A stock option is the right to purchase a fixed number of shares of stock for a fixed price in the future, during the life of the option. Some companies, particularly those in the high- tech industry, grant stock options to employees as compensation, on the theory that as the company succeeds, the company’s stock price will rise, making the option more valuable to the employee.

Employee stock options typically are subject to vesting. In other words, the employee does not receive the immediate right to buy all of the shares in the option grant, but must continue to be employed by the company for a period of years in order to receive the benefit of the entire grant.

For example, an employee who received an option grant for 4,800 shares subject to a 4-year vesting period would obtain the right to exercise 1,200 of those shares per year, as the vesting condition was met. If the vesting period was monthly, each month of continued employment would provide the employee with the right to exercise another 100 shares.

Termination of employment sooner than four years would mean that any unvested options would not become exercisable, and only the options that had vested before the termination could be used to purchase shares.

However, those rules regarding option vesting are not so straightforward in a divorce situation.

In marriage, the compensation of one spouse “earned” during the marriage is community property. The basic legal rule regarding assets acquired with community property is that they are allocated to the spouses equally at the time of divorce.

Where a stock option is granted during the marriage, and vests completely during the marriage, and the shares are purchased with the stock option during the marriage, the division of those assets in divorce is simple to calculate, since the assets are clearly community property.

If the marriage ends before the options vest, however, the answer is not as simple.

Even if an option has not vested at the time of marital separation, and even though the employee must continue employment as a condition of future vesting for the option, California courts do not treat the later vesting options as being separate property of the employee spouse who “earned” them after the marriage.

California courts provide unvested options with a treatment in divorce similar to that of retirement benefits that the employee spouse is ineligible to collect at the time of divorce, but the value of which was created, in part, during the course of the marriage.

The courts use what is called the “time rule” to determine what fraction of the unvested options should be treated as community property. In most cases, the court will use the number of months the options vested during the marriage as the numerator, and divide that number by the total number of months of vesting required under the option to determine what fraction of the unvested options are treated as community property.

If, as often occurs, the employee spouse has annual option grants, the calculation must be done separately with respect to each grant, since the number of months of vesting during the marriage varies according to the grant date. However, if an option is granted as compensation for past services, and not for the usual purpose of providing an incentive to the employee spouse to stay with the company, courts will consider the period of past services during the marriage for the purpose of calculating the portion of unvested options that is community property.

Calculating the unvested community property portion of a stock option grant is one issue; the mechanics of a divorced’ couple exercising options in the future is another.

Company stock options plans often provide that the options cannot be transferred from the employee. If options are divided in divorce the parties must make arrangements to ensure that the future exercise of those options by the non-employee spouse is not impaired and that any tax liability associated with the option exercised does not fall solely on the employee spouse.

Historically, stock options have been the usual method of stock-based compensation for employees. Recently, in reaction to the controversy over stock option accounting, Microsoft announced that it was going to stop issuing stock options and start making grants of restricted stock instead.

Unlike an option, which only gives the employee the right to buy stock in the future, a restricted stock grant provides the employee with immediate ownership of all of the granted shares. However, like an option, a restricted stock grant typically has a vesting schedule, so that the company can repurchase the shares from the employee at a below-market rate if the employee leaves sooner than the vesting schedule requires.

Logically, the existence of a vesting schedule in a restricted stock grant suggests that a division of unvested restricted stock in divorce would be calculated the way unvested options are, and there is some California case law precedent running that direction.