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Debt restructuring


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Hypothetically speaking, suppose you had debt owed by the ESOP to the selling shareholder totaling $4 million, with the company as the guarantor. Primarily because the company's payroll can't even come close to supporting a deductible contribution equal to the loan payment, the company made the loan payment directly to the selling shareholder in the prior year and that is continuing into the current year.

An option for solving what will be an annual problem is to have the company assume the ESOP's debt to the selling shareholder and negotiate a new inside loan between the company and the esop that can be supported by using deductible contributions to make the payments. Assume that would amount to $400,000. The term of the old and new esop notes would be the same so the share release would not change. The question/concern is does this restructuring create issues because of the uneven exchange of notes? A deemed dividend to the esop? A forgiveness of debt? Something else?

The parties are well aware that this hypothetical plan should not have been set up the way it was, nevertheless it was so they have to deal with what they have. Another option is a redemption, but for reasons of cost and an ongoing DOL audit the preference is to look at the restructuring first. Thoughts on the restructuring will be appreciated. Thanks.

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Some version of what you are talking about can be done and I have seen it done.  It is better then having the company make the loan payment on a note held by the ESOP.  I don't see how that wasn't a contribution even if the money never entered the ESOP.   The ESOP got the economic benefit of the payment. 

The obvious big issue is what is the write down of the note.  Most times I have seen this it is shown as some kind of gain due to the but it isn't allocated to anyone.  There is no way to allocate it.  There is no cash.  You aren't releasing shares. 

You need to get a good ERISA attorney who deals with ESOPs regularly to do this. 

The trustees need to decide if this is really in the best interest of the participants.  There was a DOL letter put out years ago about refinancing ESOP loans to extend the years and they pretty much demanded the trustee get some kind of economic benefit in the form of a guarantee of a minimum dividend going forward or a match in the 401(k) plan.  I would suggest using that as a guide.  It isn't 100% same fact set but it does give you insight to the DOL's thinking. 

https://www.dol.gov/ebsa/regs/fab_2002-1.html

In this case the issue is people will be getting less shares released then under the old note which isn't happening here but still it might be worth thinking about how the DOL thinks about this situation. 

I have one client where the attorney blessed what you are describing and no new benefits were given to the participants and their thinking was they are no worse or better off before and after.  As you say the share release rate is the same.  In fact in the case I am thinking the rank and file might have been better off as they used only contributions to fund the loan payment vs using contributions and dividends before the loan note change. 

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Let me emphasize a point in ESOP Guy's excellent response. This situation is fraught with difficult fiduciary issues and the fiduciaries could already be in deep trouble. As painful as it may be, you may need lots of lawyers (one for the company and one or more for the fiduciaries, depending on how the fiduciary arrangements were designed).  You may also need a new independent fiduciary and financial advisor(s).  Professional advice even about how to get started would be a good idea.  This is a tough situation. Did you really say that the DOL is auditing?  If so, serious consideration should be given about what to say to the DOL at each step of remedial action.  Engaging an independent fiduciary is always pleasing to the DOL, not that the DOL will say anything pleasant about this situation, no matter what.

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Thanks guys. You confirmed my thoughts. There is an independent fiduciary with counsel and a financial advisor, and the seller has counsel too. I don't believe in this obviously hypothetical situation the company has counsel other than the seller's counsel. Seller is still working there. ESOP Guy's last paragraph essentially sums up where we are. Yes, the DOL is auditing, which of course complicates everything. I think the parties will have to come up with the least worst solution. If it's restructuring, a tax expert should be consulted.

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