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Rosen v. Smith Barney

SUPREME COURT OF NEW JERSEY


June 25, 2008

MELVIN ROSEN AND JAMES D. FOX, ON BEHALF OF THEMSELVES AND ALL OTHERS SIMILARLY SITUATED, PLAINTIFFS-APPELLANTS, AND RICHARD SIRACUSA, PLAINTIFF,
v.
SMITH BARNEY, INC., SALOMON SMITH BARNEY, INC. AND SALOMON BROTHERS, INC., DEFENDANTS-RESPONDENTS, AND JOHN DOES 1-1000, INCLUSIVE, DEFENDANTS.

On appeal from the Superior Court, Appellate Division, whose opinion is reported at 393 N.J. Super. 578 (2007).

SYLLABUS BY THE COURT

(This syllabus is not part of the opinion of the Court. It has been prepared by the Office of the Clerk for the convenience of the reader. It has been neither reviewed nor approved by the Supreme Court. Please note that, in the interests of brevity, portions of any opinion may not have been summarized).

The issue in this appeal as of right -- arising from the dissent filed by Judge Harvey Weissbard -- is whether the plaintiffs' agreement to divert earnings to an incentive compensation plan violated the New Jersey Wage and Hour Law (Wage law), N.J.S.A. 34:11-4.1 to -67, or the statute's public policy.

Plaintiffs Melvin Rosen and James D. Fox are former employees of defendants Smith Barney, Inc., Salomon Smith Barney, Inc., and Salomon Brothers, Inc. (collectively Smith Barney) and participated in their employer's "Capital Accumulation Plan" (CAP). Both Rosen and Fox voluntarily executed agreements that allowed Smith Barney to use a percentage of their compensation to purchase parent company stock (Plan stock) after an initial six-month deferral period. The CAP afforded Rosen and Fox shareholding voting rights and dividends, as well as other benefits, and Plan stock ownership fully vested after a period of two years. The CAP enrollment form provided, however, that all unvested funds would be forfeited should the participant resign or be terminated before expiration of the two-year vesting period. The forfeiture provisions were consistent with the Internal Revenue Code provision permitting tax deferral.

Rosen voluntarily resigned from his employment with Smith Barney on July 1, 1994, and Fox on February 16, 1999. In each case Smith Barney invoked the CAP's forfeiture clause and retained the participant's unvested Plan stock. On October 1, 1999, plaintiffs filed a complaint alleging the CAP violated the Wage law because its terms required the forfeiture of earned wages. Plaintiffs also asserted common law tort claims of breach of contract, conversion, breach of fiduciary duty, and unjust enrichment. On January 24, 2003, Smith Barney filed a motion for summary judgment seeking to dismiss plaintiffs' tort claim. Plaintiffs cross-moved for partial summary judgment and asserted that the CAP's forfeiture provisions were incompatible with the Wage law and New Jersey public policy.

On April 23, 2004, the trial court issued a bench decision granting Smith Barney's motion for partial summary judgment on the common law tort claims. The trial court further determined that the forfeiture provision of the CAP contravened public policy and granted plaintiffs' motion for partial summary judgment. Smith Barney appealed. On June 15, 2007, the Appellate Division, in a published decision, affirmed the dismissal of the tort claims but reversed the partial summary judgment declaring the CAP null and void. The Appellate Division concluded that the CAP violated neither the Wage law nor the State's public policy, finding that public policy strongly favors freedom of contract. The Appellate Division determined that, after full disclosure, the parties freely, willingly, and knowledgably consented to the use of their compensation to be placed in this deferred investment vehicle.

Judge Weissbard filed a separate opinion, concurring in part and dissenting in part. Judge Weissbard would affirm the dismissal of the common law claims, but would also affirm the Law Division's ruling that the Smith Barney CAP violated New Jersey public policy as expressed in the Wage law. Boiled down to its essence, Judge Weissbard writes, the CAP forfeiture provision amounts to a restrictive covenant of the broadest type imaginable.

HELD: The judgment of the Appellate Division is AFFIRMED substantially for the reasons expressed in the Appellate Division's majority opinion.

