Alternative Compensation Plans: Understanding Stock-Option Plans and HESOP Contracts

Introduction

Many companies are designing and implementing alternative compensation plans to attract and retain their employees. One such example is the “SOP” or “Stock-Option Plan,” where employees receive options allowing them to acquire company shares at a predetermined price. Typically, this right expires if the employee leaves the company.

The Taxation of Stock-Options

In Belgium, tax legislation requires employees to immediately pay a withholding tax (8.5% or 17% depending on the case) on the exercise price of the underlying shares. To pay this tax, the employee must use their own funds, obtain a loan, or turn to more creative mechanisms offered by some financial institutions. One such mechanism is the “HESOP” (Hedged-Stock Option Plan) contract, which has been debated in courts.

Understanding the HESOP Contract

The HESOP contract is independent of the employer-employee relationship and is concluded between the employee and the bank. Under this contract, the employee issues a certain number of options similar to those received from the employer and sells them to the bank. In return, the bank pays the employee the equivalent of the withholding tax due.

As the beneficiary of these “mirror options,” the bank can, until a certain date, exercise these new options and demand that the employee deliver either the underlying shares corresponding to these options or their cash equivalent. To meet these obligations, the employee must keep a sufficient number of shares or cash in their portfolio. Otherwise, they will need to exercise the options granted by their employer.

What Happens When an Employee Leaves the Company Issuing the Stock-Options?

Problems arise when an employee leaves the company without informing the bank and without utilizing any contractual option to “buy back” the HESOP contract. In such cases, the bank will claim its due at the contract’s expiration by exercising the options. If the underlying share price is high, the amounts involved can be significant for the client. Therefore, the former employee’s diligence towards the bank is crucial.

2 judicial decisions of utmost importance

In two cases, the Brussels Court of First Instance faced a request from the bank for significant amounts under the HESOP contract. The bank exercised its options, while the clients, who had left the company without informing the bank and were unable to exercise their original options, argued the interdependence of the employment contract, the stock-option plan, and the HESOP contract. They claimed the HESOP contract was void due to their departure from the company.

The court confirmed that the employment contract, including a stock-option plan, and the HESOP contract are indeed separate agreements: they involve different parties, cover similar but distinct subjects, and are concluded for different purposes. The HESOP contract is intended to allow the client to pay the withholding tax due on the options received from the employer without depleting their cash reserves or taking out a loan.

However, the court deemed the bank’s request abusive and did not grant it.

These decisions were overturned on appeal[1]. The Brussels Court of Appeal confirmed the HESOP contracts’ independence. Given their optional nature and the opportunity for clients to “buy back” their HESOP contracts in time, the clients could not claim an abuse of rights. Additionally, the court emphasized that the clients had failed to inform the bank of their departure, despite being obligated to do so. These decisions could be compared with those made regarding Swap contracts, discussed below.

[1] Brussels, October 12, 2021 (2 rulings), unpublished, 2017/AR/718 and 2017/AR/719