Basic Issues

Typical cases involving a stock option plan emanating from employment include claims for the lost value of (1) options which have vested prior to termination and (2) options which would have vested in the period of fair notice.

Most plans provide to the employee the right to purchase shares at a future date based on the "strike price" which is determined usually by the trading value of the stock at the date of the grant. The plan then allows for the "vesting" of these shares over a set number of years, often the anniversary dates of the grant.

Often the plan permits the employee a defined time period to exercise vested options following termination or resignation of employment. This may be a brief time window. It may also state that all vested options terminates with the end of employment. It may also typically deny any right to exercise options on unvested shares.

The principal issue will be whether the stock option plan allows for an implied term of fair notice to be read into the stipulated dates in the plan. For example, if the plan states that all vested options must be exercised on termination or prior to, will a court extend this term by a period of fair notice. This date, however, determined, is referred to as the "valuation date".

Case law has interpreted this issue to turn on the wording of the plan, as to whether it unambiguously contracts out of the common law notice obligation. ¹ This issue is reviewed in detail here.

A further question, given litigation, will be whether (1) there is an obligation upon the employee plaintiff to purchase the shares or acquire a similar option contract on the open market, if possible and if so, (2) upon what date this event should happen. ² This then raises subject matter of the mitigation date.

The Debate

It may arguably be seen as unfair for the plaintiff to assert, for example, a claim based on options which would have been due in a notice period on January 1, 2023, wait for the litigation to reach trial and then assert, given a rising market, that the damage claim is based on the trading value of the stock at trial.

The argument will be made by the employer that, at some point in time, the damages must “crystallize”, which, in essence, is the date when the plaintiff would be expected to buy-in, notionally or otherwise and mitigate the claim.

Where there is a successful argument made that the plan may be subject to fair notice, the plaintiff may argue that under the plan, he is under no obligation to fund the purchase of the shares until the exercise date in the normal course and hence he should not be required to risk funds for acquisition of the shares following termination. In addition, there may a submission that such a purchase is unaffordable.

The employer will also argue that the plan is a discrete contract, distinct from the employment relationship and the court should not imply into its interpretation the obligation to give fair notice.

Valuation Date to Assess the Loss

Hardie v Trans-Canada is a December 1976 decision of the Alberta Court of Appeal. ³ Under the terms of the contract of employment, Hardie was entitled to employment through to January 2, 1975. Prior to that date, he had been entitled to exercise options on company stock on September 11, 1973 and again one year later on September 11, 1974.

The evidence showed that between September 11, 1973 and Sept 11, 1974, the shares traded at the top value of $1.98, and for the second period from September 11, 1974 to the date of trial, the top value was $.83.

The trial judge determined the valuation of the loss of the options in each instance by using the highest price attained for the two periods.

The Court of Appeal disagreed. This court determined that the valuation date for purposes of the damage loss was the market value when the plaintiff was first entitled to exercise the right of purchase, this being the two respective September dates. As these numbers were not in evidence, the court used the average price for the periods. Had this evidence been before the court, the claim would then have been arithmetically determined by {trading value on vesting date - strike price}.

This concept may be important for later cases dealing with the mitigation issue, an argument which was not made in this instance.

Mothersele v Gulf Canada

Mothersele v Gulf Canada, a 2003 decision of the Alberta Queen’s Bench considered the damage assessment which included a claim for vested options and options due to vest. Again, no argument was advanced as to the need of the plaintiff to mitigate by buying stock or options to replace those which had been lost.

The agreement between the parties stated that any options held by the plaintiff had to be exercised one year after the termination date, which in this case, was December 31, 2000.

In addition, 3000 shares were to vest on May 12, 2000, 2001 and 2002. As the May 12, 2000 date was within the notice period, a claim for the loss of these options was recognized.

Certain of the prior optioned share grants had become vested prior to termination. These options could have been exercised prior to termination but were not. The agreement allowed for these vested shares to be exercised for up to one year after termination.

The plaintiff affirmatively decided not to exercise these vested options as of December 31, 1999 which was his first exercisable date. However, the company then terminated these vested options and he was denied the right to exercise them. Due to this conduct of the company, the court elected to use the highest share price between December 31, 1999 and December 31, 2000. Other vested options provided a two year post termination and were treated in the same manner by the company resulting in the same valuation method.

