Leave of Absence Policies for Equity Awards

Over the years, we have advised many companies on the considerations related to suspending vesting of equity awards and/or suspending participation in an employee stock purchase plan while an employee is on a leave of absence. This seems like a relatively straightforward concept. In practice, however, it can be difficult to get right and a challenge to administer.

When determining whether to adopt a leave policy, companies will want to consider:

• the proposed terms of the leave policy
• how to communicate the leave policy
• when to implement the leave policy
• local law requirements, and
• general administration

Each of these is discussed in more detail below.

As a preliminary comment, we generally recommend that companies implement a separate leave policy for their equity awards, distinct from other leave policies companies might be maintaining. The leave policy for equity awards needs to be adopted by the body responsible for administering the equity awards, usually the Board (or a committee of the Board) of the issuing company, because typically, the treatment prescribed under the leave policy will be viewed as a term of the awards.

By contrast, other leave policies are usually adopted by the employing entity because they affect the employment relationship. And, as most of you know, we want to keep the equity awards separate from the employment relationship to the greatest extent possible, to avoid entitlement/vested rights and other claims from employees. The comments below are based on the assumption that a separate leave policy for equity awards will be adopted.  

What terms to include in the leave policy

The point of the leave policy is typically to provide for suspended vesting while an employee is on leave. That said, companies will need to decide if suspension should occur immediately when an employee goes on leave, or only after a certain grace period. Further, companies need to decide if they want to treat all leaves the same (to the extent possible under local law), or if they want to impose suspension of vesting only for certain types of leaves. 

Companies also need to decide how the suspension will actually work: will the employee be allowed to resume vesting after they return from leave and have their vesting period extended by the duration of the leave, or will the employee simply not be allowed to vest during the leave but then have a “catch-up” vesting when they return from leave? Finally, companies need to decide to which awards/plans to apply the policy. Often, we see that companies will apply leave policies to options, restricted stock units and other LTI awards, but not to ESPP.

There are special rules regarding leaves under US tax regulations depending on the type of award. For statutory options, i.e., incentive stock options (“ISO”) and options under a tax-qualified ESPP, in order for the awards to retain tax-qualified status, the employee must remain employed within the company group at all times between the grant date and ending three months before the date of exercise / purchase under US Treas. Reg. § 1.421-1. Under that same regulation, the employment relationship is treated as continuing intact while the employee is on military leave, sick leave, or other bona fide leave if the period of such leave does not exceed three months, or longer, if the employee’s right to reemployment is protected either by statute or contract.

If the leave is longer than three months and the right to reemployment is not provided by statute or contract, then the employee’s employment will be deemed to terminate on the first date immediately following such three-month period. To be clear, these rules do not mean that companies could not adopt leave policies that allow employees to be on longer leaves (and retain their awards), but it means their awards could be disqualified. Accordingly, companies offering these types of statutory options will want to track the leaves for US taxpayers to ensure the exercise / purchase remains qualified.

For nonqualified stock options, nonqualified ESPP offerings, restricted stock and/or restricted stock unit type awards, there is no risk of disqualification if the employees are allowed to vest, exercise or continue to participate while on leave. Companies have more discretion to determine the length of the applicable grace period or whether to suspend vesting / participation at all. For these types of awards, some companies choose to have longer grace periods to give themselves time to (i) collect the necessary data from human resources on whether someone is out on leave, (ii) confirm the requirements under applicable law, (iii) determine whether suspension of vesting or participation is required or possible under the particular circumstances. Some companies take the position that they will only suspend vesting or participation if the employee is on a personal and unpaid leave. Others still choose to have the rule under the US tax regulation apply consistently across all programs and award types.

How to communicate the leave policy

It is important to consider how the leave policy will be communicated to employees. We see some companies include the relevant leave terms in the award agreement with the employee. The benefit of this approach is that the terms are clearly disclosed to the employee. Some companies like to have a separate stand-alone leave policy and then include a provision in the award agreement that states the award is subject to the company’s leave policy then in effect. We have also seen companies include the leave policy in other documents, e.g., resolutions, exhibits to grant policies, and so on. When the terms of the leave policy are included in a separate document and cross-referenced in the applicable award agreement, companies will want to ensure the leave policy is easily accessible by employees.

When to apply the leave policy

Where the leave policy is in a separate stand-alone document, the policy should be applied only to awards granted on or after the date the policy is approved. The leave policy would also need to be referenced in the applicable award agreement. If the leave policy is applied to outstanding awards, this would be viewed as a modification because those terms were not part of the original grant terms. We should also note that such a modification could result in awards losing their exemption from 409A if the vesting period is extended beyond the period originally provided in the award agreement. Further, the employee’s consent likely would be required because the modification would be viewed as adversely affecting the employee’s rights.

Local law requirements

When looking to implement the leave policy and suspend vesting / participation for a particular employee on leave, companies will need to review whether the vesting / participation can be suspended under local law. In terms of the process, the company will look to the policy and then analyze the particular scenario. For example, if the company’s leave policy provides for suspension of vesting after an employee has been on leave for six months (regardless of the type of leave), the company will need to review if the suspension is permissible in light of the type of leave under the law of the relevant country. 

Unfortunately, there is little consistency in the applicable rules and, usually, every scenario has to be reviewed on a case-by-case basis. As an example, while it will be problematic to suspend vesting during maternity leaves in many countries, there are countries in which vesting may be suspended even during a maternity leave provided the award agreement is governed by US law. On the other hand, we want to note there are a number of countries that have protected leaves that require continued vesting or participation for periods of six months or longer (e.g., Australia (paid personal leave / sick leave), Canada (parental leave, pregnancy / childbirth disability leave), France (medical leave, parental leave, some training leaves), UK (maternity leave, shared parental leave, adoption leave), among many others).

As such, global companies that have implemented a leave policy typically maintain information on the various US and country-specific leaves that is tailored to their particular policy and, even then, check with an outside advisor before suspending vesting / participation to not run afoul of local law.

We should also note that even when companies adopt leave policies that are neutral under their terms, the application could result in potential indirect discrimination claims where the leave policies are applied disproportionately to a certain category of people (e.g., women). Therefore, companies will want to know their employee populations and monitor how the leave policy is being applied.

Administration

As described above, the company will always need to determine (i) whether the leave has exceeded the applicable grace period, (ii) whether the vesting / participation can be suspended under the leave terms or policy, and (iii) whether the vesting / participation can be suspended under local law.

From an administrative perspective, this means there will need to be systems in place to ensure there is timely communication regarding when employees go on leave, the type of leave, and a process for tracking the duration of leave, so the relevant parties can manage the leave policy.

Once the relevant parties have the necessary data, they will need to have a process for reviewing and analyzing the data in light of the leave policy. This can be straightforward if it relates to a factual question (e.g., how long has the employee been on leave, is this type of leave covered by our leave policy). However, once there is a question of law, the analysis can be a bit more complicated (e.g., is this a protected leave, is there a right to reemployment, is this a paid leave under local law, and so on).

As noted above, to address these issues many companies have overviews of the various US and country-specific leaves, the duration of such leaves, whether vesting / participation can be suspended after the applicable grace period under the leave policy. However, even with these overviews, companies will want to confirm there has been no change in applicable law before suspending vesting / participation.

In summary, if your company has implemented or intends to implement a leave of absence policy, what is essential is (1) regular communication between human resources and the relevant stock and ESPP teams, (2) resources to determine the current legal requirements, and (3) systems for applying the leave policy on a consistent basis.