September 2000 – Academics may have developed models for valuing unexercised options, but recent divorce court decisions are more about how to make sure ex-spouses share in the wealth generated by options than about how to value the options.

The court decisions hold the potential for inflicting financial pain on executives who thought the ordeal of their divorces was behind them. Consider the case of Richard John Kerr and his former wife, Deedee Jean Kerr. In 1996, the couple went to court in California for a permanent support hearing before the dissolution of their 20-year marriage. At the time, court documents show, Mrs. Kerr was a homemaker and Mr. Kerr was vice president of engineering at Qualcomm Inc., a wireless communications company in San Diego, with an annual salary of $159,735. Two of their four children lived at home.

When they separated three years earlier, the couple, as required by California law, had already agreed to an equal division of all their property, including options in Qualcomm stock that Mr. Kerr had acquired but not yet exercised. In addition, Mr. Kerr had agreed to pay his former wife $3,309 a month in alimony and child support, based on his salary at that time of $110,427.

Mrs. Kerr, however, asked Judge Edward B. Huntington to increase the payments – and after the hearing in 1996 he complied, raising them 45 percent, to $4,806. His reasoning, legal experts say, broke new ground. Stock options are a form of income, he ruled, and because the income that the Kerrs had received in past years by exercising Qualcomm options was a big factor in maintaining their standard of living, the calculation of alimony and child-support payments had to take into consideration the probable awarding and exercising of future stock options.

Judge Huntington also ruled that Mrs. Kerr should receive 40 percent of all income that resulted from the future exercise of her ex-husband’s options, until both children had reached the age of 18, and 25 percent after that. Mr. Kerr was free to exercise the options he currently held, as well as those awarded in the future, at any time. He also had an incentive not to exercise the options until the children reached 18. But if he declined to do so, legal experts say, his ex-wife could ask for support based on income that would be derived as if he had exercised the options.

Mr. Kerr appealed, saying the court abused its discretion and the award exceeded the needs of his ex-wife and children. But the couple negotiated a confidential settlement before a judge could issue an opinion.

Even so, the ruling was the first in a string of court decisions in several states that are setting an important precedent in divorce law, legal experts say: proclaiming options to be a form of income, rather than a form of property.

“The issue had been before the courts, but as best I know never decided,” said George Norton, a California family-law specialist who has consulted and written extensively about options cases. “In California, options are not property subject to division if they are ‘earned’ after separation. The logic then becomes they must be ‘income’ earned after separation and then subject to support awards. The concept is options can’t be ‘nothing’ – either property or income, but not nothing.”

If options are property, most legal experts say, an ex-spouse has no future claim to them. But once they are considered income, they become eligible for alimony and child support awards. And those can be changed at any time.

See also…

Business and Finance Law Forum

Divorce, Separation, Annulment