State:
July 09, 2024
In California, Stock Options Are Not Wages

by Nick Baltaxe

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Many companies, especially in the technology sphere, will provide their employees with options to buy stock at a predetermined exercise price. This is an opportunity to grow with the company and eventually sell the options for a significant profit if or when the company undergoes an initial public offering (IPO). Many employees sacrifice higher wages in exchange for stock options. However, a recent court decision has confirmed that stock options are not wages in the context of a retaliatory/wrongful termination claim.

Background

Gautam Shah began working for Skillz, Inc., in October 2015. Skillz is a mobile gaming company founded in 2012 that provides a platform for users to play video games and compete with others on their mobile devices. Shah was hired as a director of a new program the company was launching and was eventually given the title of Director of Finance and Strategy.

Upon hire, Shah signed both an employment contract and a notice of stock option grant, allowing him to buy stock options at a predetermined price. The stock options were set to vest on a four-year vesting schedule, with 25% of the 69,487 options vesting after one year, and 6.25% being vested every three months thereafter. The stock options that didn’t vest would be forfeited to the extent he left the company before they vested. Importantly, to the extent he was ever terminated for cause, his options expired on the date of his termination.

The notice of stock option grant mistakenly provided a two-year vesting schedule, and Skillz asked Shah to sign a “correction letter,” but he refused to do so. He also signed a “performance grant” in late 2016, providing him additional stock options in exchange for a salary reduction.

On January 22, 2018, Shah forwarded an email from his work account to his personal email account containing a confidential business report prepared by a consultant regarding Skillz’ potential future growth. The company didn’t believe there was a legitimate business reason for Shah to have sent the email to his personal email account. A committee was formed to investigate, and company counsel recommended terminating Shah for cause that day.

Although the committee never spoke with Shah, the Board agreed with the recommendation. That afternoon, he was terminated for cause, and although he tried to exercise his stock options, he was informed that being terminated for cause automatically terminates the options.

Shah eventually tried to exercise 100 options before being notified by Skillz that the options were void. As of the date of his termination, 39,086 of his initial options and all 21,000 of his additional “performance grant” options had vested.

In May 2019, Shah sued Skillz for breach of contract, wrongful termination, retaliation, breach of the implied covenant of good faith and fair dealing, and conversion. He claimed the email issue was a pretextual reason (a cover-up) for his termination, and the real reason was retaliation for asserting his rights to vested benefits and that Skillz breached the employment contract and notice of stock option grant. He sought to have the fully vested stock options granted and also sought tort (wrongful act) damages, punitive damages, and attorneys’ fees. He eventually dropped the breach of the implied covenant and conversion claims.

Trial Court’s Decision

Before trial, the court found the stock options were not “wages” under the labor code, which negated Shah’s retaliation and wrongful termination claims. The case proceeded to trial solely on his breach of contract claim.

The jury found Skillz breached the contracts by not allowing Shah to exercise his vested stock options under the pretext that just cause existed for his termination. It awarded a total of $11,557,173 in damages, finding the damages of the lost stock options should be measured using the price of stock after the lock-up period based on Shah’s testimony that he would have exercised all of the options that had vested as of his termination and would have held on to the stock until after the IPO.

Skillz asked the court for a new trial because it said there was no evidence it breached any contract. It also argued the jury’s award was improper because the damages should be measured as of the date of the breach—Shah’s termination. The court denied the request on the condition that Shah accept a reduction of the award to $4,358,358, which excluded lost stock options from the performance grant. He accepted the reduction, and the court entered judgment. Skillz then appealed the judgment, and Shah timely cross-appealed.

Appeals Court Favors Breach of Contract over Wage Loss

Skillz first contended it was entitled to a new trial based on errors in the jury instructions, which it alleged failed to identify any contractual obligation that was breached and impermissibly referenced the term “pretext.” The appeals court disagreed and decided the jury instructions and special verdict forms properly referenced the contract obligations Skillz breached. It held the jury was never asked to consider whether Shah was morally right to take the report but rather whether his dishonesty in doing so was just cause for termination. Because Skillz had only asked the jury to find just cause based on the alleged dishonesty and unclean hands, the jury’s finding that Shah didn’t engage in unclean hands necessarily showed that Skillz lacked cause to terminate him.

Skillz also asserted the damages amount was improper and that the damages should be calculated as of the date of the breach, while Shah believed the original jury verdict should be reinstated. The appeals court found no requirement under California law that the damages must be calculated at the date of breach. Instead, damages for the loss of stock options could be measured from a different date based on equitable considerations.

In his cross-appeal, Shah argued the dismissal of his tort claims for retaliation and wrongful termination was improper and that the court erred when it concluded stock options were not “wages.” He argued that Labor Code section 221 precludes an employer from attempting to take back any wages paid to an employee.

The appeals court held that stock options were not “wages” because they weren’t a specified (or even ascertainable) amount of money but, rather, only a contractual right to buy shares of stock. The appeals court agreed that this conclusion comported with the purpose behind Labor Code section 221 because avoiding secret kickbacks enabling the employer to avoid minimum wage laws was not a risk with stock options.

The court of appeal noted that this same conclusion wouldn’t apply to restricted stock shares, which have an ascertainable value and are immediately issued to the employee. It concluded this holding didn’t leave employees who are wrongfully denied their options without recourse because they can still pursue a breach of contract claim. Gautam Shah v. Skillz Inc. (California Court of Appeal, 1st Appellate District, 4/08/24).

Bottom Line

Because stock options aren’t considered “wages” for purposes of labor code violations, employees cannot seek tort damages and attorneys’ fees in certain wrongful termination or retaliation claims involving failure to pay stock options. However, this doesn’t apply to certain stock grants given to employees, such as restricted stock shares. Likewise, the employee still potentially has a breach of contract claim that can result in significant damage awards. Employers are best suited to use best practices before a termination “for cause,” including completion of a good-faith investigation (which requires interviewing the accused employee) and contacting counsel if there are any close calls.

Nick Baltaxe is an attorney with Duane Morris LLP in Los Angeles, California. Nick practices in the area of employment law with a focus on employment-related class action litigation and has experience defending corporations and individuals across a wide array of labor and employment disputes, including individual FEHA claims, wage and hour, class actions and PAGA claims. He can be reached at nbaltaxe@duanemorris.com.

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