The Basics of a Vesting Agreement in a Contract of Employment.

1. INTRODUCTION

It is a trite principle of contract law that parties to contract agreements are often bound by the terms in their contract agreement, by this, parties to a contract are bound by the terms expressly stated in their contract agreement, impliedly or orally agreed by the parties and those terms cannot be varied by the court or become unenforceable unless they are contrary to any statutory provision, the contract is ambiguous, the contract is unconscionable or there is an existence of a vitiating element which includes mistake, misrepresentation, illegality, undue influence, duress etc. See Baliol (Nig) LTD v. Navcon (Nig) LTD [1].

Aside the principles above, the position of the parties to the terms of a contract agreement remains sacrosanct and binding on the parties; the words of Sir. George Jessel in Printing and Numerical Registering Co. V. Sampson[2] lends credence to this position

“Men of full age and competent understanding shall have the utmost liberty of contracting and their contracts, when entered into freely and voluntarily shall be sacred and shall be enforced by courts of justice”.

This does not only accentuate the capacity of parties to a contract agreement, but also stresses the sacrosanct nature of a contract agreement. This same principle of course, is applicable to contract of employment.

In essence Vesting strictly in the context of contract of employment is the transfer of some of the units of shares, stocks or ownership of a company to an employee after the fulfillment of the terms in the vesting agreement between the employer and employee.[3]

While vesting is the process of transferring shares to an employee after the fulfilment of the terms of the vesting agreement, vesting agreement is the document exhibiting the terms and conditions of the transfer.

For context, if (x) an employee is employed in (y’s) company, x and y could have an agreement that x would earn some of the company’s stock after some number of years or upon the happening of an event, and subject to the employee’s continuous service to the company; hence it is an arrangement that gives a broader reach of incentives to the employees, giving them a shot at becoming a shareholder in a company after fulfilling their consideration in a vesting agreement.

This serves either as a means of inspiration, a means to strengthen the commitment of the employees or an innovation security that preserves the potential exit of a talented employee whose service is deemed useful in the company at least within the stipulated time in the agreement which is usually the nascent stage of a company.

There are different variations of vesting agreements in – trust, will, property and conveyancing law, start up, etc. The subject matter of these vesting agreements orbits transfers of ownership, but what is being transferred is where the differences lie.

This work will discuss vesting agreement with respect to contract of employment, the relevant laws that gives vitality to a vesting agreement, the upside and downside of a vesting agreement and the remedies available at the breach of the contract.

2. RELEVANT LAWS THAT FORM THE BASE OF A VESTING AGREEMENT

Vesting agreements in Nigeria are governed by various laws and regulations that stipulate the conditions and regulations, or underscores the bedrock under which rights, incentives or benefits could be legally transferred to another party, these laws include:

1. Constitution of the Federal Republic of Nigeria (CFRN)[4] – The constitution gives vitality to all the acts and laws in Nigeria. Section 1(3)[5] of the constitution provides that if any other Nigerian act or law is inconsistent with the provisions of the constitution, the constitution shall prevail and that other law shall be void to the extent of its inconsistency, by this provision, every act or law coming out from Nigeria must pass through the federal or state legislature, pursuant to section 4 of the CFRN[6], and further signed and passed into law by the president of the Federal Republic of Nigeria or Governor, respectively.

The constitution also created the courts where any of the parties to a vesting agreement or contract of employment can seek redress at the instance of the breach of the terms of the agreement, these courts are as follows:

1. Section 254 A[7] established the National Industrial Court.
2. Section 249[8] established the Federal High Court.
3. Section 270[9] established the High Court.

It is imperative to state that the issues of jurisdiction are not linear, the court with the requisite vires for the determination of labour disputes is the National Industrial Court, however, there are other disputes that may arise from a vesting agreement which may ignite the jurisdiction of other courts like the Federal High Court and the State High Courts.

For clarity; an action for the enforcement of the benefits that accrued from a contract of employment would be rightly instituted at the National Industrial Court; an action to determine whether a company acted in ultra vires by issuing shares by way of vesting would be rightly instituted at the Federal High Court; an action for the interpretation of a vesting agreement would be rightly instituted at the High Court, such are the vagaries of subject matters or disputes that may arise in a vesting agreement in the context of contract of employment.

