I. Overview

Equity option rights (hereinafter “EOR”) refer to the rights granted by the company to the grantee, that is, the beneficiaries of EOR, to purchase stocks/shares at the agreed price and quantity at the agreed time after authorization.[1] At present, many companies, especially high-tech companies, are keen to implement the EOR incentive scheme to attract talents and promote stable operations.

In the process of implementing the EOR scheme, the company will inevitably have disputes with employees. However, whether the disputes arising from equity option incentives are labour disputes or contract disputes is currently a major dispute in judicial practice. The determination of the cause of action of EOR disputes will also have a great impact on the jurisdiction of the case, procedural rules and the application of foreign-related laws.

II. Main Reasons for Characterising EOR Disputes as "Labour Disputes"

1. EOR are special labour remuneration for workers in addition to basic salaries.

Most of the current laws and regulations discuss EOR in the scope of labour remuneration, for example:

a) The Compensation and Appraisal Committee is responsible to draft the equity incentive scheme (Article 33 of the Measures for the Management of Equity Incentives for Listed Companies stipulates that the Compensation and Appraisal Committee designated by the board of directors of listed companies is responsible to draft the equity incentive scheme.)

b) When levying personal income taxes on personal income from equity option, it shall be calculated and paid in accordance with the applicable regulations of "wage and salary income" (Article 2 (2) of the Notice on the Collection of Personal Income Tax on Personal Stock Option Income stipulates that when an employee exercises an option, if the gap between the actual purchase price (enforcement price) of the stock obtained from the enterprise and the fair market price (closing price of the stock) on the purchase date is led by the business performance of the employee related to the work, the individual income tax shall be calculated and paid in accordance with the applicable regulations of ‘wage and salary income’.）

c) According to the equity incentive plan of the listed company, the gap between the actual purchase price (enforcement price) and the fair price of the stock (market price) at which employees obtain the stock should be recorded as the listed company's salary and salary expenditure.（Article 2 (1) of Announcement of the State Administration of Taxation on Issues Concerning the Treatment of Enterprise Income Taxes in the Implementation of Equity Incentive Plans by Chinese Resident Enterprises stipulates that if the equity incentive plan can be exercised immediately after the implementation of the equity incentive plan, the listed company can calculate the gap between the fair price of the stock at the time of actual exercise and the actual exercise payment price paid by involved employees as the salary and salary expenditure of the listed company for the year, and make a pre-tax deduction in accordance with the tax law.）

d) The authority in Tianjin directly stipulates that equity options are a way for employers to distribute wages to employees. (Article 9 of Tianjin Economic and Technological Development Zone Labour Management Regulations stipulates that in addition to monetary wages to senior management and senior professional and technical personnel, employers may also choose annual salary, profit sharing, equity options and other distribution methods.)

In judicial practice, EOR are different from the stock rights enjoyed by shareholders within the scope of the Company Law. The employer has not actually granted the corresponding stock rights to employees and registered them in the company's shareholder registration. What the employee actually enjoys is the cash value reward corresponding to the claim of virtual equity to the employer, which is a special labour remuneration given to the employee by the employer.

In a labour compensation recourse case (a Shanghai company v. Li, case No. (2018) Hu 01 Minzhong No. 6881), the courts of the first instance and second instance held that the agreement on incentive stocks was a special labour remuneration given by a Shanghai company based on Li's status as an employee. The agreement was closely dependent on the status of the employee and the performance of the labour relationship.

In addition, in a labour dispute appellate case between a company in Zhuji and Liu (case No.:(2015) Zhe Shao Minzhong No. 986), the court held that the Equity Incentive Agreement was generated from the labour relationship between the appellant and the appellee and was inextricably linked to the labour relationship between the two parties. The appellant’s voluntary incentives and compensations for the introduction of senior management personnel should be regarded as additional remuneration in addition to the basic salary of the appellee Liu’s work at the appellant’s office. Therefore, it shall be within the scope of labour disputes.

