospective damage awards.”6
Despite the inherent uncertainty in projecting how long an employee would have continued in their role but for the wrongful conduct, courts have had considerable experience with damages for future wages7 and have affirmed awards of front pay for extended periods.8
Equity is an element of employee compensation, whether considered wages or “fringe benefits”
Compensatory economic damages for a wrongful termination claim include front and back pay, the loss of fringe benefits, and other out-of-pocket expenses.9 Stock option awards are a form of fringe benefits.10
The right to recover unvested stock options in a wrongful termination case has been recognized by courts for decades.11 Courts have recognized that equity can constitute a component of a plaintiff-employee’s compensation package, along with items such as cash salary. Just like lost future salary, the value of the equity may constitute compensation that the employee would have received but for the termination. Accordingly, to make the plaintiff-employee whole, awarding the value of the equity is necessary to compensate the plaintiff and place them as close as possible to the economic situation they would have been in but for the defendant-employer’s unlawful conduct. These cases establish that a wrongfully terminated employee who was granted equity scheduled to vest during their employment is entitled to compensation for the value of those lost equity rights.12
While an employer’s stock option plan may establish certain provisions regarding the vesting, exercise, and cancellation of stock options – in particular, conditioning vesting of stock options upon continued employment – the central issue is that compensatory damages for lost stock are necessary to return the employee to the financial position they would have been in had the wrongful termination not occurred. The same is true of lost wages or salary – generally, the prerequisite to obtaining salary is continued employment. However, where the defendant’s illegal termination has deprived the plaintiff of lost salary, courts routinely award the value of future lost salary. This same analysis should be applied to lost equity to make the plaintiff whole.
The California Supreme Court recognized that stock awards are wages under California law.13 In that case, the Court held that equity shares, granted to an employee but subject to a vesting schedule, are “wages” as defined by the California Labor Code, reasoning that wages include “other benefits to which [an employee] is entitled to as part of his compensation.”14
Establishing the value of lost equity
Courts regularly calculate the value of stock.15 Courts have developed methods for ascribing value to stock in contexts such as employment cases as well as business disputes.16 Valuation methods include using the stock’s highest market value within a reasonable period or valuing the stock on the date of the breach of the obligation or wrongful termination.17 Some courts take a blended approach, basing the value of the equity as the market price of the shares on the date the employee tried to exercise their shares.18
In contrast, some courts have denied plaintiffs the value of lost equity because it is too speculative.19 As discussed above, one method courts apply to avoid an unduly speculative valuation is by fixing the value of the stock on a concrete date in the past, like the date of termination, rather than speculating about when the employee would have sold their stock or what the future value of the stock will be.20
We recommend retaining an expert economist or business valuation expert to value the equity, taking into account reduction of the future award to present value and removing any costs associated with the equity grant, such as the exercise price of stock options and administrative costs.21
Where the equity grant was provided in the form of a time-based vesting schedule, the amount of equity that would have vested can be calculated on a periodic basis (e.g., monthly, bi-annually, or annually as the case may be) along with base salary, bonus, and other benefits such as 401K matching.
In discovery, it is important to seek information regarding the valuation of the company, including any 409A valuations conducted by the company, valuation of the company provided for investors, or other relevant information. This can be accomplished through written discovery and document requests as well as depositions of corporate officers or the person most knowledgeable under Federal Rule of Civil Procedure 30(b)(6) or equivalent state law procedure.
Specific performance as an alternative
If the court or arbitrator finds that the value of stock is not ascertainable, the law provides the alternative remedy of specific performance.22 This is particularly appropriate where the company’s stock is not publicly traded.23 The finder of fact may award warrants for the stock the plaintiff would have received during the period they would have remained employed but for the wrongful termination.
Michelle Lee is a partner at Rudy Exelrod Zieff & Lowe LLP. Michelle represents workers in both individual and class action cases. She is a frequent speaker at conferences and panels on employment law issues, as well as on topics related to bias and diversity. More information available at www.rezlaw.com.
Meghan Loisel is an associate at Rudy Exelrod Zieff & Lowe LLP. Meghan has worked in employment law as both plaintiff and defense counsel. She now brings that expertise to representing employees in individual and class cases. Meghan regularly speaks on issues of California state and federal court practice.
2021 by the author.
For reprint permission, contact the publisher: www.plaintiffmagazine.com