Watching the Super Bowl earlier this month, I couldn’t help but think about the complex, multi-million dollar contracts signed by the players on the field at NRG Stadium. Signing bonuses, performance incentives, deferred money—the NFL is a highly intricate business.
As a family law attorney representing high-net-worth (HNW) clients, I can assure you those types of sophisticated contracts aren’t just for elite athletes. Estate-planning attorneys should also be aware of these issues as they may need to take compensation packages into account when preparing estate plans for clients.
Complicated Compensation Packages
More and more, our HNW clients have negotiated executive compensation packages that include not only a seven-figure salary, but also a host of other perks such as stock options, restricted stock units, long- and short-term incentives, creative retirement benefits…the list goes on. Equitably distributing these assets in a divorce can be challenging, especially when one party is the primary earner and some assets may not be quantified, vested or liquidated until well after the divorce is finalized.
In divorce cases, timing is everything. In the absence of a prenuptial agreement, the law considers income earned during the marriage to be marital property. As such, it’s to be divided equitably between the husband and wife.
However, the more sophisticated a compensation package, the more detective work it may take to achieve a truly equitable distribution on behalf of clients. Often, the HNW earner will provide package details voluntarily; sometimes it requires a subpoena.
Let’s consider stock options that were received before and during a marriage and will be received after the marriage concludes. Assume this investment increased in value during the marriage, as well as outside the marriage. In this case, the non-participating party has a stake in that income, but not all of it.
In these cases, we apply a coverture fraction to determine the portion of a benefit that was earned during the marriage. It’s a mathematical equation, with the number of years a person was in the plan during his marriage, divided by the total number of years the person participated in the plan.
If an executive received/will receive stock options annually over 20 years that are now worth $5 million, but the marriage encompassed only 10 of those years, then just one-half, or $2.5 million would be divided between the parties to achieve equity. Note the determination considers the value of the stock now, not its value at any other point.
This works well for vested stocks that can be immediately liquidated and the cash split between the parties. Often, though, we encounter restricted stock options that aren’t yet vested and can’t be transferred wholly or in part to a non-employee.
In these cases, the HNW earner can hold the stock in a constructive trust to be exercised by the non-employee spouse when vested. However, we all know the stock market is fluid, and it’s impossible to project an exact value for these investments.
Case in point, I recently represented the soon-to-be ex-wife of an executive whose company would significantly benefit from the privatization of certain government facilities. He has a compensation package with a significant amount of unvested company stock, to which she was partially entitled. Leading up the 2016 presidential election, the stock was on a downturn as it seemed the Democrats, who’d spoken against the privatization of these facilities, would be taking office. We all know what happened Nov. 8, and now the stock is soaring under the Trump administration.
Equitable Financial Arrangement
Many clients don’t want to deal with this roller coaster, and I consider constructive trusts to be a last resort. They keep the couple financially connected and require both parties to continue behaving honorably.
More often, I advise clients to allow me to negotiate an equitable financial arrangement for the shares. It’s usually at a discount, but I am firm believer in the “bird in the hand” proverb—especially when considering it results in a clean financial break.
Even in cases of amicable divorce, distribution of assets for a separating couple can be both a difficult and frustrating undertaking. Especially when a complex HNW executive compensation package is involved. It’s then that in-depth familiarity with the structure of that compensation comes into play.
As they say, knowledge can be a powerful tool.