Dividing Stock Options During Divorce in California

Some assets are easy to divide in a divorce—for example, selling a car and dividing the profits is usually a no-brainer. Dividing stock options, however, is more complicated. Stock options in a private company or unvested options can be difficult to value and divide.

California courts have determined several ways to deal with the division of stock options in divorce.

What Are Stock Options?

A stock option is the right to buy or sell a stock at an agreed-upon price and date. Many employers, especially in California's tech industry, compensate executives and employees with stock options.

Here's a typical Silicon Valley scenario: One spouse lands a great job working for a start-up company, and as part of the compensation package, receives stock options subject to a four-year vesting schedule. The couple is unsure whether the start-up will continue as is, be acquired, or fold up like many other startups.

When the couple split up, they will have to figure out what to do with the stock options. The first step is to understand some of the foundations of marital property rights in California.

California Is a Community Property State

Under California law, there is a presumption that any assets—including stock options—acquired from the date of marriage until the date the parties separate (the "date of separation") are considered community property. Community property is typically divided equally between the spouses (a 50/50 split) in a divorce.

Stock Options Can Be Separate Property

Separate property is not part of the marital estate, which means the spouse that owns the separate property, owns it separately from their spouse (not jointly) and gets to keep it after the divorce. Separate property is not subject to division in a divorce. In California, separate property includes all property that is acquired by either spouse:

• before the marriage
• by gift or inheritance, or
• after the date of separation (see below).

So, generally speaking, any stock options granted to the employee spouse before the couple married or after the couple separated are considered the employee spouse's separate property, and not subject to division in the divorce.

The Date of Separation Establishes Separate Property Rights

The date of separation is the date that one spouse subjectively decided that the marriage was over and then objectively did something to implement that decision, such as moving out. The date of separation is very important because it establishes separate property rights.

Many divorcing couples argue over the exact date of separation, because it may have a major impact on which assets are considered community property (and thus subject to equal division) or separate property. For example, stock options received before the date of separation are considered community property and subject to equal division, but any options or other property received after that date are considered the separate property of the spouse that receives them.

Coming back to our hypothetical Silicon Valley couple, let's assume that there is no argument over the date of separation. However, the couple discovers that some of the options "vested" during the marriage and before the date of separation. They now have to determine how this might impact the division.

Dividing Vested vs. Unvested Stock Options

Once employee stock options vest, employees can exercise their options to buy shares in the company at a strike price, which is the fixed price that's typically stated in the original grant or stock option agreement between the employer and the employee.

But what about those options that were granted during marriage but had not vested before the date of separation? Some people may think that unvested options don't have any value because:

• employees have no control over these options, and
• unvested options are relinquished when an employee leaves the company – they can't take these options with them.

However, the courts in California disagree with this view, and have held that even though unvested options may not have a present fair market value, they are subject to division in a divorce.

The Hug and Nelson Formulas and Stock Options

So how does the court determine what portion of the options belong to the non-employee spouse? Generally, courts use one of several formulas (often called "time rules").

Two of the main time rule formulas used are the Hug formula and the Nelson formula. In deciding which formula to use, a judge will determine why the options were granted to the employee. (Marriage of Hug (1984) 154 Cal. App. 3d 780; Marriage of Nelson (1986) 177 Cal. App. 3d 150.)

The Hug formula

The Hug formula is used in cases where the options were primarily intended to attract the employee to the job and reward past services. The formula used in Hug is:

DOH – DOS
----------------- x Number of shares exercisable = Community Property Shares
DOH - DOE

(DOH = Date of Hire; DOS = Date of Separation; DOE = Date of "Exercisability" or vesting)

The Nelson Formula

The Nelson formula is used where the options were primarily intended as compensation for future performance and as an incentive to stay with the company. The formula used in Nelson is:

DOG – DOS
----------------- x Number of shares exercisable = Community Property Shares
DOG - DOE

(DOG = Date of Grant; DOS = Date of Separation; DOE = Date of Exercisability)

There are several other time rule formulas for other types of options, and the courts have wide discretion in deciding which formula (if any) to use, and how to divide the options.

Generally speaking, the longer the time between the date of separation and the date the options vest, the smaller the overall percentage of options that will be considered community property. For example, if a specific number of options vested one month after separation, then a significant portion of those shares would be considered community property subject to equal division (50/50). However, if the options vested several years after the date of separation, then a much smaller percentage would be considered community property.

Distributing the Options (or the Value of the Options)

After applying one of the time rules, the couple will know how many options each spouse is entitled to. The next step then would be to figure out how to distribute the options or their value.

Say, for example, it is determined that each spouse is entitled to 5,000 stock options in the employee spouse's company. Here are a few of the most common solutions the non-employee spouse may receive either the options or the value of the options:

• the non-employee spouse may give up the rights to the 5,000 stock options in exchange for some other asset or cash
• the company might agree to have the 5000 stock options transferred to the non-employee spouse's name
• the employee spouse may continue to hold the non-employee spouse's share of the options (5,000) in a constructive trust until they can be sold.

Get Help

Before you agree to give up any rights in your spouse's stock options, you should talk to an experienced divorce lawyer. You might need to talk to a financial expert to find out how much the stock options might be worth.

Learn more about California Property Division Laws and California Divorce and Family Law.