ESOP | Sebi expands definition of employees

SEBI’s informal guidance defining who could quality as an employee, needs to be extended to apply to gig workers, thereby benefitting hundreds of thousands of people

Employees Stock Options (ESOPs) are widely common these days, and are a way to reward, retain, and incentivise employees. ESOPs enable a company to give an option to its employees to acquire shares at a price fixed upfront. If the value of the shares goes up, which is substantially due to contribution and work of employees, the allottees can exercise the options and acquire the shares at the pre-fixed price. Thus, they can encash the appreciation in value. Of course, if the value goes down, the employees do not lose anything. They would simply not exercise the option.

However, a critical aspect of the scheme of the law relating to ESOPs is that they can be granted only to employees. This would sound fair and a good protection against abuse of this tool. ESOPs allow an employee to acquire shares, but these are effectively at the cost of the other shareholders since their value would be diluted. This is because ESOPs would be exercised usually when the exercise price is lower than the current market price.

Hence, there need to be safeguards that these are not misused. In particular, the management and promoters should not be able to themselves benefit unfairly.

One safeguard is that under the Sebi regulations, promoters are simply barred from being issued ESOPs. The second safeguard is that the approval of the shareholders by way of a special resolution is required for issuing ESOPs.

That said, the requirement that ESOPs should be allotted only to employees creates problems, and makes it restrictive.

Today, several new groups of people render services to the company, but may not be employees in the legal sense of the term. The good example is that of the gig workers. Those who deliver food or parcels are now ubiquitous. Then there have always been consultants who are paid on the basis of work done, and do work full time or on a permanent basis. Byju’s teachers, Zomato’s delivery persons, Uber’s drivers, etc. are just some of examples of such groups.

They all have a role in the success of the company, and both, the company and such workers, can profit if they are allowed to be granted ESOPs. The particular advantage of ESOPs is that the remuneration can be paid part in ESOPs, and hence this helps in the near-term cash flow of the company while leaving scope for the employee for higher-than-expected remuneration in form of rise in value of the shares.

A question was raised to Sebi for its ‘informal guidance’ (this is a scheme under which Sebi gives its opinion on a particular issue). Are doctors, who work for a few hours for a company but free to carry on private practice and have other earnings, employees? Thus, should they be entitled to ESOPs?

Sebi, in its guidance released on January 27, gave a positive answer. A close reading of the definition of the term ‘employees’ under the Sebi SBEB regulations reveals that employees do not have to work full time for the company. Thus, in the above case the doctors would be treated as employees, and be eligible for ESOPs.

This interpretation can be extended further, and could apply also to most categories of gig workers who fit this description. This win-win tool of ESOPs could be profitably applied to many more categories. As stated earlier, there are sufficient safeguards against misuse. Notably, ESOPs can be granted only after its issue is approved by the compensation committee of the board of the company. Further, the discount on issue of ESOPs must be recognised as a cost.

Hence, this guidance by Sebi should help give an element of legal clarity on the issue, and encourage companies to use this tool in a more broad-based manner.

That said, it may be emphasised that informal guidance has limited binding effect. Indeed, it applies only to the specific facts stated. Hence, purely from a legal perspective, extending this view to other groups of workers may still carry some doubt. It would help if Sebi specifically amends the regulations and makes it explicit that the regulations will apply also to all categories of such workers, even if not having any minimum hours.

There is another issue. The Sebi regulations apply only to listed entities. For unlisted entities (and most startups are initially unlisted), the Companies Act/Rules apply. The definition for unlisted entities is narrow, and hence the interpretation given by Sebi may not apply. Hence, there is a case for amending these rules and make this benevolent tool have a universal application. The law must keep up with times, and the quicker the law is amended by Sebi and by the Ministry of Corporate Affairs, the better.

(Jayant Thakur is a chartered accountant.)

Disclaimer: The views expressed are the author's own. They do not necessarily reflect the views of DH.