Schachter v. Citigroup, Inc.

Facts

The statutory framework. Section 200, subdivision (a) defines a wage as “all amounts for labor performed by employees of every description, whether the amount is fixed or ascertained by the standard of time, task, piece, commission basis, or other method of calculation.” (Schachter v. Citigroup, Inc. (2009) 47 Cal.4th 610, 618.) Section 201, subdivision (a) provides that on discharge “the wages earned and unpaid at the time of discharge are due and payable immediately,” and section 202, subdivision (a) requires that a quitting employee’s wages “become due and payable not later than 72 hours thereafter.” (Id. at p. 615, fns. 4–5.) Section 219 provides that those wage-payment requirements cannot “be contravened or set aside by private agreement.” (Id. at p. 616.) Two adjacent provisions frame the argument: section 221 makes it “unlawful for any employer to collect or receive from an employee any part of wages theretofore paid” (id. at p. 615, fn. 6), while section 224 permits deductions “expressly authorized in writing by the employee” (id. at p. 617, fn. 8).

The Plan. Smith Barney — later a Citigroup subsidiary — ran a capital accumulation plan under which eligible employees could elect to receive awards of restricted company stock “in lieu of cash payment of a percentage of the employee’s annual compensation,” choosing 5, 10, 15, 20 or 25 percent of “total compensation in the form of restricted stock.” (Schachter, supra, 47 Cal.4th at p. 614.) The election was made prospectively, by executing a form at the end of the prior calendar year, and could differ between the first and second halves of the year. (Ibid.)

The stock came at a 25 percent discount to the trailing five-day market price, a discount set to “reflect the impact of the restrictions on the value of the restricted stock, as well as the possibility of forfeiture of restricted stock.” (Schachter, supra, 47 Cal.4th at p. 614.) For two years the shares could not be “sold, transferred, pledged, or assigned” — but participants “shall have the right to direct the vote” and to “receive any regular dividends on restricted stock shares” during that period. (Ibid.) The arrangement carried a tax benefit: participants’ restricted shares were “not included in the participating employees’ gross income for federal tax purposes until the two-year vesting period had expired.” (Ibid.)

The forfeiture asymmetry. If the employee stayed two years, title vested free of restrictions. If the employee resigned or was terminated for cause first, he forfeited both the restricted stock and the slice of annual income he had designated to be paid as stock. But an employee terminated involuntarily and without cause forfeited the shares and received back, without interest, a cash payment equal to the portion of annual compensation that had been paid as the forfeited stock. (Schachter, supra, 47 Cal.4th at p. 615.) That asymmetry — forfeiture for the employee’s own exit, restitution for the employer’s — did substantial work in the court’s reasoning.

Schachter. David Schachter was a Smith Barney stockbroker from April 28, 1992 to March 29, 1996. (Schachter, supra, 47 Cal.4th at pp. 613–614.) He enrolled on December 21, 1994, electing 5 percent of 1995 total compensation as restricted stock for both half-years; he received 44 shares on July 1, 1995 (vesting July 1, 1997) and 38 shares on January 2, 1996 (vesting January 2, 1998). He re-enrolled for 1996, taking cash only for the first half-year and 5 percent as stock for the second. He resigned on March 31, 1996 — before either vesting date — and so forfeited all of his shares and the corresponding percentage of his annual compensation. (Id. at p. 615.) [The two end-of-employment dates are the opinion’s own: it recites the employment period as running “to March 29, 1996” (id. at pp. 613–614) and then states that “[o]n March 31, 1996, Schachter voluntarily terminated his employment with the company” (id. at p. 615). Nothing in the analysis turns on the difference.]

Procedural history

Schachter filed a putative class action in May 1998, alleging that the forfeiture provision violated sections 201 and 202 and that it violated section 221 (Schachter, supra, 47 Cal.4th at p. 615), and that forfeiting compensation received as stock was an “unlawful conversion of wages” (id. at p. 616). The trial court denied the company’s summary judgment motion in its entirety on October 20, 1998. (Id. at p. 616.)

What followed was unusually protracted. A class of former employees “who have suffered financial damages as a result of the forfeiture provisions of the [P]lan” was certified; three amended complaints, a second summary judgment motion, a reassignment to a different judge, and an intervening appeal (Schachter v. Citigroup, Inc. (2005) 126 Cal.App.4th 726) intervened. (Schachter, supra, 47 Cal.4th at p. 616 & fn. 7.) The trial court then “elected to exercise its inherent authority to reconsider its original denial” under Le Francois v. Goel (2005) 35 Cal.4th 1094, and on reconsideration granted summary judgment for the company. (Id. at p. 616.)