2. The exercise of EOR is closely related to the service period and the termination of the labour relationship.

Generally, when an employer grants EOR it will request certain service period of the employee, and additional terms such as the expiration of the exercise, the exercise price, and the method of exercise. Therefore, whether the employee's EOR can be realized is closely related to the service period for the employer and the termination of the labour relationship.

In the Case No. (2016) Jing 0108 Minchu No. 28398 (Shen v. a Beijing Company), the court held that for employees can work hard to promote the development of the enterprise, increase the stock price of listed companies, and obtain the expected benefits, the essence of the company's grant of EOR to employees is the consideration equivalent to what the employee provides. Generally, in order to retain core talents, the employer will stipulate the service period for the employer when granting EOR and additional terms such as the exercise period, exercise price, and exercise method.

Besides, in the Case No. (2015) Yi Minzhong No. 3506 (Bao v. a Beijing Company), the court held that although the EOR granted to Bao was from an affiliate of the Beijing company, the EOR was obtained based on the labour relationship between Bao and the Beijing company. Meanwhile, the realization of EOR is related to Bao's service period in the Beijing company and whether the labour relationship is terminated or not.

3. EOR are granted based on labour relationship, even if the grantor is an affiliate of the employer.

Under the circumstance where the employer’s affiliated company grants the employee EOR without a labour relationship with the affiliated company, and the affiliated company grants the employee EOR based on the labour relationship between the employee and the employer; the disputes between the employee and the employer and its affiliates about EOR are arising out of the labour relationship. Therefore, the employer and its affiliates are the co-defendants in such labour disputes, which complies with the relevant provisions of the Civil Procedure Law.

In the Case No. (2019) Jing 01 Minxiazhong No. 832 (a Company v. Liu), the court held that the Company has established an associated relationship with a Beijing company through equity control and agreement control via a third company. For Liu did not provide labour for the Company, the Company granted Liu EOR because of the labour relationship between Liu and the Beijing company. In such a case, the dispute over EOR between Liu and the Company or the Beijing company was based on labour relationship. Liu filed a lawsuit against the Beijing company and the Company as co-defendants, which complied with the relevant provisions of the Civil Procedure Law.

III. Main Reasons for Characterising EOR Disputes as "Contract Disputes"

1. The property income involved in EOR does not fall within the scope of labour reward under the labour law.

The laws and regulations like the Labour Law stipulate that workers' wages shall be paid in currency, and shall not be paid in tangible goods or marketable securities instead of currency, including:

a) Article 50 of the Labour Law stipulates that wages shall be paid to the workers themselves in currency on a monthly basis.

b) Article 50 of the Explanation on Certain Articles of the Labour Law stipulates that wages shall be paid to the worker in monetary form on a monthly basis... The “monetary form” in this article excludes forms in tangible goods, securities etc.

c) Article 5 of the Notice of the Ministry of Labour on the Interim Provisions on Wage Payment stipulates that wages shall be paid in legal currencies. It is not allowed to use tangible goods and marketable securities to substitute currencies for payment.

In judicial practice, according to the Labour Law and other relevant laws, labour remuneration is the wages paid by the employer in currency, and EOR do not belong to the scope of labour remuneration stipulated by the Labour Law and other laws.

In the Case No. (2017) Chuan 01 Minzhong No, 1821 (Wang v. a Chengdu company) , the court held that, in accordance with the Labour Law and other relevant rules, labour remuneration is the wages and remuneration of the employer in monetary form, and the EOR involved in this case was not within the scope of labour remuneration stipulated by the law.

Besides, in another labour dispute case (Zhai, Case No. (2014) San Zhong Minzhong No. 05189), the court held that Zhai’s allegation, that the nature of EOR was income from wages and salaries and was within the scope of labour remuneration, did not comply with the relevant provisions of Beijing Municipal Regulations on Wage Payment. The benefits Zhai claimed in the case was not a kind of statutory labour remuneration and was not within the scope of a labour dispute.

2. The two parties are in an equal position in terms of contract status, contract execution and performance, contractual rights and obligations, etc.

