Comments on Termination of ESOP at one price and subsequent stock subs

[Guest Jim Vogl]

I have a client that wants to terminate his Corporation's ESOP. He feels that it is too expensive to maintain and the participants do not appreciate the plan. The Corporation has been successful (the stock's value has increased by 300% over 7 years). He wishes to terminate the ESOP. The Corporation also sponsors a 401(k) plan and after the termination the Corporation will add a more generous match and make discretionary employer contributions to the 401(k) plan. The ESOP owns 75% of the Corporation's stock. There is one outside shareholder that owns 25% of the Corporation's stock. An independent trustee will be hired to review the redemption price. The annual appraisal values the stock at approx. $30 per share. An appraisal will be commissioned for purposes of the Corporation's redemption of the ESOP's stock.

My problem is that the outside shareholder has been talking with an investor. The investor is willing to buy common stock from the Corporation for a premium price that will exceed the appraised price of the common stock for purposes of redeeming the ESOP's shares. The investor will not buy the stock unless the ESOP is terminated. Has anyone dealt with this situation and how did they resolve the issue? I am concerned that the price that the Corporation is willing to pay for the ESOP's stock is not fair market value.

[RLL]

Jim ---

The price that the third party investor is willing to pay would seem to be the best evidence of the stock's fair market value. The appraiser must take that price into account in determining fair market value. I assume that the investor would be buying a non-marketable, minority interest, while the ESOP is selling a controlling interest. Accordingly, the ESOP ought to receive a per share selling price that is substantially higher than the price which the investor is willing to pay.

Even if an independent fiduciary were to approve the ESOP's sale (and it's hard to believe that such approval could be obtained without the ESOP's receiving a premium price if a truly independent and knowledgable fiduciary were advised of all the facts), the ESOP's sale of stock might still be a prohibited transaction.

The fact the employees don't appreciate the ESOP may be a valid reason for terminating the ESOP....but it doesn't permit the purchase of the ESOP's stock at a price below fair market value. The fact that the stock has appreciated in value substantially over the past seven years doesn't eliminate the requirement for the ESOP to obtain a premium price as a condition for selling its controlling interest. In fact, it may be appropriate for the Board of Directors to seek competing offers for the sale of the company at the highest possible price.