Pass-Through Voting on Changes in Class of Stock with Minority ESOP Interest

[EGB]

Have ESOP with non-registration-type securites that owns 30% of the Company. Company wants to convert to S-corp, but first needs to change from 2 classes of stock to 1 class of stock. Is pass-through voting required for the change in classes of stock (is this considered a recapitalization or reclassification requiring pass-through voting)?

If the other owner of the Company (an indiviudal) owns the remaining 70% (and thus has a controlling interest), and he votes in favor of the change in the classes of stock, even if pass-through voting is typically required for this change, is it still necessary when the other owner has a controlling interest and will alone be able to dictate the outcome?

Any responses would be appreciated.

[RLL]

Depends largely on applicable corporate law. Issues to be addressed include the following: (a) Is a shareholder meeting and vote required or may the recapitalization be effected by an exchange of shares without a vote? (b) Is shareholder approval available by consent without a meeting? © What percentages of each separate class of stock are owned by the 70% shareholder? (d) Are there any provisions in the articles of incorporation that may affect this?

You shouldn't expect an answer to such a difficult question from a message board such as this. You haven't provided enough facts. Necessary legal documents need to be carefully reviewed. I recommend that you consult with legal counsel experienced in corporate, securities, and ESOP law.

[EGB]

Thanks, RLL. I wasn't really expecting to get a definitive answer here. But, I have researched these issues and the answers do not appear to be clear, which is why I was interested in some general feedback. The owner owns 70% of both classes of stock. Assume state law requires a majority vote of the shareholders to change classes of stock, The primary question (before we even get to what constititutes a reclassification or recapitalization), is whether pass-through voting is necessary, even if we have a recap. or reclass., if the ESOP participant voting is futile. That is, if the owner votes first, and votes in favor of the change in classes of stock, then it is seemingly over. Additional thoughts on this?

[ESOP Guy]

My thought is the practical one. It doens't cost much to hold the vote and if you hold it you know you have met the requirements. Since the outcome is determined holding the vote is the cheapest way to know you have followed the rules. After all the rules only state when you have to do it, it never forbids you to do it more often.

[GMK]

Whatever the situation, you have to do what the Plan Document says you have to do.

If it's a situation where the participants get to vote, then you have to count their votes (whether they can affect the outcome or not).

So, I think you're still looking at whether or not the pass-through voting applies.

[EGB]

GMK - That was really my thought as well - let's just assume that we have a recap or reclass, the law and the plan doc. would require pass-through voting, and there is no written exception in the law or the plan doc. based on the futility of the vote. Lot of hooplah to deal with to pass-through the voting, but techincally required.

[QDROphile]

Put your reading glasses on again. If the plan terms follow the language of the statute, the participants will direct the trustee to vote only with respect to matters that are submitted to the trustee (as a shareholder) for a vote. If state law and the corporate documents allow voting by written consent and the non-ESOP shareholders have enough votes to carry the day without involving the ESOP, the ESOP's vote might not be solicited. If no vote by the ESOP, no instructions on how to vote by the participants. The corporate law side of the question is determinative unless the ESOP has some contractual right to vote even in circumstances that do not otherwise entitle the ESOP to vote. The contractual right could be in the plan document, but extraordinary shareholder rights are usually in a shareholder agreement. If the ESOP trustee is not included in the voting, the ESOP trustee had better know why and agree. Voting rights are assets of the ESOP and the trustee or other fiduciary is charged with managing them properly and in accordance with plan terms.

[RLL]

QDROphile is correct about taking shareholder action without a vote ... if it can be done under applicable corporate law and the governing documents.

It may also be possible to effect the proposed reclassification/recapitalization by an exchange of shares, without a shareholder vote. If this approach were to be followed, it may be appropriate to obtain a fairness opinion for the ESOP.

If a shareholder vote is required (and action by consent is not available), the vote by the ESOP trustee must be done based on the ESOP "voting pass-through" requirement ... even if the ESOP's 30% cannot affect the result. The pass-through of voting rights likely would involve some disclosure of certain material facts, etc., to ESOP participants.