As many readers know, one of the most significant trends in equity plan design, fueled largely by investors and proxy advisors, is to eliminate single trigger vesting upon a change in control. Most folks seem to shrug off the impact of this change and assume all employees will end up vested anyway. A recent case painfully demonstrates that this is not always the case: Timian v. Johnson & Johnson.
In January 2006, Ms. Timian commenced employment with the company as a patent attorney, providing legal services to one of its subsidiaries, Ortho-Clinical Diagnostics, Inc. (OCD). The company had awarded restricted stock units (RSUs) to Timian under its long-term incentive plan (LTIP) for several years. The RSUs had a vesting period of three years, which required Timian to be employed by the company on the third anniversary of the vesting date in order to receive the value of the RSUs.
In early 2013, the company began discussions to sell OCD. The patent attorneys supporting OCD, including Timian, were included as assets to the sale and were not allowed to look for work within the company or any of its other subsidiaries. The patent attorneys were forced to either leave the company’s employment or become an employee of OCD after the sale. In January 2014, the company announced its formal intention to sell OCD. In February 2014, the company awarded RSUs to Timian based on her 2013 work performance. On June 29, 2014, the company’s sale of OCD became final, Timian’s employment with the company was terminated, and she became an employee of OCD. Upon the sale of OCD, the company terminated the RSUs granted to Timian in 2012, 2013, and 2014 on the basis that these RSUs had not vested prior to the termination of her employment. Timian lost the full value of the RSUs awarded in 2012, 2013, and 2014 and sued the company for a breach of LTIP, breach of the implied contract between employee and employer, breach of the implied covenant of good faith and fair dealing, and breach of ERISA.
The federal court ruled against Timian on each of her claims. First, the court found that the LTIP was not subject to ERISA, as has every other court that has ever considered the issue. Second, the court found that the language of the LTIP was clear; there could be no legal dispute that Timian’s employment with the company had terminated, even though she continued to sit at the same desk and perform the same job functions on the day after the sale of OCD as she did on the day before the sale. The LTIP did not provide for accelerated vesting of Timian’s RSUs. The provisions of the LTIP on change in control simply did not apply to the sale of a division of the company.
Finally, the claims for breach of the implied contract between employee and employer and breach of the implied covenant of good faith and fair dealing are based on a notion that some rules apply to the relationships among parties, even though they are not written into a contract or agreement. Courts sometimes find a breach of these implied covenants in cases of egregious conduct. However, the terms of the LTIP addressed situations like the one at issue and were clear on the outcome.
The court’s decision in Timian v. Johnson & Johnson is consistent with that of nearly every other federal court that has considered a similar issue. Some companies’ LTIPs would provide for accelerated vesting for an employee terminated solely because of a sale of a division of the company. However, this LTIP did not. Executive compensation professionals should take care in considering all of the terms of a stock plan or employment or other agreements because the courts will uphold those terms for better or worse.