Treatment of Equity-Based Awards in Divorce

Divorces that involve equity in a business are complicated. Because business interests can be considered marital property, they may be subject to equitable distribution. Unfortunately, any transfer of equity can upset the balance of ownership in a company. Suddenly, a spouse who was not an owner could suddenly gain equity and a say in how a business is run.

At Lawrence Law Office, we have helped many business owners successfully complete a divorce. When equity is in play, however, our focus broadens to include preserving our client’s interest in a way that creates the fewest headaches.

How to Transfer Equity

Deciding how to transfer equity requires taking a close look at how assets are held. When they are part of a voluntary employer-sponsored benefit plan, then the Employee Retirement Income Security Act of 1974 (ERISA) comes into play. ERISA is a federal law that requires a party to obtain a Qualified Domestic Relations Order (QDRO) before dividing a 401k retirement plan. Once the plan sponsor receives a valid QDRO, the sponsor is obligated to comply and divide the account.

Not all equity is held in this type of plan, however. If not, then the equity plans are not subject to ERISA, so the plan sponsor will not have to comply with a QDRO. The company therefore does not have to transfer the shares to the spouse who receives them under the divorce decree. Instead, the plan could instead transfer the economic value of the shares.

Actual Transfer versus Economic Interest

If a stock plan is not subject to a QDRO, then there are two approaches to dividing it up: transfer the economic interest of the award or transfer the actual shares. Let’s look at how each situation plays out.

Economic Interest

Here, only the economic interest of the shares is transferred. But the shares stay in the name of the spouse who owned them before divorce. However, the spouse who receives the shares can direct the exercise of any options and is entitled to shares upon the vesting of awards.

This type of transfer is easy on the plan administrator, who still only needs to deal with the employee whose name is still on the stock. Also, any transfer would disqualify Incentive Stock Options from preferential tax treatment. Transferring the economic interest does not.

There are some challenges, however, with this approach. The ex-spouses would need to communicate effectively so that all transactions can be undertaken for the benefit of the transferee spouse, who is not an employee. Given the nature of many divorces, this will not work.

There are also tax considerations. The employee spouse who keeps the award will have to pay taxes on it, which might mean he or she must seek reimbursement from the ex-spouse. Getting this reimbursement can be difficult.

Trading the stock can also be a challenge, since it might be subject to blackout periods to not run afoul of insider trading laws.

Actual Transfer

An actual transfer is what it sounds like. The ex-spouse getting the equity (the transferee) becomes the owner of the equity. The grantee spouse ceases to be the holder of the equity.

There are some advantages to this approach. One is control. The ex-spouses do not need to deal with each other after the transfer is completed. This can be a benefit if the divorce is not amicable and the couple will no longer communicate well.

The ex-spouse who receives the equity will no longer be subject to blackout periods. He or she also should be exempt from Section 16 reporting.

Sometimes, however, actual transfer is prohibited for a variety of reasons. Companies might find reporting requirements unduly burdensome or they might want to limit who can become an owner in a company. Before deciding on how to divide equity, you should meet with an attorney who is experienced in this area of law.

Release of Claims

Some business owners are liable for business debts and obligations. If so, then the parties must exercise extreme caution when transferring equity.

For example, the ex-spouse receiving the equity wants to make sure that the transferor spouse is releasing all of their interests with the transfer. If not, then he or she could burden the transferee with legal obligations unknowingly.

The transferor spouse should also seek indemnity from the company in the event he or she is named as a defendant in future litigation. A mutual release of claims is also often appropriate.

Get the Legal Help You Need

As the foregoing makes clear, equity-based awards in divorce raise many thorny issues. Obtain the legal help you need by contacting Lawrence Law Office to schedule an initial consultation.