Dismissing a senior executive who has significant incentives, such as restricted shares and stock options, can be a minefield.

Can an employer forfeit an employee's incentives on the basis that it has grounds to summarily dismiss the employee but chose not to terminate on that basis and give him notice instead? The short answer is yes, but this must be supported by the facts and the rules of the incentive scheme, and, if litigated, arguments must be articulated properly. Otherwise, it can backfire on the employer (as shown in a recent Hong Kong case)!

The China Gas case

The facts

The China Gas case concerned two senior executives who brought a claim against their former employer, as it refused to honour the exercise of their stock options.

The senior executives, Li and Xu, both PRC nationals, were the chairman and vice chairman of China Gas. Between January 2004 and October 2005, China Gas granted these two senior executives stock options for 10 million shares and 95 million shares respectively.

In early March 2011, the Board of Directors of China Gas resolved to remove Li and Xu from their positions as company directors and it did so without terminating their employment contracts. Both senior executives, seeing the writings on the wall, then gave notice to China Gas to exercise their stock options. A few days later, China Gas terminated Li and Xu's employment by payment in lieu of notice.

Arguing they were no longer eligible to exercise their rights under the scheme rules, China Gas refused to honour their requests to issue the shares. Consequently, the two executives took China Gas to court for an order compelling the company to allot and issue the shares to them, or pay them damages in lieu of those shares.

The Judgment: The Court of Appeal was unanimous in finding in favour of the senior executives and they were awarded HK$25 Million and HK$254 Million respectively.

What Went Wrong?

  • At the time the senior executives exercised their stock options, they were still employees of the company.
  • The company argued (unsuccessfully) that the senior executives' stock options had lapsed under the stock options scheme because the company "would be entitled" to summarily dismiss them.
    • However, neither the key facts nor the grounds for forfeiture were properly articulated in the company's defence.
    • The company failed to explicitly state that it was as a matter of fact entitled to summarily dismiss the senior executives.
    • The grounds on which the board of directors had made the determination that it was entitled to dismiss the executives were also not explained.
  • The company also argued (unsuccessfully) that the executives did not comply with the PRC exchange control regulations in exercising their stock options and therefore should not be allowed to exercise those options. However, the Court of Appeal disagreed with this because the company should be responsible for obtaining any required governmental approval to permit the grant or exercise of the options. As such, it should not take advantage of its own wrong.

Key Takeaways

  • Incentive plan drafting: Check that the company's rights and remedies are properly reserved under the incentive scheme rules.
  • Have proper record of the decision: There should be a proper paper trail to show there was a determination by the company to forfeit the incentives and that there are valid grounds to do so and the basis for the decision to terminate the executives.
  • Planning is key: Having a coordinated and well-thought out approach is key to implementing any company decision.
  • Articulate your defence: If it comes to litigation and if there is proper basis and supporting facts to forfeit the incentives, articulate the case properly. Don't ask the Court to infer the basis of forfeiture and don't sit on the fence!