Phantom Stock Plans: Risks and Rewards

Stock options are a popular way for emerging companies to provide incentive pay to employees.  For some companies, however, stock option plans may not be feasible or may present tax or corporate difficulties that render them problematic.  For these companies, a phantom stock plan may be an attractive alternative.

Generally, a phantom stock plan is an agreement whereby a company grants (or sells) to certain employees a contract right to fictional shares of stock (“phantom stock”) and agrees to pay the employee the value of his or her vested shares at a future date upon the occurrence of specified events.  The value of phantom stock is typically based on the employer’s common stock, thereby permitting the employee to benefit from any appreciation in the value of the company.  In many ways, phantom stock is analogous to nonvoting common stock; phantom stock does not represent equity in the company, however, making such plans attractive to closely held corporations.

But companies should be aware of some critical risks that phantom stock plans might pose.  For example:

  • Are Fiduciary Duties Owed?  While the law is clear that corporate officers and directors owe fiduciary duties to shareholders, it is unclear whether fiduciary duties are owed to phantom stockholders.  If such duties are imposed, they might create additional obligations beyond those created by the phantom stock plan itself.
  • Does ERISA Apply?  Depending on how the plan is structured, a phantom stock plan may come under the umbrella of ERISA.  If ERISA applies, the employer will owe fiduciary duties to all plan participants.
  • Are Phantom Stock Payments Considered a Wage? “Wages” include “any form of compensation that is a byproduct of the employment relationship.”  E.g. Durand v. HIMC Corp, 151 Wn. App. 818, 831 (2009).  If phantom stock payments are deemed wages, nonpayment may create personal liability for corporate officers and permit the employee to seek double damages under wage-and-hour laws.

Some of these issues are addressed in more details in  D. Kyle Sampson, The Fiduciary Duties of Corporate Directors to “Phantom” Stockholders, 62 U. Chi. L. Rev. 1275 (1995), although many of the positions articulated in this note have not been tested in the courts.

— Ryan Solomon

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