The same valuation method was used for the options that had not vested.

Neither of the above cases discussed a mitigation obligation as was set out by the Supreme Court of Canada, as reviwed below, in Asamera.

Mitigation Obligation SCC

In Asamera, a simplified version of the facts showed that the plaintiff corporation sued to obtain the return of 125,000 shares of Asamera which the plaintiff had loaned to its president who had defaulted in returning them on the agreed due date. Baud Corp. sued for the value of the shares incremental to the stipulated date. The issue arose as to whether Baud was required to mitigate its damages by the purchase of alternate shares on the due date and hence could not sue for the incremental loss beyond this date.

The plaintiff argued that the requirement to purchase these shares would mean that it was buying shares in a speculative undertaking under the control of the person in breach and in a position adverse to that of the plaintiff.

The stock had shown some serious fluctuations in value. From the initial date of the loan, the shares dropped $3 to between $1.62 and $1.87 in November of 1985 and again to 29 cents on December 31, 1960. After this date, the shares had been recovered to $1.21 by March of 1965. The plaintiff argued that it should not be required to assume such risk of buying a volatile stock as of December 31, 1960. It is to be noted that Brooks had an option to buy the shares as of December 31, 1960 at $2, which formed the basis of the damage claim at trial. Brooks also had sold shares in 1957 and 1958 from $1.50 to $1.80 and hence using a valuation of 29 cents would have allowed him to profit.

The plaintiff also obtained an injunction preventing Brooks from selling the shares on July 27, 1960. It hence argued with the protection of this injunction it should not be required to buy these same shares as it was also seeking specific performance. Brooks, however, sold these shares as was pleaded on July 6, 1967, such being the pleading date. The replacement cost of the shares upon this date was $541,250. The shares had been then selling at $4.33, as a median price.

The Court did note that the rule of mitigation has exceptions, and the plaintiff may not, on occasion, be required to incur significant risk and expense:

There may, as already discussed, be instances where mitigation will not require a plaintiff to incur the significant risk and expense of purchasing replacement property, but in any case the plaintiff must crystallize his claim either by replacement acquisition or in some circumstances by prompt litigation expeditiously prosecuted which will enable the court to establish the damage with reference to the mitigative measures imposed by law. The failure of the appellant either to mitigate or litigate promptly makes difficult the task of applying these principles to the circumstances of this case.

The court hence contemplated mitigation by the acquisition of alternative shares or where this is not possible or too speculative, to promptly litigate.

The Court noted that the plaintiff could have moved with “reasonable speed to institute and proceed with legal action either to recover the shares, and that if that was not possible, then to recover damages”. In this instance the litigation consumed 18.5 years.

Given the magnitude of the funds required to buy back in, which in this case was between $800,000 and $1,000,000 in 1960 yet, the Court determined a “reasonable time” would be allowed after the buy in date.

It is to be noted that the claim for specific performance failed, particularly given the inordinate delay.

The case was further complicated by the request of Brooks “sometime prior to 1966” to refrain from enforcing its claims and that the share value had revived by the end of 1966.

The Court used the fall of 1966, extended to the fall of 1967 by the need to consider and acquire funds, as the buy in date for mitigation and hence the damage claim crystallized as of this date.

The general proposition was then determined that there was a mitigation obligation and that the relevant date was a reasonable time period following the valuation date. The court stated as follows:

Subject always to the precise circumstances of each case, this will impose on the injured party the obligation to purchase like shares in the market on the date of breach (or knowledge thereof in the plaintiff) or, more frequently, within a period thereafter which is reasonable in all the circumstances. The implementation of this principle must take cognizance of the realities of market operations, including the nature of the shares in question, the strength of the market when called upon to digest large orders to buy or sell, the number of shares qualified for public trading, the recent volatility of the price, the recent volume of trading, the general state of the market at the time, the susceptibility of the price of the shares to the current operation of the corporation and similar considerations.