The EOR agreement which is granted by an employer to the employees is a commercial agreement between the parties in the equal position, which has the following reasons:

a) From the perspective of the parties’ positions, the labour relationship between the employee and the employer is the selection condition of the employer as the offeror to the offeree. Such restriction on the offeree does not necessarily lead to the unequal position of the contracting parties；

b) From the perspective of the execution and performance of the contract, the employee may choose to accept or not accept the granted EOR, and may also choose to exercise or not to exercise the EOR before the expiration after acceptance. The employee, as the offeree, is not subject to identity-related restrictions;

c) From the perspective of the rights and obligations stipulated in the contract, it is equal that the employer grants EOR to enable employee to buy the stocks at a preferential price as property incentives and, at the same time, the employee performs the obligation of loyalty to the employer. The aforesaid obligations is the core content of the rights and obligations of both parties in the equity option incentive.

In the case (2016) Zhe Minzhong No. 504 (Fu v. a software company and a holding company), regarding the legal relationship established by the parties with respect to the EOR contract, the court held that 1) the property income involved in the EOR was not the employee's salary, bonus, welfare and other labour rewards; 2) the rights and obligations constructed by both parties in the EOR contract did not belong to those in the labour contract; 3) the EOR contract signed by the two parties on stock option incentives shall be regarded as an ordinary commercial contract between equal entities. In summary, these EOR contracts are agreements between equal civil entities to establish, modify, and terminate the relationship of civil rights and obligations. The disputes arising out of EOR are contractual disputes, in which laws and regulations subject to regulate the contractual relationship between equal civil entities shall be applicable. Therefore, this court determined that the cause of action of this case was a contract dispute based on the nature of the contract and the content of the dispute between the two parties.

3. Under the circumstance where EOR is granted by an affiliate of the employer, and there is no labour relationship between the grantor and the grantee

Due to the labour relationship between the employer and the employee, the affiliated company of the employer provides the employee with EOR. However, in the EOR incentives, the rights and obligations between the employer’s affiliated company and the employee thereof are either the statutory rights and obligations of the employer or affiliated company in the labour law, or those of the worker in competing for labour opportunities and exercising labour rights. Therefore, there is no labour relationship between the employer’s affiliated company and the grantee rather a normal contract relationship.

In the case (2018) Zhe 01 Minzhong No. 7357 (Feng v a network company), the court held that the nature of the legal relationship between the parties was an ordinary contractual relationship rather than a labour contract relationship. The rights and obligations set by a foreign company and Feng in EOR incentives were not the statutory rights and obligations of employers or affiliated companies in the labour law. Those rights and obligations were not necessary for the employees to seek labour opportunities and exercise labour rights. Based on the aforesaid, they were not the rights and obligations of labour contracts. Feng had the right to choose to accept or not accept the EOR, and also had the right to choose to purchase or not to purchase before the expiration of EOR after acceptance. Feng's intention as the offeree was not subject to be restricted related to the identify as an employee. Therefore, the Notice of the Grant of Options by an Overseas Company was essentially an agreement between equal civil entities to establish, modify, and terminate the relationship of civil rights and obligations, which was an ordinary unnamed commercial contract. According to the nature of the contract and the content of the dispute between the two parties, the cause of action of this case shall be determined as a contract dispute.

IV. The Main Impacts of the Characterisation of the Case

1. Jurisdiction

a) If it is identified as a "labour dispute", the jurisdiction of the labour dispute shall be the labour dispute arbitration committee in the place where the labour contract is performed or where the employer is located.

According to Article 21 of Labour Dispute Mediation and Arbitration Law, the jurisdiction of labour disputes shall be the labour dispute arbitration committee at the place where the labour contract is performed or where the employer is located.

According to our understanding, the provisions of this article on labour dispute jurisdiction are mandatory legal provisions. The parties are not permitted to change the above jurisdiction by agreement. If the employer and the employee agree to change the above-mentioned jurisdiction, such an agreement shall be deemed invalid because of the "violation of the mandatory provisions of laws and administrative regulations".

b) If it is identified as a "contract dispute", it shall be under the jurisdiction of the court at the place of the defendant's domicile or the place where the contract is performed, or the jurisdiction may be agreed on by the parties to the contract.

