ESOP & Founder Exit Disputes in India 2026: Vesting, Exercise, Forfeiture, Good Leaver, Bad Leaver & 2025 SEBI Changes

By Adv. Govind Bali | Fastrack Legal Solutions LLP

Equity compensation disputes usually begin when someone leaves. While the relationship is healthy, ESOP grants, founder vesting and future equity often appear straightforward. Once there is a resignation, termination for cause, founder dispute, funding round or IPO, the same documents may generate questions about vested options, exercise windows, forfeiture, compulsory transfer, valuation and whether the company can reclassify a departing employee as a “bad leaver”.

Quick answer

An ESOP is not the same thing as a share. Before exercise and allotment, the employee ordinarily holds contractual/statutory option rights under the scheme, grant letter and applicable law. Whether a departing employee keeps vested options, loses unvested options, can exercise after termination, or must transfer already-issued shares depends on the scheme rules, grant terms, Companies Act requirements, SEBI regulations for listed companies, and any shareholder/founder agreements.

1. ESOP legal framework in India

For unlisted companies, the principal framework includes Section 62(1)(b) of the Companies Act, 2013 and Rule 12 of the Companies (Share Capital and Debentures) Rules, 2014. For listed companies, the SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021 apply, as amended from time to time.

2. Listed-company rules were amended in 2025

The SEBI Share Based Employee Benefits and Sweat Equity Regulations were amended in September and December 2025. One important change permits an employee who is identified as a promoter or part of the promoter group in an IPO draft offer document to continue holding and/or exercising options, SARs or other benefits that were granted at least one year before filing the draft offer document, subject to the regulations and applicable law.

This matters for startup founders and senior employees whose status changes during the IPO process.

3. Grant, vesting, exercise and allotment are different stages

Stage	Meaning
Grant	Option is offered subject to scheme terms
Vesting	Employee becomes entitled to exercise specified options
Exercise	Employee elects to purchase/subscribe at exercise price
Allotment	Shares are actually issued and shareholder rights arise

Many disputes arise because employees treat “vested option” as synonymous with “share ownership”. It is not.

4. Minimum vesting period

Applicable ESOP frameworks ordinarily require a minimum period between grant and vesting, subject to specific exceptions. The plan document should specify the vesting schedule precisely.

5. What happens on resignation?

The answer depends on the scheme. Common structures provide that:

unvested options lapse on the last working day;
vested options remain exercisable for a defined post-exit window;
or vested options must be exercised before the last working day.

Because these outcomes are materially different, the grant letter and scheme should not use vague phrases such as “options will be dealt with as the Board deems fit.”

6. What happens on termination for cause?

Many plans distinguish ordinary termination from termination for cause. A “cause” definition may include fraud, gross misconduct, confidentiality breach, conviction, dishonesty or serious fiduciary breach.

The legal risk arises where the company labels a routine performance termination as “cause” only after the dispute begins, in order to cancel vested rights.

7. Good leaver vs bad leaver

Founder agreements often use good-leaver/bad-leaver concepts. A good leaver may retain vested equity or sell at fair market value. A bad leaver may be required to transfer at cost, nominal value or a discounted value.

Drafting should define:

what triggers each status;
who decides;
whether the person has a hearing;
valuation date;
valuation methodology;
who purchases the shares;
and completion mechanics.

8. Founder shares are not ESOPs

Founders frequently hold issued shares subject to reverse vesting. This is different from holding employee options. If a founder has already been allotted shares, taking them away requires a legally valid transfer, buyback, call option or other permitted mechanism.

9. Reverse vesting

Reverse vesting usually means the founder initially owns shares but agrees that a portion remains subject to repurchase or compulsory transfer if the founder leaves before milestones are met.

The arrangement must be tested against:

Companies Act transfer rules;
Articles;
SHA;
FEMA if non-resident parties are involved;
valuation;
tax;
and restrictions on company buybacks.

10. Can the company simply cancel vested options?

Not merely because it wants to. The company must identify the contractual and regulatory basis. If the scheme expressly provides that vested options expire after a defined exercise window following termination, that clause may govern. If the plan preserves vested options, the company cannot casually rewrite the bargain after exit.

11. Can unvested options be forfeited?

Typically, yes, if the scheme lawfully provides for lapse of unvested options upon cessation of employment. But the precise cessation date and reason can be disputed.

12. Gardening leave and notice periods

If an employee resigns with a three-month notice period, the question may arise whether vesting continues through the notice period or stops on resignation date. The answer should be specified in the scheme and employment documents.

13. Termination date vs last working day

These dates can differ. A plan should state which date determines vesting and exercise. Without clarity, significant value may turn on a few days.

14. Exercise window after exit

Common windows include 30, 90 or 180 days, but there is no universal private-company rule that every employee receives the same period. The plan must comply with applicable law and the company’s own approved scheme.

15. Failure to communicate exercise window

A company that relies on a short exercise window should maintain evidence that the employee received the governing plan, grant letter and exit communication. Litigation becomes harder where the company claims forfeiture based on a document never supplied to the employee.