The Court of Appeal affirmed on three independent grounds: that Schachter had been paid all earned wages, some as stock carrying immediate voting and dividend rights and some as cash (Schachter, supra, 47 Cal.4th at p. 616); that, at most, the omission of the intermediate step “of delivering the money to [Schachter] before implementing his request to use it to purchase the designated restricted stock amounts to a deduction of wages for an authorized use, a transaction expressly permitted by section 224”; and that in any event his claim “would still fail as a matter of law because he could not show the funds used to purchase the shares were actually earned.” (Id. at p. 617.) On that last point the court invoked Neisendorf v. Levi Strauss & Co. (2006) 143 Cal.App.4th 509, 524, reasoning that “[u]nder basic incentive compensation plans the point at which the wage is actually earned is determined by the parties’ agreement.” (Id. at p. 617.) The Supreme Court granted review. (Id. at p. 618.)

Issue

Whether an incentive compensation plan’s forfeiture provision — under which an employee who resigns or is terminated for cause before a two-year vesting date loses both the restricted stock and the portion of annual compensation directed into that stock — violates Labor Code sections 201, 202 and 219, which require payment of all earned, unpaid wages on termination or resignation and forbid private agreements circumventing that requirement. (Schachter, supra, 47 Cal.4th at p. 613.) Framed as the court framed it, the operative question is whether any “earned and unpaid” wages were owed — and therefore forfeited — at the moment of resignation. (Id. at p. 618.)

Holding

Reasoning

1. Restricted stock is a wage — the concession that sharpens the case. The court began by construing “wages” broadly, to “include not only the periodic monetary earnings of the employee but also the other benefits to which he is entitled as a part of his compensation.” (Schachter, supra, 47 Cal.4th at p. 618, quoting Wise v. Southern Pac. Co. (1970) 1 Cal.3d 600, 607.) It then added, in its own voice, that “[i]ncentive compensation, such as bonuses and profit-sharing plans, also constitutes wages” (ibid., citing Neisendorf v. Levi Strauss & Co. (2006) 143 Cal.App.4th 509, 522, Lucian v. All States Trucking Co. (1981) 116 Cal.App.3d 972, 974, and Ware v. Merrill Lynch, Pierce, Fenner & Smith, Inc. (1972) 24 Cal.App.3d 35, 44). It then agreed with the Court of Appeal that the restricted stock was a wage. (Id. at p. 619.) That agreement matters. It forecloses the reading — sometimes advanced by employers — that equity awards sit outside the Labor Code altogether, and it means the decision cannot be defended on a characterization theory. Everything rests on timing.

2. Cart before the horse: section 219 is derivative. Schachter’s structural argument was that the Plan was an unenforceable agreement under section 219, so its terms could not defeat his section 202 claim. The court accepted his premises but reversed the order of operations. He “correctly suggests that section 219 prohibits an employer and employee from agreeing, even voluntarily, to circumvent” the wage-payment provisions, and correctly argued that prospective waivers of section 201 and 202 rights are “illegal and unenforceable.” (Schachter, supra, 47 Cal.4th at p. 619.) But, as the company put it and the court agreed, “Schachter has put the cart before the horse.” (Ibid.) “Before Schachter can argue that the Plan constitutes an improper agreement under section 219, he must demonstrate that the Plan’s forfeiture provision violates sections 201 and 202 . . . . This he cannot accomplish.” (Ibid.) Section 219 protects earned wages; it does not manufacture them.

3. Compensation terms may be altered prospectively and by agreement. The court grounded the employer’s freedom to structure pay in the at-will presumption. “There is, of course, a strong common law presumption that an employee may be demoted at will.” (Schachter, supra, 47 Cal.4th at p. 619, quoting Scott v. Pacific Gas & Electric Co. (1995) 11 Cal.4th 454, 464–465.) Because discharge is presumptively at will under section 2922, the passage continues, that presumption extends to lesser forms of discipline as well. (Id. at p. 620.) That presumption “similarly and necessarily authorizes an employer to unilaterally alter the terms of employment, provided that the alteration does not violate a statute or breach an implied or express contractual agreement.” (Id. at p. 620.) A fortiori for bilateral change: “It cannot be questioned that employers and employees are free to prospectively and bilaterally alter the terms of employment. As we recently noted, ‘[s]traight-time wages (above the minimum wage) are a matter of private contract between the employer and employee.’” (Ibid., quoting Gentry v. Superior Court (2007) 42 Cal.4th 443, 456.)

