Disqualified person at default or time of promissory note?

[Guest BJW]

When is a person or party determined to be a disqualified person or party in interest (with regard to an ESOP)? At the time of default on the promissory note or at the time the note was signed (this individual was a disqualified person at the time the note was signed but would not be considered a disqualified person at the time of the default - if the status is also determined at default) When is "disqualified person" or "party in interest" status determined with regard to an ESOP? Thank you for any insight.

[RLL]

Hi BJW ---

With respect to an ESOP transaction, the status as a "disqualified person" or a "party in interest" is determined at the time of the transaction. In connection with an ESOP loan, if the lender is a party in interest EITHER at the time of the loan (being incurred by the ESOP) OR at the time a promissory note is in default, the special "default rule" in the ESOP regulations (which limits the ability of the lender to satisfy the loan against assets, including collateral, of the ESOP) would apply to that lender.

[Guest BJW]

RLL-

Thanks for your thoughts.

The two stockholders were disqualified persons at the time of the sale of stock to the ESOP. So you think they would still be considered disqualified at the time of the default? Also do you think the value of the stock would be the value now at the time of default or at the time of original purchase by the esop? The stock is now worth considerably less (approximately one-half). This means that more stock would have to be given to the stockholders to satisfy the note therefore in the end leaving the stockholders unsecured. Any thoughts?

[RLL]

BJW ---

As noted in my previous post, if the noteholders were parties in interest at the time of the ESOP loans, they continue to be treated as such for purposes of the special "default rule" of the ESOP loan regulations.

For purposes of the default rule, shares of employer stock pledged as collateral for the ESOP loan are treated as having the value determined as of the time of the default. The pledged shares are worth what they're worth. Obviously, a decline in value can result in the collateral becoming worth less than the amount of the unpaid debt.

The selling shareholders should have considered this possibility at the time they agreed to take promissory notes from the ESOP....particularly in light of the fact that a transaction whereby an ESOP borrows funds to acquire outstanding shares from existing shareholders almost always results in an immediate decline in value of the shares (unless, in certain cases, when the shares are purchased by the ESOP for a price less than fair market value).

Are the ESOP loans guaranteed by the company? If so, is that guarantee supported by a security interest in any assets of the company?

The primary security for most ESOP loans is the guarantee of the company (and the underlying assets of the company), not the shares pledged as collateral by the ESOP.