Court: Court of Appeals for the Second Circuit; February 12, 1995; Federal Appellate Court
Plaintiffs John Bradley and Charles Lamb filed a lawsuit in the District of Connecticut against Emhart Corporation for damages due to an alleged breach of contract. Following a bench trial, the court ruled in favor of the plaintiffs. The defendants, Emhart Corporation and others, appealed, arguing that the court incorrectly determined that amendments to the company's Stock Option Plans, adopted on December 22, 1988, applied to the plaintiffs' stock options at the time of their separation. They also claimed that Emhart failed to demonstrate the elements of accord and satisfaction. The appellate court upheld the District Court's decision.
Bradley and Lamb were former employees of Emhart; Bradley had been with the company for 19 years and was the President of the Hardware Division, while Lamb had three years of service as the Director of Advanced Engineering and Manufacturing Technology. Both were notified of their termination effective January 31, 1989, due to corporate restructuring. In December 1988, they signed Termination Agreements outlining their benefits upon termination, which included severance pay, medical coverage, pension benefits, accrued vacation pay, and counseling services. The agreements stated that any rights to outstanding stock options would be governed by the respective stock option plans and agreements.
The Stock Option Plans aimed to incentivize selected key employees and were administered by a management committee. The plans allowed the committee to designate stock options as Incentive Stock Options (ISOs) as per Internal Revenue Code provisions. Employees were required to sign Option Agreements, binding them to the terms of the plans, which included the committee's authority to interpret and amend the plans. Each agreement stipulated that options became exercisable over a four-year period, with 25% becoming exercisable each year. Section 6 of the Plans detailed the terms and conditions governing the granting of options.
Section 6(g) of the Agreement to Serve requires employees granted options to remain employed by Emhart Corporation or its subsidiaries for at least one year from the option grant date. Section 6(e) outlines that upon termination of employment, except for death or gross misconduct, an option holder can exercise their options only to the extent permitted at the termination date, with options expiring unless exercised within three months post-termination. An ambiguity exists regarding the status of portions of options that were not exercisable at termination but could become so within the three-month window. Plaintiffs Lamb and Bradley interpreted this section as allowing them to retain all portions of their options during this period. Emhart argued against this interpretation, claiming a company practice to cancel non-exercisable options upon termination. The District Court sided with the plaintiffs' understanding.
Section 10 of the Plans allows Emhart's Board of Directors to amend the Plans, provided they do not alter previously granted options without holder consent, thereby protecting option holders from adverse changes. In mid-1988, discussions about adding a change in control provision to the Plans arose due to altered tax laws and takeover concerns. On December 22, 1988, the Board amended the Plans to include section 6(i), which made all outstanding options immediately exercisable upon a change in control. A letter was sent on February 24, 1989, to inform option holders of these amendments and to obtain their consent, but Lamb and Bradley did not receive this letter and thus did not consent.
On March 19, 1989, Emhart entered into a merger agreement with Black & Decker Corporation, which stated that all outstanding Emhart stock options would become fully exercisable on the merger date, regardless of prior exercisability status.
On April 4, 1989, Richard F. Vitkus, Senior Vice-President of Emhart, informed all Emhart stock option holders that following Black & Decker's acquisition of Emhart shares, all outstanding stock options would become fully exercisable and vested, allowing option holders to receive cash equal to the difference between the option exercise price and the $40 Tender Offer price. This memo was received by Bradley and Lamb. Black & Decker completed the purchase on April 28, 1989, which triggered the Change in Control Amendment.
Key facts regarding Lamb and Bradley include: they signed Termination Agreements in December 1988, held stock options due to their tenure, and the Agreements referenced the Stock Option Plans, which allowed amendments. The Plans were amended on December 22, 1988, to make options immediately exercisable upon a change in control. Bradley and Lamb's employment ended on January 31, 1989, and their options were valid until April 30, 1989.
On April 28, 1989, Robert Byrnes, Vice-President of Human Resources, sent a memo about cashing out stock options, including checks for the net amount corresponding to unexercised shares held as of April 27, 1989. The memo stated that the payment fulfilled Emhart's obligations under the stock option agreements. Both Bradley and Lamb received cash out memoranda and checks reflecting only the exercisable portions of their options at the time of separation. They expected to receive payment for all shares covered by their options due to the amendments but believed the checks were issued in error. After depositing the checks, they contacted Emhart, only to be informed they were not entitled to payment for non-exercisable shares.
