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Disputes arising from equity incentive schemes are often complex due to their unique characteristics, particularly when the incentive recipients hold dual roles as employees. Those disputes intersect with multiple legal frameworks including the Company Law, the Securities Law and the Labour Law, which means an even higher level of complexity.

Based on the means of settlement, equity incentives are broadly categorised into two types: equity-settled and cash-settled. Equity-settled incentives include stock options, restricted shares and employee stock ownership programmes, where recipients acquire company equity directly or indirectly, and benefit from its appreciation.

Cash-settled incentives, by contrast, use equity valuation as a basis for monetary payouts without transferring actual ownership, resulting in fewer disputes. This article focuses on equity-settled incentives and examines key areas of contention to guide legal practice.

Procedural challenges

The primary challenge of an equity-settled incentive dispute lies in whether the case should be determined as a labour dispute or an ordinary civil dispute. This classification directly impacts not only the applicable proceedings but also the choice and application of legal provisions, thus playing a decisive part in resolving the dispute.

Labour disputes. Some courts classify such disputes as labour-related, emphasising their close connection to the performance of employment contract, and regard them as a manifestation of the rights and obligations of both parties within the framework of labour relations.

For instance, Haidian District People¡¯s Court of Beijing ruled, in Chang Guanghu v Xiamen Yuanting Information Technology (2020), that equity incentives derived from the performance of obligations under the labour contract, and thus fell under labour dispute jurisdiction.

Civil disputes. Other courts treat them as ordinary civil disputes, arguing that equity as a property right transcends traditional labour relations. In the ruling of He Mengying v Harbour Biomed (2022), the Pudong New Area People¡¯s Court of Shanghai classified the dispute as a civil one without specifying reasons in detail.

Notably, Beijing Municipal No. 1 Intermediate People¡¯s Court issued three landmark reports in 2023, namely: (1) Typical Cases of Labour Disputes Involving Equity Incentives; (2) Preliminary Exploration of the Trial Path for Unified Civil Cases Involving Equity Incentives from the Perspective of Labour Disputes; and (3) Research on the Common Dispute Adjudication Rules for Civil Cases Involving Equity Incentives from the Perspective of Labour Disputes.

These reports analysed the nature of equity incentive disputes and concluded: ¡°Where an employment relationship exists between the incentive recipient and the provider, disputes arising from the delivery of equity incentives constitute disputes over labour remuneration, and thus should be classified as labour disputes under article 2.5 of the Labour Dispute Mediation and Arbitration Law.¡±

On 12 December 2023, the Supreme People¡¯s Court issued the Exposure Draft of Interpretation on Several Issues Concerning the Application of Law in Labour Dispute Cases (II) (not yet in effect). Article 1 mandates that where equity incentives are granted by an employer to an employee as labour remuneration under employment relationship, ¡°disputes arising from the employee¡¯s seeking equity incentive payments or compensation for related losses shall be classified as labour disputes, except those related to the exercise of equity rights.¡±

Although the draft is not yet legally effective, it reflects judicial trends toward recognising equity incentive disputes arising from employment relationships as labour disputes, potentially influencing judicial practice.

Substantive challenges

Nature of employees¡¯ income derived from equity incentive schemes. Under an equity incentive scheme, an employee acquires company stock at a price below market value. The resulting income, either from the price differential between the market value of the target stock and the agreed purchase price, or from the gains realised upon the sale of the stock, constitutes income derived from equity incentives.

There is significant controversy over the nature of these two types of income, and whether they are identical. Judicial perspectives are broadly divided into two categories: the labour income theory; and the non-labour income theory.

However, even courts adopting the labour income theory occasionally exhibit ambiguity in their reasoning. Some judgments ambiguously describe such income as ¡°a component of labour remuneration or employee benefits granted by the company¡±, as seen in Huai Chao v Beijing Guorui Xingye Properties and Guorui Real Estate (2020), ruled by Beijing Municipal No. 4 Intermediate People¡¯s Court.

Courts adhering to the non-labour income theory often distinguish equity incentive proceeds from traditional labour compensation such as fixed salaries, bonuses and benefits, citing their close link to a company¡¯s performance. Alternatively, they may exclude such earnings from labour income based on the statutory form of payment.

However, they have yet to justify why equity incentives should not be classified as welfare benefits. A notable example is Hu Dong v Allianz China Life Insurance (2023) ruled by Shanghai Municipal No. 1 Intermediate People¡¯s Court, which omitted substantive analysis on this point.

Identification of incentive providers. In real practice, the equity incentives may be awarded by an entity other than the employer. Typical entities include: (1) a shareholder of the employer; (2) an affiliated company; and (3) a partnership company acting as an employee shareholding platform.

Some courts attribute equity incentives to shareholders¡¯ personal actions, as the agreements and grants occur directly between the company shareholders and the company employee. This is upheld in Lin Jie et al. v Lu Lu (2021), ruled by Beijing Municipal No. 3 Intermediate People¡¯s Court.

Other courts delve into the substantive nature of the issue, holding that while the profit rights from equity incentive shares originate from shareholders, it does not imply that the incentives constitute shareholders¡¯ personal acts, or that the rights and obligations under the equity incentive schemes are borne individually by the shareholders.

Instead, shareholders¡¯ actions are based on the employer¡¯s arrangement, indicating the employer as the awarding entity of the equity incentives, as seen in Ouyang Li v Mind Education (2021), ruled by Beijing Municipal No. 1 Intermediate People¡¯s Court.

Shaw Zhao is a partner and He Yanling is an associate at Jingtian & Gongcheng