Protection of Employee Equity Rights During M&A Transactions: Is the Indian ESOP Framework Adequate?

[Vaanya is a student at Indian Institute of Management Rohtak.]

In December 2025, Unacademy amended its employee stock option plan (ESOP) to reduce the exercise period for former employees from 10 years to merely 30 days. This contentious resolution was the result of acquisition talks with UpGrad at a nearly 90% reduced valuation from 2021. Because the window was so abruptly shortened, former employees were placed in a financially strained position as they were required to exercise all their vested ESOPs within a one-time 30-day period at the exercise price and simultaneously incur immediate tax liability without receiving prompt liquidity. Unacademy’s co-founder, Gaurav Munjal, defended this decision by presenting the alternative scenario where the former employees wouldn’t have exercised their option: due to the valuation taking place at a substantially decreased price, investors could enforce their liquidation preference which would leave ESOP holders with nominal economic value. The intention was to convert them into shareholders, allowing them to participate in the merged entity rather than letting their options to lapse without value. 

Even though the ed-tech company put this divisive policy in abeyance for the time being, it revealed a broader issue pertaining to the treatment of ESOP holders in companies undergoing acquisitions: Indian law is silent on the legal nature of a vested ESOP, and what follows in terms of protection of holders’ interests during a change-of-control transaction.

This predicament is relevant in light of the growing number of startups in India, the allure of ESOPs as employee compensation in any company’s early stages, and the highly-scalable nature of startups, making them attractive acquisition targets- thereby necessitating a deeper inquiry into the shortcomings of the domestic legal framework in protecting employees’ financial rights and interests. In this piece, the author argues for the legal recognition and protection of vested but unexercised ESOPs by characterising them as accrued economic entitlements that should not be retrospectively impaired during acquisition transactions. 

The Domestic Law on ESOPs

Section 62(1)(b) of the Companies Act 2013 allows companies to issue ESOP to its employees. Further, Rule 12(5)(a) of Companies (Share Capital and Debentures) Rules 2014 (SCD Rules) permits variation of scheme terms by special resolution “provided such variation is not prejudicial to the interests of the option holders” in case of unlisted public and private companies, and similarly for listed corporations, Regulation 7 of the Securities and Exchange Board of India (SEBI) (Share Based Employee Benefits and Sweat Equity) Regulations 2021 (SBEBSE Regulations) bars scheme changes “prejudicial to the interests of employees.” 

The question here is: what is the legal character of a vested but unexercised ESO, and, how does it affect the treatment of former employees (who left the company pre-acquisition holding such ESOs) and current employees?

Vested ESOPs as an Emerging Economic Interest 

A vested ESO does not confer ownership of stocks. It is a mere contractual right to exercise the option as per the ESOP scheme. From the perspective of an employer, the ESOP scheme is the final determiner of the employees’ rights and it should be easily amendable during change-of-control events to facilitate smooth transactions. More than a reward of service, an ESO is an instrument of talent retention and long-term value creation. Treating former employees the same as current employees undermines the retention objective. Thus, retrospective amendments, as in the case of Unacademy, are more easily justified and differential treatment between current and former employees is a commercially defensible move. Treating former and current employees equally may dilute the incentivisation purpose of ESOs and impede in post-closing equity capital management. Outstanding options represent uncertainty by exposing the buyer to contingent liabilities and increasing warranty and indemnity risks under the share purchase agreement. A clean cap table and bounded liabilities cannot be compromised.  

On the contrary, from the perspective of former employees, once an ESO vests it ceases to function primarily as a retention incentive and becomes earned remuneration for services already rendered. The date of vesting marks the point at which the employee has fulfilled performance or service conditions. Even if the payment (by way of exercise) may be postponed, the entitlement has already accrued. Compare this to a deferred bonus- since the employee has already completed their side of the bargain, it is only fair that they expect no retrospective reduction of the value of compensation already earned. In this case, differential treatment of former employees is completely unjustified. 

Under the law of contracts, a clear differentiation is drawn between mere expectations and accrued contractual rights, or an executory promise and an executed entitlement. For instance, gratuity under the Code on Social Security 2020 has long been treated as deferred wages that vest on completion of qualifying service, and cannot be arbitrarily withheld. Applying this principle to ESOPs, before vesting, an employee has not yet completed the service conditions so they are not entitled to any right. However, post-vesting, the employee has already rendered the agreed-upon services and earns the fair right to exercise it, thereby crystallising the employer’s obligation. Thus, the employee possesses an accrued contractual right. 