16. Death and permanent incapacity

ESOP regimes commonly contain special treatment for death and permanent incapacity. The company should verify the current statutory/regulatory position before applying ordinary resignation rules.

17. Employee vs consultant

Not every consultant qualifies as an “employee” for statutory ESOP purposes. Startups sometimes promise “ESOPs” contractually to advisors without checking eligibility. The compensation may need a different legal structure.

18. Promoters and promoter group

Eligibility rules differ between listed and unlisted contexts and have evolved. The 2025 SEBI amendment is particularly important where an employee becomes identified as promoter/promoter group in the IPO process but already received options at least one year before the draft offer document.

19. ESOP pool dilution disputes

Investors often require an ESOP pool to be created pre-money, which economically dilutes founders more than the incoming investor. The term sheet, SHA and cap table should state clearly:

pool size;
whether calculated pre- or post-money;
whether future increases are reserved matters;
who bears dilution.

20. ESOPs in acquisition transactions

On a change of control, options may be:

accelerated;
cashed out;
rolled into buyer options;
cancelled for consideration;
or continue under the existing plan.

The plan should specify treatment of vested and unvested awards.

21. Acceleration clauses

Single-trigger acceleration occurs on the corporate event itself. Double-trigger acceleration generally requires both a corporate event and a subsequent employment event. The distinction materially affects founder/investor economics.

22. ESOPs and IPO

IPO preparation raises questions about promoter status, lock-ins, plan compliance, disclosure and exercise. The 2025 SEBI amendments make current regulation review essential.

23. Valuation disputes

Private-company employees often discover that exercising vested options requires paying exercise price plus tax on the perquisite value. Disputes may arise where the valuation has materially increased.

Companies should not promise “cheap equity” without explaining tax and liquidity risk.

24. Tax is not the same as legal vesting

Tax treatment and legal entitlement are related but distinct. A tax event does not by itself decide whether an option was lawfully vested or forfeited.

25. ESOPs and restrictive covenants

Some plans attempt to condition vesting on non-compete or non-solicit obligations. Post-employment non-compete restrictions must still be tested against Section 27 of the Indian Contract Act. Equity compensation does not automatically make an otherwise void restraint enforceable.

26. Clawback for misconduct

Clawback clauses may require repayment or surrender where fraud, misconduct or financial restatement is discovered. The clause should define trigger, decision-maker, lookback period and remedy.

27. Can already-issued shares be clawed back?

That is materially different from cancelling unexercised options. Once shares are issued, a legally recognised transfer or repurchase mechanism is required. The company cannot simply delete the shareholder from the register without authority.

28. Company buyback risk

A clause saying “the company will buy back all bad-leaver shares at nominal value” may fail if it does not comply with statutory buyback law. Often the purchaser should be structured as another shareholder or permitted transferee, subject to law.

29. Articles must support compulsory transfer mechanics

If a founder’s shares must transfer on a leaver event, the Articles should be aligned with the SHA. Otherwise the company may face difficulty registering the transfer or acting against a refusing founder.

30. Power of attorney clauses

Transaction documents sometimes authorise another person to execute transfer forms if a leaver refuses. Such clauses must be carefully drafted and legally valid; they are not a substitute for the underlying transfer right.

31. What documents should an employee collect?

ESOP scheme;
grant letter;
vesting schedule;
exercise notices;
board/shareholder approvals;
employment contract;
termination/resignation correspondence;
cap table statements;
tax statements;
exit communication.

32. What documents should the company preserve?

approved scheme and amendments;
grant records;
vesting calculations;
compensation committee/board decisions;
exercise records;
share allotment filings;
employee acknowledgements;
termination basis;
valuation reports.

33. Arbitration of ESOP disputes

Whether an ESOP dispute is arbitrable depends on the documents, parties and nature of relief. Contractual claims often can be arbitrated; statutory corporate remedies may not be displaced.

34. Employment forum vs commercial forum

A senior executive may pursue contractual rights in arbitration or civil/commercial proceedings, while a worker-level dispute may engage labour law. Status and relief matter.

35. ESOP dispute checklist for employees

Identify scheme.
Check grant date.
Calculate vested quantity.
Identify cessation date.
Check exercise window.
Check cause/bad-leaver definition.
Preserve exit communications.
Determine forum.

36. ESOP dispute checklist for companies

Confirm board/shareholder approval.
Apply scheme consistently.
Document cessation date.
Do not invent “cause” after exit.
Notify exercise deadline.
Preserve valuation basis.
Align SHA/AoA for founder transfers.

37. Related Fastrack Legal Solutions resources

38. Primary regulatory reference

For listed companies, review the current SEBI (Share Based Employee Benefits and Sweat Equity) Regulations, 2021, last amended 4 December 2025.

39. Key takeaway

ESOP disputes are document-driven. The value of an award can depend on the difference between grant, vesting, exercise and allotment, and on a single definition of “termination date” or “cause”. Founder equity adds another layer because already-issued shares require lawful transfer mechanics rather than simple option cancellation.

Disclaimer

This article is for general legal education and does not constitute solicitation or case-specific advice. Equity compensation may involve company law, securities regulation, tax, FEMA, employment law and contractual issues.

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