Are Restricted Stock, Stock Options and Restricted Stock Units Community or Separate Property? Are Restricted Stock, Stock Options and Restricted Stock Units Community or Separate Property?
Restricted stock units, or RSUs, stock options, and restricted stock all present the same problem in divorce: Are they community or separate property? Separate property is not divided in divorce.
What is Community and Separate Property?
Texas Family Code §3.002 defines community property as “the property, other than separate property, acquired by either spouse during marriage.” Separate property is defined in §3.001 as the property owned by a spouse before marriage; acquired by the spouse during marriage by gift or inheritance; and the recovery for personal injuries sustained by a spouse during marriage. Compensation earned during marriage is community property. Compensation earned before or after marriage is separate, and is not divided in divorce.
Restricted Stock & Options Partially Acquired During Marriage
RSU’s, stock options, and restricted stock all involve deferred compensation. After an employee fulfills a requirement to the employer she receives a benefit, which is often linked to the employer’s success. The time during which the employee is earning the benefit can be the vesting period. When the benefit “vests,” the employee becomes entitled to it.
Consider a five-year vesting period: Employee is granted restricted stock or options that cannot be exercised (sold) until after employee has been employed five years. In year three, after 30 months, employee marries. At that point employee cannot use the benefit because the vesting period has not ended. Employee must remain employed another 30 months to earn the benefit. During that second 30 months employee will be married. Compensation earned during marriage is community property, divisible in divorce. Had employee received annual bonuses during the two years before employment those would be separate property because they were earned before marriage. A bonus for employment during marriage is community.
The vesting period combines community and separate benefits. Are the shares and units separate, community, or both?
Similarly, RSU’s, stock options, or restricted stock awarded during marriage with a vesting period that will expire after divorce present the same problem. Some of the vesting period was during marriage (community property) and the rest is after marriage (separate property). The stock is worthless to the employee without both periods. It cannot be entirely community or separate.
The Texas Family Code Has Instructions for Calculating the Community & Separate Portions
Fortunately, §3.007(d) of the Texas Family Code has the answer:
“(d) A spouse who is a participant in an employer-provided stock option plan or an employer-provided restricted stock plan has a separate property interest in the options or restricted stock granted to the spouse under the plan as follows:
(1) if the option or stock was granted to the spouse before marriage but required continued employment during marriage before the grant could be exercised or the restriction removed, the spouse’s separate property interest is equal to the fraction of the option or restricted stock in which:
(A) the numerator is the sum of:
(i) the period from the date the option or stock was granted until the date of marriage; and
(ii) if the option or stock also required continued employment following the date of dissolution of the marriage before the grant could be exercised or the restriction removed, the period from the date of dissolution of the marriage until the date the grant could be exercised or the restriction removed; and
(B) the denominator is the period from the date the option or stock was granted until the date the grant could be exercised or the restriction removed; and
(2) if the option or stock was granted to the spouse during the marriage but required continued employment following the date of dissolution of the marriage before the grant could be exercised or the restriction removed, the spouse’s separate property interest is equal to the fraction of the option or restricted stock in which:
(A) the numerator is the period from the date of dissolution of the marriage until the date the grant could be exercised or the restriction removed; and
(B) the denominator is the period from the date the option or stock was granted until the date the grant could be exercised or the restriction removed.
(e) The computation described by Subsection (d) applies to each component of the benefit requiring varying periods of employment before the grant could be exercised or the restriction removed.”
Although the formula seems complicated, it greatly reduces the cost of litigation. Resources need not be spent arguing about whether the assets are 100% community or separate, or a proportion of each. A spreadsheet can make the calculations. It requires the documentation for each grant or award of RSU’s, stock options, or restricted stock. This is typically an award or grant letter. Sometimes, the letter is general and is followed up by a detailed statement of the vesting schedule. The number of units and vesting schedule for each grant is essential.
The Community Portion May be Divided between the Spouses or Awarded to One
The formula determines the community and separate portions. The separate portion is not divided in divorce. The community portion can be divided or awarded 100% to one spouse. It is not a calculation of the share belonging to the non-employee spouse. The portion belongs to the community estate and will divided with real property, retirement, etc.
Valuing Restricted Stock, RSU’s, & Stock Options in Divorce is Difficult
The formula in 3.007 helps apportion ownership of the shares or units. It gives no basis to value them. Because the shares cannot be sold until the vesting period expires, their current value is useless because the employee spouse might not satisfy the requirements for vesting. Many grant or award letters give the employee nothing even if the employer terminates employment during the vesting period. The fairest option is to award each spouse a specific number of the community shares, to be received after vesting.
Most Grants Prohibit Dividing the Shares or Units before Vesting, Which Might be After Divorce
The vesting may take place after the divorce is finished. Most RSU’s, stock options, and restricted stock awards prohibit alienation of the benefit before vesting. They cannot be transferred until after they vest. The plan can usually legally ignore a divorce decree ordering it to transfer units to a former spouse before vesting. The decree can order the former spouse to sell the shares and turn over the money after they vest. If the plan allows, the shares can be transferred by the former spouse, without selling them, after they vest.
Options are Limited if Former Spouse Refuses to Cooperate after Divorce
If the employee former spouse refuses to transfer the shares or turn over the money, the only option is a lawsuit. It’s best to divide property as much as possible in divorce and avoid post-divorce obligations. With these assets, there’s no good way to do that. Awarding 100% of the community portion to the employee spouse means no post-divorce entanglement. But if one spouse receives 100% of a community asset, the other must receive something to reach an equitable division. The shares or units cannot be valued until they vest, so calculating a corresponding asset to the other spouse is impossible.
An option is for a trustee to hold an asset awarded to the employee spouse, with a court order to transfer it to the employee spouse after the obligations regarding the stock or units is satisfied. The trustee will usually be a lawyer. The court will order the lawyer to hold an asset, usually real estate or money, in trust until the employee spouse has satisfied the obligation.
A Marital Agreement Avoids All This
A prenup or postnup may designate all employment benefits as separate property. If done correctly, the agreement avoids these issues.
Employ an Experienced Lawyer & Learn the Details of the Grants
Whether you are the employee granted or awarded the stock options, restricted stock or RSUs’, or the spouse, learn the terms of the grant or award, the vesting periods, and the numbers of shares or units in each grant or award. Also, hire a lawyer who understands not only the Family Code but also how these deferred compensation tools work, and the options in divorce.