Ryan S. Carroll

The Massachusetts Appeals Court recently affirmed the practice that a general release, including one provided in the context of an employment separation, extinguishes the signing party’s rights to all claims predating that release.  However, that general statement does not come without some caveats.

Alan MacDonald (MacDonald), had two separate terms of employment with Jenzabar, first as a CFO and later as a “Mergers and Acquisitions Researcher”.  During his first term of employment, MacDonald executed an employment agreement which provided for: (i) the issuance of a number of shares of preferred stock and (ii) an option to acquire 1,516,000 shares of common stock.  MacDonald and Jenzabar would enter into two additional agreements relating to his equity.  MacDonald then left Jenzabar and had not received his preferred shares nor exercised any of his vested interests.  At a later date, MacDonald joined Jenzabar for the second time and left shortly thereafter.  After his second departure, MacDonald and Jenzabar executed a severance agreement which provided for Jenzabar to continue to pay MacDonald’s salary and other benefits for six months in exchange for a general release of all claims, an affirmation and extension of a confidentiality obligation and an agreement that the severance agreement terminated and supersedes all other oral and written agreements or arrangements between MacDonald and Jenzabar.  After he signed the severance agreement, MacDonald attempted to exercise his option and Jenzabar denied the request, citing the release.  Litigation then ensued as to MacDonald’s rights to the equity and the enforceability of the severance agreement.

In MacDonald vs. Jenzabar, the court ruled that the general release provision and a merger and integration clause in the severance agreement extinguished MacDonald’s rights to the equity.

The general release language (“from any and all claims, liabilities, obligations, promises, agreements, damages, causes of action, suits, demands, losses, debts, and expenses . . . of any nature whatsoever, known or unknown, suspected or unsuspected, arising on or before the date of this Agreement.“) was held to be both clear and broad and that MacDonald released all rights to the preferred stock and option.  Further, the court cited that, “a general release disposes all claims and demands arising out of any transactions between the parties” and that “any intended exception should have been expressly stated.”

Lastly, the court ruled the merger and integration clause contained in the severance agreement clearly extinguished all rights to the promised preferred shares and the option.

This case is an overall win for employers with respect to their separation arrangements. The case also illustrates the significance of any single word or phrase (or lack thereof) in a tightly-worded document, such as a release, when under the microscope of a court’s review.  Any ambiguity in this context creates risk for each party, and conversely creates negotiating leverage in terms of pre-litigation negotiations, leading to unnecessary cost and other negative impact for both parties.

Tags: ambiguity, common stock, contract ambiguity, employment agreement, general release, preferred stock, promise of equity, release, separation agreement, severance agreement, stock options

Employee stock options are an essential component of compensation in technology companies.  Options and other equity incentives allow employers to attract and retain talented personnel who hope to profit from a successful sale of the business that they help create.  While there has been substantial attention in recent years to the manner in which options are awarded, a topic less often discussed, but equally important, is how they may be rightfully terminated by an employer following a separation.  A recent decision by a New York appellate court’s decision in Lenel Systems Intl. v. Smith illustrates what can arise if this issue is not expressly addressed in the option agreement.

In Lenel, an employer sought to terminate an employee’s stock options who had violated his noncompetition agreement after leaving Lenel’s employment.  While the stock option agreement did not have an express provision entitling the company to terminate the agreement, it did provide that the employee’s agreement not to compete was consideration for the options.  Not having the express right to terminate, the employer sought to rescind the option on equitable grounds.

The court summarized that rescission is an equitable remedy that allows a court to declare a contract void from its inception.  As a general rule, rescission of a contract is permitted where there is a breach of contract that is material and willful, or so substantial and fundamental “as to strongly tend to defeat the object of the parties in making the contract.”  The court rejected the defendant’s argument that an express forfeiture clause in the option agreement was required in order for option to be subject to rescission.  Instead, the court reasoned that the noncompetition covenant was the sole consideration for the option agreement, and when the defendant chose to compete with Lenel “in violation of the only material condition of the agreements,” he would give up his right to the stock options promised in exchange.

In is also worth noting that two of the appellate judges dissented from this decision, arguing that the consideration for the option consisted of two parts, one being the compliance with the covenant during the term of employment and the other part for the post-termination period.  The dissent reasoned that since the defendant did comply with the covenant during his six years of employment with Lenel, it cannot be said that he did not provide any consideration for the option, thereby reducing the argument in  favor of rescission.

As a lower appellate court decision, the Lenel case is more likely to lead an academic interest than to have an binding impact on the law on this issue.  However, the case illustrates that while rescission may be available as a remedy for employers, it is a difficult path to travel and that addressing termination rights in the option agreements may be advisable.

Tags: equitable remedies, new york law, rescission, stock options