Right to Demand Distribution in Stock

[Scott]

A non-publicly traded company with an ESOP (Plan A) desires to purchase all of the shares held by Plan A so that Plan A no longer holds company stock and is basically a profit-sharing plan. Plan A will ultimately be merged into the company's 401(k) plan (Plan b), where the participants will be able to direct the investment of their accounts.

After the repurchase of the shares, must Plan A continue to provide that a participant has the right to demand that his benefit be distributed entirely in company stock? My first thought is that this right is a protected benefit under 411(d)(6) and must remain, but this just doesn't seem to be a logical requirement.

Treas. Reg. 1.411(d)-4 Q&A-2(d)(iv) indicates that an employer can eliminate an optional form of benefit by substituting cash distributions for distributions in stock if the stock ceases to be readily tradeable. It seems to me that if stock has never been readily tradeable, the employer ought to be able to do the same.

Any thoughts?

[RLL]

Several thoughts:

* The company cannot unilaterally decide to purchase all the ESOP's shares. An ESOP fiduciary must agree to sell the ESOP's shares to the company.

* IRC Section 411(d)(6)© and ERISA Section 204(g)(3) provide ESOP exemptions to the "anti-cutback" rule. The terms of the statutory exemptions are very broad and should permit the elimination of the right to demand distributions in stock. Although the underlying IRS regulations seem to not permit elimination of the right of participants to receive distributions in company stock, the legislative history of the ESOP exemption (in the Senate Finance Committee report on the Tax Reform Act of 1986) states that the right to demand stock may be limited when "the plan ceases to be an ESOP."

* In my experience, the IRS has often issued determination letters when the participants' right to demand stock was eliminated in a situation where an ESOP sold all its stock, was merged into another plan and ESOP status was terminated.

* If the company's stock (held outside the ESOP) is "substantially owned" by individuals who are employees of the company, the charter or bylaws could be amended to limit ownership as described in IRC Section 409(h)(2)(B)(ii)(I), and the right to demand stock could be eliminated, as permitted under the IRS regulations. The right can also be eliminated if the company is an S corporation.

[This message has been edited by RLL (edited 09-08-1999).]