Shares sold to ESOP subject to a buyback provision or a voting trust so that seller can maintain control

[Guest ladycpa]

I have a C corporation ESOP that the majority shareholder owns >51% and the ESOP owns the rest. The shareholder is contemplating selling his shares to the ESOP but wants to maintain control. He is the sole trustee of the plan. The plan will be leveraged to purchase the shares.

I don't think that the shares are "registration-type" securities. Therefore, the plan states that the trustee will vote the shares held as collateral, and that the participants will be allowed to direct the trustee to vote the shares that are held in their company stock account with respect to corporate matters such as the approval or disapproval of a merger or consolidation, recapitalization, liquidation, dissolution or a sale of substantially all the assets of the corporation.

Since he is the trustee, I think he would basically maintain control in voting those shares, except in the corporate matters mentioned above, in which the pass-through voting rules would apply. Of course, as a fiduciary, he would have to make sure that he was acting in the best interests of the participants and meeting all the other fiduciary duties when voting those shares.

Corporate counsel would like to set up a voting trust to vote those shares or have a "buyback" provision or call option so that he can preserve the option to acquire those shares in the future if he wanted. Neither of these sound appropriate, and they would admit to not being ERISA attorneys. Can I tell them an emphatic "no"?

[BeckyMiller]

Since ESOPs are prohibited transactions waiting to happen, your client is advised to move cautiously whenever taking actions that seems to remove rights from the plan. I am not an attorney and even if I was I suspect that I would give the same answer. In this conversation, the plan should be represented by competent ERISA/ experienced ESOP counsel. The trustee (even if totally well intentioned) is negotiating with himself.

I guess that is an emphatic NO, maybe just not in the context you wanted...

[Guest ladycpa]

Thanks for your response -- maybe I won't give them an emphatic no but caveat the heck out of it and encourage them to discuss with an ESOP attorney!

[Kirk Maldonado]

The answer to the question about a call option (referred to above as a "buyback") is pretty straight-forward. Treasury Regulation 54.4975-7(b)(4) provides as follows:

[N]o security acquired with the proceeds of an exempt loan may be subject to a put, call, or other option, or buy-sell or similar arrangement while held by and when distributed from a plan, whether or not the plan is then an ESOP.

Thus, if the shares held by the ESOP were purchased in a leveraged transaction, they can't be made subject to a call option.

[Guest ladycpa]

Thanks for your response and citation!