ESOP Refinancing and Code Section 133

[Guest Lori Basilico]

Bank A made loan to Employer A ("Bank Loan"). Employer A lent proceeds of Bank Loan to ESOP ("ESOP Loan"). Bank Loan qualified as a a securities acquisition loan under Section 133 of the Code. Bank Loan was made prior to 1989, and was not subject to the pass through voting requirements. Prior to the full repayment of Bank Loan, Employer A refinances Bank Loan with Bank B. Bank B does not utilize the 50% interest deduction. The refinancing extends the term of the loan past the term of the original loan, possibliy triggering the pass through voting rules. Can we argue that pass through voting is not applicable because the lender is not utilizing the 50% interest deduction of Section 133?

[RLL]

YES...The voting rights requirement of former IRC Section 133(B)(7) applies only to a loan with respect to which the lender is claiming the 50% interest exclusion.

[This message has been edited by RLL (edited 07-27-99).]

[Guest Beth N]

RLL - Are you saying that once a 133 loan has been repaid, the ultra-pass-through rule of 133(B)(7) no longer applies? Do you have a citation or other authority?

[RLL]

Once the 133 loan has been repaid, it appears that there is no sanction under the IRC or ERISA if the ESOP were amended to delete the voting pass-through required under Section 133(B)(7). Voting rights are not a "non-terminable" right under the ESOP requirements of Reg. Section 54.4975-11. Of course, the employer would have to notify the ESOP participants that voting rights have been taken away.

[Guest Jim Vogl]

Maybe I'm asking the same question but in my client's situation there was a 133 loan designed as a "mirror" loan. The Bank Loan has been paid off but the ESOP Loan has a couple of more years. No 50% interest exclusion deduction is being taken anymore. The client has had a substantial downsizing and wishes to extend the loan out so that future employees can get some benefits from the ESOP. What I hear you saying is that since no entity is taking an interest exclusion and the reason for the refinancing is arguably consistent with IRS rulings, it would be ok to refinance the loan (by the way there was a second loan to which 133 didn't apply which we would also refinance). Is there any limit on the length of the extended term?

[RLL]

Jim ---

The prior discussion was limited to the voting rights requirement under former Section 133(B)(7) of the IRC.

Refinancing of an ESOP loan is subject to the "primary benefit" requirement of IRC Section 4975(d)(3) and ERISA Section 408(B)(3), as well as the general fiduciary rules of ERISA Section 404(a)(1). Acceptable terms for refinancing of an ESOP loan depend on facts and circumstances.

[Guest Jim Vogl]

I guess I got a little ahead of myself. Let me rephrase. If the Bank Loan has been paid off and refinancing the loan is determined to be in the "exclusive interests" of plan participants, then can the 133 loan be amended to extend the loan term beyond 7 years from the original loan term. The bank loan (i.e. mirror loan was prepaid) and only the loan between the Co. and the ESOP remains.

[RLL]

Jim ---

The seven-year limit under former IRC Section 133 will no longer apply. The loan may be extended, subject to IRC Section 4975(d)(3) and ERISA Sections 404(a)(1) and 408(B)(3). It would be advisable for the ESOP's agreement (to extend the loan term) to be made by an independent fiduciary.

[Guest Jim Vogl]

Thanks Ron for your input, its greatly appreciated. The Company has a corporate trustee that will need to sign off on the extension. I plan to review the PLRs related to this matter to see if their situation is justified. It seems that their situation is similar to some of the rulings. They've had a downsizing, their economic situation has improved lately but they are still not out of the woods, and because the stock value has gone up somewhat the expenses affect their income statement and they are in a business in which their income statement and balance sheet are essential to their business. The only concern I have is that another lawyer completed a recent 2nd loan and that lawyer could have structured the 2nd Exempt Loan over a longer loan period but failed to do so. Refinancing so soon after the 2nd loan makes me a little nervous.