Share Option Plans in the Light of a Recent Decision of the Court of Cassation

In this context, the examination and evaluation of ESOP in the decision of the 9th Civil Chamber of the Court of Cassation dated 29.11.2022^[2] (“Decision”) is essential as it contains hints reflecting the perspective of the Turkish judiciary on the nature of the ESOP and the implementation of its provisions. 

Before analyzing the content of the Decision, it would be useful to make a brief assessment of the nature of the ESOP. 

An Overview of Share Option Plans

Share certificates, stock options, or other equity instruments are granted as an element of remuneration in addition to salaries and other benefits provided to employees. It is also possible for shares and stock options to be granted as part of a bonus agreement rather than as an element of basic salary.^[3] It is also possible to issue the ESOP as a share purchase option to provide physical share certificates to the employee, free of charge or at a value below the actual value of the shares, depending on the fulfillment of the specified conditions. In essence, the option granted to the employee regarding the transfer of ownership of the shares is a contractual formative right where the employee who has the option right can establish a share purchase agreement with a unilateral declaration of will.^[4] Again, in practice, it is common to pay the employee the amount of the financial rights provided by the shares (phantom stock option) without transferring the ownership of the shares to the employee.

ESOP generally requires the employee to work for the agreed period of time in the company in order to have the option to purchase shares. Also, pursuant to ESOP, the employee's option right may be conditional upon meeting or exceeding certain performance criteria. ESOP contains provisions on how the transfer price of the shares or the financial rights to be provided in exchange for the shares will be determined. Although ESOP is usually made as a separate contract from the employment contract, the termination of the employment contract by the employer for a just cause or by the employee is regulated as one of the situations that terminate the option contract.

Summary of the Decision

In the receivable lawsuit filed by the employee against the employer company and the foreign company that granted the right to purchase shares, the Court of First Instance partially accepted the lawsuit, and upon the appeal of the decision by the defendants, the Regional Court of Appeal reversed the judgment of the Court of First Instance, re-established a judgment on the merits and again partially accepted the lawsuit. The decision of the Regional Court of Appeal was appealed by both the defendants and the claimant. 

While the claimant was working under an indefinite employment contract as the general manager of the Turkish subsidiary of the foreign defendant, which provides electronic payment services, his employment contract was terminated due to the allegation that he obtained an unfair advantage and embezzled money. Since there was a share purchase option agreement between the claimant employee and the main shareholder of the subsidiary company, a company of US origin, and therefore both defendants should be considered as employers, and since the criminal case against the claimant was rejected on the merits and finalized, the collection of unpaid severance and notice pay, premium, annual leave, and other receivables due to wrongful termination was sued. The defendant company claimed that the employment contract was terminated for just cause, that there were no annual leave receivables, and that it was not responsible for this agreement since the option agreement was made with the American company. The other defendant American company claimed that it was not the employer of the claimant, that American law applies to the share option agreement that the US courts were competent, and that the share option agreement was terminated due to the rightful termination of the claimant's employment contract and that the lawsuit should be dismissed. 

In its decision, the Court of First Instance ruled that the termination was found to be unjustified by the decision of the Criminal Court, that the civil judge is not bound by the acquittal decision given by the criminal judge, but that all the facts put forward by the defendant's attorneys as grounds for just termination were evaluated in the criminal court and were not found to be fixed, therefore, the termination occurred without just cause and awarded severance and notice pay. The Court of First Instance also evaluated the Option Agreement and ruled that both defendants were jointly and severally liable for the labor rights including the stock option receivable of USD 1,665,973.62. 

As a result of the evaluation made within the scope of the appeal application, the Regional Court of Appeal, in summary, decided that the termination was unjustified and that the claimant was entitled to severance and notice pay since the defendant subsidiary company, which had the burden of proof regarding the just cause termination of the employment contract of the employee claimant, could not prove that the employee was harmed by the acts of the employee or unfair competition. The District Court of Appeal ruled that the “Non-Qualified Share Option Grant” agreement signed between the claimant employee and the defendant American company gave the claimant the right to receive a certain number of shares in a certain period, the purpose of which was to ensure the continuation of loyalty to the company, and that these defined shares gave the right to purchase the shares of the parent company traded on the stock exchange at a low price and only after certain periods had passed, at the end of the period, for example, in the concrete case, it was decided that the first date of accrual was decided to start on July 1, 2010 by taking 25% and to end on July 1, 2016, with a further 25% every three months, and that this right provided was a premium in result and nature. In the evaluation made by the Court, it was ruled that although a certain amount of cash must be deposited by the employee in return for the “Non-qualified Share Option Donation” agreement, if there is an increase in value between the shares received and the amount given, the difference will belong to the claimant by deducting the difference during the sale, regardless of whether the option has been exercised in full or not in case the contract is terminated by justified termination of the employment contract, and in case of other reasons for termination, the options that are vested and exercisable can be exercised, but the options that are not vested and exercisable will be deprived. The Court found that in the share purchase transaction, the claimant was able to cash out the price by selling through an e-trade transaction without depositing any price and selling through a system where the difference would be paid to the claimant, and as per the Delaware Law report and other expert reports received by the Court, it was ruled that the claimant did not have the right to purchase shares after the date of termination of the employment relationship, but before. The Court of First Instance's reasoning that the dates of acquisition and the dates of utilization were confused was found erroneous and a total of USD 827,536.32 was ruled as it was understood that the 30000 USD bonus premium paid to the claimant with the explanation of quarterly bonus was not paid. The 9th Civil Chamber of the Court of Cassation, in its appellate review, upheld the decision of the Regional Court of Appeal, as the decision was by the procedure and law according to the mutual claims and defenses of the parties, the documents they relied on, the legal rules that should be applied to the dispute and the characterization of the legal relationship, the conditions of the case, the rules of trial and proof and the reasons stated in the decision, and the reasons put forward by the attorneys of the claimant and the defendants in their petitions for appeal were not deemed to be of a nature that would require the decision to be reversed.

