A federal court in Florida has just ruled that restricted stock (on which most incentive stock options are based) cannot have any value merely because it is restricted. (Visit Site below for Court Opinion.) Williamson v. Moltech Corporation began in New York in 1995. Although now in bankruptcy court, New York law, not bankruptcy law, applies in this case.
Restriction of stock is typically utilized by early-phase companies who want to award employees and/or attract necessary employees. The stock is restricted because when the company goes into an initial public offering (IPO), the underwriters of the offering do not want the company principals selling their stock at the IPO since this would undermine confidence in the company. Usually the restriction is lifted after a period of time following the IPO.
This new ruling would mean that any company can award incentive stock options based on restricted stock and then abrogate its agreement, leaving its employee with no recourse. This would be the case, even if the company value had increased astronomically. Clearly, this does not meet the test of reason.
This ruling destroys as impractical the use of incentive stock options and the restricted stock underlying them for compensation purposes. Companies that desire quality technologists and managers, but with little cash with which to compensate them, will now find the formerly-valuable technique of awarding incentive stock options to be snubbed by knowledgeable employees, who realize that the company can breach its incentive stock option agreement with its employee at any time with impunity. Thus, at any time after helping to build the company, the employee could be left with nothing for their sweat equity efforts. Since companies will no longer be able to compensate their employees with stock options, more cash will be required, leading to a drying up of technological advance.
Additionally, the court failed to observe the previous ruling of the courts of New York denying summary judgment to Moltech on the damage claim related to the incentive stock options, even though the court is bound to give comity to the New York ruling under res judicata. (Visit Site below for New York Summary Judgment Denial.) The court gives no apparent reason for its utter disregard for the prior New York ruling.
New York law requires that damages be measured at the time of the breach. Oscar Gruss & Son, Inc. v. Hollander, 337 F.3d 186 (2d Cir. 2003). Further, where there is no market for stock, as is the case with restricted stock, a hypothetical market model is used to establish the value between a buyer and a seller. Boyce v. Soundview Technology Group, Inc. 2004 WL 2334081 (S.D.N.Y. 2004) vacated and remanded as to damages by Boyce v. Soundview Technology Group, Inc. 464 F.3d 376 (2d Cir. 2006); Boyce is similarly a bankruptcy case. Thus, although the Williamson v. Moltech matter was in bankruptcy court, the ten-year later bankruptcy can have no effect on the value at the time of the breach. The court appears to have struggled with this, both recognizing that the valuation must take place as of the time of the breach under New York law, but also bringing in language related to the cancelling of stock through the bankruptcy plan approval, which is clearly inapplicable.
Of further interest is the earlier hearing before the court. (Visit Site below for Hearing Transcript.) The reader will find the comments by the court at the top of page 31 very interesting, since this hearing was prior to the court receiving any evidence as to valuation from Williamson. In fact, evidence of the restricted stock value was put before the court by Williamson in the form of un-refuted valuations, among others having been performed by Moltech’s own analysts/auditors, including Price-Waterhouse and sales of stock by Moltech (outright common stock sales were made as were preferred instruments convertible to common stock).
Thus, if the ruling this case were to be upheld it would result in a loss of stock options by employees holding them if their company decided to breach their incentive stock option agreements. Companies could breach such agreements pre-IPO leaving the employee high and dry with no high value stock subsequent to the IPO. Naturally, incentive stock options would lose their luster for compensation. New high technology companies would suffer.
The case is currently under appeal in the U.S District Court for the Northern District of Florida, Gainesville Division, Case No. 1:07-cv-00016.