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Employee Stock Option Plan (ESOP) – Companies Act, 2013

October 7, 2015
This write-up examines various provisions governing Issue of Employee Stock Option Plans as applicable to ‘Unlisted Public Companies’.
  1. IntroductionThe idea that employees should have an ownership stake in the company led to the emergence of concept of Employee Stock Option Plan (ESOP). The concept of ESOP is believed to be the brain child of an American, Louis Kelso, who is a lawyer, economist and philosopher who persuaded a Senator from Louisiana, to support legislation legalizing ESOP’s. Definition of “Employee Stock Option” was first incorporated by way of a clause (15A) in Section 2 of the Companies Act, 1956, based on the recommendations of Working Group. Section 62 of the Companies Act, 2013 further incorporates enabling provision for the issue of ESOPs subject to the sanction of special resolution and compliance with Rules (in case of unlisted public company) and SEBI Regulations (in case of listed companies).
  2. Objective of issuing ESOPsThe objective of issuing ESOP is to:
    • Provide incentive to attract, retain and reward employees of the company
    • Motivate employees to contribute to the growth and profitability of the company
  3. Some important definitions under ESOPs:
    • What is an ‘option’ in stock options?An option in stock option gives the employee the choice- a right but not an obligation – to purchase the shares of the company on the fulfillment of the conditions mentioned in the ESOP plan at the price decided at the time of grant of options.
    • What is a grant?The eligibility of a particular employee (depending on the criteria set) for grant of stock options based on his role and performance is known as grant of option.
    • What is vesting?Vesting has two components – Vesting percentage and vesting period. Vesting period is the period on the completion of which the said portion can be exercised. Vesting percentage refers to that portion of total options granted, which the employee will be eligible to exercise.
    • What is exercise?The activity of converting the options granted to an employee into shares by paying the required exercise price is known as exercise of options.
    • What is exercise price and exercise period?Exercise price is the price; the employee has to pay to convert the options into shares. The exercise period is the period within which the employee can decide to exercise the stock options.
    • What is the effective date of exercise?The effective date of exercise is the date on which the Company allots the shares.
  4. Issue of Employee Stock Options by Unlisted Public CompanyAs per provisions of Sec 62(1)(b) of Companies Act, 2013, “where at any time a company having a share capital proposes to increase its subscribed capital by the issue of further shares, such shares shall be offered to employees under a scheme of employees’ stock option, subject to special resolution passed by the company and subject to such conditions as may be prescribed.” Sec 2(37) of Companies Act, 2013 defines “employees stock option” which means, ‘the option given to the directors, officers or employees of the company or of its holding company or subsidiary company or companies, if any, which gives such directors, officers or employees, the benefit or right to purchase, or to subscribe for, the shares of the company at a future date at a pre-determined price.’ The above provision needs to be read with Rule 12 of The Companies (Share Capital and Debentures) Rules, 2014. As per the said Rule, a Company, other than a listed company, shall not offer shares to its employees under a scheme of employees’ stock option, unless it complies with the following requirements, namely:-
    1. Sanction by Special ResolutionThe issue of Employee Stock Option scheme shall be approved by the shareholders of the company, by passing a Special Resolution.
    2. Employees to whom ESOPs may be issuedFor the purpose of the Section 62(1)(b) and Rule 12, “Employee” means –
      1. A permanent employee of the company who has been working in India or outside India; or
      2. A director of the company, whether a whole time director or not but excluding an independent director; or
      3. An employee as defined in clause (a) or (b) of a subsidiary, in India or outside India, or of a holding company of the company or of an associate company,but does not include-
        1. An employee who is a promoter or a person belonging to the promoter group; or
        2. A director who either himself or through his relative or through any body corporate, directly or indirectly, holds more than 10% of the outstanding equity shares of the company.
    3. Disclosures in the explanatory statement annexed to the notice for passing of the resolutionThe company shall make the following disclosures in the explanatory statement annexed to the notice for passing of the resolution –
      • the total number of stock options to be granted;
      • identification of classes of employees entitled to participate in the Employees Stock Option Scheme;
      • the appraisal process for determining the eligibility of employees to the Employees Stock Option Scheme;
      • the requirements of vesting and period of vesting;
      • the maximum period within which the options shall be vested;
      • the exercise price or the formula for arriving at the same;
      • the exercise period and process of exercise;
      • the Lock-in period, if any;
      • the maximum number of options to be granted per employee and in aggregate;
      • the method which the company shall use to value its options;
      • the conditions under which option vested in employees may lapse e.g. in case of termination of employment for misconduct;
      • the specified time period within which the employee shall exercise the vested options in the event of a proposed termination of employment or resignation of employee;
      • a statement to the effect that the company shall comply with the applicable accounting standards.