The plaintiffs filed a diversity action in the U.S. District Court for Connecticut, seeking the cash-out value for shares covered by non-exercisable portions of their options, asserting these remained outstanding under the Change in Control Amendments. Emhart contended that the Amendments did not apply to Lamb and Bradley's Plans and Agreements.
Emhart asserted an affirmative defense claiming that Lamb’s and Bradley’s acceptance of cash-out checks constituted an accord and satisfaction, discharging any obligations Emhart had. Additionally, Emhart counterclaimed, alleging that the plaintiffs breached the release provision of their Termination Agreements. After a three-day bench trial, the District Court determined that the Change in Control Amendments were applicable to Lamb and Bradley. It concluded that Emhart did not establish the essential elements of accord and satisfaction and the plaintiffs' claims did not violate the Termination Agreements, resulting in a judgment for the plaintiffs and an award of damages.
Emhart is appealing this judgment, arguing that the District Court's adoption of the plaintiffs’ proposed findings necessitates a stricter standard of review than the usual clearly erroneous standard. However, referencing the Supreme Court case Anderson v. City of Bessemer City, the excerpt clarifies that even verbatim adoption does not alter the standard; findings can only be reversed if clearly erroneous.
Emhart presented three arguments against the applicability of the Change in Control Amendments to Bradley and Lamb: first, the amendments were allegedly not incorporated into the Termination Agreements; second, even if incorporated, they represented a material modification of the Stock Option Plans requiring additional consideration, which was not provided; and third, portions of the plaintiffs’ options that were not exercisable at separation were canceled and thus not "outstanding" under the amendments.
Regarding incorporation, Emhart contended that the Stock Option Agreements were not properly referenced in the Termination Agreements, asserting that rights were established at the signing date rather than at separation. The District Court determined that the language of the Termination Agreements indicated that rights would be assessed post-separation, thus rejecting Emhart's argument.
The Termination Agreements adequately satisfy Connecticut law regarding the incorporation by reference of non-existent documents, specifically the Emhart Stock Option Plans and Agreements. Under Connecticut law, when parties execute a contract referencing another instrument, it is interpreted as integrating the terms of both documents into a single agreement, provided the parties had knowledge of and assented to the incorporated terms. The parties had two opportunities to review the Stock Option Agreements: when they were initially drafted and again upon incorporation into the Termination Agreements. Each party was aware of and agreed to all provisions, including amendment provisions stipulated in section 10 of the Plans.
Section 10 allows Emhart's Board of Directors to amend the Plans without affecting previously issued options, provided they adhere to specific restrictions. These restrictions include limits on increasing the number of shares reserved, fixing option prices, extending the terms of the Plan, and altering section 10 in ways that negate these conditions. Consequently, Emhart's agreements with Lamb and Bradley, through the incorporated Stock Option Agreements, contain clear standards for subsequent amendments. This establishes evidence of the parties' knowledge and assent to potential amendments, validating the incorporation under Connecticut law. Emhart contends that applying the amendments to the Plaintiffs’ Stock Option Plans would result in a material change requiring additional consideration.
Emhart asserts that no additional consideration was exchanged for modifications to the Stock Option Agreements. It is established that material modifications of a contract require additional consideration when they represent a new agreement. However, in this case, the Agreements did not constitute a new contract, as the employees' commitment to serve Emhart or its subsidiaries provided sufficient consideration for the options granted. The Agreements explicitly allowed for amendments under specified terms and conditions, indicating that the original contract contemplated such changes. Therefore, the Amendments did not necessitate further obligations from either party, qualifying them as non-material modifications.
