Disputed ESOP – Selak v National Tiles Co Pty Ltd

In the case of Selak v National Tiles Co Pty Ltd & Ors (No 4) [2024] VSC 438 (Selak v National Tiles), the Supreme Court of Victoria (Court) considered whether a company breached an option agreement governed by the terms of an Employee Share Option Plan (ESOP) by requiring an option holder to execute an undisclosed shareholders’ agreement as a condition of exercising vested options.  

The decision provides guidance on the drafting and operation of ESOPs, particularly where the terms of a future shareholders’ agreement are not finalised at the time the options are issued.  It reinforces that Courts will enforce the commercial terms of a transaction agreed between the parties, even where an option holder considers the resulting bargain is economically unfavourable.  There were a total of five (5) decisions in this matter with the substantive decision being No 4.  The issues determined by the Court in Selak v National Tiles included the contract claim, the claim that arose in tort and whether Mr Selak had actually suffered any damage.

Background to the ESOP dispute

Mr John Selak, a former director of National Tiles Co Pty Ltd ACN 007 381 599 (Company), entered into an option agreement with the Company in April 2016 (Option Agreement).  The Option Agreement incorporated the terms of an Employee Share Option Plan (ESOP).  The ESOP was intended to incentivise and reward eligible participants for company performance.

Under the ESOP and Option Agreement:

• Mr Selak was granted 4,000,000 options to acquire shares in the Company;
• 3,200,000 options vested in April 2020 (Vested Options);
• The exercise price was 12.3 cents per option;
• The total exercise price payable on exercise of the Vested Options was A$393,600.

A condition of the Option Agreement required any option holder wishing to exercise options to execute a shareholders’ agreement in terms approved by Frank Walker Group Pty Ltd ACN 100 126 403 (Majority Shareholder).

At the time the Options were issued no shareholders’ agreement had been provided as part of the Option Agreement.

In May 2020, the Company provided Mr Selak with a proposed shareholders’ agreement (PSA).  He refused to execute it, asserting that it was “draconian, unreasonable and unacceptable” with his primary concern being that there was a claimed absence of minority shareholder protections that restricted his ability to transfer shares in the event he exercised the option and became a shareholder.

He also objected to clause 13.7 of the PSA and the valuation regime under the permitted transfer provisions of the PSA, which he contended exposed him to compulsory acquisition of his shares at an unfair value potentially below the exercise price payable under the Option Agreement.

Issues before the Court

The Court considered whether:

• the Company breached the terms of the Option Agreement by requiring execution of the PSA which was not disclosed in the original ESOP offer documentation;
• the Company breached implied cooperation obligations arising under the Option Agreement and ESOP; and
• whether any alleged breach caused loss to Mr Selak.

Alleged breach of express contractual terms

Mr Selak contended that the Option Agreement required all “relevant terms and conditions” relating to the shares to be disclosed in the original 2016 offer letter.

He argued that the PSA introduced new and undisclosed terms including clause 13.7 dealing with share valuation under the permitted transfer regime and that this constituted a breach of clause 2.2.1(k) of the Option Agreement.

The Court rejected that assertion.

It held that the Option Agreement expressly contemplated that a shareholders’ agreement would be prepared and approved by the Majority Shareholder at a later time.  The inclusion of additional terms in the PSA, including valuation provisions, did not breach the Option Agreement merely because those terms were not expressly set out in the 2016 offer documentation.

Alleged breach of implied cooperation obligations

Mr Selak also alleged that the Option Agreement contained implied cooperation obligations requiring the Company to act so as not to deprive him of the benefit of the Option Agreement and ESOP.

He argued that by insisting on the terms of the PSA in its proposed form undermined the commercial purpose of the ESOP and deprived the options of economic value.

The Court accepted that cooperation obligations may be implied in commercial contracts to ensure that parties can obtain the benefit of their bargain.  However, it found no breach on the facts.

In particular:

• the Company had not insisted that the PSA be executed only in its proposed form;
• the Company had invited discussion and negotiation of its terms; and
• Mr Selak did not meaningfully pursue those negotiations.
• The Court held that any implied cooperation obligations did not entitle Mr Selak to a wholesale revision of the commercial bargain or to insist upon more favourable commercial terms.

Construction of key contractual concepts

Meaning of “shareholders’ agreement“

The requirement to execute a shareholders’ agreement referred to an agreement approved by the Majority Shareholder and not inconsistent with the Option Agreement and ESOP.  It did not require all terms of that agreement to have been fixed or disclosed at the time the options were granted.

Meaning of “value“

In construing provisions dealing with transfers and buy-back rights, the Court held that references to “value” were to be interpreted as “fair value” being what is just and equitable in the circumstances rather than strictly market value.

Causation and loss

Even if a breach were established, the Court found that Mr Selak failed to establish causation or loss.

The Court accepted that, given the economic uncertainty arising during the COVID-19 period and the deterioration of the relationship between Mr Selak and the Majority Shareholder, it was unlikely that he would have exercised the Vested Options and paid the exercise price in any event.

Judgment

The Court dismissed the claims.  It held that:

• the Company did not breach the Option Agreement by requiring execution of a shareholders’ agreement approved by the Majority Shareholder;
• there was no breach of any implied cooperation obligations; and
• the plaintiff failed to establish causation or loss.

Significance of the decision

ESOPs may incorporate future shareholders agreements

The decision confirms that option documentation may validly require execution of a future shareholders’ agreement, even where that agreement has not been finalised at the time options are granted.

Courts will enforce the commercial structure agreed

Courts will not rewrite commercial arrangements merely because one party considers the outcome commercially unattractive.  Implied cooperation obligations do not guarantee an economically favourable result.

Importance of careful drafting and integration

The case highlights the importance of ensuring that ESOP documentation clearly:

• contemplates execution of a future shareholders’ agreement;
• identifies approval rights of majority shareholders; and
• addresses valuation and compulsory transfer mechanisms.

Takeaways for employers and potential issuers of ESS Interests

Companies implementing ESOPs should:

• ensure that option documentation and shareholders’ agreements are properly integrated;
• clearly state whether future shareholders’ agreements may include additional terms;
• carefully draft valuation and compulsory transfer provisions; and
• obtain legal advice when establishing or revising employee equity arrangements.

Early and careful structuring of employee equity arrangements remains critical to minimising dispute risk.

Links and further references

Cases

Selak v National Tiles Co Pty Ltd & Ors [2023] VSC 438 – dispute in relation to the falsification of books

Selak v National Tiles Co Pty Ltd & Ors (No 2) [2024] VSC 409 – uplift of documents subject to subpoena

Selak v National Tiles Co Pty Ltd & Ors (No 3) [2024] VSC 431 – application to stay judgement pending application for uplift and inspection of documents.

Selak v National Tiles Co Pty Ltd & Ors (No 4) [2024] VSC 438 – ESOP dispute

Selak v National Tiles Co Pty Ltd & Ors (No 5) [2024] VSC 504 – Legal costs

Further information

If you need advice on Employee Share Option Plans for your business, contact us for a confidential and obligation‑free discussion.

Disclaimer

This article contains general commentary only.  You should not rely on the commentary as legal advice.  Specific legal advice should be obtained to ascertain how the law applies to your particular circumstances

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