Qualifier on Asamera

The court in this instance did note that the record before it was lacking. This is an important point which may weaken the impact of the decision as a precedent:

“An appellate tribunal in such an appeal as this is in an invidious position.  The record at trial is deficient.  In the result precise evidence as to market conditions, credit facilities, rates of interest, borrowing power of the appellant, effect on market price of mitigative action by it, the time reasonably required to acquire by purchase such a volume of shares on the open market, and other evidence relevant to the assessment of damages is not before this Court.  On the other hand, the transaction occurred 20 years ago, and the trial which was extensive and no doubt expensive, was completed seven years ago.  To direct a reassessment of the damages would be time-consuming, difficult to carry out after such a lapse of time, and expensive for the parties.  Faced with these unsatisfactory alternatives, an appellate Court must discern if at all possible from the record the elements necessary to permit the completion of the assessment process.”

It is to be noted that the court in Asamera postponed the mitigation date from the date of the breach by the context of the case. This factors included the large number of shares, the market volatility, a request by the defendant to postpone acting on the claim and the time to acquire financing and to obtain the shares on the open market.

This above cited passage was noted with approval in a 2007 decision of the Ontario Superior Court which declined to determined the valuation date on a summary judgment application, choosing to defer this decision to the trial judge. ⁴

Asamera was reviewed by the Ontario Court of Appeal in a claim made by the plaintiffs against their trading house for the improper sale of securities. The Court determined that the does arise a mitigation obligation. The starting point of this analysis is the date of the breach: ⁵

Turning then to a determination of the mitigation period in the instant appeal, the starting point, according to Asamera, is that the obligation to purchase like shares arises on the date of breach or knowledge thereof in the injured party. This appropriately reflects the principle that underlies the duty to mitigate; namely, that the injured party may not recover losses that could have been avoided by him or her taking reasonable steps after the wrong.

This being stated, the court will then review the particular context of the case to determine what, if any adjustments may be required for this event. Here, the court saw a fairly short period of time following the breach to see the mitigation obligation arise.

Mitigation Date - Fair Time After Breach

Drayton v WCW Western Canada Water is a May 1991 decision of the British Columbia Supreme Court. The plaintiff successfully asserted a breach of share warrant agreement which were due to the plaintiff in July of 1989. He claimed that he would have exercised these warrants and from the shares obtained, he would have realized a profit of $187,000.

The plaintiff had sued for specific performance which was dropped on the eve of trial and a damage claim then asserted. The defence had asserted that, given this tactic, the damages should have been valued as of the date of trial, when, not coincidentally, they were valued dramatically lower. The court denied this submission and did comment on the analysis of Asamera:

 In determining when to calculate the appellant's damages, Estey J. gave detailed consideration to the principles of mitigation and held that the appellant's duty to mitigate under all the circumstances of the case, arose within a reasonable time after the date of breach and, in particular, after litigation involving the contract was recommenced following a period of dormancy at the request of the respondent.

The court concluded that the mitigation buy-in date should be “within a reasonable time after the breach”, which in this instance, was not in October as asserted by the plaintiff, but rather in August.

A similar conclusion was reached in a 2019 Ontario case in which the trial judge had found, based on the plaintiff's evidence that he would have exercised his RSU and stock option grants "at the earliest possible opportunity. The motion judge interpreted this to be 5 months, based on prior sales activities of the plaintiff. The plaintiff cross-appealed on this issue, to no avail. ⁶

Duty to Mitigate Found

The Ontario Superior Court considered the mitigation obligation in Murray v Xerox, a trial decision of Hoy, J. in May of 2004.  The essential issue became when does this duty arise and what impact this has upon the damage calculation.

The Plaintiff was a long term employee of Xerox and as such under the terms of an Incentive Stock Right Agreement, was entitled to 2300 common shares of the company provided that he remained employed until the age of 60 or had commenced early retirement prior to this date with the approval of the CEO. ⁷

The market price of the shares had fluctuated dramatically from December 31, 1994 to the date of trial, such being July 20, 2005. The 2,300 shares were valued at $16.50 on this date, peaked to $59 on December 31, 1998 and fell to $13.80 on December 31, 2003.

The plaintiff asserted that the past practice of the plaintiff showed a pattern of holding vested options for a two year period and the damage assessment should reflect a valuation two years following the breach.

The defendant argued that the correct approach was to determine a reasonable date when the plaintiff may reasonably have mitigated his loss by purchasing Xerox shares on the public market at which time his loss would be crystallized.

