Employee Stock Options/Ownership Plan is a widespread practice in the modern world, which, unlike other countries, is still a new practice in the field of corporate law in the Republic of Armenia.
Before the 2021 amendments, the RA Law “On Joint Stock Companies” (hereinafter referred to as “Law”) stipulated that “Employees of the company may be provided with employee stocks, which may be common or preferred, in accordance with the procedure established by the company charter. The employee’s stocks are distributed among the company’s employees at the expense of the special employee share fund for this purpose, from the stocks bought back by the company from its shareholders.” This mechanism was not flexible and did not have much application in Armenia. After the legislative amendments of 2021, the application of this institution became more regulated, allowing the distribution of stocks to employees through the additional allocation of shares instead of a special fund for employees of companies, moreover, the legal possibility of issuing financial derivatives was also introduced.
In the framework of this article, we will look into the main key regulations of Employee Stock Ownership (hereinafter referred to as “ESOP”) in the light of RA legislation.
What is ESOP and how it is being conducted?
For decades, many companies have tried to use different methods of motivating employees to increase their involvement in the company’s affairs, achieve long-term success, as well as increase the efficiency of the company’s operations. One of the policies used by companies is ESOP (Employee Stock Option Plan or Employee Stock Ownership Plan). The difference between these two concepts is that in the first case, the company gives the employee a stock option, and in the second case, it transfers ownership of a portion of the company’s stocks.
In general, the concept of ESOP can be given the following definition: It is a policy (regulation, program, other internal act) adopted by the company (corporation), according to which the latter provides for its employees (including the persons included in its management bodies) appropriate compensations for the equity capital of the company (corporation) or its parent organization. instruments (stocks, options, other equity instruments).
Moreover, within the framework of RA legislation, the company must be a joint-stock company, and if the company takes the step of employee shareholding, it should also take into account that after having 49 shareholders in the company, it should be reorganized into an open joint-stock company. At the same time, the employee’s ownership right to the stock must be registered in the securities accounting system: the register.
What are the benefits to the employee and the employer if they participate in the company’s ESOP?
The main advantage for the employees is the opportunity to become a shareholder of the company at a lower price. After acquiring ownership of the stocks, the employee has the choice to:
- Either sell his shares in whole or in part,
- Either retain ownership of all or part of his stocks without alienating them, to remain a shareholder of the company with all related rights (right to receive dividends, right to vote in general meetings, etc.).
This practice allows employees, among other things, access to more information about the company as shareholders. Employees may participate in the company’s decision-making, but the ESOP may limit the employee-shareholder’s right to vote on certain matters.
On the other hand, employee stock allows an employer to motivate and retain its employees by involving them in the company’s profit-making process. The company shows its trust in its employees and thus can contribute to increased productivity.
How can our lawyers help you with employee share ownership?
Our team of experienced lawyers is ready to advise on almost all aspects of ESOP, from the plan drafting to implementation. To make this process faster, smoother, and more efficient, our team is ready to:
- discuss the implementation of the ESOP,
- design the ESO plan,
- provide advice on the tax consequences of ESOP,
- provide legal support regarding stock transfer transactions,
- provide legal advice on the tax consequences of employee shareholding,
draft all necessary legal documents, etc.
What clauses should an ESO Plan contain?
According to RA legislation, the ESOP must include the following provisions:
- Classification of employees: Which employees are eligible to receive stock or stock options? Classification can be based on the employee’s position, and salary. The plan is a motivational tool, so it should be clear to the employee what the participation criteria are.
- Issuance of shares or options: the program should provide detailed procedures for the acquisition, use, transfer, and sale/repurchase of stocks or stock
- Privatization or concession: what are the privatization process and requirements, the mechanism for calculating ownership rights, which cannot be more than 3 years according to RA legislation?
- Pricing: what is the pricing mechanism for stocks/options?
- Rights and responsibilities of the employee after the vesting period of stocks or stock
- Rights and responsibilities of the employee in case of leaving the company.
The ESO plan is developed and approved by the company’s general meeting of shareholders.
What is an option; what is the difference between an option and a stock; and what is the vesting period?
In contrast to a stock, according to the RA legislation, a stock option is the right to buy or sell stocks at a certain price during a specified period. That period is called the “vesting period”, during which the employee acquires ownership of the stock. Usually, that period ranges from 3 to 5 years. With a stock option, the employee does not yet own the stock.
What are the other legal requirements to implement ESOP?
Firstly, under Article 41, Part 3 of the Law, “The total nominal value of the stocks distributed among the employees and provided as a result of the final calculation of derivative financial instruments shall not exceed the statutory capital, and the number of votes provided by these stocks shall not exceed 25 percent of the votes provided by the company’s voting shares.”
Moreover, it should be noted that RA legislation provides for the possibility of different classes of ordinary shares, so the company can provide employees with separate classes of stocks.
Secondly, according to Article 41, Part 5 of the Law, “Employees’ shares or derivative financial instruments are allocated (provided) among employees with their written consent. Employee shares or derivative financial instruments may be issued without payment, and the amount paid for the shares may be lower than the nominal value of the relevant type or class of shares of the company.“
Thirdly, based on the logic of Article 41, Part 9 of the Law, we can note that the employee-owners of the stock are given the same rights as defined by the Law and the statute for the owners of the corresponding type or class of stocks. That is, except for the limitations of Article 41 of the Law, shareholder-employees have the same rights as the owners of each type or class of stocks of the company, under the Law and the company’s charter. It also follows that, according to the legal regulations, the nominal value of the stocks of the employee should not differ from the nominal value of the corresponding type or class of stocks of the company.
Is there a prohibition on the alienation of stocks by employees?
Yes, the Law has limited the period of employee ownership of stocks. This means that the Law reserves the right to the company to limit the transfer of shares or options by employees to third parties, but not more than 3 years from the date of allocation (issuance) of stocks or derivative financial instruments to the given shareholder.
Can the company buy back the stocks allotted to the employee?
In the event of termination of the employment relationship with the employee, the Company has the right, but is not obligated, to buy back the employee’s shares at their market value, but not less than the nominal value. The Company shall not be entitled to such right in the event that the employment relationship is terminated on the basis of the employee’s retirement.
What are the tax consequences of employee stock options?
Although the Law provides for more detailed regulations related to the program, the tax consequences arising from employee share ownership are not so clear. However, it is clear that the remuneration received by the employees within the framework of the program, as a type of income received, should not be included in the tax base of income tax, but among the deductible incomes for the purpose of determining the tax base of income tax.
The Law entitles the heir(s) to claim or redeem those stocks from the company at market value but not less than par or exchange those stocks for other stocks of the company upon the death of an employee of the company who was granted ownership of the company’s stocks/options, such possibility is envisaged by the company’s charter.
Our team of experienced lawyers is ready to advise on almost all aspects of ESOP, from the plan drafting to implementation. To make this process faster, smoother, and more efficient, our team is ready to:
- discuss the implementation of the ESOP,
- design the ESO plan,
- provide advice on the tax consequences of ESOP,
- provide legal support regarding stock transfer transactions,
- provide legal advice on the tax consequences of employee shareholding,
draft all necessary legal documents, etc.
