A "cliff" refers to a time period that must pass before an employee's options vest. It's typical for startups to offer options with a 1 year "cliff" to keep employees from walking away with equity if they don't stick around.
Say an early hire is offered 4% equity with no cliff. That means that .083% will vest each month, and that early employee could walk away with more than tenth of a point of equity after 2 months, likely before they contribute enough value to the company to justify such equity.
Startup employees should view equity as a bonus anyway, and make sure they're earning a market rate unless they're earning really significant equity, because best case scenario the equity will be significantly diluted before an exit, and more likely, the company won't make it to exit, and the stock options will therefore be worthless.
That being said, if the rumor in the article is true, its still a massive dick move, and it probably also cost the company a substantial amount of money in severance pay.
EDIT: It looks like it's Illegal in california (where OnLive is located) to claw back stock options by firing employees without cause [1]. Therefore, if the rumor is true, then OnLive probably had to pay the employees some cash equivalent of the stock options and get them to sign a termination agreement.
P.S. I'm not a lawyer and have nothing more than a cursory understanding of this stuff. This is definitely not legal advice and you should verify everything I say on your own.
If your options (1 option = chance to buy 1 share, at a price that's typically fixed when the options was issued) vest over a three year period, it means you would be issued 1/(12*3) of your total options per month, for three years.
A common clause in such a vesting schedule is a "1 year cliff", meaning you don't actually get any options granted to you for the first year of employment. After a year, you get a third (1 of 3 years) worth of options in a lump sum, then the usual monthly amount each month after that.
If you fire employees before they reach their cliff, they don't get any options, and won't benefit at all from any liquidation event / sale / etc.
