Why your equity plan's forfeiture clause may not hold up

George Gershwin's It Ain't Necessarily So, with lyrics by Ira Gershwin, debuted in Porgy and Bess in 1935. The song playfully questioned whether accepted truths were, in fact, true at all.

Regular column readers know we often say the same thing about employment contracts. What appears to be clear on paper frequently turns out to be legally unenforceable.

The same is also true of another document employees often overlook entirely: the equity compensation plan.

Increasingly, executives and professionals are paid through salary, bonuses and an ownership stake in their employer. That equity may take the form of restricted share units (RSUs), stock options, deferred share units, performance share units or outright shares. In many cases, it represents the most valuable part of the employee's compensation package.

Yet remarkably, some employees have never even seen the document that governs it. And of those that have, few have thoroughly read it.

The details are usually buried in a separate "plan" rather than in the employment agreement itself. That plan determines when awards vest, when they may be exercised and, most importantly, what happens if employment ends.

Almost invariably, the employer points to a clause stating that all unvested awards are forfeited immediately upon termination.

The starting point in every wrongful dismissal case is simple. An employee wrongfully dismissed is entitled to the financial position they would have occupied had they continued working throughout their reasonable notice period. That includes every component of compensation they would have received – salary, bonuses, benefits and, unless validly excluded, equity compensation.

This is where many employers – and surprisingly, many employees – misunderstand the law.

The forfeiture clause in the equity plan is not automatically enforceable. Courts have repeatedly held that a termination clause in an employment contract that purports to strip an employee of common law notice rights must be clear and unambiguous. If the equity plan's forfeiture language is buried in a separate document, or if the employee was never given a copy of the plan, a judge may find the clause unenforceable.

The key question is whether the employee understood and agreed to the forfeiture at the time of hiring. If the plan was referenced only in passing, or if the employee signed an offer letter that simply said "equity is governed by the company's stock option plan" without attaching the plan itself, the employer may be on weak ground.

Several Canadian cases illustrate this. In Battiston v. Microsoft Canada Inc., the Ontario Court of Appeal held that an employee's entitlement to RSUs during the notice period depended on the language of the plan and whether the termination clause in the employment contract was valid. When the termination clause was found to be unenforceable, the employee was entitled to the RSUs that would have vested during the reasonable notice period.

The same reasoning applies to stock options, performance share units and deferred share units. The compensation an employee would have earned during the notice period is not limited to salary.

What does this mean for employees? First, read the equity plan before signing anything. If the plan says unvested awards are forfeited on termination for any reason, ask whether that language would survive a court challenge. Second, keep a copy of the plan and any amendments. If the employer changes the plan after you join, the original terms may still govern.

For employers, the lesson is equally clear. A forfeiture clause buried in a separate plan, without clear cross-reference in the employment agreement, may not protect you. The safest approach is to include the forfeiture language directly in the employment contract, with a clear statement that the employee has received and read the equity plan.

The courts have made one thing plain. Equity compensation is real compensation. And the rules that govern it are subject to the same scrutiny as any other term of employment.