Tag Archives: vesting

ESOP vesting: Can it be paused during maternity leave?

Employee Stock Option Schemes (“ESOPs”) are structured by companies such that the employees are granted options which is a right that vests over a period of time. Upon vesting the employee can ‘exercise’ and shares are allotted by the company (or transferred by the Trust, if the ESOP is administered by a Trust).

The question is, can the vesting be paused / stopped for reasons such as sabbatical, unauthorized leave, garden leave, maternity leave etc.?

Sabbaticals, garden leave is usually a program / policy that a company would have and they spell out treatment of full pay, partial pay, benefits and the like.

Unauthorized leave is usually treated as mis-conduct and is treated per company’s policies.

However, maternity leave is a statutory right and the pay and other benefits cannot be stopped or paused during this period.

The United Nations Convention on the Elimination of all forms of Discrimination Against Women (“UNCEDAW“), which India is a signatory to, mandates under Article 11 that State Parties are required to ensure that the female employees would have a right to pay or comparable benefits without loss of employment, seniority or social allowances.

India being a signatory to the UNCEDAW is bound under the obligation of pacta sund servanda Article 26 and Article 18 providing for the obligation not to defeat the object and purpose of a treaty of the Vienna Convention on the Law of Treaties (“VCLT”).

Vesting of ESOP during Maternity Leave

The vesting of options stays in effect as long as the employee remains in the employment of the company. A female employee’s employment, during maternity leave, cannot be terminated in accordance with Section 12 of the Maternity Benefit Act 1981 and it shall be unlawful for her employer to discharge or dismiss her during or on account of such absence.

The said position has been upheld in the case of Neera Mathur v Life Insurance Corporation of India[1] where it was held that the employment of a female employee shall be protected and it would be wrongful on part of the employer to terminate the employment of the female employee during the period of maternity leave. The same position was upheld in the case of Bharti Gupta (Mrs.) v. Rail India Technical and Economical Services Limited and Ors[2] wherein it was held that Section 12 of the Act underscores the independent and inflexible nature of the liability to mandate that no woman employee can be dismissed on account of her pregnancy. It is the right of the employee to get medical benefits since such grant of maternity benefit is according to the mandate of the law.

Section 5 of the Maternity Benefit Act 1981 states that female employees cannot be denied the emoluments such as continuation of employment and payment of wages on account of being on maternity leave. This position has been upheld by the Supreme Court in the case of Municipal Corporation of Delhi v. Female Workers (Muster Roll) and Ors[3].

ESOP taxation is treated as a perquisite. Ie. at the time of exercise, the difference to exercise price and fair market value is taxed as perquisite. Shares when sold are subject to capital gains tax.

An inference can be drawn from the above, that vesting of ESOP cannot be suspended, paused during maternity leave.

Author: Mr. Spandan Saxena

[1] AIR 1992 SC 392

[2] 2005 VII AD (Delhi) 435

[3] AIR 2000 SC 1274.

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Creation of ESOP Trust – Why complicate?

Many small sized organizations prefer to have the Board approving the grant of stock Options.  In large organizations, they either have a Compensation Committee or set up a Trust. Many Indian companies, including Infosys Limited, have used trust route to implement ESOP scheme.

We recommend startups opt the administration of ESOP by its Board of Directors rather than creation of a Trust (per Indian Trusts Act).  A startup recently approached us for cleaning up the mess they had created in their ESOP grants and wounds they had self-inflicted in creation of their ESOP Trust, which triggered this post.

A Trust for ESOP works as follows:

  1. A Trust is formed under the Indian Trusts Act, and the Trust Deed is registered with the jurisdictional Sub-Registrar.
  2. The ESOP Trust receives stock either from company by way of fresh allotment or by purchasing from existing shareholders in open market or the owner of the company may sell shares of his holding to the ESOP Trust.
  3. The ESOP Trust usually obtains its funds through a loan either from a financial institution or from the seller or a combination of institutions and seller. A company can extend loan to the Trust for purchasing the Shares. There is a specific provision in the Companies Act, which permits such loan. (Sec. 77(2) (b) and (c)

 The ESOP Trust then allots shares to employees on exercise of their right in exchange of cash and repays its loans.

 Additional Information, if the company is a listed entity:

 SEBI guidelines do not mention ESOP Trust and thus creation of trust to administer the ESOP scheme is optional. SEBI guidelines also do not specify any accounting principles to be followed in case of grant of options through a trust. A committee appointed by SEBI had recommended that since this is a consolidation issue rather than an ESOP issue, the ESOP trust should be consolidated with the company under AS 21 and the existing ESOP guidelines should be applied by the consolidated entity.

 TRUST SET BY THE COMPANY FOR THE BENEFIT OF EMPLOYEES:

 ESOP Trust (a Private Trust formed as a separate entity, but not being a charitable Trust) can be formed under the Indian Trust Act, 1882.

  1. Shares of the company can be held by the Trustees is held as beneficial owners. Hence Form 22-B declaring beneficial ownership has to be filed with ROC. (Sec 153 of Companies Act).
  2. Board of Trustees is controlled by the Company (indirectly by being nominated as trustees).
  3. Company may give loan to the trust to buy shares (earmarked for ESOP) (U/s 77 of Companies Act).
  4. Trust uses the funds to buy shares of the Company.
  5. Employees of the Company are granted Options by the company.  Decision to grant Options is controlled by the Compensation Committee of the Company.
  6. On exercise of the Options, the trust transfers shares (held by it) to the employee.
  7. While transferring the shares to the employees by the trust, the Share Transfer Form (Form 7B) has to be executed by the Trust and the employee.
  8. The share transfer form has to be approved in the Board Meeting (BM) of the company and then the employee becomes a shareholder of the company. After which they are issued share certificates and the Register of Members is updated accordingly by the Company.
  9. If the options lapse due to separation, the options remain with the Trust and Trust can issue fresh grant letters for the remaining options (based on the decision of the Compensation Committee).
  10. The cash received on exercise (by the employee) is used to repay loan taken by the Trust.
  11. Compensation cost to be recorded as if the Options were granted directly by the Company.

 Startups are you hearing us?

Disclaimer: This is not a legal opinion and should not be construed as one. Please speak with your attorney for any advice.