Compliances relating to ESOP under Companies Act 2013

INTRODUCTION

The Employee Stock Option Scheme (“ESOP Scheme”) is an employee benefit plan where the employees of a company, its subsidiary and/or holding company, receive a grant of option which gives a right to purchase or subscribe to the shares of the company at a predetermined price on a future date (“Employee Stock Option”, “ESOP” or “Option”).

There are many benefits for a company introducing an ESOP Scheme. To list a few, it helps retain existing talent and attracting new talent; it is widely used by start-ups, where the ESOP Scheme helps to lure in good talent in the initial days when high pay packages are not feasible. With the help of ESOP, organizations can avoid cash compensation as a reward, thereby saving on immediate cash outflow.

For employees, they would benefit when the company’s share prices soar, this serves as an incentive for them to put in their 100%. It gives a sense of ownership to the employees, fostering enthusiasm and belonging to the company.

There are two ways to issue and allot shares to the employees under ESOP they are – Direct Route & Trust Route. For the purpose of this article we shall focus on the direct route, where a Company issues stock options under ESOP to the eligible employees and such employees after the vesting period is over directly exercise their options and Company allots shares against options exercised by the employees. Here in this route mainly fresh issue of shares is done thus employee becomes shareholder of a company.

Let us dive into the key definitions, procedures and provisions relevant to the subject matter.

1.WHAT IS ESOP AND WHO ARE ELIGIBLE TO RECEIVE IT?

a) Definition of ESOP as per the Act: As per section 2(37) of the Companies Act, 2013, ‘Employees Stock Option’ is defined as the option given to the directors, employees, or officers of the company or of its holding or subsidiary company, granting them the right to purchase or benefit from subscribing for the shares of the company at a predetermined price on a future date.

b) Eligible Employee: According to the Act, the following are considered directors, employees, or officers of the company who are be eligible to receive ESOPs from a company:

–  a permanent employee of a company who has been working in India or outside India;

– a director of a company, whether a whole-time director or not, but excluding an independent director;

–  an employee, as defined above, of a subsidiary, in India or outside India, or of a holding company of the company, but excluding:

i. an employee who is a promoter or a person belonging to the promoter group; or

ii. a director who, either himself or through his relative or any body corporate, directly or indirectly holds more than 10% of the outstanding equity shares of the company.

(Provided that in the case of a startup company, which is registered with the Department for Promotion of Industry and Internal Trade (DPIIT), the conditions mentioned in sub-clauses (i) and (ii) above shall not apply for up to 10 years from the date of its incorporation or registration.)

2. TIMELINES ASSOCIATED WITH VESTING, EXERCISE, AND ISSUANCE OF SHARES THROUGH THE ESOP SCHEME

a) Date of Grant of Option: This is the date when the Options are issued or granted to the eligible employees by a company.

b) Vesting Period: It is the period from the date of grant of Option to the date when the Employee is eligible to exercise the Options. According to the Act, the vesting period should be a minimum of 1 year from the date of grant of the Option.

(Provided that in a case where Options are granted by a company under its ESOP Scheme in lieu of Options held by the same person under an ESOP 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.)

c) Exercise Period: This is the period within which the employee is eligible to exercise the Options for issuance of shares after completion of the vesting period. The Company has the discretion to determine the exercise period.

d) Exercise Price: This is the predetermined price fixed by the company at which the employees can pay and exercise the Options granted and vested. Companies are free to decide the exercise price, which may be issued at a discount or premium but the exercise price determined by the Company shall not be less than the par value of the shares.

e) Lock-in Period: This is the period during which the employees are restrained from selling the shares to any person post the date of issue of shares. A company has the freedom to decide the lock-in period associated with shares issued.

3. PROCEDURE TO ISSUE EMPLOYEE STOCK OPTION

a) The Articles of Association of the Company should provide for the issue of ESOP. If not, the Articles of Association should be amended to include enabling provisions.

b) Call and hold a Board Meeting by giving at least 7 days’ prior notice, along with necessary disclosures in the agenda of the meeting. It is to be noted that the issue of ESOP cannot be approved by circular resolution.

c)  The Board Meeting should be convened to approve:

• the Employee Stock Option Scheme
• Calling of Extra-Ordinary General Meeting (“EGM”) and approval of the notice calling the EGM.

d)  Notice of the general meeting along with an explanatory statement is to be sent to all directors, auditors, shareholders and secretarial auditors of a company at least 21 days before the date of the meeting.

e) At the the general meeting, an Ordinary Resolution, in the case of a Private Limited Company, or a Special Resolution, in the case of a Public Limited Company, is required to be passed by the shareholders of a company.

f) A company is required to make all mandatory disclosures, as provided in the Act and the rules made thereunder, in the explanatory statement annexed to the notice calling the general meeting.

g) Grant and issue of options to the eligible employees.

h) File Form MGT-14 with the Registrar of Companies within 30 days of passing the resolution in the general meeting.

i) The company must maintain a Register of Employee Stock Options in Form SH-6, and the company secretary or any other person authorized by the Board must forthwith enter therein the particulars of Options granted.

j) After vesting period when eligible employees exercise their options, Company is required to convene Board Meeting to allot shares under the ESOP scheme to the employees who exercised the option.

4. PROVISIONS RELEVANT TO ELIGIBLE EMPLOYEES HOLDING ESOP

a) In the event of resignation or termination of employment, all Options not vested in the employee as of that day shall expire. However, the employee may exercise the Options granted to him which are vested within the specified period, subject to the terms and conditions under the ESOP Scheme granting such Options as approved by the Board.

b) The Options granted to employees shall not be transferable to any other person.

c) The Options granted to employees shall not be pledged, hypothecated, mortgaged, or otherwise encumbered or alienated in any other manner.

d) No person other than the employees to whom the Options are granted shall be entitled to exercise the Option, except in the case where the death of the employee occurs while in employment; all the Options granted to him until that date shall vest in the legal heirs or nominees of the deceased employee.

e) If the employee suffers a permanent incapacity while in employment, all the Options granted to him as of the date of permanent incapacitation shall vest in him on that day.

5. CONCLUSION

We have reached the end and after a lot of research and analysis on the topic of Employee Stock Option (ESOP), it can now be said that the one of the best ways to reward employees, enhance profitability, generate the spirit of ownership and make employees more loyal towards the Company is issue and allotment of shares to the eligible employees under the Employee Stock Option (ESOP).

However, a company is required to ensure it complies with all applicable rules, guidelines and law while preparing the ESOP Scheme Plan, determining the eligibility of employees and Directors, preparing and maintaining various secretarial records, filing of necessary returns, and making subsequent disclosures annually, to avoid any legal implication or conflict with the employees.

Thus, if planned and executed properly considering all aspects, and complying to all applicable laws, the Employee Stock Option (ESOP) becomes a way to attract the best talent for the Company and promises a stable career to the employees while the company exploits its potential to its fullest.

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Disclaimer: The information provided on this blog is for general informational purposes only and does not constitute legal, financial, or tax advice. While we strive to ensure the accuracy and timeliness of the content, laws and regulations regarding Employee Stock Ownership Plans (ESOPs) may change and vary based on jurisdiction. Readers are strongly encouraged to consult with a qualified company secretary, financial advisor, or other professional to obtain advice specific to their individual circumstances or business needs. The use of this blog and its content does not create an attorney-client relationship.