Long term incentives and share options can be complex areas to deal with in a case of divorce. Julian Ribet, Partner at Ribet Myles Family Law, provides insight into how courts view these areas and what paraplanners need to be aware of when helping financial plan for divorcing couples.
It’s increasingly common for employee renumeration packages to include Long-Term Incentive Plans (LTIPs) and share options. Paraplanners and financial technicians will be used to reviewing and analysing such investments – but when making these judgements in the context of a client’s divorce, it’s important to understand how the courts will treat these assets.
Firstly, the courts will determine what assets are matrimonial and thus shareable (those earned during the marriage), and those non-matrimonial (rewards earned after separation or likely to in the future). This can be a tricky distinction to make as these assets can overlap marriage and separation. For example, awards such as cash or shares are performance-based, which could be years in the making but granted to the employee following the separation, or an individual may divorce half way through their share options’ vesting period.
A time-based apportionment will then be applied by the courts, separating out what was ‘earned’ during the marriage, from the part which relates to post-separation and future performance. For example if a couple separates in the middle of a six-year vesting period of an LTIP award, the courts may deem the first 3 years as matrimonial, which therefore can be shared, and the remaining 3 years as non-matrimonial i.e. the other ex-spouse wouldn’t be entitled to this part. However if the grant date of the shares is after the separation, vested or not, the court could treat it as non-matrimonial.
Valuing such assets can be tricky, and much depends on when the vesting period ends, and what the share price then is – which can of course fluctuate, in some cases dramatically. Equally, the spouse may have to reach certain targets as part of the vesting schedule, and the net value may then be impacted by tax obligations.
This is when financial advisers and accountants may be brought in to provide an expert financial report, using valuation methods to provide an accurate picture. These include discounting the potential award to factor in risk of forfeiture, employee performance criteria not being met and vesting conditions. For example, a graded vesting will involve an individual receiving an increased percentage each year of their vestment – they may receive 10 per cent in the first year, and 50 per cent in the third year. So an accurate valuation needs to take into account the value of the entitlement awarded at those points and having regard to when the parties’ separation was.
Thought will be given to practical arrangements after the court decides how the LTIP and/or share options are to be split between the separated couple. The court tends to use the following options: offsetting, deferred sharing, and trust arrangements. Which option is taken will depend on the ability of the parties to cooperate with each other once the divorce is finalised, and /or the financial needs of each spouse.
In offsetting, the non-owning spouse will be awarded a larger share of other assets such as savings or property in exchange of a share in their ex-spouse’s LTIP or share options. This allows both parties to move on without continuing to be tied together, however if the share’s value at the time of divorce is unclear, it may be difficult to offset fairly.
Deferred sharing requires a degree of future cooperation between the parties, so once the share vests, which could be years after the divorce, the owning spouse will need to pay their ex-partner the proceeds determined by the original financial settlement agreement. In cases, particularly when the matrimonial award is complex, but where there is cooperation between the parties, trusts arrangements can be used to ensure the shares are allocated fairly once the value is realised.
Taxation will also need to be factored into the net value of the awards, which lawyers in conjunction with financial advisers will consider to ensure the financial settlement is fair and one spouse isn’t subjected to an unfair tax burden, and is deferred or offset fairly. Income tax and national insurance may be due once an award vests, and capital tax gains tax may also need to be paid. Sharing the potential tax liability fairly between the parties is important. As we know this can change from Budget to Budget.
LTIPs and share options can be an important part of each spouse’s financial stability following a divorce. They can be hotly contested between a divorcing couple, but also unwieldy too, with their values reliant on certain criteria being met and share prices. When working with financial advisers on LTIPs and share options in a divorce – whether providing an expert financial report, or working with a spouse’s lawyers on the fairness of a settlement, it’s important to factor in how the legal process will consider such assets and to fairly reflect the uncertain value of those assets when seeking to achieve a fair outcome.
