EMPLOYEE STOCK OPTIoN SCHEME

1. IntroductionThe idea that employees should have an ownership stake in

the company led to the emergence of concept of Employee Stock Option
Plan (ESOP). The concept of ESOP is believed to be the brain child of an
American, Louis Kelso, who is a lawyer, economist and philosopher who
persuaded a Senator from Louisiana, to support legislation legalizing
ESOP’s. Definition of “Employee Stock Option” was first incorporated by
way of a clause (15A) in Section 2 of the Companies Act, 1956, based on
the recommendations of Working Group. Section 62 of the Companies
Act, 2013 further incorporates enabling provision for the issue of ESOPs
subject to the sanction of special resolution and compliance with Rules (in
case of unlisted public company) and SEBI Regulations (in case of listed
companies).

2. Objective of issuing ESOPsThe objective of issuing ESOP is to:

o Provide incentive to attract, retain and reward employees of the
company
o Motivate employees to contribute to the growth and profitability of
the company

3. Some important definitions under ESOPs:

o What is an ‘option’ in stock options?An option in stock option gives
the employee the choice- a right but not an obligation – to
purchase the shares of the company on the fulfillment of the
conditions mentioned in the ESOP plan at the price decided at the
time of grant of options.
o What is a grant?The eligibility of a particular employee (depending
on the criteria set) for grant of stock options based on his role and
performance is known as grant of option.
o What is vesting?Vesting has two components – Vesting percentage
and vesting period. Vesting period is the period on the completion
of which the said portion can be exercised. Vesting percentage
refers to that portion of total options granted, which the employee
will be eligible to exercise.
o What is exercise?The activity of converting the options granted to
an employee into shares by paying the required exercise price is
known as exercise of options.
 o What is exercise price and exercise period?Exercise price is the
price; the employee has to pay to convert the options into shares.
The exercise period is the period within which the employee can
decide to exercise the stock options.
o What is the effective date of exercise?The effective date of exercise
is the date on which the Company allots the shares.

4. Issue of Employee Stock Options by Unlisted Public CompanyAs per

provisions of Sec 62(1)(b) of Companies Act, 2013, “where at any time a
company having a share capital proposes to increase its subscribed
capital by the issue of further shares, such shares shall be offered to
employees under a scheme of employees’ stock option, subject to special
resolution passed by the company and subject to such conditions as may
be prescribed.” Sec 2(37) of Companies Act, 2013 defines “employees
stock option” which means, ‘the option given to the directors, officers or
employees of the company or of its holding company or subsidiary
company or companies, if any, which gives such directors, officers or
employees, the benefit or right to purchase, or to subscribe for, the
shares of the company at a future date at a pre-determined price.’ The
above provision needs to be read with Rule 12 of The Companies (Share
Capital and Debentures) Rules, 2014. As per the said Rule, a Company,
other than a listed company, shall not offer shares to its employees under
a scheme of employees’ stock option, unless it complies with the following
requirements, namely:-

o Sanction by Special ResolutionThe issue of Employee Stock

Option scheme shall be approved by the shareholders of the
company, by passing a Special Resolution.
o Employees to whom ESOPs may be issuedFor the purpose of the
Section 62(1)(b) and Rule 12, “Employee” means –
a. A permanent employee of the company who has been
working in India or outside India; or
b. A director of the company, whether a whole time director or
not but excluding an independent director; or
c. An employee as defined in clause (a) or (b) of a subsidiary, in
India or outside India, or of a holding company of the
company or of an associate company,but does not include-
i. An employee who is a promoter or a person belonging
to the promoter group; or
ii. A director who either himself or through his relative or
through any body corporate, directly or indirectly,
 holds more than 10% of the outstanding equity shares
of the company.
o Disclosures in the explanatory statement annexed to the
notice for passing of the resolutionThe company shall make the
following disclosures in the explanatory statement annexed to the
notice for passing of the resolution –

a. the total number of stock options to be granted;

