Re-evaluating ESOPs in times of the COVID-19 pandemic

The company will need to prepare an ESOP scheme, pass necessary resolutions and frame a separate stock option grant letter for each employee who can participate in the scheme. Such essential groundwork is often neglected by employers while offering employees their ESOP entitlements in the appointment letters. It is incumbent on companies, particularly those companies engaged in raising funds, to take the utmost care in ensuring the ESOP scheme is correctly put in place before the ESOPs are taken into account to calculate fully diluted capitalization tables.

The details of granting, vesting, and exercise of the stock options being offered, including the timelines, trigger events, lock-in period restrictions, and other conditions should be clearly spelt out in the ESOP scheme and/or the grant letters. Any variation in the terms of the originally approved ESOP would need shareholders’ approval and comply with such other conditions as prescribed under the Companies Act, 2013 (and the rules formulated thereunder).

By definition, an ESOP is for the benefit of a company’s employees, directors, and the employees of its holding company(ies) and/or subsidiaries. Typically, neither consultants nor independent directors are allowed to participate in ESOPs. Even more importantly, founders or promoters of a company cannot participate in an ESOP unless the company is a registered start-up under Indian law. If the intent is to allow founders or promoters of a company to participate in such stock benefit schemes, companies will need to adopt alternate structures (which are discussed briefly here).

Employees and directors of companies in India are also allowed to participate in ESOPs of their holding companies outside India, either under a cashless scheme or where a price component is involved. However, if an employee or a director in India were to exercise such an option, several tax-related compliances are applicable, and these should be considered carefully before opting for participation.

Companies that are not intent on adopting full-fledged ESOP schemes may prefer to choose a “phantom stock option scheme” where, instead of stock options and shares, employees are given the benefit of notional shares and appreciation in the value thereof. Some companies may also allot shares to an employee welfare trust upfront, which can then be transferred by the trust to employees. or as may be permitted by the trust and scheme documents.

Both employees and employers must pay close attention to the manner in which ESOPs will be dealt with, in the event that the employer company undergoes an acquisition or merger. Employees must also clearly understand the terms of vesting of the company’s ESOP, and its granting and vesting schedule, all of which affect their actual benefit from the scheme. Further, the employee must be clear on the rules governing her ESOP in the event that she resigns/retires, or her services are terminated by the employer. It is likely that the employee will still be able to exercise the stock options for a certain period after the employment has ended, depending on the terms of the scheme.

As with all things equity, the impact of the current pandemic and resultant restrictions on ESOPs remains to be seen. However, employees must carefully consider the value of their stock options, and the terms of the ESOP of their employer company, in the event that they consider resigning from their job or the employer company is likely to downsize and offer a severance package. Uncertain times need certain cautions.