ESOP may default on promissory note

[Guest BJW]

The ESOP purchased shares of stock from two individuals who were the controling shareholders in exchange for a promissory note from the ESOP itself (making payments to the two shareholders each month). The Company is not financially doing well and wants to discontinue making monthly contributions to the ESOP and thus they would default on the promissory notes. (The only collateral for the promissory notes are the stocks purchased). What will happen if the Company stops contributing to the ESOP (25% discretionary) and thus the notes are in default? I understand that the notes may not be accelerated but are in default only as the monthly payment comes due. What recourse do the two individuals have against the ESOP, company, stock, and employees? What happens to the rest of the employees since no stock will be released (since no loan payment will be made) and thus the employees will not recieve stock in their accounts? What liability does the company, ESOP and fiduciaries have with regard to this transaction. May the employees sue the Company. The promissory notes and the ESOP language is silent as to the remedy. Thanks for any help provided.

[RLL]

BJW ---

You are dealing with a complex situation. The rights and obligations of the various parties will be governed by the specific terms of the ESOP plan documents and the ESOP stock purchase documents and promissory notes, as well as the rules under ERISA. No one can provide appropriate guidance here without a careful review of the documents, as well as a complete understanding of all the surrounding circumstances.

Each of the parties should obtain the advice of separate counsel experienced in ESOP matters in order to determine their best courses of action. In this regard, the ESOP should also be represented by an independent fiduciary.

Good luck.

[Guest BJW]

Thank you for your response. I think I have a very difficult research task on my hands. Any suggestions of texts or resources which may be helpful. There is little case law I have been able to locate on the subject.

[RLL]

BJW ---

This is not something that should involve "difficult research." It's a matter of interpreting various parties' rights and obligations under the applicable documents, and then likely negotiations among the parties (noteholders, Company and ESOP fiduciary) to arrive at a satisfactory resolution.

[Guest mab]

RLL,

A qt. for you or anyone else. Since a note from the ESOP has to be nonrecourse with the only collateral being the stock involved, is there anything that prevents the Corp from guaranteeing a note to one or more shareholders from the ESOP using as collateral corporate assets, receivables and the like?

I know in a leveraged deal a bank can require (and typically does) such a guarantee from the Corp. but when there is no lender involved, I have fear of PT issues although I think the PT exceptions to ESOPs would still apply here.

Tx.

[RLL]

Hi mab ---

A corporate guarantee of an ESOP's purchase money note to a selling shareholder constitutes an extension of credit within the purview of the "ESOP loan exemption" under ERISA section 408(b)(3) and IRC section 4975(d)(3). In such a situation, the selling shareholder is the lender.

[Kirk Maldonado]

I want to echo the admonition of RLL that you get separate counsel (who is well-versed in ESOP matters) and an independent fiduciary. That is the first and most important thing you can do.

[Guest mab]

RLL,

Tx for the timely response.

M.

[Guest CJS]

The following comes from the IRS manual that is used to audit ESOP's.

"If the employee puts shares to the employer received in a total distribution, make sure the employer provides adequate security and pays reasonable intrest on the unpaid portion. A put option is not adequately secured if it is not secured by any tangible assists.

For example, adequate security may be an irrevocable letter of credit, a surety bond issued by a third party insurance company rated "A" or better by a recognized insurance rating agency, or by a first priority perfected security intrest against company assets capable of being sold, foreclosed upon or otherwise disposed of in case of default. Promissory notes secured by a company's full faith and credit are not adequate security . Nor are employer securities adequate security."

You can get to that document by going to www.irs.gov/irm/page/0,,id=21743,00.html Look under 4.72.4.2.8.1

Hope that this helps you.

[RLL]

Hi CJS ---

How is your post relevant to this topic?

The provision of the IRS manual which you've quoted deals with a promissory note provided to an ESOP benefit distributee who "puts" his distributed shares to the company and receives payment over a period of years.