b. identification of classes of employees entitled to participate
in the Employees Stock Option Scheme;
c. the appraisal process for determining the eligibility of
employees to the Employees Stock Option Scheme;
d. the requirements of vesting and period of vesting;
e. the maximum period within which the options shall be
vested;
f. the exercise price or the formula for arriving at the same;
g. the exercise period and process of exercise;
h. the Lock-in period, if any;
i. the maximum number of options to be granted per
employee and in aggregate;
j. the method which the company shall use to value its options;
k. the conditions under which option vested in employees may
lapse e.g. in case of termination of employment for
misconduct;
l. the specified time period within which the employee shall
exercise the vested options in the event of a proposed
termination of employment or resignation of employee;
m. a statement to the effect that the company shall comply with
the applicable accounting standards.
 PricingThe companies granting option to its employees
pursuant to Employees Stock Option Scheme will have the freedom
to determine the exercise price in conformity with the applicable
accounting policies, if any.
 Shareholders’ approval by way of separate resolutionThe
approval of shareholders by way of separate resolution shall be
obtained by the company in case of:
a. grant of option to employees of subsidiary or holding
company; or
b. grant of option to identified employees, during any one year,
equal to or exceeding one percent of the issued capital
(excluding outstanding warrants and conversions) of the
company at the time of grant of option.
 Variation of terms of ESOSThe company may by special
resolution, vary the terms of Employees Stock Option Scheme not
yet exercised by the employees provided such variation is not
prejudicial to the interests of the option holders. The notice for
passing special resolution for variation of terms of Employees Stock
Option Scheme shall disclose full details of the variation, the
rationale therefore, and the details of the employees who are
beneficiaries of such variation.
 Minimum vesting periodThere shall be a minimum period
of one year between the grant of options and vesting of option. In a
case where options are granted by a company under its Employees
Stock Option Scheme in lieu of options held by the same person
under an Employees Stock Option Scheme in another company,
which has merged or amalgamated with the first mentioned
company, the period during which the options granted by the
merging or amalgamating company were held by him shall be
adjusted against the minimum vesting period required under this
clause.
 Lock-in-period for shares issued on exercise of optionThe
company shall have the freedom to specify the lock-in period for
the shares issued pursuant to exercise of option.
 Right to receive dividendsThe Employees shall not have
right to receive any dividend or to vote or in any manner enjoy the
benefits of a shareholder in respect of option granted to them, till
shares are issued on exercise of option.
 Forfeiture/ Refund of amount paid by employees under
ESOPThe amount, if any, payable by the employees, at the time of
grant of option-
a. may be forfeited by the company if the option is not
exercised by the employees within the exercise period;  or
b. the amount may be refunded to the employees if the options
are not vested due to non-fulfillment of conditions relating to
vesting of option as per the Employees Stock Option Scheme.
 Options not transferable
a. The option granted to employees shall not be transferable to
any other person.
b. The option granted to the employees shall not be pledged,
hypothecated, mortgaged or otherwise encumbered or
alienated in any other manner.
 Who can exercise the option
a. No person other than the employees to whom the option is
granted shall be entitled to exercise the option.However, in
 the event of the death of employee while in employment, all
the options granted to him till such date shall vest in the legal
heirs or nominees of the deceased employee.
b. In case the employee suffers a permanent incapacity while in
employment, all the options granted to him as on the date of
permanent incapacitation, shall vest in him on that day.
c. In the event of resignation or termination of employment, all
options not vested in the employee as on that day shall
expire. However, the employee can exercise the options
granted to him which are vested within the period specified
in this behalf, subject to the terms and conditions under the
scheme granting such options as approved by the Board.
 Disclosures in Board of Directors ReportThe Board of
directors, shall, inter alia, disclose in the Directors’ Report for the
year, the following details of the Employees Stock Option Scheme:
(a) options granted; (b) options vested; (c) options exercised; (d) the
total number of shares arising as a result of exercise of option; (e)
options lapsed; (f) the exercise price; (g) variation of terms of
options; (h) money realized by exercise of options; (i) total number
of options in force; (j) employee wise details of options granted to;-
(i) key managerial personnel; (ii) any other employee who receives a
grant of options in any one year of option amounting to five
percent or more of options granted during that year. (iii) identified
employees who were granted option, during any one year, equal to
or exceeding one percent of the issued capital (excluding
outstanding warrants and conversions) of the company at the time
of grant;
 Register of Employees Stock Options
a. The company shall maintain a Register of Employee Stock
Options in Form No. SH.6 and shall forthwith enter therein
the particulars of option granted under clause (b) of sub-
section (1) of section 62.
b. The Register of Employee Stock Options shall be maintained
at the registered office of the company or such other place as
the Board may decide.
c. The entries in the register shall be authenticated by the
company secretary of the company or by any other person
authorized by the Board for the purpose.

Rule 12(11) specifically provides that, where the equity shares of the
company are listed on a recognised stock exchange, the Employees Stock
Option Scheme shall be issued, in accordance with the regulations made
by Securities and Exchange Board of India, in this behalf. SEBI (Share
Based Employee Benefits) Regulations, 2014 issued in October 28, 2014
(applicable from the even date) have replaced the erstwhile SEBI
Employee Stock Option Scheme and Employee Stock Purchase Scheme
Guidelines (applicable for listed companies) 1999.