Unusual Employment Benefits: Carried Interests

Financials-Eric-Robertson-Goranson-Bain-Ausley-Divorce-and-Family-Law-Attorney-Texas.Carried interests, which are also known as performance fees or profits interests, are often the primary incentive payment mechanism for general partners and managing members of hedge funds, private equity funds, and venture capital firms. A carried interest is a share of profits the managers of private equity funds receive as compensation. This method of compensation seeks to motivate the general partner or fund manager to work toward improving the fund’s performance. Carried interests generally become available to fund employees after all the initial capital that the limited partners contribute is returned along with a previously agreed upon rate of return.

Distributions of carried interests in most private equity funds are subject to the terms and conditions of the limited partnership agreements of the respective entities that hold the carried interest, which usually contain terms for vesting, cross-collateralization, and restrictions on transfer, among other terms and conditions. Normally, an individual will only participate in deals acquired during the individual’s tenure with the firm. Carried interests may have unusual vesting schedules, for instance, a portion may vest annually for the first three or four years after the initial acquisition, with the final portion vesting as long as eight to ten years after the initial acquisition. Many firms have carried interests that vest on a per-investment basis, where the vesting period starts when a fund makes an investment and pertains to each investment on an individual basis.

These assets are difficult to characterize when a carried interest is acquired during marriage, but vests over a period of time that extends past the date of divorce. Although carried interests vest in a manner similar to that of stock options, restricted stock plans, and other property interests in employment benefits covered by Texas Family Code §3.007, carried interests are not specifically mentioned with the other property interests listed in the statute. Therefore, when carried interests vest after divorce, we need to know how the unvested carried interests should be characterized. Given their similarity to stock options and restricted stock units, it is reasonable to argue that §3.007 should be expanded to include these types of employee benefits.

Because carried interests are a component of an employee’s compensation, requiring the employee’s post-divorce time, toil, and effort to enhance the value of the community estate’s carried interest assets, such enhancement may give rise to a claim of reimbursement against the community estate and in favor of the employee’s separate estate for the value of the enhancement. Remuneration for the employee’s work post-divorce clearly would be the employee’s separate property. If part of that remuneration relates to continued work on behalf of property characterized as community, then a potential reimbursement claim would arise because the employee’s separate property efforts would enhance the value of a community asset.

Characterization-of-Assets-Eric-Robertson-Goranson-Bain-Ausley-Divorce-and-Family-Law-Attorney-TexasExisting reimbursement principles might support such a claim. At least, this could be asserted as an equitable claim a Court could consider in rendering a just and right division of the community estate, creating the possibility of a decline curve on the net value of the community property’s portion of the carried interests related to post-divorce work done by the employee. The attorney should be clear and careful when characterizing these assets and their effect on the division of property.

This post was written by Eric Robertson.