Valuation of Stock on Default of Loan

[Guest ptpnthr]

Can you set a predetermined value of stock to be transferred in satisfaction of the ESOP loan upon default or must the value be determined on the date of the default or maybe most recent valuation date? Any insights?

[Guest Larry Goldberg]

The stock should be valued as of the date of the transfer back to the company. If the company cannot pay for the updated valuation due to financial distress, then as a practical matter the most recent valuation may have to be used by the trustees. In addition, the ESOP and the company could agree to use a predetermined value that related back to a prior year when the stock value was higher (such as the date of the ESOP's original stock acquisition). The value to be used cannot be less than the value at the time of the transfer back to the company.

Treas. Reg. Sec. 54.4975-7(B)(6) provides that "In the event of default upon an exempt loan, the value of plan assets transferred in satisfaction of the loan must not exceed the amount of default." The regulation implies that the value is determined at the time of the transfer of the stock back to the lender. The method to be used to determine value is not stated. The valuation rules in Treas. Reg. Sec. 54.4975-11(d)(5) do not specifically cross-reference the -7(B)(6) default rules. Of course, Section 401(a)(28)© of the Code would require an independent appraiser to determine value, but does not specify that value must be determined on the transfer date. But, since the transfer in default to the employer would appear to be a sale or transfer of assets from the plan to a party-in-interest under Section 406(a)(1)(A) or (D) of ERISA, one should comply with the sale exemption under Section 408(e) of ERISA. The Department of Labor has taken the position that Section 408(e) requires the value of stock transferred from a plan to a party-in-interest be determined as of the date of the transfer (See DOL Prop. Reg. Sec. 2510.3-(18)(B)(2)(ii)). Finally, as the regulation says "must not exceed", a transfer in default that uses an older but higher value for the shares would not cause a violation of the default rule, since the ESOP is better off using the higher stock value.

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[Guest ptpnthr]

Thanks.