Under the Companies Act, 2013 ("Act"), Employee Stock Option Plans (or "ESOPs") are plans primarily designed to have the employees invest in the stock of the employer sponsoring the same. They form part of the employees' remuneration structure and are usually unaccompanied by any upfront costs. This incentivizes the employees to align their performance with the interests of the shareholders. An organization seeking to increase its subscribed capital through the issuance of further shares may offer to its employees a scheme of stock options upon attaining a special resolution by the company and complying with the Act and the Companies (Share Capital and Debentures) Rules, 2014 ("Rules").
This fragmented form of offering ownership to the employees of a company ensures the lock-in of the said securities for a specified duration of time, thereby simultaneously offering the employees a future benefit and the company, the scope to retain its employees while securing their positive performance. ESOPs are also not accompanied with any upfront costs and may be refused by the employee. Further, ESOPs lower the post-tax cost, and contributions of both cash and stock are tax deductible for the companies.
For the safety and growth of these allotted shares, they may be held by a trust until the employee resigns from the company or retires. After the said resignation or retirement, the employee may regain the shares and choose to redistribute or void them.
The Acts requires that for an employee to enjoy an ESOP scheme, he/she must be covered under the ambit of the definition of 'employee'.
Ambit of 'Employee'
The Rules define 'employee' as a permanent employee or director (regardless of whether he/she is a whole-time director or not and/or working in India or not). Rule 12(1) of the Rules elaborates on this further by stipulating that ESOPs may be issued to any employee who is a permanent employee (regardless of whether they are working within or outside of India), any director who is not an independent director or any permanent employee/director of a subsidiary (in or outside India) or associate/holding company.
The exclusions are independent directors, directors who do not have material or pecuniary relationship with the company or its related persons (except sitting fees); an employee who is a promoter or a person belonging to the promoter group and a director who either himself or through his relative or through any body corporate, directly or indirectly holds more than 10% of equity shares of the company.
Procedure for issuance
The issuance of ESOPs is primarily governed by Section 62(1)(b) of the Act and Rule 12 of the Rules. For such an issuance, the company is required to have an ESOP scheme in place. This scheme must first be passed in a Board Meeting and then a general meeting of the shareholders for gaining the approval for the ESOP Scheme by way of a special resolution. The draft minutes of the said board meeting are then required to be sent to the directors within 15 (fifteen) days and MGT-14 is required to be filed with the Registrar of Companies within 30 (thirty) days of passing the resolution.
Before the aforementioned special resolution is passed, a disclosure of the scheme's particulars is required to be made. The said disclosure of particulars ought to be done by way of an explanatory statement which must disclose the total number of ESOPs to be granted, appraisal process for determining eligibility, requirements of vesting and period of vesting, exercise price/pricing formula, exercise period, method of accounting, lock-in period, conditions under which vested options may lapse, etc.
Separate resolutions may also be passed in case of grant of ESOPs to employees of a subsidiary/holding company or in case the ESOPs are granted to identified employees equal to or exceeding 1% of the issued capital.
This process would typically be followed by the sending of the options to the employees of the company for the purchase of the said ESOPs. A register bearing the details of these individuals would also be maintained in Form SH-6.
The company would first identify which employees are eligible for the stock options under the ESOP scheme and issue the options to the employees. Upon being granted the ESOP, the employees would have the right to apply for the securities granted to him/her within the vesting period, which would extend to at least 1 (one) year from the grant of the option. Typically, companies would also stipulate a lock-in period in the plan to ensure that the employees don't sell the shares in the open market or transfer them in any other manner right after allotment of the securities. Ultimately, the employee could choose to exercise the option of buying the said securities during the exercise period in order to convert his/her right to owning the stock and enjoy the advantages of a shareholder—like receiving dividends and exercising voting rights, etc. The options granted to employees are not allowed to be transferred, pledged, hypothecated, mortgaged or otherwise encumbered in any manner. In case of death of an employee while in employment, all the options granted to him till such date vest in the legal heirs of the deceased employee. In the event the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, vest in him on that day. In the event of resignation or termination of employment, all options not vested in the employee as on that day will expire. However, in any such event, the employees can exercise the options granted to him which are vested within the specified period, subject to the terms and conditions of the ESOP scheme.
ESOPs have become a common gateway for companies to retain talent and boost employee performance, serving as a continuing boon for the companies and a future benefit for the employees. The grant of ESOPs by organisations in India to employees across the board has spread awareness about the benefits of such plans and has started to play a major role in helping organisations stand out as ones that reward employees willing to align with their long-term objectives.
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