Appraisal Timing/Stock Redemptions

[RLL]

Your counsel is correct that the ESOP must receive not less than "fair market value" as of the transaction date if it sells shares to the company.

An alternative would be for the ESOP to distribute the shares to the terminated participant and for the company to give a "put option" (offering to repurchase the shares from the terminated participant) at the 12/31 appraised fair market value. This is permitted under Section 409(h) of the Internal Revenue Code and would avoid having to get an updated valuation.

[This message has been edited by RLL (edited 05-12-2000).]

[Guest SDS]

Situation #1:

The Plan Year End is 12/31 which means we are getting our 12/31 stock appraisal sometime in March or April. Now we want to convert all of the terminated participant's stock to cash by having the company redeem those shares (our plan is 100% stock, no cash accounts).

In the past we have used the 12/31 appraisal price to redeem those shares immediately upon receiving the appraisal (March/April). Legal counsel is now telling us that we must have a second appraisal done as of the date of redemption so that the ESOP is selling at or above "current fair market value".

Any suggestions on how others are purchasing shares without using cash from within the Plan?

[Dawn Hafner]

Similar issue, but concerning terminating an ESOP. Can the employer simply buy all of the stock from the ESOP at termination by having a separate appraisal done? Or are ESOP terminations completed by issuing stock as the distribution and then participants sell back through a put option if they wish? Does the first situation violate the ESOP rule that employees must be able to demand their distribution in the form of stock?

[RLL]

Dawn ----

The employer cannot "simply" buy all of the ESOP's employer stock. An ESOP fiduciary (hopefully, an independent fiduciary) must agree to sell the ESOP's employer stock to the employer for a price not less than fair market value (the fiduciary may negotiate for a price in excess of appraised fair market value).

Upon termination of an ESOP, the participants have the right to receive benefit distributions in shares of employer stock (accompanied by a put option if the stock is not readily tradable), unless the ESOP provides for only cash distributions under one of the exceptions in IRC Sec. 409(h)(2) applies. As an alternative, it may be possible under IRC Sec. 411(d)(6)© to amend the ESOP (upon its termination) to provide for all cash distributions.

[Kirk Maldonado]

While I agree with RLL that you should be able to amend the ESOP in accordance with the statutory provisions, I think you should know that the applicable regulations do not authorize amending the ESOP in that regard.

However, this appears to be a technical glitch, and many practitioners feel comfortable taking action in reliance on the statute (even without support in the regulations).

This glitch has been pointed out to officials at the IRS and Treasury Department on numerous occasions, and (to the best of my knowledge) none of them have ever indicated that the "glitch" was intentional.

[RLL]

Kirk ---

I think that the so-called "glitch" in the regulations for the "ESOP exception" in IRC Section 411(d)(6)© was clearly intentional on the part of the IRS. There are several aspects of those regulations that narrow the "ESOP exception" well beyond what was contemplated by the statutory language and the Senate Finance Committee Report under the Tax Reform Act of 1986.

If it were merely an "unintentional technical glitch" the IRS National Office could easily have taken steps over the past decade to fix the problems (that have repeatedly been pointed out) in the regulations, most recently in connection with the pending proposed changes to the Section 411(d)(6) regulations.

Fortunately, the IRS district and regional offices have been administering the "ESOP exception" in a manner which generally conforms to the legislative history of Section 411(d)(6)©, rather than by strictly applying these defective & inappropriate regulations.

But we shouldn't assume anything other than the obvious fact that the IRS continues to be skeptical about ESOPs and frequently applies the rules applicable to ESOPs in a manner that is far more restrictive than what is a reasonable interpretation of the statutory provisions. This has been the case for the 25+ years since the enactment of ERISA.

[Guest Beth N]

RLL - What is the solution for non-publicly traded employers who sell all their stock? Are you saying that if the ESOP fiduciaries vote the ESOP stock in favor of the company's sale of all its stock to a buyer (or passes through the vote to the participants, more likely), that distributions in cash only are allowed? Alternatively, could the employer amend the ESOP to be a profit sharing plan as of the date of the stock sale, so that all accounts are essentially liquidated of employer stock as of the date of the stock sale? Any other advice? I have two clients with ESOPs who are negotiating the sale of their companies (stock sales) and are asking me how to handle the ESOPs. Their preferred end result is to terminate the ESOP (full vesting is acceptable) and distribute cash to the participants. How do we get there?