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UNIT APPRECIATION RIGHTS When Cash Does Not Equal Ownership

Published onAug 02, 2016
UNIT APPRECIATION RIGHTS When Cash Does Not Equal Ownership

As publicly traded companies (“PTC”) continue to grow both in revenue and profits, non-publicly traded companies (“NPTC”) have found themselves competing for employees. For many employees, an important factor when choosing where to work is compensation. One form of compensation in which PTC have historically prioritized are stock grants and also stock options. In essence, PTC either award stock or present a favorable price at which to buy stock in the company for a particular employee. Largely reserved for key executive employees, such compensation increasingly became an attractive incentive for employees. The benefits also favored companies, for now the employees had an additional incentive to increase the value of the company. The utilization of stock options and grants has incentivized competing employers within the same markets to offer alternative employee packages to maintain and attract desired employees. This usually resulted in an increase in other forms of compensation areas such as base salary, vacation time, insurance benefits etc.

Within the last two decades however, private companies have increasingly used a compensation structure known as unit appreciation rights (“UAR”). UAR are similar to stock options and grants in that they offer a form of compensation tied to the value of a company. However, no stock is issued to the employee. Instead, a UAR (also known as phantom rights, or phantom stock plans and similar to stock appreciation rights) acts as a placeholder for a cash amount to be paid at a specified future date. Accordingly, because the holder of the UAR does not actually hold an equity interest in the company, the employee is not entitled to rights and privileges normally enjoyed by a member of a PTC, including inspection and voting rights. Additionally, making a UAR plan requires no capital investment from the employee. Therefore, the employer is able to make an incentive-based compensation offer without requiring the employee to buy into the plan.

Exercising rights under a UAR plan comes without a premium cost requirement and the payments are typically in cash. Typically, the UAR will not result in any payout unless the value of the business grows prior to an employee’s decision to exercise the UAR. For example, a UAR may only provide compensation in the event a term of employment has been completed. Therefore, the existing value of the current equity partners as of the grant date is not diluted by the UAR issuance. Instead, the UAR holder receives only a share of future growth. The recipient of the UAR is not required to make an investment beyond the services required to receive and earn the opportunity to exercise the UAR.

This form of compensation creates a key question of whether or not an employer owes a fiduciary duty to an employee with regards to a UAR plan. In short, a fiduciary relationship creates both a duty of care and a duty of loyalty between the employer and employee. Should courts find that UAR plans attach a fiduciary duty for the employer to properly maintain the plan with sufficient funding, oversight, etc., it is likely that UAR plans will continue to grow in size. On the other hand, should courts find that UAR plans do not attach a fiduciary duty, then contract law will govern and therefore the contractual rights bargained for by the employee in the employment agreement will be subject to the implied duties of good faith and fair dealing? Finding that fiduciary duties are attached will likely make a UAR more attractive to the employee and less attractive to the employer because the attachment of fiduciary duties insures additional layers of protection for the employee in instances where the value of a company decreases. In such a case, the employee can sue the employer on a claim for a breach of fiduciary duties. On the other hand, criticism of extending fiduciary duties to UAR is likely to assert violations of the basic tenets of contract law: let the parties bargain for what they want. Therefore, if a UAR plan explicitly excludes fiduciary duties, and the employee consents, then the terms of the contract should govern any dispute without attaching fiduciary duties. If the employee wanted fiduciary duties to attach then they should have bargained for it.

While there are many additional criticisms of UAR plans, the decision of courts to decide the question of attaching fiduciary duties has the potential to streamline this unique form of compensation as a mechanism for NPTC to attract and retain desired employees.  Moreover, it can also serve as an additional form of compensation for an employee to bargain for.

Khalif Timberlake is a third year law student at Wake Forest University School of Law and first year student at Wake Forest University School of Business. He holds a Bachelor of Arts in both English and International Affairs. Upon graduation, he intends to practice corporate and employment law.

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