Otley v. Otley

⁵⁴³ JAMES R. EYLER, Judge. This case presents issues involving marital property and child support. The principal issue is whether corporate stock options that are unexercisable and have no market value at the time of divorce can constitute marital property subject to distribution, by court order, on an if, as, and when basis. We shall answer that question in the affirmative and discuss computation of the marital portion of such options.

As a result of our answer to the question, we shall reverse the judgment of the circuit court. We perceive no other error. FACTUAL BACKGROUND On February 3, 2000,' Theresa Otley, appellant, filed a complaint for absolute divorce and other relief in the Circuit Court for Montgomery County against Christopher Otley, appellee. Appellee filed a counterclaim for a limited divorce and other relief.

The parties were married on March 23, 1985, and separated on January 23, 2000. The parties have two children, ages 14 and 11. Appellant has a bachelor’s degree and a master’s equivalency degree in early childhood special education. During the marriage, appellant was employed by the Montgomery County Public Schools as a special education teacher.

In that capacity, appellant worked full time until the birth of the parties’ first child in 1988, and thereafter, worked seven-tenths of a full schedule, or 5.6 hours per day. During the marriage, appellee worked for various employers as a financial control officer. In 1999, appellee began working for Destiny Health, Inc. as financial controller. Pursuant to a written employment agreement, appellee received a salary, bonus eligibility, and stock options, the latter pursuant to a stock option agreement (Option Agreement).

The Option Agreement gave appellee the right to purchase 54,176 shares of stock issued by his employer at $1 per share. The grant of the option to purchase was subject to a vesting ⁵⁴⁴ schedule. The Option Agreement provided that the right to exercise an option to purchase 10,000 shares (Founders’ Stock Option) was “earned and vested immediately” 1 upon execution of appellee’s employment agreement and related documents. Appellee exercised that option in January or February, 2000.

The right to exercise the remaining option to purchase 44,176 shares (First Option) was “earned and vested” as follows: twenty-five per cent (approximately 11,000 shares) on July 1, 2000; twenty five per cent on July 1, 2001; twenty five per cent on July 1, 2002; and twenty-five per cent on July 1, 2003. All vested portions of the First Option had to be exercised within thirty days following July 1, 2003, or they were forfeited. As of the time of trial in May 2000, the right to exercise the First Option with respect to the first twenty-five per cent of shares had vested, but appellee had not exercised it. Appellee testified that he had not exercised the right because the fair market value of the shares was approximately fifty cents per share, which was less than the option price.

The Option Agreement also provided that, if employment ceased, for any reason, the unexercised but vested portions of the First Option could be exercised for a period of three months after termination, subject to certain specified conditions. In the event of appellee’s disability or death, the vested portions of the First Option could be exercised for a period of twelve months following disability or death by appellee’s legal representative. The First Option became exercisable in full in the event of a change in control of appellee’s employer, as described in the Option Agreement. Finally, the Option Agreement recited that it was binding, and appellee’s rights under it could not be assigned or transferred.

At the time of separation of the parties, appellant earned $39,000 per year, and appellee earned a base salary of $107,000 per year. At the time of trial, appellant earned ⁵⁴⁵ $48,000 per year. Appellee earned a base salary of $113,480 and had recently received a $16,000 bonus. When the parties separated, they agreed on a division of their then liquid funds.

Appellee used $10,000 of those funds to exercise the Founder’s Stock Option for 10,000 shares. At the time of separation or soon thereafter, the parties also agreed that they would have joint legal custody of the children and appellant would be the custodial parent, subject to an agreed visitation schedule. On February 1, 2000, appellee began paying appellant $1,346 per month child support, also by agreement. On October 20, 2000, at the time of the hearing on appellant’s claim for pendente lite relief, the court entered a consent order.

Pursuant to that order, appellee began paying appellant $2,000 per month alimony and $952 per month child support. At that time or thereafter, the parties agreed that the $1,346 per month previously paid would be treated as alimony for income tax purposes. On May 2, 2001, open and unsettled issues were tried on their merits, and on August 1, 2001, the court entered judgment. The court granted an absolute divorce, awarded alimony to appellant in the amount of $2,000 per month for 96 months, child support to appellant in the amount of $952 per month, and $3,500 to appellant for attorney’s fees.

