When a company is acquired in a stock sale, its shareholders are routinely required to sign what is known as a Letter of Transmittal (“LOT”). Standard LOTs include a release of all claims. But, due to a quirk of California employment law, including a release in an LOT may create unintended consequences.

In a typical private-company acquisition, shareholders of the acquired company will include current or former employees who were granted stock options or restricted stock that vested as they performed labor. As a result, California law may treat that equity as wages entitled to a variety of protections under the California Labor Code (“L.C.”).

Whether a given equity award constitutes a “wage” is unsettled. L.C. 200 broadly defines “wages” to include “all amounts for labor performed by employees.” A standard option or stock grant would seem to satisfy this definition as it is an “amount” (i.e., 5,000 shares) that is “ascertained by the standard of time” (i.e., 1/48 of the shares vest every month if the employee provides “continuous service”).

California state courts have gone both ways. Schachter v. Citigroup, Inc., 47 Cal.4th 610, 619 (2009) (restricted stock = wage); Ware v. Merrill Lynch, Pierce, Fenner & Smith, Inc., 24 Cal.App.3d 35, 44 (1972) (profit sharing plan = wage); International Business Machines Corp. v. Bajorek, 191 F. 3d 1033, 1039 (9th Cir. 1999) (stock options are not “wages”); Falkowski v. Imation Corp., 309 F. 3d 1123, 1130 (9th Cir. 2002)(stock options are not “wages”); McAfee v. Metropolitan Life Insurance Co., No. Civ. S-05-0227 WBSKJM, 2006 WL 1455431, at fn.7 (E.D. Cal. May 23, 2006)(distinguishing Bajorek and finding “stock options” do constitute “earnings” under an ERISA plan).

This ongoing debate is the surf breaking on a dangerous reef. L.C. 206.5 states that an “employer shall not require the execution of a release of a claim or right on account of wages due.” If a stock option is a wage, then an LOT that includes a release is void under L.C. 206.5; worse, if L.C. 206.5 voids the release, then the LOT also violates California’s Unfair Competition Law (“UCL”).

Although the UCL does not authorize damages it does permit restitution, including “payment of wages unlawfully withheld from an employee.” Cortez v. Purolator Air Filtration Products, 96 Cal. Rptr. 2d 518, 528 (2000). Thus, an employee who executes an LOT that violates L.C. 206.5 could not only void the release but also seek return of the shares transferred by arguing they were acquired “by means of an unlawful practice that constitutes unfair competition.” Id.

Upon return of those shares, the employee might seek to have their value appraised at a price far in excess of what the acquirer agreed to pay. Given the UCL’s four-year statute of limitations, this invites sort of claim could be very attractive when 20-20 hindsight suggests the target company stock was purchased for too little.

And fast throught the midnight dark and drear,

Through the whistling sleet and snow,

Like a sheeted ghost, the vessel swept

Tow’rds the reef of Norman’s Woe.

Longfellow’s poem The Wreck Of The Hesperus contains a litany of cautions preceding disaster. For this reef, suggestions are more fraught with the uncertainty of the case law. But, two recommendations are in order.

First, there is no Aristotelian golden mean whereby a “narrow” release of certain limited claims is permitted. L.C. 206.5 voids any “release of a claim or right” on account of wages due. Thus, the release should be an all or nothing proposition. There is no knot to tie to neaten up a release and make it serviceable.

Second, all other things being equal, you should cut the release out of the LOT. If there are employment claims lurking from current or former employees, there are other and better ways to batten those hatches: due diligence investigation pre-purchase along with tightly drafted representations and warranties.

But, Captain, my mates and I will sail whatever course you set.