Transaction between ESOP Company and party in interest

[Tot]

A 100% owned ESOP company has some outstanding debt with an unrelated bank.  A outside director of the ESOP Company is willing to refinance the loan at a lower rate.  What legal authority prevents this transaction from being an indirect prohibited transaction between the plan and a party in interest?  I'm thinking the ESOP exception to the plan asset rule set forth in 2530.3-101(h)(3).

[Luke Bailey]

On ‎1‎/‎3‎/‎2020 at 12:57 PM, Tot said:

A 100% owned ESOP company has some outstanding debt with an unrelated bank.  A outside director of the ESOP Company is willing to refinance the loan at a lower rate.  What legal authority prevents this transaction from being an indirect prohibited transaction between the plan and a party in interest?  I'm thinking the ESOP exception to the plan asset rule set forth in 2530.3-101(h)(3).

I'm not seeing this as a plan asset issue. What you are saying is that the outside director is going to pay off the bank in exchange for the ESOP's giving him a promissory note on similar terms with a lower interest rate? Of course the transaction will involve plan assets. The loan may in principle qualify for the ESOP loan exemption of Sec. 4975(d)(3) and related ERISA section and regs. The outside director will need to recuse him- or herself from all decisionmaking regarding the loan for a variety of reasons, and other fiduciary safeguards would be required.

[Peter Gulia]

Beyond considering prohibited-transactions exemptions and other fiduciary issues, both the corporation's fiduciaries and the plan's fiduciaries might consider whether it is prudent to check whether there might be other lenders ready to provide financing on equally favorable, or even more favorable, terms.

 

[ESOP Guy]

Except for the interest rate are all the other terms the same?  

If other terms start to change like the term of the loan thought needs to be given if those other changes make sense for the plan and the participants.   As a rule the DOL is skeptical of refinancing ESOP loans for longer terms without something of value given to the participants.  

[Tot]

The current loan is NOT an  "exempt loan" as defined in the IRS regulations.  Rather, it is a commercial term loan between the ESOP company and a bank, secured by real estate owned by the ESOP company.  The outside director is financially well off.  Company management is considering asking the outside director to take over secured loan, but with a lower interest rate than it can get with a commercial lender (i.e., the proposed new loan would be more favorable to the ESOP company than any loan it can obtain from a commercial lender), but company management was concerned that such transaction is a prohibited transaction.  My thought was that the lending transaction between the outside director and the ESOP company  - not with the ESOP trust - is not considered a PT because the plan asset regulation does not consider assets of an ESOP company to be assets of the ESOP.  

[Luke Bailey]

Gotcha. Makes more sense.

The director is a DQ'd person under 4975(e)(2)(H), but you are saying the loan is between the bank and the ESOP-owned company, and the company's assets are not plan assets, so the transactions between the director and the company do not involve "plan assets."

But take a look at 29 CFR 2509.75-2(c), 4th paragraph, and in any event tread VERY carefully. I don't have enough facts to do anything more than help you sort out the issues you talked about. Do not infer any answer to your question from my posts.

[Tot]

If the ESOP exception to the plan asset rule doesn’t provide relief from the PTs, isn’t every transaction between the ESOP company and its employee-participants, such a paying base pay (which better not be unreasonable compensation), a PT?

There are some ESOP cases where the plan trustees and company management are the same individuals and participants have  been able to successfully assert breach of fiduciary duty when management is paid excessive compensation, but curiously these cases don’t even discuss such transactions also being PTs.

[Degrand]

Since this not an ESOP loan, it is a corporate decision to refinance a commercial loan.  The loan between the corporation and the ESOP will continue to be treated as an exempt loan. The only issue is whether the board is a making a good business decision in the best interest of the shareholder (i.e. the ESOP).  29 CFR 2509.75-2(c), 4th paragraph is not applicable because the party is interest (the board member) isn't not dealing with the ESOP.  I agree that the Company should seek other bids which would allow them to compare the terms.  If the board member provides better terms, the corporate can/should move forward with refinancing the loan.   

[Luke Bailey]

3 hours ago, Degrand said:

29 CFR 2509.75-2(c), 4th paragraph is not applicable because the party is interest (the board member) isn't not dealing with the ESOP. 

Degrand, I am never sure what 29 CFR 2509.75-2(c) is actually saying in a particular context, but it is not inapplicable. You are saying it is inapplicable, I think, because you are relying on the plan asset rule to say that the company's assets are not assets of the ESOP, and therefore the loan and repayment of it does not involve plan assets. But the whole point of 29 CFR 2509.75-2(c) is to override the plan asset rule where 29 CFR 2509.75-2(c) applies. It is a codification of some specific instances where a Rollins-type  "indirect" transaction with plan assets will be deemed to have occurred.

[Tot]

Assuming I can get passed the PT because of the plan asset exemption, my concern was whether the transaction could still be a PT because of the direct “ or indirect” language in the statute.

[Luke Bailey]

Tot, I think there is always going to be some level uncertainty under Rollins, because it specifically avoided application of the plan asset regs and said that under the facts and circumstances there the transactions between an entity owned by the plan and a DQ'd person, even though technically not involving plan assets under the regs, was nevertheless an "indirect" PT. Rollins involved an IRA that owned some very high percentage (98%) of the equity of a corporation that was an "operating company," and transactions between that operating company and the owner of the IRA. Obviously, that is an extreme situation, because the IRA owner controlled both the IRA and the corporation. Your outside director presumably does not control the ESOP or the ESOP-owned corporation. Nevertheless, since Rollins did not provide a bright line, there has to be some risk. Presumably at a minimum the outside director should recuse him-/herself from decision, there should be an independent appraisal and search for competitive offers, etc. But you should also consider seeking an Adv. Op'n or individual exemption from DOL.

[Tot]

Thanks for all the valuable insights.

[Degrand]

What plan assets are being used?  With all do respect, I disagree and most ESOP professional would too.  By your analyses, liabilities from the Company to a DQ person (nonqualifed comp or refinancing non-ESOP loans) would be a PT and would have to meet an exception.  That is simply not true.  

The loan is between the company and the bank.  The ESOP fiduciaries are not involved if the Company refinances the bank debt.   As long as the debt between the ESOP and Company is not being refinanced, it is not considered a refinancing that would have to comply FAB 2002-1.