Allocating Stock Options Between Community and Separate Property

By George H. Norton, of Counsel, Lakin · Spears, and Garrett C. Dailey, President, Attorney's Briefcase, Inc.

Reproduced from commentary in Lawgic's California Pre/Post Marital Agreements

If options are granted before marriage but require that the employee remain with the company after the parties' date of marriage in order for them to vest, then there must be an allocation of the options between community and separate property interests. In re Marriage of Hug (1984) 154 Cal.App.3d 780, 201 Cal.Rptr. 676 allows a court to equitably allocate options based on the specific facts of each case. No one formula must be automatically applied in any individual case. Although the trial court retains broad discretion to arrive at an equitable method, most judges recognize the time rule as being an accepted means of accomplishing that end.

George Norton believes that in most cases options are earned in equal increments over the entire period of a grant and that the "Norton Method" should be applied in most cases. Under the Norton Method, a single grant is allocated by looking at the entire period from commencement of earning to full vesting and treating as community property that fraction that represents the time during that period in which the parties were married and living together. The Norton formula may be expressed by the following:

TM/(DOE to DOVFull) x Total Grant = CP shares

DOE = Date earning of first option under grant commences

DOVFull = Date of full vesting

TM = Time married and living together from DOE to DOVFull

In In re Marriage of Harrison (1986) 179 Cal.App.3d 1216, 225 Cal.Rptr. 234 the appellate court applied a formula that has front-weight characteristics, i.e., efforts in the beginning of the vesting period are deemed to have more value than efforts later. Use of the Harrison Method front-weights the value of the earner's efforts despite the fact that the earner does not receive a front-weighted vesting. Under the Harrison Method, each block within a single grant is allocated separately by looking at the period from commencement of earning of the first option in the grant to the date on which that block vests and treating as community property that fraction that represents the time during that period in which the parties were married and living together. The allocations for each block are then added together to get the total allocation for the entire grant. The Harrison formula may be expressed by the following:

SUM of . . . TM/(DOE to DOVBlock) x Block = CP shares

DOE = Date earning of first option under grant commences

DOVBlock = Date block vests

TM = Time married and living together from DOE to DOVBlock

In a post-marriage determination, the Harrison (front-weighting approach) benefits the community but in a premarital agreement it will benefit the party with the options. The attorneys for the parties should understand the approach taken and carefully decide which formula they choose to use and even consider their own formula which may have elements discussed in the case of Marriage of Hug.

Note that the date the options are exercised is not a consideration in determining the community share.

As emphasized in In re Marriage of Hug, the time rule is not the only method that may be used to allocate options between separate and community interests. It may be that all of the work to earn them was done before marriage and all the employee has to do is survive in order for them to vest. In situations such as this, a method that allocates a greater share to the separate property may well be the more equitable manner of characterization.

Remember to provide for the allocation of the associated income tax consequences. Unlike most assets, income tax consequences are usually taken into consideration when valuing and/or dividing stock options. See In re Marriage of Nelson (1986) 177 Cal.App.3d 150, 222 Cal.Rptr. 790 and In re Marriage of Harrison, supra, 179 Cal.App.3d 1216.