Put at Book Value?

[dmwe]

I've got a client with a C Corp ESOP that is struggling. The Plan holds Preferred Stock and very little cash. Any sizeable distributions over the last couple of years have involved the participants Putting the stock back to the Company for a 5-year note.

Printed on the back of the stock certificate is that the price per share will be the most recently audited fully diluted book value at the prior November 30.

The certified appraised value is just over $8 but the book value is negative. The client thinks that participants Putting the stock to the Company at this point get nothing because the book value is negative.

That can't be right can it?

[MoJo]

I've got a client with a C Corp ESOP that is struggling. The Plan holds Preferred Stock and very little cash. Any sizeable distributions over the last couple of years have involved the participants Putting the stock back to the Company for a 5-year note.

Printed on the back of the stock certificate is that the price per share will be the most recently audited fully diluted book value at the prior November 30.

The certified appraised value is just over $8 but the book value is negative. The client thinks that participants Putting the stock to the Company at this point get nothing because the book value is negative.

That can't be right can it?

If the company has a "negative net worth" (note - that may be different than having a negative book value, as assets may be worth more than they are carried on the "books" of the company), then it is insolvent, and essentially the stock is worthless. The question is, what is the appropriate measure of the worth of the company (and thence, it's shares of stock). Fair market value, based on an objective appraisal is ("probably" - because I'm a lawyer and never deal in aboslutes) a better measure than book value - but will cost some bucks to obtain.

[ESOP Guy]

Double check the plan language it usually defines how the price for the put is determined.

But in the end I don't know how they can show a price $8/share on the certificate and then pay $0/share. If they are putting $0/share on the certificates then they better be able to justify why they are not using the appraised value. This is the type of behavior the DOL loves to catch and beat people up over.

[dmwe]

The Put Option form clearly states that it is the current market value as of the last valuation date so I'm not sure how the client thinks he can use the book value instead.

[masteff]

Printed on the back of the stock certificate is that the price per share will be the most recently audited fully diluted book value at the prior November 30.

How is the printing on the back of the certificate not a binding contract?

[MoJo]

How is the printing on the back of the certificate not a binding contract?

For several reasons: 1) the printing on the back of the stock may define the relationship between the company and the shareholder - but the shareholder is a trust under the control of an ERISA fiduciary - and not, doing most relevant time frames, the beneficiary; 2) when the beneficiary becomes a shareholder, they receive the benefits promised under the terms of the plan - as governed by ERISA and the Code - which, to the extent they conflict with the printing on the back of the stock certificate (to which they have neither assented to, nor been given consideration to accept) would preempt state "contract" law; and 3) the language says "current market value" which is as much a term of art as a precise defintion. Put three appraisers in a room, you'll get 4 appraisals - with one of them being "what do you want it to be?"

[Marcus R Piquet]

IRC §409(h)(1)(B): " . . . if the employer securities are not readily tradable on an established market, [participant] has a right to require that the employer repurchase employer securities under a fair valuation formula."

Treasury Regs §54.4975-11(d)(5) clarifies: ". . . valuations must be made in good faith and based on all relevant factors for determining the fair market value of securities. . . . value must be determined as of the most recent valuation date under the plan. . . . a determination of fair market value based on at least an annual appraisal independently arrived at by a person who customarily makes such appraisals and who is independent of any party to a transaction under §54.4975-7(b)(9) and 12) will be deemed to be a good faith determination of value."

GAAP book net value and fair market value are two completely different things.

Also remember that if a promissory note is given in exchange for redeemed/put shares, the note must be adequately secured. Per IRC §409(h)(5): If an employer is required to repurchase employer securities which are distributed to the employee as part of a total distribution, the requirements . . . shall be treated as met if - (A) the amount to be paid for the employer securities is paid in substantially equal periodic payments (not less frequently than annually) over a period beginning not later than 30 days after the exercise of the put option . . . and not exceeding 5 years, and (B) there is adequate security provided and reasonable interest paid on the unpaid amounts . . ."

Usually an insolvent company is going to have a hard time providing adequate security.