    4. PricingThe companies granting option to its employees pursuant to Employees Stock Option Scheme will have the freedom to determine the exercise price in conformity with the applicable accounting policies, if any.
    5. Shareholders’ approval by way of separate resolutionThe approval of shareholders by way of separate resolution shall be obtained by the company in case of:
      • grant of option to employees of subsidiary or holding company; or
      • grant of option to identified employees, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant of option.
    6. Variation of terms of ESOSThe company may by special resolution, vary the terms of Employees Stock Option Scheme not yet exercised by the employees provided such variation is not prejudicial to the interests of the option holders. The notice for passing special resolution for variation of terms of Employees Stock Option Scheme shall disclose full details of the variation, the rationale therefore, and the details of the employees who are beneficiaries of such variation.
    7. Minimum vesting periodThere shall be a minimum period of one year between the grant of options and vesting of option. In a case where options are granted by a company under its Employees Stock Option Scheme in lieu of options held by the same person under an Employees Stock Option Scheme in another company, which has merged or amalgamated with the first mentioned company, the period during which the options granted by the merging or amalgamating company were held by him shall be adjusted against the minimum vesting period required under this clause.
    8. Lock-in-period for shares issued on exercise of optionThe company shall have the freedom to specify the lock-in period for the shares issued pursuant to exercise of option.
    9. Right to receive dividendsThe Employees shall not have right to receive any dividend or to vote or in any manner enjoy the benefits of a shareholder in respect of option granted to them, till shares are issued on exercise of option.
    10. Forfeiture/ Refund of amount paid by employees under ESOPThe amount, if any, payable by the employees, at the time of grant of option-
      • may be forfeited by the company if the option is not exercised by the employees within the exercise period;  or
      • the amount may be refunded to the employees if the options are not vested due to non-fulfillment of conditions relating to vesting of option as per the Employees Stock Option Scheme.
    11. Options not transferable
      • The option granted to employees shall not be transferable to any other person.
      • The option granted to the employees shall not be pledged, hypothecated, mortgaged or otherwise encumbered or alienated in any other manner.
    12. Who can exercise the option
      • No person other than the employees to whom the option is granted shall be entitled to exercise the option.However, in the event of the death of employee while in employment, all the options granted to him till such date shall vest in the legal heirs or nominees of the deceased employee.
      • In case the employee suffers a permanent incapacity while in employment, all the options granted to him as on the date of permanent incapacitation, shall 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 shall expire. However, the employee can exercise the options granted to him which are vested within the period specified in this behalf, subject to the terms and conditions under the scheme granting such options as approved by the Board.
    13. Disclosures in Board of Directors ReportThe Board of directors, shall, inter alia, disclose in the Directors’ Report for the year, the following details of the Employees Stock Option Scheme: (a) options granted; (b) options vested; (c) options exercised; (d) the total number of shares arising as a result of exercise of option; (e) options lapsed; (f) the exercise price; (g) variation of terms of options; (h) money realized by exercise of options; (i) total number of options in force; (j) employee wise details of options granted to;- (i) key managerial personnel; (ii) any other employee who receives a grant of options in any one year of option amounting to five percent or more of options granted during that year. (iii) identified employees who were granted option, during any one year, equal to or exceeding one percent of the issued capital (excluding outstanding warrants and conversions) of the company at the time of grant;
    14. Register of Employees Stock Options
      • The company shall maintain a Register of Employee Stock Options in Form No. SH.6 and shall forthwith enter therein the particulars of option granted under clause (b) of sub-section (1) of section 62.
      • The Register of Employee Stock Options shall be maintained at the registered office of the company or such other place as the Board may decide.
      • The entries in the register shall be authenticated by the company secretary of the company or by any other person authorized by the Board for the purpose.
    Rule 12(11) specifically provides that, where the equity shares of the company are listed on a recognised stock exchange, the Employees Stock Option Scheme shall be issued, in accordance with the regulations made by Securities and Exchange Board of India, in this behalf. SEBI (Share Based Employee Benefits) Regulations, 2014 issued in October 28, 2014 (applicable from the even date) have replaced the erstwhile SEBI Employee Stock Option Scheme and Employee Stock Purchase Scheme Guidelines (applicable for listed companies) 1999.
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