Restricted stock units (RSUs) are becoming a more common type of compensation in California.  Instead of the employee receiving stock shares immediately, they are granted according to a vesting plan and distribution schedule.  The vesting schedule is very important and should be clearly understood.

The employee will need to stay with the company for a certain period of time or achieve performance targets before being entitled to the shares. Upon vesting, the shares are considered income for the employee.  A percentage of the shares are withheld by the company for income taxes. The employee receives the remaining (after-tax) shares.

California law is vague when it comes to dividing RSUs in a divorce. There is no single rule or formula. In fact, courts are allowed to craft a different solution for each different situation.

RSUs in a divorce can be complicated.  There’s often room for negotiation.  As with other assets in a divorce, it’s prudent to approach them as follows:

• List them out and understand them (including the vesting schedule) fully.
• Characterize them as community or separate property or a mixture of the two. If a mixture, try to work out and agree upon the percentages of the shares that are community and separate property.
• Value them.
• Negotiate who will receive them or exactly how they will be divided.

Characterizing

In general, anything (including RSUs) earned during a marriage is community property.  California law sees it this way whether or not during the marriage the actual compensation or full vesting has occurred.  RSUs earned before marriage or after separation are separate property.

But sometimes they are earned both inside and outside of the period of the marriage.  Courts have noted that they could be construed, depending on the particular facts of the case, as compensation for either past, present or future services or a combination of these.  And sometimes the company’s intention behind the grant of the RSUs is not entirely clear.

RSUs Granted During the Marriage and Vested Afterwards

The most common issue concerning Restricted Stock Units in California divorces arises when they were granted during the marriage but vest after the couple’s date of separation.  California appellate case law has two “time rule” formulas that can be applied to such RSUs.  These are different formulas to reflect different possible reasons they were granted to the employee spouse, e.g.:

• to attract the employee to the job;
• as a reward for past performance;
• as an incentive to continue working for the company; and/or
• as an incentive for high future performance.

The Hug case viewed them as a form of deferred compensation.  The Hug formula says that the fraction of the RSUs that are community property is (the period of time between when the employee started work for the company and the couple’s date of separation) divided by (the period of time between when the employee started work for the company and the date the RSUs vest).  If, for example, the employee worked for the company during the marriage for 36 months prior to the date of separation and the RSUs don’t vest until 12 months after separation, 36 / (36+12) = 3/4 of them would be considered community property.

The Nelson case viewed them as primarily future incentives for performance.  The Nelson formula says that the fraction of the RSUs that are community property is (the period of time between when they were granted and the couple’s date of separation) divided by (the period of time between when they were granted and the date they vest).  If, for example, they were granted during the marriage 12 months prior to the date of separation and don’t vest until 36 months after separation, 12 / (12+36) = 1/4 of the RSUs would be considered community property.

Which formula to apply?  It depends on the facts of your situation.  If you are negotiating a settlement, perhaps with the help of a divorce mediator, you get to choose and you may come up with your own formula.

Valuing RSUs

If the employee granted the RSUs leaves the company before they vest, their value may end up being zero.  Therefore, it may be tempting to consider unvested ones to have a value of zero.  However, the law does not see it this way.  Even if only part of the vesting period is during the marriage, and they are still unvested, the marital community has earned some interest in them.

In a divorce, what price should you apply to the RSU shares?  If the court decides the matter, the court will normally use the current market price.  There may be some logic in using the market price on the couple’s date of separation.  But the law generally indicates that they would be valued with a current market price.

Options for Division

When working out your own settlement, you can be creative as regards the RSUs.  When at least some portion of them are community property, here are some common options for giving the non-employee spouse his/her share:

• Sell some vested RSU shares to generate cash. Note that there may be capital gains tax to pay due to the sale;
• Agree to wait until the they vest and then sell shares to generate cash for the non-employee spouse. Again there may be capital gains tax to pay;
• Give the non-employee spouse other marital assets equal in value to their share of the community property RSUs.