2. Labour Act[10] – This is the principal legislation that guides the relationship between an employer and an employee, Section 7 (1)[11] of the Labour Act outlines the necessary terms of a contract of employment.

Section 7(1)(h)[12] – provides that a special condition may also be incorporated in a contract of employment, this special condition may be a vesting clause, however, section 7(3)[13] is to the effect that a contract agreement can direct an employee to any other document necessary in the course of his employment, this too could be a vesting agreement annexed to a contract of employment, so by implication, a vesting clause might form part of the terms of the contract of employment or, be a separate agreement, highlighting the terms and conditions to bind the parties to the vesting agreement.

Note that the express terms of a contract of employment governs any aspect of the relationship between the employer and the employee but where the terms are unfair or tainted with ambiguity, it will be left to the court to imply the terms either by statute, custom, practices etc. See Amodu V Amode[14]

3. Company and Allied Matters Act 2020[15] – The Company and Allied Matters Act regulates and supervises the formation, incorporation, and management of a company.

Section 141 of CAMA[16] provides that the issuance of shares is subject to the provisions of the articles of association of a company, hence, the method of issuance of shares by vesting shall be incorporated in the articles of a company for it to be effective.

Section 149 of CAMA[17] vests the power to allot shares in a private company on the directors subject to the direction and conditions imposed in the article or in the general meeting while the power to allot shares of a public company is subject to the provisions of the Investment and Security Act. Compliances to these sections are vital.

    3. TYPES OF VESTING

a. Time Based Vesting: This type of vesting is sub divided into two, which are Graded and Fixed vesting.

i. Graded Time-Based Vesting – This type of vesting vests after the effluxion of the duration stipulated in the vesting agreement (the vesting schedule), this duration could be periodically or partly until all the shares have fully vested on the employee.

This type of vesting normally has a four-years vesting schedule, with a cliff vesting occurring after the cliff period (usually one year). If the employee leaves the company before the completion of the cliff period, he leaves with nothing, but if he leaves after the cliff period, he leaves with the units of shares that have vested.

Using the x and y hypothesis, in a vesting agreement with 4 years schedule between x and y, the parties to the contract may agree that some units (1/4) of shares would be transferred to x after the first one year of the vesting schedule, which is the cliff period, after which the total units of the shares will continue to vest proportionally monthly, until the completion of the 4 years, subject to the employees continuous service in the company.

If the employee leaves after a year, then he leaves with the (1/4) of the units of the shares that have vested, if the employee leaves before the completion of the cliff period, he leaves with nothing.

Sample of a vesting clause: 100% of the employees’ shares (100 units of shares) shall be unvested shares, 25% of the shares shall vest after a cliff period of 1 year from the date of the grant of the shares to the employee, and the remaining 75% of the shares shall vest proportionally every month until the completion of the remaining 36 months, subject to the employee’s continuous service to the Company.

In essence, if what was granted to the employee is 100 units of shares, to vest after 4 years, 25 units of shares will be transferred to the employee after the cliff period, then 1/36 of the shares will continue to vest proportionally every month until the completion of the employees 4 years in the office.

 ii. Fixed Time-Based Vesting – This type of Vesting vests fully after the completion of the total vesting period or schedule, in this type of vesting, there is no cliff period and shares do not vest on the employees periodically, until after the full vesting period. E.g. in a vesting agreement with 4 years vesting schedule, no unit of share shall vest on the employee until he completes 4 years with the company.

b. Milestone Based Vesting: This type of vesting is contingent upon the happening of an event, or attainment of a goal or milestone by the employee as stipulated in the vesting agreement. E.g. The vesting of the units of shares could be contingent upon the employee facilitating a contract with an investor or facilitating the issuance of grant by the government.

c. Hybrid Vesting: This type of vesting is a hybrid of time based and milestone based vesting, for the shares of the company to vest on an employee, he has to stay for a stipulated number of years at the company and also attain a stipulated goal or milestone while at it.

d. Immediate vesting: This type of vesting vests immediately after the employment of the employee, time and milestone do not influence the vesting schedule, thus, all units of shares due for the employee are transferred to him right from the beginning of his employment.

3. ADVANTAGES AND DISADVANTAGES OF VESTING AGREEMENT

Some of the upsides of a vesting agreement are:

1. It serves as a source of motivation to employees.
2. It serves as a means to retain talented employees in the company.
3. It enhances the dedication and productivity of employees.

