Just What Is “Income” in the World of Equitable Distribution?

I was reminiscing with some colleagues about how the world of “compensation” has evolved in the past 40 years. Back in 1985, life was easy. People were paid a salary and could expect an extra week of comp to be paid as a bonus at years’ end. If you were high up on the executive chain the bonus could be substantial; perhaps a month’s wages instead of a week.

Then the world invented incentive comp. Now you were bonused based on stock price, or some algorithm of sales, profits, EBITDA or comp paid to comparable companies. Having represented some of the folks who received these handsome rewards, I would sometimes ask if they ever understood how some of these algorithms worked. The answer was inevitably a sheepish “No” unless it was a straight stock option or stock price based formula.

In 2009 things got complicated when the stock market dipped by 40% on a temporary basis and wiped out a lot of potential comp. It took three years to get back to 2008 levels but has been on a hot streak ever since. Meanwhile, gun shy executives have come to expect a cocktail of executive comp such as we described in the preceding paragraph. Options, performance stock, incentive stock and bonuses structured to keep them from running off to the competition.

In recent years the actual salary of the executive looks more like a downpayment on the total compensation package. In 2017 I was consulted by a spouse whose husband has recently been recruited to join senior management of a publicly traded manufacturing company. The move in 2014 took him from a $200,000 salary with a normal bonus to $350,000 + stock + options + a formula based bonus. By 2017 that combination was probably in the $450,000 range. The parties had separated in 2015 and so he was claiming that just about all of the non-salary compensation was “post separation.” At the time I was inclined to agree.

Eight years later and 30 months after I retired the case still goes on. The stock options which were awarded in 2014 at $24 a share have twice hit $80 a share. We had a record hearing for several days in 2022 when the stock was at $50 a share. A year later it had fallen to $10 a share and today can’t muster $4 unless it’s a good day.

In 2020 the executive signed an employment agreement with a $450,000 wage plus “incentives.” Since then, I have made it my hobby to keep track of how those “incentives” have worked out for a company whose share price seems to be what a physician would describe as in extremis. (that’s latin for near death). What I found was that depending on the year, the executive for this beleaguered company was reporting income from the company that averaged $1.4 million and once exceeded $2 million.

The beauty of having a case where the spouse is a senior executive for a public company is that you can watch compensation on an internet channel called “EDGAR”. Whenever stock or equivalents are awarded or exercised the company has to notify Uncle EDGAR with a public filing you can read on the internet. And every year there is a document filed called a 10-K that lays it all out for you. To be clear you can’t take Uncle EDGARs numbers to the bank in support or alimony proceedings because EDGAR uses a valuation formula called “Black Scholes.” Messrs. Black and Scholes did win a Nobel Prize for their algorithm but many executives cry that they can’t always get the money Black & Scholes say their compensation is worth.

What seems to have occurred in the case I had was that once the stock fell off the cliff, management decided to find newer and more creative ways to structure compensation that were not centered on stock price. If you can get it, you should read the comp agreements and look for change in control provisions. In a nutshell they typically provide that if a senior manager is fired without cause, he/she will pull in 18 months of compensation as a severance and every incentive in play will automatically vest. Call it a ”farewell kiss.”

In a word “comp” has become “complicated.” And in a divorce setting it needs some attention so that a judge or hearing officer can grasp just what wealth is being “stored” for future use. In the case of companies that are registered with the Securities and Exchange Commission (and that includes some companies that don’t trade on open markets) EDGAR is a place to start. But, in every case where a closely held business is involved, you want to see “all agreements to which the executive is a party.” That request should go to the employer itself rather than the executive because even forthright spouses can forget what they are signed up for.

A court may ask you why this is relevant if the property is not marital. That’s when you should haul out your copy of 23 Pa.C.S. 3502 and note the separate estate, sources of income, opportunities for future acquisitions and economic circumstances of the parties at the time of trial are all factors which the court must evaluate in forming a distribution. In the case I have been describing the executive’s post separation acquisitions eclipse anything the parties accumulated in their 20 year marriage and so long as the one spouse continues in senior management, the harvest will always be abundant.

A final note: every lawyer needs to be familiar with MacKinley v. Messerschmidt 814 A.2d 680 (Pa.S. 2002). That case hold that courts are to treat deferred incentives like stock options to be income available for support once the asset vests, rather than when the fruit of the deferred comp is pulled from the tree. This is a support case but a useful device in equitable distribution to show that a vested asset is an available resource.