In the first Court of Appeal decision following the Supreme Court's recent decision in Prachaseisoraedj v. Ralphs Grocery Co., Inc., 42 Cal.4th 217 (2007), the Second District upheld a compensation plan that allowed an employee to direct his employer to purchase shares in the company's stock on his behalf with a portion of his cash compensation. The court upheld the plan even though participants forfeited the stock and the money used to buy it if they were discharged or voluntarily terminated within two years. Schachter v. Citigroup, Inc., -- Cal.App.4th -- , 2008 WL 162244 (Cal. App. January 18, 2008) ("Schachter II").
The plan at issue was designed to encourage the retention of high-level employees. Under the plan, the employee directed a portion of his cash compensation be used for the purchase of company stock at 25 percent below the then market price. Id. at *1. For two years the stock was restricted, and could not be sold or transferred. During this time, the participating employee retained the right to receive dividends and to direct votes of the shares. If the employee voluntarily terminated his employment, or was terminated for cause during the two years, he forfeited the shares of stock and the money used to purchase them. Id. After two years, the shares of stock became fully vested with the employee, free of all restrictions. Id.
In 1994, the plaintiff signed an agreement directing his employer to pay him 5 percent of his total compensation "in the form of restricted stock out of all cash compensation." Id. He received shares of restricted stock in 1995 and 1996 in accordance with the plan's terms. Then on March 31, 1996, plaintiff voluntarily terminated his employment, forfeiting all shares of stock and the money used to purchase them. Id.
On summary judgment, plaintiff argued that the plan, in effect, simply deferred employee wages. The Labor Code provides that when an employee is discharged, or when an employee quits, "wages earned and unpaid at the time of the discharge are due and payable immediately." Cal. Labor Code §§ 201, 202. If the plan deferred payment of earned wages, the employee argued, then the failure to pay these wages upon termination would violate Sections 201 and 202. The plaintiff sought restitution of the purchase price of forefeited stock under Business & Professions Code §§ 17200 et seq., damages for conversion, and "waiting time" penalties under Labor Code § 203. Schachter v. Citigroup, Inc., 126 Cal.App.4th 726, 731 (2005) ("Schachter I") (reversing judgment on procedural grounds).
The Second District, however, held that these Labor Code sections were inapposite because the "economic reality" was that plaintiff had already been paid all cash wages due to him. Plaintiff chose to use his cash compensation by authorizing his employer to purchase stock on his behalf. Schachter II, 2008 WL 162244, at *4.
At most, the court held, the cash taken from the employee's paycheck for stock purchases was a permissible wage deduction. Id. at *5. Thus, there was no violation for the withholding because Labor Code section 224 permits deductions that are expressly authorized by the employee in writing, which plaintiff did here.
Moreover, the forfeiture provision did not violate the Labor Code. Plaintiff "received the full benefit of his bargain." Id. "As part of his negotiated compensation package, [plaintiff] requested and received . . . both a present and conditional interest in the form of shares of restricted stock." Id. Plaintiff received all bargained for compensation. The "[r]ealization of any additional benefit (including avoiding a loss on his investment purchase) was part of the risk, not a guarantee, of his chosen compensation bargain." Id.
Plaintiff argued that the compensation was the stock, and not the cash used to purchase it. Therefore, plaintiff asserted that he had not been paid wages earned because there was no ascertainable value to the restricted stock. In rejecting this argument, the court said that the Labor Code "does not prescribe how the value is to be determined or otherwise prohibit employees from negotiating a compensation package that includes as a part of their wages a conditional future interest in a valuable asset." Id. at 6. Plaintiff's bargain had real value, the "present right to receive dividends (and vote the shares) and a contingent future interest in freely marketable shares with a significant potential for a return greater than the cost of the stock." Id. Therefore, the court held, that the restricted shares of stock could constitute wages under the Labor Code.
Moreover, the court rejected plaintiff's argument that the plan violated Labor Code § 212, which provides that payment in checks or other "acknowledgement of indebtedness" must be "payable in cash, on demand, without discount." The court held that even if the shares of stock were paid in lieu of a cash payment "those shares were not given as instruments of indebtedness of compensation; to the contrary, they were the compensation." Id. at *7 (emphasis in original).
The court went on to state that the defendant employer would not have violated the Labor Code, even if the court took the view that plaintiff was never paid the compensation through any means. The court reasoned that a wage is not earned until certain agreed upon preconditions are met. Wages "may be contingent on future events, including the employee's continued employment as of a specific target date, without running afoul the Labor Code's prohibitions against the forfeiture of wages." Id. Therefore, there could be no violation where plaintiff agreed that his compensation would consist of cash payments and a retention-based conditional interest in stocks, with the latter being earned only if he remained with the employer for two years. Id. at *7-8. When the plaintiff left his employer, he had not perfected his right to payment, and thus had no right to receive either the restricted stock, or the funds used to purchase it.
As a practical matter, the Schachter decision provides employers with greater flexibility in the implementation of non traditional compensation plans designed to meet the unique needs of employers. Following this decision, employers should feel confident that restricted stock shares or conditional compensation plans, as part of a overall compensation scheme, will be favorably viewed by the courts.
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