The California Supreme Court has agreed to review an appellate ruling in a class action brought by employee participants in an incentive compensation plan maintained by Salomon Smith Barney ("Smith Barney," a subsidiary of Citigroup). The case has broad implications for employers who maintain employee stock purchase plans that include forfeiture provisions requiring departing employees to forfeit any or all shares they have purchased under the terms of the plan.

In Schachter v. Citigroup, the California Court of Appeal rejected an employee's contention that a stock purchase plan maintained by Salomon Smith Barney violated California's Labor Code by requiring employees to, in effect, forfeit earned wages. The California Supreme Court ruling is expected to clarify the scope of California's wage payment statute, and resolve the question of whether the statute prohibits the forfeiture of stock purchased with employee earnings under the terms of an employee stock purchase plan.

Under Smith Barney's plan, employees have the option of using a portion of their earnings to purchase shares in the company's stock at a price below the stock's market value. If the participating employee resigns or is terminated for cause within a two-year vesting period, the employee forfeits any stock that has been purchased. In Schachter v. Citigroup, the plaintiff, David Schachter, noted that upon forfeiture, the employee lost the purchased stock as well as the earnings used to purchase it, and claimed that as a result, Smith Barney had failed to pay him (and a class of similarly situated employees) all wages that were due at the time he left the company, in violation of Sections 201 and 202 of the California Labor Code.

A central issue that will likely be addressed by the California Supreme Court is whether or not the employee's forfeiture of purchased shares amounts to an unlawful forfeiture of wages used in making the purchase. The Court of Appeal held there was no such unlawful forfeiture. In reaching this conclusion, the court examined the "economic reality" underlying the plan's provisions, noting that, in substance, the employee's authorization designating a percentage of his earnings to be used to purchase stock under the plan was no different than a two-step process, in which the employee is paid his wages in cash, and uses the cash to purchase restricted stock. The court pointed out that Schachter had authorized, in writing, the diversion of a percentage of his earnings into the stock purchase plan, and noted that this procedure complied with California Labor Code § 224, which allows an employer to withhold or divert any portion of an employee's wages for the benefit of the employee when the deduction is expressly requested and authorized by the employee in writing. Thus, the court determined that, even if Schachter had not been directly paid the money used to purchase the restricted stock, the funds had been lawfully deducted pursuant to his authorization.

The Court of Appeal also addressed the important issue of whether, and when, the "wages" claimed by Schachter were "earned." The court concluded that Schachter had no statutory claim for unpaid wages, because neither the forfeited shares, nor the money used to purchase those shares had actually been earned at the time of his departure from the company. The court observed that the point at which wages are earned under an incentive compensation plan is determined by the parties' agreement and is generally contingent on future events, such as the employee's continued employment as of a specific target date. Here, the court determined that Schachter did not earn the disputed amounts, because he "necessarily agreed his compensation would consist of cash payments and retention-based conditional interest in shares," which would only be earned if he remained with his employer for two years. Because Schachter had not fulfilled that condition at the time of his departure, he had not earned the restricted shares, and so had no right to receive them, or the funds used to purchase them.

Whether or not the California Supreme Court agrees with the holding and/or the rationale of the Court of Appeal, we anticipate that its decision in Schachter v. Citigroup will have a significant impact on the ongoing efforts of plaintiff's attorneys to apply California's wage payment statutes (and their significant penalty provisions) to incentive compensation plans. We will continue to monitor this area, and keep you apprised of developments as they occur.