Forgiveness of Payment under ESOP Promissory Note

[Guest myarbrough]

Client sold his shares to his Company's ESOP in exchange for a note FROM the ESOP itself. Compay is doing poorly, so client decided to forgive one of the payments due from ESOP last year.

Any thoughts on the tax treatment to client or ESOP. ESOP trust is tax exempt - Can there be income to ESOP from forgiveness of debt by the former shareholder ?

[BeckyMiller]

You need to get some professional advice. One approach to this issue can result in virtually no income tax consequences. Another approach arrangement can make it look like your seller contributed capital to the company which then made the payment to him.

A simpler approach might be to just defer the payment and tack it onto the end. But, watch out, this might change your collateral release method on the loan.

Another approach is to refinance the current year's payment.

All of these require the ESOP fiduciary to think about what is going on.

Can fall into that trap of no good deed goes unpunished.

Get a good ESOP attorney.

[pjkoehler]

What do the terms of the ESOP loan note provide in the event of borrower's default on a scheduled payment? If the methods of curing the borrower's default do not include lender's "forgiveness," and they may well not because that would hardly be commercially reasonable, you'd be well advised not to ignore the terms of the note and follow some ad hoc procedure. A typical method of curing the default when the ESOP defaults due to the employer's failure to make a contribution is to transfer unallocated shares back to the lender in an amount equal to the missed payment(s). See Treas. Reg. 54.4975-7(B)(6).

[RLL]

pjkoehler ---

Why would you transfer shares back to the lender if the lender doesn't want the shares back? The normal arrangement for pledging shares as collateral for the ESOP loan does not require that shares be transferred to the lender in the event of default....it merely provides that as a remedy available if the lender so elects.

I like BeckyMiller's approach of merely extending the term of the loan. If this is done properly, there should be no adverse consequences to any party.

[pjkoehler]

I guess what I'm saying is that the methods of curing the borrower's default should be prescribed in the note. The thread describes the proposed method inconsistently. Forgiveness and granting the plan a payment holiday and tacking the missed payment to the end are distinguishable and neither is probably one of the prescribed methods. The plan document may not have pledged securities release rules that adapt to either transaction. So you have fiduciary "document's rule" issues for one thing. If the tacking extends the repayment period, the requirement that the loan be for a specific term may be an issue for another. Reg. 54.4975-7(B)(13).

[RLL]

pjkoehler ---

Have you not ever heard of a borrower & lender renegotiating the terms of a promissory note?

An ESOP fiduciary may certainly renegotiate the terms of an ESOP loan, including extending the term of the loan, without violating the ESOP loan regulations, so long as such loan modification is "primarily for the benefit" of the ESOP participants. A modification of an ESOP loan to prevent a default (and possible resulting loss of shares by the ESOP) and to alleviate the employer's financial difficulties (thereby possibly protecting the value of the ESOP's investment in employer stock) may very well be in the best interests of the ESOP participants.

ESOP fiduciaries must exercise their responsibilities by investigating all such options that may be available. The ERISA "document rule" certainly does not prevent a fiduciary from agreeing to modify applicable documents in appropriate circumstances in order to protect the interests of the ESOP and its participants.

[pjkoehler]

RLL - ever heard of reading the first message in a thread? It helps to keep the comments on point; to wit: "client decided to forgive one of the payments due from ESOP last year." I'm sure you're going to tell me that this should be interpreted as evidence of renegotiation rather than the lender's ad hoc departure from the terms of the note. What's the point of engaging in the formalities of renegotiation and dealing with those sticky contract law issues like consideration, enforceability, statute of frauds, etc.; when the parties are content to make-it-up as they go along.

[RLL]

pjkoehler ---

The discussion in this thread was changed (by BeckyMiller and you) from the issued raised in the original message. I never responded to the first message....I just followed up on the discussion as it subsequently developed.

According to the original posting, there was no default on the ESOP loan and nothing to renegotiate.....the lender unilaterally waived his right to a payment due from the ESOP.