How are Incentive Stock Options Treated in Bankruptcy?


Many companies that are publicly held companies and privately held give employees incentive stock options each year.  These shares usually vest at a predetermined percentage each year the employee stays employed by the company.  The company allows the stock to vest over a period of time to ensure the employee to make continued efforts on behalf of the company to receive the full grant of stock options.  The language of incentive plans may differ significantly.  This article discusses how purely incentive stock programs are treated if the stock incentive plan is not a qualified retirement account.  The specific language of a plan may make this article not applicable.  To determine the treatment of your incentive stock options when filing bankruptcy you should seek the counsel of an experienced attorney in your jurisdiction.

Most stock incentive plans have a section which defines the purpose of the plan.  When determining how the stock is treated the purpose section will most likely control.  Many plans will have language that provides the stock incentive plans is to motivate key employees to produce a superior return to the stockholders of the company and promote recruiting and retention of talented key positions.  This means that the plan is most likely not meant for retirement purposes or designed and used for retirement purposes.  The fact that these same companies usually have a 401k plan, or other retirement plan for the employee to participate in, is further evidence that their stock incentive plan is not for retirement purposes.  If the plan is not for retirement purposes or designed and used for retirement purposes the plan cannot be protected or exempted in bankruptcy as a qualified retirement account.

At the same time the stock incentive plan may not have to be solely used for retirement purposes though.  The stock incentive plan may have dual purposes such as supplementing income and to provide for retirement too.  The purpose of the plan must be scrutinized closely to determine if the company has designed for a dual purpose.

The Court will also look to see how the employee has used the stock incentive plan.  If the employee has exercised stock options prior to the filing of the bankruptcy case, the use of the funds received will be a factor as to how the plan is being used.  If the funds are used to improve a home or buy a car, theses uses of the funds are clearly not for retirement purposes.

In addition, a stock incentive plan may still be protected if the plan is subject to ERISA (Employee Retirement Income Security Act).  Whether the plan is subject to ERISA is again a fact based analysis as to how the plan is administered and the purpose and nature of use of the funds.  Factors include if payments under the plan are made after retirement, or skewed towards retirement, communications regarding the plan indicate the plan is maintained for purpose of maintaining retirement, or if the surrounding circumstances provide a reasonable person can ascertain the intended benefits are for retirement purposes.

The bottom line is if you have a stock incentive plan in which you have received stock options a close examination of the stated purpose of the plan, how the plan is administered, and how the funds can be used and when must be reviewed in detail to determine whether the plan can be protected in bankruptcy.

For more information regarding stock incentive plans and bankruptcy please contact our Oakland bankruptcy lawyer or bankruptcy attorney to determine your rights when filing for bankruptcy protection under Chapter 7 or Chapter 13 of the Bankruptcy Code.