4. It enhances the success of the company.
5. It is helpful to companies at nascent stage who may have little or no resources to pay their workers, and/or to retain their workforce.
6. A company can buy back the unit of shares that has not been issued to the employee as an unissued share, this situation could help when the company intends to raise its equity, the shares bought back from the employee could be allotted to its members or offered to the public in the case of a public company rather than raising or altering the share capital.

See also, Section 186 (d) of CAMA[18] which provides that a company may buy back its shares by purchasing the securities issued to the employees of the company pursuant to a scheme of stock option or any other similar scheme.

Below are some of the downsides of a vesting agreement:

1. Breach of the Vesting Agreement – Breach of contracts by parties to a contract is peculiar to all contract agreement, an employer or employee may breach the terms of the vesting agreement or the employment agreement, hence exposing the other party to the contract to damages or loss e.g. wrongful termination of the contract of employment that has a vesting clause or breach of a vesting agreement annexed to the contract of employment.
2. Liquidation, winding up or restructuring of the employer’s company – the terms of a vesting agreement may become impossible or be forced to vary at the occurrence of any of the above listed events.
3. Fall of the value of stocks – the stock value of a company might fall as a result of an unforeseen factor thereby depreciating the value of shares held by the employee.
4. Employers company does not generate profit from the allotment of shares to the employee by way of vesting, viz, the transfer of shares to the employee in a vesting agreement is often on the consideration of the services rendered by the employee and not on the money paid for those shares.

Note that these downsides are not a cul de sac to the employees’ rights as there are remedies available for his exploration and (No 4) might not be a disadvantage in the real sense of it as whatever a company or an employer loses in profit, he earns or earned it back in the services that was rendered by the employee which contributed to the success of the company.

4. REMEDIES AVAILABLE TO PARTIES AT THE EVENT OF THE BREACH OF A VESTING AGREEMENT

i. Specific performance – This remedy constrains a party to do what he is obligated to do by the vesting agreement.

ii. Damages – The court may award damages to either of the parties for the breach of the terms of the vesting agreement or the contract of employment.

iii. Acceleration – When a supervening event occurs at a time when the shares have not fully vested, either because of wrongful termination, restructuring or sale of the company; the scheduled benefits in the vesting agreement might be transferred to the employee wholly or by quantum meruit depending on the term in the vesting agreement, thus, it’s a situation whereby the veil of vesting so to say is lifted and then the employee would be paid as though the shares or stocks had vested.

Acceleration is most often a clause in a vesting agreement, the parties seeing the possibility of a supervening event may include acceleration as a clause in the employment agreement or a vesting agreement.

Acceleration clause may be structured thus: “in the event of involuntary termination of x contract as a result of the restructuring of y or any other supervening event, x unvested shares shall become fully vested as though he has completed the stipulated vesting schedule in this vesting agreement.”

5. CONCLUSION

Vesting agreement is such that needs a high level of meticulousness, thus, both parties are to conduct due diligence before entering into such agreement. The employer must ensure that the employee, who is a party in the contract has the requisite talent, skill and knowledge needed for the success and sustenance of the business of the company, while the employee has to look at the prospects of the employer’s company and at other important documents of the company like the Memorandum and Articles of Association. It also goes without saying that the service of an expert is highly demanded in drafting a contract agreement of any nature.

REFERENCE

[1] (2010) LPELR-717(SC).

[2] (1875) L.R. 19 E q. 462 at 465.

[3] Vesting: What it is and how it works <https://www.investopedia.com/terms/v/vesting.asp> accessed on the 10^th day of September 2024.

[4] Constitution of the federal republic of Nigeria, 1999 as amended.

[5] Ibid., p. 2

[6] Ibid., p. 2

[7] Ibid., p. 2

[8] Ibid., p. 2

[9] Ibid., P. 2

[10] Labour Act, 2004

[11] Ibid., p. 3

[12] Ibid., p. 3

[13] Ibid., p. 3

[14] (1990) LPELR-466(SC)

[15] Company and allied matters act 2020

[16] Ibid

[17] Ibid., P. 3

[18] Ibid., P. 3

About the Author

Stanislaus Azike is a Legal Practitioner, who specializes in Corporate, Commercial, Taxation and Labour Law. He is an astute litigator and a regulatory compliance officer.