On November 2, 2009, the California Supreme Court issued an opinion in the case of Schachter v. Citigroup, Inc., S161385, addressing the forfeiture of unvested stock in lieu of compensation and the relationship to Labor Code sections 201, 202 and 219. This decision is of significant impact for employers with incentive compensation agreements that contain forfeiture provisions, and provides some much needed breathing room for employers to enforce legitimate plans.

Citigroup, Inc. offered a voluntary incentive stock compensation plan that provided participating employees with shares of restricted company stock in lieu of a portion of that employee's annual cash compensation. This plan included a provision that should an employee resign or be terminated for cause before such stock shares vested, the stock (and the portion of cash compensation that was directed to be paid as restricted stock) would be forfeited. The Supreme Court analyzed whether this forfeiture provision violated Labor Code sections 201, 202 and 219, which provides employees be paid all earned but unpaid wages upon termination or resignation and prohibiting any agreements to the contrary. The Court determined the provision did not violate the Labor Code sections because no earned, unpaid wage remained outstanding at termination based on the terms of the plan.

David Schachter was employed as a stockbroker by Smith Barney, Inc., now a subsidiary of Citigroup, Inc. from April 28, 1992 to March 29, 1996. Mr. Schachter was part of a group of key individuals who had the opportunity to participate in the Capital Accumulation Plan (the "Plan"), which provided the option to elect between 5 and 25% of participating employee's total compensation in the form of restricted stock that did not fully vest for a two year period after the election. The Plan further provided that if an employee voluntarily left the company or was terminated for cause before the two year period expired, the employee forfeited his right to the stock and the compensation the employee directed be paid in the form of the stock. If such employee was terminated without cause, however, that employee would receive a cash payment equal to the portion of the annual compensation paid for the forfeited stock.

Mr. Schachter enrolled in the Plan during three separate six month periods, but Mr. Schachter voluntarily terminated his employment in March 1996; prior to the expiration of the respective vesting periods. Mr. Schachter filed a putative class action alleging: (1) the Plan's forfeiture provision violated Labor Code sections 201 and 202, requiring prompt payment of all earned wages at the time of separation of employment; (2) it violated Labor Code section 221, prohibiting an employee from returning wages to an employer; and (3) it constituted the unlawful conversion of wages by forfeiting the percentage of annual compensation received in the form of restricted stock.

When Mr. Schachter executed the Plan election forms providing for less cash compensation and agreed to the provisions and rules of the Plan, he essentially renegotiated the terms of compensation with the company, and elected various of combinations of cash and restricted stock. By executing such an agreement, he further understood and accepted that the restricted stock would have limited and conditional present value that would not fully vest until two years later, if he remained employed. The Court of Appeal determined this necessarily meant he would not have earned the conditional interest in the shares until he remained with the company for that two year period. Thus, when he elected not to remain for that period, he did not earn, and had no right to, either the restricted stock or the funds used to purchase it. The Supreme Court agreed with this logic.

As incentive compensation is not earned until any condition(s) precedent to receiving such incentive compensation is satisfied, including remaining employed for a particular period of time, Mr. Schachter could not have yet earned such compensation. Indeed, by electing the restricted stock, which carried risk as well as reward, Mr. Schachter could not assert that he should have been paid in cash that portion he elected to receive in restricted stock. Rather, his "bargained for wages" were paid in full and the only element not paid was the restricted company stock that he never earned based on his choice to not perform the condition precedent of remaining employed for the two year vesting period. The Court further declined to extend the pro rata earning theory applicable to vacation through Suastez v. Plastic Dress Up Co., 31 Cal. 3d 774, 781 (1982) on the ground that such holding was limited to vacation pay and was not considered inducement for future services in the same way as incentive compensation. Thus, there were no earned but unpaid wages and therefore no violation of either Labor Code sections 201, 202 or 219.

Based on the reasoning of this decision, it is critical for employers to clearly define any conditions precedent or vesting requirements with respect to incentive compensation, and make such requirements clearly known to employees. While this decision is beneficial to employers, employers should nonetheless approach any situation involving a forfeiture of wages with caution and seek advice of counsel to ensure the conditions and analysis set forth by this decision and other relevant laws are satisfied.