There was no evidence introduced to suggest that the plaintiff was not financially able to “buy in” at the sum required, which in this instance was $319,417. The trial judge, however, did pay heed to this and similar factors which may have influenced the determining this issue:

While the amount in issue is significant, I believe that Mr. Murray was in a position to finance the purchase of replacement Shares without difficulty on his retirement on December 31, 1994, had he wished to. There was no evidence to the contrary. Replacement shares were readily available: no market factors affect the mitigation period

The court accordingly capped the damage claim as of this date, the date of the breach, accepting the argument that on such date there was a duty to mitigate to minimize the loss.

Both parties appealed unsuccessfully.

The authorities for this proposition of the need to mitigate and hence the date to determine the damage award was the Supreme Court of Canada decision in Asamera Oil v Sea Oil and Hunt v TD Securities.

The facts of the Murray case lend for an easy application of Asamera as there was clearly a fixed date when Murray was required to put up the cash for the equity position. The circumstance of a typical share option plan may be more difficult.

Asamera and Employment Cases

In an employment context, generally, the plaintiff will have two likely claims, the first relating to vested shares held on termination and the second relating to his right to be entitled to vest additional shares from the initial grant within the notice period.

Most plans allow the employee the right to exercise vested shares for a given time period from the date of termination. Hence there is a time period within which the employee is not required to spend funds. Presuming that this right is violated, must the plaintiff purchase the same number of these shares on the date of the breach or may he argue that his “damage date” is the expiry of this time period or even later?

The same questions will arise will respect to the shares which would vest in the notice period? Must he mitigate on that expected vesting date or may he wait until the same extended period or even later? In either circumstance will the financial ability of the plaintiff to do so be relevant?

The typical fact situation is different from that in Murray and in Asamera. What influence will these distinctions have upon the mitigation obligation?

Strike Price under Water

Hibberd v Hurricane Hydrocarbons, a 2006 decision of the Alberta Queen’s Bench dismissed the claim for share options but did provide its analysis of the damage claim, which was clearly obiter, but did deal directly with these issues.

In Hibberd, the defendant asserted that on the date of apparent default was April, 2000, the plaintiff should have bought in. The court noted, however, on this date, the options were out of the money as the strike price was under market. The court continued:

In my view, part of the value inherent in the Hurricane stock options was the right of the holder to wait at least until the share price exceeded the strike price before exercising the options. Assuming that there was an oral agreement or arrangement between Mr. Hibberd and Hurricane that Mr. Hibberd’s options would not be terminated prior to their expiry terms, or his consulting status would be preserved, Mr. Hibberd was entitled to wait, to a point in time that was reasonable under the circumstances,  to exercise his options.

As to vested options, the court looked to the above decision in Mothersele and concluded that, with respect to vested options, there would not be a mitigation obligation until the end of the contract period which allowed time to exercise the options. Given on these facts, further, that the plaintiff promptly litigated, there would be no obligation to mitigate up until the end of the contracted period.

In this case, however, on the relevant date on which the options vested, the strike price exceeded the market and hence no mitigation obligation was reasoned.

The facts showed that the Stock Option Agreements would have expired on March 11, 2011 for 50,000 options and July 21, 2001 for a further 50,000, but for the termination clause. The plaintiff had asserted an oral agreement to the effect that the termination clause would not apply to him and assuming this to be so, the options would hence have expired on the above dates.

The Court saw the damage date not based on the argument that it should be soon after the apparent breach of June 2000. The end result was not much different, this being September 2000 but the logic of the selection of this date was past trading practices. The theoretical damage claim was reduced to $190,000. Effectively this became the “mitigation date”. ⁸

In a 1999 decision of the Ontario Court, Roberts, J., found that the plaintiff was not required to mitigate by acquiring the shares in the open market with respect to his claim for the value of lost options. The plaintiff was allowed to refrain from such a purchase until the date set out in the option plan. ⁹

The court did take into contextual factors, including that the plaintiff was a conservative investor, that the market for the shares was modest, and the impact of a large sale on the sale price.

The important point is that the date set for the buy-in or mitigation is reflective of the plaintiff's personal situation and market forces, that is, there is a reasoned assessment of the setting of such a date and is not reflexive.