Client Alert

California Supreme Court Upholds Forfeiture of Incentive Compensation

November 11, 2009

Ethan Lipsig and Jeffrey D. Wohl

In a closely watched case involving the Smith Barney Capital Accumulation Plan, the California Supreme Court has ruled unanimously that state law does not prohibit an employer from forfeiting an employees incentive compensation when the employee quits or is terminated for cause before the date that the compensation vests. Schachter v. Citigroup, Inc., No. S1611385, 2009 Cal. LEXIS 11056 (Nov. 2, 2009).

But in dicta, the court suggested an exception to its ruling: If an employee is terminated without cause, then the employee still may be entitled to a pro rata share of the compensation at issue. The court did not elaborate on what would constitute cause in this context, whether the reason for the termination would make a difference, or whether an express provision in the incentive-compensation plan would eliminate the potential exposure. It therefore is unclear how far this exception may go.

For California employers that have incentive-compensation plans with forfeiture provisions, as well as those employers considering adopting such plans, Schachter is required reading to ensure that the plans are properly drafted to be enforceable under state law, and that the decision whether to pay out incentive compensation in a particular case is lawful.

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