4. Schachter renegotiated his own pay — and received all of it. Applying that principle, the court characterized the election forms as a restructuring rather than a deduction: “When he executed the Plan election forms, Schachter essentially renegotiated the terms of his compensation with the company.” (Schachter, supra, 47 Cal.4th at p. 620.) He understood that the stock “would have limited and conditional present value and would not fully vest until two years following the date he received it, provided he remained employed by the company.” (Id. at p. 621.) The court adopted the company’s framing wholesale: Schachter’s “bargained-for ‘wages’ have been paid in full. He received all of his promised cash compensation, received immediately exercisable voting and dividend rights in the restricted stock, and was awarded contingent rights of full ownership in that stock. The only thing that has not been ‘paid’ is something Schachter never ‘earned’ — fully vested [company] stock.” (Id. at p. 622.)

5. Incentive compensation is earned only when the condition precedent is satisfied. This is the doctrinal core. Incentive compensation, “whether in the form of a traditional cash bonus program or a more complex restricted stock plan, is generally understood as an ‘“inducement to employees to procure efficient and faithful service.”’” (Schachter, supra, 47 Cal.4th at p. 621, quoting DLSE, Enforcement Policies and Interpretations Manual (rev. 2006) § 35.1, quoting Duffy Bros. v. Bing & Bing (N.Y.App.Div. 1926) 215 N.Y.S. 755, 758.) Eligibility to receive it “‘is properly determined by the . . . plans’ specific terms and general contract principles.’” (Ibid., quoting Neisendorf, supra, 143 Cal.App.4th at p. 523.) The court paired a strong statement of the protective policy with a firm limit on it: while “‘[t]he public policy in favor of full and prompt payment of an employee’s earned wages is fundamental and well established . . .’” (the ellipsis is the court’s), “‘nothing in the public policy of this state concerning wages . . . transforms [a] contingent expectation of receiving bonuses into an entitlement.’” (Ibid., quoting Smith v. Superior Court (2006) 39 Cal.4th 77, 82, and Neisendorf, supra, 143 Cal.App.4th at p. 522.) Hence the rule, and the consequence the court attached to it: “Only when an employee satisfies the condition(s) precedent to receiving incentive compensation, which often includes remaining employed for a particular period of time, can that employee be said to have earned the incentive compensation (thereby necessitating payment upon resignation or termination).” (Ibid.)

6. The involuntary-termination carve-out and the prevention principle. The court paused on the Plan’s asymmetry and explained why it is not an anomaly but a doctrinal requirement. The cash-back provision for employees terminated without cause “is consistent with contract law principles prohibiting efforts by one party to a contract to prevent completion by the other party.” (Schachter, supra, 47 Cal.4th at p. 622.) Quoting the DLSE manual: “If the employee is discharged before completion of all of the terms of the bonus agreement, and there is not valid cause, based on conduct of the employee, for the discharge, the employee may be entitled to recover at least a pro-rata share of the promised bonus.” (Ibid.) The commission cases supply the analogy and the aphorism — “‘“He who shakes the tree is the one to gather the fruit.”’” (Ibid.) The court then closed the loop on the facts: “Here, Schachter’s actions — not the company’s — resulted in the loss of Schachter’s contingent incentive compensation. As such, Schachter is not entitled to ‘gather the fruit’ because he failed to perform the condition necessary to do so — in this case, remain employed with the company until two years had passed from the date he received the restricted stock.” (Id. at pp. 622–623.)