Pursuant to the agreement of the parties prior to trial, the court ordered joint legal custody to the parties, physical custody to appellant, visitation rights to appellee, use and possession of the marital home and personal property therein to appellant for a period of three years, and equal division of marital property. The court stated that, in light of the parties’ agreement to divide marital property equally, there was no need to address the question of whether there should be a monetary award. With respect to the division of marital property, prior to the presentation of evidence, the parties submitted a joint statement of marital and non-marital property. The statement included agreed values for each item of property, except for ⁵⁴⁶ appellant’s defined benefit pension plan and an item identified as “Destiny Stock Options.” Under a column headed “Fair Market Value,” the entry for appellant’s pension plan and the entry for the stock options was “if, as, when.” Of particular significance to this appeal, the court held that “unexercised stock options in Destiny Health Care Inc. are not marital property because no value could be proven at the time of trial.” ISSUES Appellant contends that the court erred (1) in holding that the unexercised portions of the First Option had to have value for the court to order distribution on an if, as, and when basis, even though the parties agreed that the option otherwise met the definition of marital property and further agreed to divide marital property on an equal basis; and (2) in not increasing the amount of child support and making it retroactive to the date of filing of the complaint. 2 With respect to the first issue, appellant requests an order that appellant is to receive, on an if, as, and when basis, fifty per cent of any profit realized on shares of stock acquired by appellee pursuant to an exercise of the First Option.

With respect to the second issue, arguing that the court did not make appropriate findings, appellant requests that this case be remanded to the circuit court to further address the issue. Appellee filed a cross appeal and •contends that the court erred in not making findings with respect to two bank accounts that were first disclosed by appellant during her testimony. ⁵⁴⁷ DISCUSSION 0) Before further addressing the particular issues herein, we pause to set forth the relevant conceptual framework. When identifying and dividing marital property in a divorce proceeding, a court must follow a three-step process. Md. Code Ann. (1999 Repl.Vol., 2001 Supp.), Fam.

Law §§ 8-203— 8-205 (hereinafter FL §§ 8-203 — 8-205). In the first step, the court determines what property is marital. FL § 8-203. In the event of a dispute, the court makes the final determination.

Id. In making this determination, the court must consider FL § 8-201 (e), which classifies all property acquired during the marriage as marital unless it was given as a gift or inheritance to one spouse, excluded by a valid agreement, or is directly traceable to one of those sources or to property acquired prior to the marriage. In the second step of this process, the court assesses the value of all marital property. FL § 8-204.

Section 8-204(b)(1) of the Family Law article provides that a court “need not determine the value of a pension, retirement, profit sharing, or deferred compensation plan” unless a party has given notice, as required in subsection (2), that the party objects to a distribution on an if, as, and when basis. Finally, in the third step, the court may transfer ownership of an interest in a pension, retirement, profit sharing, or deferred compensation plan, or grant a monetary award, or both, as an adjustment of the rights of the parties. FL § 8-205. In determining the amount and method of payment of an award or terms of transfer of ownership of an interest, the court shall consider the factors set forth in FL § 8-205(b).

In the case before us, the circuit court found that the unexercised portions of the First Option were not “deferred compensation” and did not fall within any of the other exceptions in section 8-204(b)(l). Consequently, the court concluded that it was required to value the option, and because there was no evidence that it had any value, the court could not order its distribution as marital property. ⁵⁴⁸ The portion of the court’s order addressing the First Option applied to the unexercised right to acquire approximately 44.000 shares. At trial, there was no dispute with respect to the Founders’ Stock Option to acquire 10,000 shares, which had been exercised prior to trial. The parties agreed that those shares were marital property.

On appeal, appellee concedes that the court erred with respect to the right to acquire approximately 11,000 shares that vested on July 1, 2000. In other words, appellee concedes that the right to acquire those shares constituted marital property, subject to distribution on an if, as, and when basis. Appellee maintains, however, that the portions of the First Option that had not vested as of the time of trial — the right to acquire the remaining shares (approximately 33,000 shares)— do not qualify as marital property. We address the disposition of the unvested portions of the First Option in the context of the three-step process.

Step One: Determining What is Marital Property This Court considered the question of whether unexercised and unvested stock options can constitute marital property in Green v. Green, 64 Md.App. 122 , 494 A.2d 721 (1985). The parties disagree with respect to the holding in Green . To the extent that Green requires clarification, we attempt to do so now. In that case, the husband had a stock option plan that allowed him to purchase a total of 20,000 shares of his employer’s stock exercisable over five years in 25% installments.

Id. at 131-32 , 494 A.2d 721 . At the time of exercise, Mr. Green had to be an employee or his employment must have been recently terminated (within ninety days). Prior to trial, Mr. Green had exercised his right to purchase a total of 15.000 shares. Id.

