Perilous Waters in Divorce Proceedings: Considering Issues That Arise When A Divorcing Couple Seeks to Divide Stock Options or Restricted Stock

Dividing marital assets in a family divorce is often difficult.  The division of assets in a divorce becomes even more challenging when at least one of the spouses owns stock options or restricted stock.  For the reasons discussed in this post, divorcing spouses who own stock options or restricted stock should seriously consider entering into a settlement that maximizes the parties’ financial objectives and avoids the risk associated with litigation in divorce court.

Employment Retirement Plans Create Stock Options and Grants

Stock options and restricted stock are typically granted as part of an employee retirement plan.  The employee’s rights to the stock and options are usually contingent on the employee remaining employed for a set number of years.  This is known as the vesting period.  If the employee quits or is terminated before the vesting period is completed, the employee loses these rights.

Under Texas law, unvested benefits like stock options and restricted stock are contingent property interests that are subject to division in divorce.[1]  The fact that the benefits of the stock option or restricted stock have not fully vested by the time of divorce does not affect their status as community property, as long as the unvested benefits were acquired during the marriage.[2]

Texas Law Requirements for Division of Stock Options/Restricted Stock

The divorce court will divide stock options and restricted stock between the spouses based on the value of the community’s interest at the time of divorce.[3]  Texas courts use the following formula to determine what benefits the non-employee spouse is entitled to receive:

This formula for dividing stock options and restricted stock is set forth in the Texas Supreme Court’s opinion in Berry v. Berry[4], and is known as the Berry formula.  

After the divorce court applies the Berry formula, it has wide discretion on how to divide community property between the spouses.  A divorce court could order the employee spouse to pay the other spouse a lump sum in lieu of the non-employee’s interest in the options and stock.   In the alternative, the divorce court may order the employee spouse to turn over the options and stock, or their proceeds when the interests vest.  In that case, it is important to for the spouses to be able to track the change in value of these interests because the increases (or decreases) in the value of stock options and restricted stock are also community property subject to division.[5]

Risks Associated with Stock Options/Restricted Stock

If the divorce court orders a future division of these interests upon vesting, it is important that the non-employee spouse be aware of the risk that these interests may be lost if the employee spouse quits or is fired.  The loss of employment generally extinguishes these rights for the employee and as such also extinguishes the non-employee spouse’s interests.

Divorcing spouses who own stock options and restricted stock would be well-advised to consider reaching a property division settlement that is designed to achieve their financial objectives.  They can and should take matters into their own hands to avoid a ruling by the divorce court that imposes a result completely at odds with their own objectives.

Benefits of Negotiated Divorce Settlement

A negotiated property division in the divorce has the potential to provide the spouses with the following benefits when stock options and restricted stock are part of the marital estate:

  • The parties determine the value of their assets rather than having the value imposed on them by the divorce court;
  • By negotiating an agreed division of particular assets, the owners avoid the risk of being saddled with unfavorable decisions made by the divorce court;
  • Dividing assets in a manner that takes into consideration the applicable tax laws and which minimizes the tax burden to all parties;
  • Developing a “business divorce plan” that allows for continued co-ownership of some or all of the assets for some period of time to allow for higher values to be achieved for both parties after the divorce has become final; and
  • Avoiding a rancorous, expensive courtroom battle that provides no long-term benefit for the spouses or their children.

Divorce cases that involve substantial private company investments require a thoughtful approach to the problem of dividing these assets in a way that best preserves and maximizes value for all of the parties involved.  In most cases, a carefully structured, negotiated settlement provides both spouses with a better outcome than the results of a court-ordered decree.

[1] Boyd v. Boyd, 67 S.W.3d 398, 409 (Tex. App. 2002).
[2] Id. at 410.
[3] Grier v. Grier, 731 S.W.2d 931, 932 (Tex. 1987).
[4] Berry v. Berry, 647 S.W.2d 945, 946–47 (Tex. 1983).
[5] Grier, 731 S.W.2d at 932.