According to Article 23 and Article 34 of Civil Procedure Law, for regarding the jurisdiction of contract disputes, the parties may agree in writing to surrender to the court at the place of the defendant’s domicile, the place of performance of the contract, the place where the contract was signed, the place of the plaintiff’s domicile, and the location of the subject matter that have actual connections to the dispute. In the absence of an agreement, it is default that the court at the place of the defendant’s domicile or the place where the contract is performed shall have the jurisdiction over the case.

2. Procedural Rules

The characterisation of EOR incentive disputes not only determines whether applicable law is contract-related laws or labour-related laws, but also determines the difference in the application of the procedural rules of the case. The details are as follows.

a) If it is identified as a “labour dispute”, the arbitration procedure will be prerequisite, which means that the employer has a more burden of proof.

If it is identified as a “labour dispute”, the arbitration procedure will be prerequisite. The parties shall submit the case to the labour arbitration first. If they are not satisfied with the arbitration reward, they can appeal the case to the court.

At the same time, in the process of handling “labour disputes”, employers often assume a more burden of proof. At the same time, in the process of handling “labour disputes”, employers often assume a stricter burden of proof.

b) If it is identified as a “contract dispute”, the civil procedure will be directly applied, which means that the employer and the employee have the equal burden of proof.

If it is identified as a “contract dispute”, the civil procedure can be directly applied. The domestic law does not stipulate the pre-procedures for resolving contract disputes, and parties to the contract can directly file the lawsuit to the court.

At the same time, in the process of handling “contract disputes”, the general rules for the allocation of burden of proof will be applied, which is “who claims is responsible to prove it”.

3. Applicable Laws in Foreign-related Cases

a) If it is identified as a “labour dispute”, it is general that the applicable law shall be that of the employee's place of work.

Article 6 of the Interpretation of the Supreme People's Court on Several Issues Concerning the Application of the Law of the People's Republic of China on the Application of Laws in Civil Relations Concerning Foreign Affairs (1) stipulates that under the circumstance where the laws of the People's Republic of China do not clearly stipulate that the parties is allowed to choose the applicable law for foreign-related civil relations, if the parties make a choice, the people's court shall determine that the choice is invalid.

Article 43 of the Law on the Application of Laws in Foreign-related Civil Relations stipulates that the laws at the working location of labourers shall apply to labour contracts; if it is difficult to determine the working location of a labourer, the laws at the main business place of the employer shall apply. The laws at the dispatching place of labour services shall apply to labour dispatches.

It can be inferred that in the legal relationship of foreign-related labour contracts, since the domestic law does not entitle the parties to choose the applicable law of the labour contract, once it is identified as a "labour dispute", the applicable law of the case will be determined based on the employee's work location.

b) If it is identified as a “contract dispute”, the parties can choose the applicable law by mutual agreement.

Article 43 of the Law on the Application of Laws in Foreign-related Civil Relations stipulates that the parties concerned may choose the laws applicable to contracts by agreement. If the parties do not choose the applicable law, the applicable law shall be that of the habitual residence of the party whose fulfillment of obligations can best reflect the characteristics of this contract or that of closest relationship with this contract.

It can be seen that if the EOR incentive dispute is identified as a “contract dispute” and the foreign-related civil relationship is involved, the parties can choose the applicable law aby mutual agreement.

V. Conclusions and Suggestions

In judicial practice, there still exists different understandings and practices on the nature of equity option disputes. The different characterisation may lead the case to a completely different direction. When a dispute arises, it’s a better strategy to seek support from leading decisions and make a full and comprehensive analysis to resolve such disputes.

[1] Cf. Chen Qingqing and Wu Jinglian, Research Report on the Regulations and Policies of Stock Option Rights Incentive Scheme, China Financial and Economic Publishing House, 11 Ed., page 13.