Ultimately, vested but unexercised ESOPs represent an intermediate economic interest that deserve legal recognition and protection. Particularly during takeovers, when ESOs tend to be cancelled, replaced or cashed out, the vulnerability of separated employees becomes more pronounced. At present, acquirers deal with vested but unexercised ESOs by cashing out the employees of the target (which results in cancellation of the options in exchange for a payment equal to the fair market value of the target’s shares, or payment of the spread), or allow employees to exercise their options before closing. In practice, acquirers follow a hierarchical structure by dividing the workforce into active employees, good leavers and bad leavers. This raises scope for arbitrariness in decision-making.

The problem herein is that the current legal framework does not define the very nature of the interest being altered during acquisitions. Rule 12(5)(a) of the SCD Rules and Regulation 7 SBEBSE Regulations prohibit amendments that are “prejudicial” or “detrimental” to employees’ interests but fall short of explaining the composition of that interest. If a vested but unexercised ESOP is considered as a mere contractual privilege revocable in accordance with the plan, then almost any amendment authorised by the scheme and passed by special resolution would be permissible. Conversely, if vesting does create an economic entitlement that is worthy of protection, then amendments that materially diminish its value should require meaningful justification. In situations where commercial efficiency is paramount and acquirers routinely cancel or replace employee equity awards, the relative economic position of employees who have already earned their awards takes a backseat. Balancing the both is eventually left to the drafting of the ESOP scheme and the wisdom of the Board.  

SEBI’s Informal Guidance and the Contours of “Prejudicial Treatment”

For listed entities, the SBEBSE Regulations go beyond the general variation clause discussed above. Regulation 9(8) addresses acquisition scenario in the following manner: where an employee’s granted benefits are affected by a scheme of arrangement, amalgamation, merger or demerger, their treatment must be specified in the scheme itself, provided that “such treatment shall not be prejudicial to the interest of the employee.” The undefined nature of this standard is brought into light by controversies such as Unacademy. At present, there is no published interpretive letter under SEBI's informal guidance scheme which construes Regulation 9(8) or explains what constitutes prejudice in such transactions. Published guidance has instead focused on narrower questions, such as the interaction between buyback regulations and ESOP vesting requirements.

The 2021 Expert Group Report recognised that the earlier SBEB Regulations lacked clarity on the corporate actions that required adjustments to employee awards and the manner in which such adjustments should be made, including in the case of mergers. Still, its discussion remained confined to the mechanics of adjustments and did not delve into the substantive content of employee-protection standard. Thus, SEBI has yet to articulate the meaning of employee interest that Regulation 9(8) seeks to safeguard.

Comparative Perspective from the United States (Delaware)

Delaware law emphasises on the fiduciary duty of the board on the matter of treatment of employee equity in an acquisition scenario. In In re Trados Inc. Shareholder Litigation, the Delaware Court of Chancery dealt with a merger in which the board approved a transaction that allocated the entire deal consideration to a management incentive plan and preferred stockholders with nothing. The court reasoned that the board’s fiduciary duty of loyalty ran to the stockholders as the residual claimants of the corporation’s value, and that this duty required the board to seek the best value reasonably available for all residual claimants. It effectively affixed an external standard of fair dealing on the directors rather than following whatever the letter of the constitutive documents permits. 

This is perhaps most analogous to the oppression-and-mismanagement jurisdiction under the Companies Act 2013 which alludes to unfair prejudice and abuse of majority power. However, what the Delaware law conveys to us is that it is perhaps the board’s conduct during an acquisition and not just the scheme’s text which should be the object of scrutiny. 

Recommendation

To recognise vested ESOPs as accrued contractual entitlements in practice would translate to granting monetary value to the employees whenever vested awards are modified. Ideally, any amendment which affect ESOPs during acquisitions should satisfy two principles: value preservation and no material detriment. The latter could manifest as longer exercise windows, lower exercise prices, consensually changed vesting conditions and the acquirer undertaking to negate any disproportionate tax consequences. This is a proposed beneficial interpretation that gives substantive meaning to “prejudicial to the interest of option holders” under the law. 

Conclusion

Employee equity has a central role to play in India’s startup sphere, and so the law should not be treating vested but unexercised ESOPs as mere contractual privileges variable at the will of the buyer. By recognising vested ESOPs as protected economic interests and interpreting the statutory prohibition on prejudicial amendments to require preservation of economic value, a more principled balance can be struck between deal efficiency and employee protection.