Phantom Share Option Agreements
Introduction
In our previous article, “Share Option Agreements in Turkey: Legal Framework and Practical Uncertainties” we examined the legal infrastructure of share option agreements that allow employees to acquire actual company shares, thereby enhancing their loyalty and incentivizing performance. We also discussed key points to consider, and uncertainties encountered in practice. The legislative gaps and restrictions highlighted in that article indicate that agreements providing phantom shares (virtual shares) have become a more attractive alternative. In this article, we will analyze the legal nature of phantom share option agreements signed with employees and the critical aspects to consider in practice.
General Structure of Phantom Share Option Agreements
Phantom share option agreements are typically signed with employees considered as key personnel. The primary purpose of these agreements is to offer employees financial gains proportional to the company’s growth or success without granting them actual ownership of company shares. Under these agreements, employees do not acquire real shares but obtain financial rights tied to the economic value of the shares.
Phantom share option agreements are usually implemented through an agreement separate from the employment contract. Employees become entitled to economic benefits based on specific conditions and/or triggering events outlined in the phantom share option agreement. These criteria often include conditions such as working for the company for a certain period, achieving specified performance targets, the company receiving external investments, or completion of a merger or acquisition transaction. Phantom share option agreements can incorporate various vesting models by combining different durations and conditions.
One of the key advantages of this system is that it allows employees to obtain financial benefits proportional to the company’s growth and/or development without being granted the managerial rights and obligations associated with share ownership. Employees under this structure do not obtain shareholder rights such as voting in general meetings, requesting special audits, accessing company information, challenging general meeting resolutions, or filing liability claims against board members. For companies, this model enhances employee retention and incentivizes performance without altering the company’s shareholding structure.
Share option agreements can be structured as hybrid agreements granting employees various rights and benefits, including provisions on profit sharing. The distribution of profit to employees is subject to specific regulations under Article 403 of the Turkish Code of Obligations and Articles 519 to 523 of the Turkish Commercial Code (“Law no. 6102″). However, in general, the rights granted to employees in phantom share option agreements provide financial instruments that are not directly tied to the company’s profit and can be exercised after a certain period of time, whereas the direct distribution of profit shares to employees means they receive a direct share of the profit earned during a specific period.
In other words, in the implementation of phantom share option agreements, employees are not shareholders of the company, but they can benefit from the increase in the value of shares under certain conditions; profit sharing, on the other hand, is directly related to the allocation of a portion of the annual profit to employees. From this perspective, distributing profit shares to employees differs from the implementation of phantom share option agreements. Therefore, the distribution of profit shares to employees is not covered in this article.
Unlike agreements that provide actual share ownership, there is no explicit legal provision in Turkish law governing phantom share option agreements. Therefore, when structuring such agreements, it is crucial to consider the applicable principles of labor law.
Key Considerations Under Labor Law When Structuring Share Option Agreements
An analysis of Turkish Court of Cassation precedents reveals that share options are considered an employee incentive scheme tied to an employment relationship. Consequently, financial gains provided under share option agreements are deemed “bonuses” under Article 32 of the Turkish Labor Law No. 4857 (“Law No. 4857”)[1].
Therefore, consideration of labor law provisions is essential when structuring share option plans. Since the relevant decision pertains to a share option agreement that provides actual share ownership, it underscores the necessity of taking labor law regulations and case law into account not only in phantom share option agreements but also in those granting actual share ownership.
Under Article 5 of Law No. 4857, employers cannot discriminate between employees when providing bonuses or similar benefits. Differentiated bonus payments among employees in similar positions may lead to claims against the employer under the principle of equal treatment[2]. Bonus schemes should be based on concrete, objective, transparent, and measurable criteria, with limited discretionary power for the employer[3]. These principles should be considered when drafting share option agreements and selecting eligible employees.
The Court of Cassation has ruled that modifications to established bonus schemes constitute a material change in working conditions and require the employee’s consent. For instance, if a system is in place where bonuses are granted upon achieving certain targets, the employer cannot unilaterally change those targets or withhold payments without the employee’s written approval[4].
One of the most common issues encountered when drafting share option agreements arises in relation to whether the exercise of the right is conditional upon the validity of the employment contract or the employee having worked for a certain period within the company. In numerous decisions concerning bonus schemes, the Court of Cassation has adopted the view that employees are not required to remain employed until the end of the period entitling them to a bonus, that the requirement to be employed at the time of payment—if stipulated in the bonus scheme—holds no significance, and that employees have a right to claim a bonus proportional to their period of employment[5].
In the coming period, it remains an important issue to monitor whether the Court of Cassation will adopt this perspective in the context of share option agreements, whether it will distinguish between share option agreements granting actual share ownership and phantom share option agreements, and whether it will take a different approach for different termination scenarios.
Within this framework, employee bonus schemes should be analyzed from labor law, social security, and tax perspectives, and agreements should establish clear and objective criteria to minimize potential disputes
Conclusion
One of the key reasons for preferring phantom share options is to overcome the challenges associated with traditional share option structures. In conventional share option agreements, employees acquire shareholder status, which grants them rights such as attending general meetings or exercising pre-emptive rights. This may create operational difficulties, especially for startups seeking investments or companies with dynamic structures. Phantom share options mitigate these challenges by providing a more flexible and practical alternative.
However, before implementing a phantom share option plan or a plan that grants actual share ownership, companies must carefully analyze the advantages and potential drawbacks of the proposed system. Furthermore, share option agreements should be structured in compliance with labor law principles, ensuring that employee benefits are clearly defined, and potential disputes are minimized as much as possible.
[1] Court of Cassation, 9th Civil Chamber, Case No. 2022/7885, Decision No. 2022/15517, dated November 29, 2022
[2] Court of Cassation, 9th Civil Chamber, Case No. 2014/12590, Decision No. 2015/26625, dated September 29, 2015
[3] Court of Cassation, 22nd Civil Chamber, Case No. 2016/19779, Decision No. 2019/18430, dated October 8, 2019
[4] Court of Cassation, 9th Civil Chamber, Case No. 2011/25567, Decision No. 2013/22792, dated September 17, 2013.; Court of Cassation, 9th Civil Chamber, Case No. 2012/6620, Decision No. 2013/29187, dated November 13, 2013; Court of Cassation, 7th Civil Chamber, Case No. 2013/3564, Decision No. 2013/10046, dated May 29, 2013
[5] Court of Cassation, 22nd Civil Chamber, Case No. 2013/13238, Decision No. 2014/19097, dated June 24, 2014; Court of Cassation, 22nd Civil Chamber, Case No. 2014/27449, Decision No. 2014/30296, dated November 4, 2014; Court of Cassation, 9th Civil Chamber, Case No. 2022/6466, Decision No. 2022/8025, dated June 16, 2022