Of the remaining 5,000 shares, the right to purchase one-half, or 2,500 shares, had vested and could be exercised at the time of trial. The right to purchase the other 2,500 shares could not be exercised at that time, i.e., they were unvested. Mr. Green had to continue to work for his employer in order for the right to purchase the remaining 2,500 ⁵⁴⁹ shares to vest. Mr. Green’s rights in the stock were nontransferable except by will or the laws of intestacy.

In determining whether the option constituted marital property, we first considered whether it was “property.” Id. at 133 , 494 A.2d 721 . We determined that stock options, whether vested or unvested, are property because: As with pension plans, restricted stock option plans [ ] are a form of employee compensation, providing to the employee the right to accept within a prescribed time period and under certain conditions the corporate employer’s irrevocable offer to sell its stock at the price quoted. If the employer attempts to withdraw that offer, the employee has ‘a chose in action’ in contract against the employer. We therefore conclude that stock option plans, like other benefits in an employee’s compensation package, constitute ‘property’ as used in the definition of marital property.

Id. at 136 , 494 A.2d 721 . Because the option was acquired during the marriage, we concluded that at least some portion of the stock option was marital property under FL § 8-201(e). We see no difference between the unvested and unexercised right to purchase 2,500 shares of stock in the Green case, and appellee’s unvested and unexercised right to purchase 33,000 shares in the case before us. Despite the fact that appellee has to perform work in the future, after dissolution of the marriage, the option itself was acquired during the marriage.

Property includes “obligations, rights and other intangibles as well as physical things.” Id. at 134 , 494 A.2d 721 (citations omitted). In Green , we noted that unvested stock options “can be described as the right to choose whether or not to purchase” the stock in the future. Id. at 137 , 494 A.2d 721 . Green was decided in 1985.

More recently, the Court of Appeals considered a stock option plan and treated it as a type of deferred compensation, as the term is used in section 8 of the Family Law Article. In Klingenberg v. Klingenberg, 342 Md. 315 , 675 A.2d 551 (1996), a stock option agreement allowed Mr. Klingenberg to purchase 15 shares of stock in the ⁵⁵⁰ company that employed him. Although he exercised the option during marriage, the agreement provided that the shares were his exclusively, and it limited his ability to sell the shares on the open market. Id. at 321-22 , 675 A.2d 551 .

The employer agreed to repurchase the shares at a generous valuation in the event of Mr. Klingenberg’s retirement, death, or disability. Mrs. Klingenberg argued that, because the stock option was deferred compensation, it fell within FL § 8-205, and the court could re-title her portion of the shares in her name. The Court of Appeals decided that the stock option was a type of deferred compensation and remanded the case to the circuit court to address disposition under FL § 8-205. Id. at 325, 675 A.2d 551 .

The Court of Appeals noted that deferred compensation generally means earning money in one year but not receiving that money until a subsequent tax year. Id. at 328 , 675 A.2d 551 . The Court of Appeals reasoned, however, that “while some deferred compensation plans may ‘simply delay distribution of cash payments to employees,’ a deferred compensation plan may. also accomplish other goals, such as tying receipt of the deferred compensation to continued performance by the employee or including covenants not to compete.” Id. at 328 , 675 A.2d 551 (citations omitted). The Court noted that the stock option plan was designed to retain top company officials, and the full value of the plan would not materialize unless the employee remained with the company until retirement.

Id. at 329 , 675 A.2d 551 . The Court of Appeals concluded that the stock option plan was a type of deferred compensation' contemplated by FL § 8-205. Id. In Klingenberg , the option to purchase was exercised during marriage; thus the operative portion of the plan before the Court was the restriction on the transfer of stock.

Presumably, the restriction on transfer negatively affected its value. The employer, on the other hand, agreed to pay a generous value if Mr. Klingenberg remained employed until retirement, death, or disability. In the case before us, the transfer of stock was restricted, but it was subject to a right of first refusal by the employer and, if not exercised, by non-selling shareholders. There was no repurchase agreement, and there was no ⁵⁵¹ set price.

Despite these differences, our holding in Green is consistent with the discussion in Klingenberg , and Green remains viable. Additionally, as was implied in Green , we hold that stock option plans such as those involved in Green and in the case before us constitute “deferred compensation” plans within the meaning of FL 8 — 204(b) (1) and 8-205(b). We have since distinguished the stock option property lights in Green and Klingenberg from mere pre-emptive rights, or rights of first refusal, to purchase stock. Ross v. Ross, 90 Md.App. 176, 183 , 600 A.2d 891 (1992).