1. Incentive compensation plans in general, and the CAP in particular, find their authorization within the terms and provisions of the Wage and Hour Law itself. Neither the fact that there was a vesting period attached to full and complete ownership of the interest, nor the fact that the CAP included a forfeiture provision, violates any of the provisions of that statute. There were two significant benefits of the CAP that made it attractive to plaintiffs, namely, the ability to purchase securities at a deep discount and the tax benefits accorded to it as a deferred compensation plan. The very features of the CAP about which plaintiffs now complain were part and parcel of the latter. Moreover, the Court rejects the assertion that the CAP's inclusion of, and defendants' potential invocation of, a forfeiture provision, operates as a penalty that therefore violates public policy in some fashion. The Court discerns nothing to support the conclusion that the forfeiture provisions which were an integral part of defendant's CAP deferred incentive compensation program and in which plaintiffs voluntarily participated, violate the Wage and Hour Law or the public policy that it represents and embodies. (Pp. 2-7)

JUSTICES LaVECCHIA, WALLACE, RIVERA-SOTO, and HOENS, and JUDGE EDWIN H. STERN, temporarily assigned, join in the Court's opinion. CHIEF JUSTICE RABNER and JUSTICES LONG and ALBIN did not participate.

Per curiam.

Argued March 26, 2008

We affirm substantially for the reasons expressed in the thorough and persuasive Appellate Division majority opinion authored by Judge Lihotz. See Rosen v. Smith Barney, Inc., 393 N.J. Super. 578 (App. Div. 2007). We add only the following comments by way of further explanation for our decision to affirm, in which we focus only on the issues raised in the dissent. See R. 2:2-1(a)(2).

This dispute concerns a challenge by plaintiffs, Melvin Rosen, James D. Fox, and others similarly situated, to an incentive compensation plan, called the Capital Accumulation Plan (CAP). The CAP was offered to them during the time when they were employed by defendants, Smith Barney, Inc., Salomon Smith Barney, Inc. and Salomon Brothers, Inc., and plaintiffs concede that they were voluntary participants in the CAP. Their complaint, however, challenged the CAP as being in violation of our Wage and Hour Law, N.J.S.A. 34:11-4.1 to -67.

Our review of that governing statute demonstrates that incentive compensation plans in general, and the CAP in particular, find their authorization within the terms and provisions of the Wage and Hour Law itself. See N.J.S.A. 34:11-4.4(b)(2). That statutory pronouncement, although generally prohibiting an employer from "withhold[ing] or divert[ing] any portion of an employee's wages," N.J.S.A. 34:11-4.4, expressly provides for exceptions when the amounts withheld or diverted are devoted to specifically authorized purposes. N.J.S.A. 34:11-4.4(b). More specifically, subsection (2) of that section of the statute permits wages to be withheld or diverted for the purpose of:

Contributions authorized either in writing by employees, or under a collective bargaining agreement, for payment into company-operated thrift plans; or security option or security purchase plans to buy securities of the employing corporation, an affiliated corporation, or other corporations at market price or less, provided such securities are listed on a stock exchange or are marketable over the counter. [N.J.S.A. 34:11-4.4(b)(2).]

The CAP, the plan in which these plaintiffs participated, was entirely voluntary and its terms were fully disclosed to each of them. The funds, derived from plaintiffs' compensation at their direction, were invested in "securities of the employing company . . . listed on a stock exchange," as the statute contemplates. Ibid. Plaintiffs' interest in the CAP was defined, and both the indicia of and control over that interest, through plaintiffs' receipt of dividends and their ability to exercise voting rights, were immediate. Neither the fact that there was a vesting period attached to full and complete ownership of the interest, nor the fact that the CAP included a forfeiture provision, violates any of the provisions of the Wage and Hour statute.

