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Voting Rights for an ESOP Restructuring?


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Trying to understand what rights the ESOP shareholders have under the following scenario.

A company is moving from Situation A to Situation B.

Situation A:

100% ESOP-owned S-Corp holding company

Situation B:

~10% equity ownership of an LLC

~90% ESOP-ownership of LLC

IRS Code §409(e)(3) requires that an ESOP allow the participants to vote the shares in their account for the following events:
1. any corporate matter involving mergers, or consolidations
2. the sale of all or substantially all of the corporation’s assets
3. re-capitalizations
4. reclassifications
5. liquidations
6. dissolutions
I'm unclear as to whether or not the shift from holding company to LLC counts as any of the terms above. I can't find clear IRS definitions of these--but the shareholders were not given an opportunity to vote and the restructuring has already taken place.
Should the shareholders have gotten a vote?
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I would clarify your question: You can't have a conversion to an LLC without having a shareholder vote. But, the shareholder is the ESOP trustee(s), not the ESOP participants. I would be willing to bet that as part of the LLC conversion, there was a shareholder vote and the "shareholder", i.e., the ESOP trustee(s) approved the conversion.

What you're really asking is whether the ESOP participants should have been permitted to direct the voting rights of shares allocated to their individual accounts. And, in order to answer this question, we'd need to know more about how the conversion was actually structured. Many states offer a relatively streamlined conversion process where the shareholder(s) of the corporation by operation of law exchange stock for LLC membership interests. I suppose one could argue that, similar to a sale of stock, this is an "investment decision" by the ESOP trustee(s) and voting pass-through is not required.

But, having said all this, I think it'd be hard to make the case that voting pass-through was not required here.

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I would tend to say a pass through vote should have happened but on these issues I tend to error on the side of caution.

As a side note this is one of those odd situations I just never understand. This transaction had to have had lawyers involved. I am just stunned none of them sought out the advice of an ERISA attorney to see if there were any issues they aren't thinking of because they don't know anything about ESOPs and that is an important factor here. Or if there is was an ERISA attorney then it should be a matter of documenting why they though the trustee could do the voting and no pass through voting rights triggered.

I would recommend talking to the trustee. If it is an outside trustee I am sure they had this conversation and can document why no pass through vote happened. If it is an inside trustee then it is more likely no such conversation happened. And that would just go to show yet another reason why outside trustees might be worth the cost.

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I agree with what was said above. It's a little unclear what happened as you describe it, but it does seem odd that there was no pass through voting, or at least some documentation as to the decision on pass through voting.

It never hurts to ask. You could go to the trustee with these questions, or sometimes there's an internal ESOP committee. Often the CFO is very involved in ESOP issues. Or the company's general counsel or outside counsel...

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Totally agree with the notion of going to the company's trustee, CFO, or counsel. Not looking to stir up trouble with the management of the company though considering my limited holdings compared to theirs. For the record, there is an outside trustee, and everyone keeps saying the trustee voted on our behalf, but that's where I get confused.

Based on the IRS / ERISA law, are there clear situations for when the trustee can vote on your behalf and when they can't? For example, should the company be purchased, we do get a 1 vote per person yea or nea on that matter. So why doesn't the restructuring fall under the same guidelines.

Is this a way for management to shift cash to their new equity portion away from the ESOP?

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If there is an outside trustee (and in particular if it was a bank or trust company) I am 99.99% sure they have a legal opinion from an attorney on the voting issue. Their downside to not have such an opinion is too great compared to the costs saved by not getting such an opinion.

Likewise if the outside trustee is a bank or trust company I would be more relaxed as to if this change is designed to help or harm the participants/company.. The trustee has a legal duty to only the trust and the participants. Once again the downside to not doing that well are rather large.

Having said all of that I still would encourage you to ask questions. All of these questions seem like fair questions that people ought to have the answer to them.

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