In Ross , we noted that, unlike stock options that are irrevocable offers to sell stock in the future, pre-emptive rights are a “mere possibility or expectancy, contingent upon specified but uncertain triggering events.” Id. The reason stock options are property interests is precisely because the triggering events are certain. If the spouse works until the triggering date, the right to purchase is irrevocable. In contrast, pre-emptive rights may never vest, regardless of the employee’s efforts.

As indicated above, Green is controlling with respect to the issue under discussion. We also note, however, that courts in other jurisdictions have frequently held that stock options, even if unvested, constitute property, and at least some portion of such options, if acquired during marriage, constitute marital property. See Bornemann v. Bornemann, 245 Conn. 508 , 752 A.2d 978, 986 (1998); In re Marriage of Frederick, 218 Ill.App.3d 533 , 161 Ill.Dec. 254 , 578 N.E.2d 612, 618 (1991); Baccanti v. Morton, 434 Mass. 787 , 752 N.E.2d 718, 727 (2001); Davidson v. Davidson, 254 Neb. 656 , 578 N.W.2d 848, 854-55 (1998); Salstrom v. Salstrom, 404 N.W.2d 848, 850 (Minn.App.1987); Fisher v. Fisher, 564 Pa. 586 , 769 A.2d 1165, 1169 (2001) (“We have independently researched the decisions of our sister states which have decided the issue ... they are unanimous, or nearly so, in treating unvested stock options identically with unvested pensions.... We therefore conclude that ... stock options earned during [the] marriage prior to separation be considered to be marital assets.”); Chen v. Chen, 142 Wis.2d 7 , 416 N.W.2d 661, 663 (App.1987) (“A stock option contract, like an unvested pension, is not a mere ⁵⁵² gratuity, but an enforceable contract right....

It is an economic resource, comparable to pensions and other employee benefits, and thus a form of property.”). Additionally, the Internal Revenue Service (IRS) recognizes that a property right exists at the time that the option is granted. See 26 U.S.C. §§ 421-424 (2002). Appellee’s Option Agreement explicitly defines the options as “intended to qualify as an Incentive Stock Option within the meaning of Section 422 of the Internal Revenue Code of 1986, as amended.” Section 422 is a part of Subchapter D: Deferred Compensation and Title II: Stock Options.

Id. Although the IRS excludes certain income from the exercise of stock options, it recognizes that the initial grant of the option is a property interest. Id. Thus, in line with the majority of other states, and consistent with federal tax treatment, we reiterate the holding in Green that unexercised and unvested stock options can constitute marital property.

What portion is marital property? We are not finished with step one, however, because a determination that stock options are marital property under FL section 8-203 is only part of the required analysis. While an employee may acquire a stock option during marriage, all of the benefit, i.e., profit, realized from the option will not necessarily be marital property. The non-employee spouse is entitled to an equitable share of only the marital portion of a stock option.

Green did not discuss this issue, but in holding that unvested stock options can constitute marital property, we analogized to pension plans. Similarly, it is appropriate to analogize to pension plans to determine the marital portion of an unvested stock option. In a typical situation, assuming that the option is acquired during the marriage, part of the time the employee spouse needs to work in order for an option right to vest will occur during the marriage. If the option has not yet vested at the time of trial, the employee spouse will need to continue to work after dissolution of the marriage to reach the required length of service to trigger the vesting.

The combination of ⁵⁵³ time and events, during and after marriage, determines whether a specific option right has vested. We conclude that the marital portion of unvested stock options can be determined by application of a coverture fraction, 3 just as coverture fractions have been approved for pension assets. See Bangs v. Bangs, 59 Md.App. 350 , 475 A.2d 1214 (1984). In Bangs , we approved the circuit court’s use of the following coverture fraction to determine the marital portion of pension assets: time married divided by total years of employment credited toward retirement. 4 Id. at 356 , 475 A.2d 1214 .

We reasoned that the court did not err in using this fraction because it separated from the total benefits earned during employment the portion that could be traced to the time the couple was married. Id. Because Maryland follows the “source of funds” theory to determine which property is marital, a court must determine when each piece of property is acquired. Id. at 363 , 475 A.2d 1214 ; FL § 8-201(e).

The “source of funds” theory requires that “ ‘acquisition’ must not arbitrarily and finally be fixed on the date that a legal obligation to purchase is created. Rather, ‘acquisition’ should be recognized as the on-going process of making payment for acquired property.’ ” Bangs, 59 Md.App. at 363 , 475 A.2d 1214