Repurchase for terminees - running out of cash

[Guest John Sample]

I have a small company ESOP, the company by-laws do not allow stock ownership outside of the plan. When the plan distributes a terminees balance, the shares are repurchased by the active participant's cash accounts. Very straight forward.

This year three significant distributions have occured, which have used all of the cash in the plan ($449,969 down to $805). The company has been making 15% profit sharing contributions to fund for these distributions.

This year, when I repurchase the shares of the terminees receiving a distribution, there is not enough cash in the active participant's accounts, I also have to use the cash in the terminated participants accounts.

I have reviewed the past seven years' allocation reports and terminated participants have never repurchased shares before. If a terminee decides to leave their money in the plan, they share in the appreciation or deperciation of the company stock and the gain or loss in their cash account until they are paid.

The plan document does not address the repurchase of shares, as far as active / terminated employees. Do I have a problem this year? The company and their attorney (who wrote the ESOP document) do not think so.

Thank you.

[RLL]

It's not your problem as a TPA. The company is probably the party responsible for interpretation of the ESOP plan document, and the company's legal counsel has advised the company. You're merely following their (presumably, written) instructions.

The approach sounds reasonable. Not every detail of plan administration must be specified in the plan document.

This looks like an example of poor repurchase obligation planning.

[Guest helmethead]

Make sure you are not susceptible of being considered a fiduciary of the ESOP, e.g., exercising discretion in reference to the administration of the ESOP.

[KJohnson]

I have a similar circumstance when the Plan is running out of cash and distributions can only be made in cash because stock ownership is restricted to active employees.

Can you give the Plan a "put option" to sell stock in the terminated employee's account back to the employer to cover the amount of any distribution?

The Plan does have a provision where stock can be sold back to the employer, but the allocation of the cash received has to be allocated pro-rata to participants accounts. This seems to lead to a convoluted process where stock would be sold from the account of everyone to raise cash that would be applied prorata to all accounts, that cash would then be used from those accounts to buy back the shares of the terminated participants. It would seem simpler to allow the plan to have a "put" option with the employer where it can sell to the employer the shares of a terminated participant's account to raise adequate cash for the distribution.

I realize that there would have to be adequate valuations and the fiduciary issues related to the sale back to the employer, but are there other issues? 54.4975-11(a)(7)?

[RLL]

You don't need a "put option" so long as the employer is willing (and able) to repurchase stock from the ESOP as needed to fund cash distributions. As an alternative, the employer may want to consider making cash contributions to the ESOP to fund the benefit distributions.

With regard to the allocation issue, the ESOP can be amended to specify the desired treatment with respect to the cash proceeds received. With appropriate plan language there should be no additional problems.

[KJohnson]

Thanks RLL

So I take it there would be no discrimination or cutback problem with an amendment that would change the allocation of stock sold from pro-rata for all participants to a method that would allocate the shares of stock to be sold and the cash generarted from that sale first from the account of any participant entitled to a distribution?

[RLL]

No "cutback" problem as there is no effect on participants' accrued benefits. No discrimination issue as there is no favorable treatment for highly compensated employees and all participants are treated in a similar manner.