Regarding unvested options, Emhart contends that these portions were not outstanding at the time of the merger and therefore not subject to the Change in Control Amendments. Emhart argues that its practice of canceling unvested options for terminated employees is valid, relying on section 6(e) of the Plans, which states that a terminated employee can only exercise vested options. The District Court disagreed, interpreting section 6(e) as recognizing the entirety of the options and distinguishing between vested and unvested shares only for the purpose of informing the optionee post-termination. Testimony from Emhart's corporate counsel and a Senior Vice President indicated that section 6(e) did not explicitly state that unexercisable portions would be canceled upon termination. Additionally, any ambiguity in contract language is to be construed against the drafter.
The District Court interpreted the relevant provisions in favor of Lamb and Bradley, affirming that the unvested portions of their stock options remained outstanding upon their separation from Emhart. It concluded that, under Section 422A of the Internal Revenue Code, the incentive stock options granted to Emhart employees were to be deemed outstanding until fully exercised or until the expiration of defined limitation periods. The Court ruled that the Plaintiffs' options were outstanding at the time of the merger and should have been accelerated like other options. Section 13 of the Plans allowed for stock options to be granted under 422A, explicitly stating that provisions related to incentive stock options (ISOs) were to be interpreted in alignment with this purpose. Section 422A stipulated that options could not be exercisable while any prior ISOs were outstanding, defining “outstanding” as options that remain effective until exercised or expired. Emhart's argument that the definition of “outstanding” in 422A(e)(7) applied solely to (b)(7) was rejected; instead, the Court held that the definitions in the Plans must be read together to clarify the rights of option holders. Specifically, the provisions indicated that options for terminated employees stay outstanding until three months post-termination, after which they expire by lapse of time.
Regarding the claim of accord and satisfaction, Emhart asserted that the Plaintiffs' acceptance of cash-out checks constituted such an agreement. For an accord and satisfaction to be valid, there must be a genuine dispute about the debt, a negotiated agreement to settle the claim, and a new agreement based on new consideration. The Court found no evidence supporting that cash-out checks were intended as a new contract between Emhart and the Plaintiffs, concluding that no accord and satisfaction existed.
Evidence indicates that no dispute existed between Emhart and the plaintiffs, Lamb and Bradley, when the checks were cashed. Witnesses from Emhart expressed surprise at the subsequent dispute over the check amounts. Both plaintiffs believed the checks did not fully satisfy the debt and thought the matter could be resolved, unaware that cashing the checks would extinguish their rights. Emhart cites County Fire Door Corp. as precedent; however, that case involved a pre-existing dispute and explicit terms that the check was full satisfaction of the debt, which was not present here. The lack of a meeting of the minds and the plaintiffs' unawareness of the implications of cashing the checks led to the conclusion that Emhart could not establish its affirmative defense of accord and satisfaction. The District Court's judgment is upheld.
The case was initially a class action with four plaintiffs but was amended to retain only Lamb and Bradley. Two Stock Option Plans from Emhart Corporation, the 1983 and 1986 Plans, were relevant, with no significant differences between them for this appeal. The Plans outlined that in the event of a Change in Control, all options become fully exercisable, a provision amended by the Board for both Plans. Lamb and Bradley signed Termination Agreements releasing Emhart from claims except those related to these Agreements. The District Court determined that claims regarding the Stock Option Plans were not discharged since they were incorporated into the Termination Agreements. Emhart’s argument that the Plans are not the principal agreement focuses on ensuring that standards are part of the original agreement rather than future incorporations.
Two separate incorporations are identified: the incorporation of the Plans and Agreements into the Termination Agreements, and the incorporation of future amendments to these Plans and Agreements. The first incorporation establishes a primary agreement with standards for guiding future amendments. Emhart is barred from contesting Lamb and Bradley’s entitlement to benefits under the Amendments due to their lack of consent, as Emhart failed to provide a consent letter, thereby forfeiting this defense, as supported by Burns v. Gould. Stock options represent a contractual relationship between employer and employee, underpinned by the employee's continued employment. The employer must reasonably expect to gain the intended benefit from the stock option grant. The District Court analyzed the law as it was at the time the Plans and Agreements were created in 1983 and 1986, noting significant amendments in 1988 and 1990 that revised the relevant statute. Specifically, Section 6(e) of the Plans stipulates the conditions under which an option holder's employment termination affects their options, allowing exercise only within a three-month period following termination, barring misconduct or death.
