Overlapping put option period

[Guest gaham]

Anyone see any problem with the following. Employer with a calendar year ESOP has decided to terminate it. They anticipate that distributions will be made in late Nov. but no later than Dec. 31. Plan document provides (in a manner that I believe is consistent with Sec 409(h)(4)) for two put option periods: one 60 day period beginning following the date of distribution and the other 60 day period beginning on the first day of the plan year following the plan year in which the distribution occurs. In this case, this will result in overlapping put option periods. I believe this is okay but I wonder whether anyone else has dealt with this issue. Thanks in advance.

[RLL]

Hi gaham ---

I think that the real problem here may result from the late November distribution date.

Assuming that the 12/31/01 fair market value would be used for the first put option, the valuation is "stale" in November. If there has been a rising value (since 12/31/01), the repurchase would not be "under a fair valuation formula," as required by IRC section 409(h)(1)(B).

The dual put option periods requirement of section 409(h)(4), which must take into account the "fair valuation" requirement of section 409(h)(1)(B), did not contemplate a distribution so late in the plan year without there being an updated valuation.

In addition, note that the second put option period would not begin until the fair market value as of 12/31/02 has been determined and communicated to those distributees who did not exercise put options during the first put option period. This probably would eliminate your concern over having "overlapping" put option periods.

[Guest gaham]

Thanks RLL-

A new valuation will be made; however, the employer is confident that the new value will not be greater than the value as of 12/31/01, it is likely to be less.

What is your authority for saying that you must wait for a new valuation before the second 60 day period begins? How do you reconcile that with the plan provision that specifies when the period is to begin?

[RLL]

gaham ---

Read the Senate Finance Committee explanation of IRC section 409(h)(4). The purpose of the two put option periods was to give the distributee the right to wait until a new (possibly higher) valuation is available in the following plan year.

The plan provision does not conform to IRC section 409(h)(4). I assume that you've received (or will receive) an IRS determination letter on the termination of the ESOP. Maybe the ESOP fiduciary must insist upon an amendment as a condition of making the termination distributions, as there should be an opportunity for the distributees to wait and sell stock at the 12/31/02 valuation.

[KJohnson]

RLL

Assuming that the 12/31/01 fair market value would be used for the first put option, the valuation is "stale" in November. If there has been a rising value (since 12/31/01), the repurchase would not be "under a fair valuation formula," as required by IRC section 409(h)(1)(B).

I thought that under 54.4975-11(d)(5) you could use the last annual valuation for the put option.

[RLL]

KJohnson ---

Reg. section 54.4975-11(d)(5) was adopted in 1977. Section 409(h) was added to the IRC in 1978. Therefore, the "fair valuation formula" requirement of IRC section 409(h)(1)(B) would supersede the 1977 regulation to the extent of any inconsistency.

In addition, in connection with a termination of the ESOP (which is the case described in the original question), the fiduciary requirements of ERISA might preclude the trustee from making liquidating distributions to participants at a time when the put option valuation would be eleven months old and possibly not representing current fair market value.

[KJohnson]

Thanks RLL--I agree that a termination may change the analysis.

As to a "normal put" what about a plan that says that the put is based on the last annual valuation? It appears that there is a built in "fix" for any valuation issues by having the two put periods and the participant can simply wait for the next valuation. Would you amend the Plan that has a determ letter to say that the put has to be FMV at the time of the put?

[RLL]

KJohnson ---

Making any benefit distribution from an ESOP based on a valuation of company stock that is 11 months old is a bad practice and involves many traps for the unwary. There are all sorts of potential issues regarding disclosure, consent, elections, fair valuation formula, fiduciary responsibility, securities laws, etc. Accordingly, many institutional trustees of closely-held company ESOPs will not process benefit distributions based on valuations that are "stale."