Employee Stock Option Plans (ESOPS): Legal Framework in India

Employee Stock Option Plans (ESOP) means when the shares of the company offer shares to the employees of the company. In the ESOP the shares are given to the employees free of cost or at a rate less than the face value of the shares. ESOP is given to the employes for the company’s value growth and profits and the employees can directly benefit through the appreciation of their stock holdings.

Advantages of Employee Stock Option Plan (ESOP)

• Help to improve the productivity of the Company.
• Employee Retention.
• Help to generate a sense of ownership towards the employees.
• Build a strong public image of the Company.
• Guides to encourage the employees to perform well in their roles in the Company.
• The Employee Stock Option Scheme (ESOP) also helps the organization to maintain long-lasting relationships with the employees.
• Raises the faithfulness of its Employees.
• Offers a sense of job security and satisfaction to the Employees.
• Helps in wealth creation for the employees.
• Help to create a motivated and committed workforce for the organization.

Legal framework governing ESOPs

Legal Framework of the ESOP is covered under:

• The Companies Act, 2013
• SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021
• Income Tax Act, 1961(for tax implication)  

Eligibility for ESOPs

• Employees
• Officers
• Directors of the company, its subsidiaries, or holding companies

Provision related to the ESOP as per the Companies Act, 2013

The companies Act,2013, clause (1)(b) of Section 62 along with the Companies (Share Capital and Debentures) Rules, 2014, relates to the allotment of shares to the employees and it provides the conditions and procedures for issuance of shares under the ESOPs scheme.

Shareholder Approval

The Stock option cannot be offered without the approval of the shareholder in the general Meeting. The Company is required to pass the special resolution and obtain the following approval from the shareholders:

• The companies must obtain the allowance of subsidiary to the employee or holding company.  and
• Grant of more than 1% or equal of capital issued to the identified employees during any one year. The capital which is issued should exclude conversions and outstanding warrants of the company during the time of the grant of the option to the employee.   

Pricing

The Company has a right to determine the price of the shares to be given to the employes under the ESOPs scheme. The price of shares under the ESOP Scheme cannot be less than the fair market value of the shares as determined by the registered Valuer of the IBBI.

Lock-in Period

• As per the SEBI Guidelines, there is a minimum period of one year between the allowance of options and reserving  of options.
• For the private company, the company has the right to state the lock-in duration for the shares issued pursuant to use the option.
• No dividend is given if the shares are issued to the employees under the ESOPs scheme.

Transferability of an Option

• Employees cannot transfer shares to any other person and the same are non-transferable
• Under ESOPs scheme, the shares cannot be pledged, assumed, mortgaged or otherwise isolated in any other way.
• If the employee dies during the employment, the shares will be given to the legal heirs or nominees of the departed employee.
• If the employer is completely incapable of working during employment, all options allowed on the date of inability will be given on that day.
• In the event of resignation or termination of the employee, all un-vested options as on the date of resignation/termination shall expire.

Variation of Terms of the ESOP

The company by special resolution in a general meeting varies the terms of ESOP offered pursuant to an earlier resolution of a general body but not yet exercised by the employee provided such variation is not prejudicial to the interests of the employee.
The notice for passing on such a special resolution shall disclose full details of the proposed variation along with the rationale and details of the beneficiaries of the same.

Failure to Exercise Option

If within the excise period, the employee did not use the grant of option then the company will forfeit the amount payable by the employee at the time of the grant of option. The company can also refund the amount to the employee at the time of grant of option if the option is not vested due to non-fulfillment of condition which relates to the vesting of option as per the ESOP.

Process for the Issuing Employee Stock Options by a Company

• The Nomination and Remuneration Committee (NRC) (if applicable) shall identify the employees, officers and Directors who are eligible for ESOPs and determined the criteria for eligibility for ESOPs.
• Prepare the Draft Scheme of Employee Stock Option Plan (ESOP) and take valuation report issued by the registered valuer of IBBI.
• Draft the Notice of Board Meeting and call the Board Meeting.
• Pass the recommendations for the allocation of shares through ESOP, approve the draft scheme and valuation report to determine the price of shares to be issued pursuant to ESOP in the Board Meeting.
• Pass the resolution in the Board Meeting to issue the Notice for calling the Extra Ordinary General Meeting of the Members.
• File the Form MGT-14 with the Registrar of Companies for the resolution for the issuance of shares through ESOP, approve the draft scheme and valuation report to determine the price of shares to be issued pursuant to ESOP in the Board Meeting.
• Call the Extra Ordinary General Meeting and pass the special resolution for issuing ESOP.
• Pass the separate Special Resolution if any employee holds up to 1% of paid-up Share Capital of the Company in any financial year and the Company still wants to give him/her Employee Stock Option.
• Within thirty days of passing the special recommendations along with the submission of important documents, a company should file Form MGT-14 with the Registrar of Companies.
• Call the Board Meeting to grant options to the eligible employees and pass the Board Resolution.
• The company should send options to its directors, employees, and officers to purchase the shares under ESOP.  
• Prepare a ‘Register of Employee Stock Options’ in Form No.SH-6 and mention the details of the ESOP allocated to the employees, Directors or officers of the company.
• Call the Board Meeting to allot shares under the ESOP scheme to the employees who exercised the option.
• Call the Board Meeting, authorize allotment of shares under ESOP and allot shares to eligible employees who exercised the options.
• A company with the duration of 30 days from the date of board resolution file Form MGT-14 and PAS-3 with the Registrar of Companies.

Disclosure Requirements in The Board Report

• Total number of options granted under the scheme of ESOPs.
• Details of vesting, exercise price, route of ESOPs, source of shares (Fresh issue or acquisition from secondary market).
• Material changes in the Scheme if there are any during the year.
• Disclosure in terms of Accounting Standards.
• Diluted EPS on issue of ESOP shares.
• Method to compute intrinsic and fair value of shares.

What happens when an employer does not issue shares promised under ESOPs?

Since there was a contract between the employer and the employee accepting the shares under the ESOP’s scheme. If the employer does not issue shares promised under ESOPs, then there is breach of contract and legal action will be taken by the employee against the employer as mentioned in the clause related to the breach of contract in the contract.

The employee can also ask for the demand written explanation for the non-issuance and seek compensation for losses.
Before going for legal action employees can raise the issue with HR or management and go for the mediation or the arbitration.

What happens when an employee does not accept shares under ESOPs scheme?

• The Shares can be lapse after the period ends and the same cannot be converted into equity.
• The shares usually go back to ESOP as per the scheme and can be issued to the other employees who are interested, reserved for future grants and back to the company with the heading of unissued share capital.
• If the employees refuse to accept shares under ESOP then they also lose the chance to buy the shares of the company, which is less than the fair market value.
• The employees who don’t accept the offer will not get the same offer in the future.