Evaluation of the Decision

The Decision includes the assessments on whether the termination of the employee's employment is justified or not, and the assessments made by the Court of First Instance and the Court of Appeal on ESOP are analyzed below. The most important and noteworthy issue in the Decision is the legal characterization of the share option agreement signed between the Claimant's general manager and the US-based parent company. The Court of First Instance evaluated the Option Agreement and the share incentive plan (equity investment plan) signed with the employee as “providing an incentive for the employees of the parent company and its subsidiaries to share in the success of the Parent Company and to continue working for the parent company and its subsidiaries” and ruled that the benefits provided to the employee by the share option granted to the employee are bonuses within the meaning of Article 32 of the Labor Law No. 4857 and therefore both defendants are jointly and severally liable for the labor rights including the stock option receivable. In its assessment of the Option Agreement, the Regional Court of Appeal stated that:

“Under the heading “Nature of the Option Agreement”, the first paragraph of the option agreement between the US-based parent company and the claimant states that the compensation committee of the company granted stock options within the framework of the .... Systems Inc.'s 2006 Equity Incentive Plan”. The amended and restated 2006 equity incentives plan of F1 Systems Inc. states in Article 1 of its purpose statement that the purpose of the equity incentives plan is to provide an incentive for officers, other employees, potential employees, directors and consultants of F1 Systems Inc. and its subsidiaries and affiliates to share in the success of the Company and to remain in the service of the Company and its subsidiaries. From this article and the formation of the stock incentive plan, it is clear that the existing option agreement is an option agreement granted to employees. In other words, unlike the general options traded in financial markets, the recognized share option is a type of option offered as an incentive to the employee based on the employment relationship (contract). For these reasons, the earnings provided to the claimant by F1 Systems Inc. with the share option agreement, in addition to the root wage and its supplements provided by F1 Turkey, are considered a premium within the meaning of Article 32 of the Labor Law No. 4857, and it is concluded that there is a joint employment with the event subject to the lawsuit and therefore the defendants are jointly liable for the labor rights provided by both companies.”

In this context, the assessment made by the Court of First Instance regarding the nature of the ESOP subject to a foreign law has been confirmed by the Court of Appeal and the Court of Cassation. Although it is understood from the decision of the Regional Administrative Court that there is an expert opinion from a Delaware Lawyer, it is not understood whether the court evaluated the legal nature of the ESOP according to the law governing the Option Agreement. On the contrary, it is understood from the expression “.... recognized stock option, unlike the general options traded in financial markets, is a type of option offered as an incentive to the employee based on the employment relationship (contract). For these reasons, the earnings provided to the claimant by F1 Systems Inc. with the stock option agreement, in addition to the root wage and its supplements provided by F1 Turkey, are considered a premium in the sense of Article 32 of the Labor Law No. 4857, and there is an employment with a union with the event subject to the lawsuit ....”, in the judgment that the court evaluated the ESOP according to Turkish law. The first thing that comes to mind here regarding ESOP is that the court should apply the law of the State of Delaware, which the parties expressly chose, to the obligations arising from the ESOP pursuant to Article 24/1 of the International Private and Procedural Law No. 5718 (“IPPL”). Since there is a foreign element in the ESOP, another provision that may be applied by the courts that comes to mind is Article 27/1 (Employment contracts). However, even in this case, the court would have to apply the Delaware law chosen by the parties, without prejudice to the minimum protection that the employee would have under the mandatory provisions of Turkish law. For the aforementioned reasons, the decision of both the Court of First Instance and the Regional Court of Appeal that the share purchase option provided to the employee by evaluating the ESOP according to Turkish law is a bonus within the meaning of Article 32 of the Labor Law No. 4857 and that the defendants are jointly liable for this amount does not seem to be a decision taken at least in accordance with the IPPL. 

Conclusion

For the reasons explained above, it is considered that it is not appropriate to apply Turkish labor law directly in the characterization of ESOP and to establish a judgment accordingly, while it is necessary to assess according to the foreign law chosen in the ESOP by the IPPL. In addition, the conclusion reached in the aforementioned Decision, that the ESOP is a premium for the creditor employee, is not a general rule independent from the provisions of the contract and is valid against every ESOP. In our opinion, the provisions of each ESOP agreement should be evaluated separately by the judge who will resolve the dispute, and in this evaluation, the conclusion should be reached by taking into account the purpose of the parties and the law applicable to the contract.