In addition, there were two significant benefits of the CAP that made it attractive to plaintiffs, namely, the ability to purchase securities at a deep discount and the tax benefits accorded to it as a deferred compensation plan. The very features of the CAP about which plaintiffs now complain were part and parcel of the latter. That is because, in order to qualify as a deferred income plan, the CAP was required to comply with federal tax law. The Internal Revenue Code permits deferral of income taxes on earned wages, like those that were the source of the funds utilized by these plaintiffs for purposes of their participation in the CAP, only if the plan meets the Code's specific criteria. See 26 U.S.C.A. §§ 83, 409A. In particular, although there are a variety of ways to structure a plan so that it qualifies for these tax benefits, the one identified in section 83 of the Code, that would apply to the CAP, includes a requirement that there be a substantial risk of forfeiture. 26 U.S.C.A. § 83(a). That is to say, this section of the Code permits individual taxpayers, like these plaintiffs, who receive property, like their interest in the CAP assets, in exchange for services, to exclude it from their gross income as long as it remains "subject to a substantial risk of forfeiture" or until "the first time the rights of the person having the beneficial interest in such property are transferable." Ibid.

This section of the Internal Revenue Code specifically defines "subject to a substantial risk of forfeiture" as including "if such person's rights to full enjoyment of such property are conditioned upon the future performance of substantial services by any individual." 26 U.S.C.A. § 83(c)(1). Alternatively, a different, potentially applicable section of the Internal Revenue Code, 26 U.S.C.A. § 409A, governing nonqualified deferred compensation plans, permits taxpayers to qualify for favorable tax treatment if the compensation is retained by the employer for a period of time and remains at a "substantial risk of forfeiture" until payable to the employee. 26 U.S.C.A. § 409A(a)(1)(A)(i).

In order for the employees to participate in the CAP, they were required to agree to put that compensation at a "substantial risk of forfeiture." In doing so, however, the employees agreed to a term that the CAP included as a mechanism for achieving the benefits of favorable treatment under the Internal Revenue Code. Nor do we find any evidence that our Legislature regards these terms of our federal tax statutes as raising any public policy concern. Instead, we read the relevant provisions in the Internal Revenue Code, 26 U.S.C.A. §§ 83, 409A(a)(1), that create the qualifying grounds for plans like the CAP, as being in harmony with our Wage and Hour Law, see N.J.S.A. 34:11-4.4(b)(2) (permitting participation in deferred compensation plans).

Moreover, we reject the assertion that the CAP's inclusion of, and defendants' potential invocation of, a forfeiture provision, operates as a penalty that therefore violates public policy in some fashion. Our traditional analysis of unenforceable penalty provisions arises in the context of liquidated damage clauses that are only operative in breach of contract claims. See, e.g., Metlife Capital Fin. Corp. v. Washington Ave. Assocs. L.P., 159 N.J. 484, 498-99 (1999) (explaining liquidated damages and holding that contractual term that purports to fix an "unreasonably large" sum as liquidated damages will not be enforced); Wasserman's Inc. v. Twp. of Middletown, 137 N.J. 238, 247-48 (1994) ("A penalty is the sum a party agrees to pay in the event of a breach, but which is fixed, not as a pre-estimate of probable actual damages, but as a punishment, the threat of which is designed to prevent the breach."); accord Restatement (Second) of Contracts § 356 (1981). As we have recognized, in that context, a contractual term fixing an unreasonably large liquidated damage amount is a penalty, which is unenforceable on grounds of public policy. Metlife, supra, 159 N.J. at 498-99; Wasserman's Inc., supra, 137 N.J. at 247-48.

We see, however, no manner in which the CAP forfeiture provision could be so construed. Plaintiffs were not signatories to any separate contractual agreement that would have prevented them from ending their employment with defendants; as a result, any decision they might make to leave their employment would not have been a contractual breach as to which a liquidated damages clause would arise or be imposed. That being the case, the operation of the forfeiture clause, because it is unrelated to an underlying breach of contract, cannot be understood to be such a penalty.

In summary, we discern nothing to support the conclusion that the forfeiture provisions, which were an integral part of defendant's CAP deferred incentive compensation program and in which plaintiffs voluntarily participated, violate the Wage and Hour Law or the public policy that it represents and embodies.

The judgment of the Appellate Division is affirmed. JUSTICES LaVECCHIA, WALLACE, RIVERA-SOTO and HOENS and JUDGE EDWIN H. STERN, temporarily assigned, join in the Court's opinion. CHIEF JUSTICE RABNER and JUSTICES LONG and ALBIN did not participate.

Justice LaVecchia PRESIDING

20080625

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