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How discretionary can a discretionary share plan be?

Posted by Chris on July 09, 2012

In December 2011 the Court of Appeal considered whether an employer had acted in a discriminatory way in allocating discretionary share options. The decision provides useful guidance to employers.

In the case of Hosso v European Credit Management Ltd, the applicant's employer, a fund manager company, operated a discretionary share option scheme for the benefit of employees generally. The scheme was not, however, mentioned in any employee's contract of employment or in any other relevant literature, such as a staff handbook. Share options were granted to the applicant, but she subsequently discovered that an equivalent male employee peer had been granted options over a larger number of shares. The applicant brought claims under both the Equal Pay Act 1970 and the Sex Discrimination Act 1975, although, in the event, her latter claim was out of time. 
The case went as far as the Court of Appeal, which held that, because there was no contractual term in relation to which the applicant was able to claim she had experienced less favourable treatment than an equivalent male employee, her claim could not be within the scope of the Equal Pay Act 1970 and therefore failed.
 
The relevant legislation is now contained in the Equality Act 2010, which replaces both the Equal Pay Act 1970 and the Sex Discrimination Act 1975. However, the principles in this case are likely to continue to be relevant under the newer legislation.
 
The key point for companies operating share option schemes is that, to limit the risk of equal pay claims by employees on grounds of discrimination, the awards must be entirely discretionary. Similar principles are also likely to apply to claims on grounds of sex discrimination. Although an incentive scheme can be mentioned in a contract of employment or staff handbook, this should be limited to matters such as eligibility in order to minimise the risk of a discrimination claim, and there should be no reference which might be interpreted as conferring an entitlement on participants. For other reasons why it is advisable to omit reference to share plans in an offer letter or employment contract see here.
 
In this case, the EAT suggested that even if a plan is incorporated by reference into a contract of employment, provided that the way in which the employer determines the amount to be awarded and whether an award will be made in any given year is discretionary, the plan is not regulated by the contract of employment.
 
Ensuring that any share plan arrangements fall outside the employment contract and including confidentiality clauses in any option agreements are sensible measures for an employer to take but this case should not be taken as giving employers carte blanche to be entirely partisan in their equity awards. The downtime and cost to business of defending an action such as this ought to be reason enough to ensure that board discretion is exercised with due consideration to the merits of individuals and that the rationale behind discretionary awards can withstand scrutiny.