7. Suastez distinguished, not extended. Schachter’s best argument was analogical: vacation pay vests pro rata under Suastez v. Plastic Dress-Up Co. (1982) 31 Cal.3d 774, so incentive compensation should too. The court refused, and the refusal rests on a clean functional distinction. Suastez struck down an anniversary-date eligibility rule as “a condition subsequent which attempts to effect a forfeiture of vacation pay already vested,” prohibited by section 227.3. (Schachter, supra, 47 Cal.4th at p. 623, quoting Suastez, supra, 31 Cal.3d at p. 781.) But that turned on what vacation pay is: Suastez “expressly acknowledged ‘that vacation pay is not an inducement for future services, but is compensation for past services.’” (Ibid., quoting Suastez, supra, 31 Cal.3d at p. 782.) Incentive compensation is the opposite — an inducement for future service. The court then turned Suastez’s own reservation against Schachter, quoting its acknowledgement that “‘[i]f vacation pay served simply to induce employees to remain on the job for a certain period of time, then interpreting eligibility requirements as a condition precedent to the vesting of vacation pay would not be unreasonable.’” (Ibid.) That is precisely this case. There was no dissent and no separate concurrence.

Significance

Schachter is the California Supreme Court’s clearest statement that the Labor Code’s prompt-payment rules operate on earned wages and do not themselves dictate when compensation becomes earned. That question is answered by the parties’ agreement, subject to statutory limits. For equity compensation, deferred bonuses, retention awards and similar structures, the decision supplies the governing frame: a properly drafted, prospectively elected, condition-precedent plan survives sections 201, 202 and 219 even though the award is conceded to be a wage.

The concession that restricted stock is a wage is the underappreciated half of the holding. It means Schachter cannot be cited for the proposition that equity awards escape the Labor Code. It also means the timing analysis carries the full weight — and timing is a drafting question, which is where the litigation has migrated.

The decision’s limits track its rationale. The vesting condition here was continued employment for a fixed period, and the plan returned the cash equivalent to employees terminated without cause. The court’s prevention-principle discussion (p. 622) strongly suggests that a plan forfeiting the compensation of an employee the employer fired without cause would face a different analysis. And the Suastez distinction is functional, not formal: a benefit that is in substance “compensation for past services” rather than an “inducement for future services” remains on the Suastez side of the line whatever the plan calls it. (Schachter, supra, 47 Cal.4th at p. 623.)

Read alongside Suastez, the pair now marks the two poles of California vesting doctrine — earned-as-you-work compensation that cannot be forfeited, and inducement compensation that is not earned until the condition is met.

Key quotes

“We conclude that the Plan’s forfeiture provision does not run afoul of section 201 or 202 because no earned wages remain unpaid upon termination for cause or resignation.” (Schachter v. Citigroup, Inc. (2009) 47 Cal.4th 610, 623.)

“Only when an employee satisfies the condition(s) precedent to receiving incentive compensation, which often includes remaining employed for a particular period of time, can that employee be said to have earned the incentive compensation (thereby necessitating payment upon resignation or termination).” (Id. at p. 621.)

“The Court of Appeal concluded, and we agree, that the shares of restricted stock issued to Schachter also constituted a wage.” (Id. at p. 619.)

“[O]ur ruling in Suastez was limited to vacation pay and cannot extend to voluntary incentive programs, like the one at issue in this case.” (Id. at p. 623.)

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Practice pointer

Open questions

Sections 221 and 224. Schachter pleaded a section 221 violation (Schachter, supra, 47 Cal.4th at p. 615), and the Court of Appeal had reasoned in the alternative that the arrangement was at most an authorized deduction under section 224 (id. at p. 617). The Supreme Court resolved the case on sections 201, 202 and 219 and did not adopt or reject the section 224 rationale. Whether an election of this kind is properly analyzed as a deduction remains unsettled at the Supreme Court level.

Forfeiture after a without-cause termination. The Plan returned the cash equivalent to employees terminated without cause, so the court never had to decide whether a plan that forfeited it would be enforceable. Its discussion of the prevention principle and pro rata bonus recovery (id. at p. 622) signals the answer without supplying it.

The functional boundary of Suastez. The court distinguished vacation pay as “compensation for past services” rather than “an inducement for future services” (id. at p. 623), but gave no test for hybrid benefits that serve both functions — a retention bonus keyed to work already performed, for example.

Conversion. The conversion cause of action pleaded in 1998 (id. at pp. 615–616) is not addressed in the opinion.

The tax-deferral objection. Schachter argued the holding “renders the Plan’s income tax deferral a sham if not an outright fraud.” The court answered practically, observing in footnote 10 that title 26 United States Code section 83 requires a “substantial risk of forfeiture” for deferral to be available, so paying out on resignation “would in all likelihood jeopardize the validity of the tax deferral.” (Id. at p. 622, fn. 10.) That is an observation about tax consequences, not a holding about the Labor Code.