Is it Legal to Be Paid as a Contract Employee in Company Stock?

The practice of being paid as a contract employee in company stock and then selling that stock back to the company to receive dividend payments is a complex and controversial subject. While the legal aspects are varied and nuanced, this article seeks to demystify the situation by exploring the implications and potential legal challenges involved.

Understanding the Context

Firstly, it's important to clarify that the dividend aspect of such transactions is problematic. Once you sell the stock, you no longer have any claim to the dividends. This means that the premise of receiving dividend payments after selling the stock back to the company is inherently flawed.

Legal and Regulatory Considerations

The scenario you're describing is particularly relevant in the context of private companies. Public companies typically have strict regulations about the sale and transfer of their shares. Private companies, on the other hand, might have their own internal mechanisms for stock issuance and repurchase. However, there are certain requirements that must be met:

Accredited Investor Requirements

In a private company setting, only accredited investors (individuals with a net worth of at least $1 million excluding their primary residence, or an annual income of $200,000 or more for individuals or $300,000 for couples for the past two years) are allowed to purchase such stock. If someone pays services in exchange for company stock, it is essentially equivalent to purchasing the stock. Therefore, the individual receiving the stock must meet the accredited investor requirements to avoid legal issues.

Contract Employee vs. Employee

Often, contract employees are legally classified as employees, which means the company assumes the risk of being sued for non-payment of wages. In Massachusetts, there's a 3X penalty for failing to pay employees, and this penalty can be personally levied against top executives and directors, even if the company is bankrupt.

Risk of Stock Value Declining

If the company is an early-stage startup, there is a significant risk that it may fail, leading to a decline in the value of the stock. Both the individual and the company should carefully consider the risks involved before entering into such arrangements. Consulting with legal experts is highly recommended to navigate these complexities.

Stock Repurchase and Dividends

When shares are repurchased by the corporation, the seller no longer has any claim to undeclared dividends. This can be a critical consideration, as dividends are paid to current shareholders, not to former shareholders unless the stock is sold after the dividend date.

Corporations' Board Authority

The corporation's board of directors has the authority to award treasury stock as they see fit. Thus, the terms of the agreement should be clearly defined to avoid any ambiguity or legal disputes in the future.

Conclusion

In summary, while it may seem attractive to be paid as a contract employee in company stock and then sell it back to the company for dividends, there are numerous legal and financial considerations that must be addressed. Both the individual and the company should thoroughly assess the risks and consult with legal professionals to ensure compliance with relevant laws and regulations.

By carefully considering these factors, companies and employees can better navigate such complex arrangements and avoid potential legal pitfalls.