DOL claims that independent ESOP trustee overpaid for the majority owner’s stock and sued the company’s directors for breach of fiduciary duty. The purchase price was 2.5 times higher than the prior 5 years ESOP valuations.
March 29, 2021
One exit strategy for a retiring business owner is to sell his or her company to an ESOP. However, there are ERISA risks for transaction participants if the ESOP overpays for the owner’s stock.
As a result, it is common for the target’s board of directors to appoint an independent ESOP trustee to purchase the owner’s stock for the ESOP. Nevertheless, target directors may have ERISA liability if the independent ESOP trustee overpays for the stock.
The target in this deal was a Minneapolis based manufacturer. The son of the founder was the board chairman and owned 76% of the company and in 2010 was about 80 years old. The ESOP owned the rest.
The ESOP stock valuation for the five years before the closing fluctuated from $14 to $34 per share. The target had a 5-member board which included the president, VP of Finance and VP of Human Resource. All directors served as ESOP trustees.
The board began looking at an ESOP transaction in the spring of 2011. The seller brought a financial advisory firm to the board for consideration of a sale of his stock to the ESOP in March or April of 2011 that had experience in ESOP transactions.
On April 28, 2011, the firm made a presentation to the board. In its presentation, the firm estimated that the seller’s stock was worth $28.7 million, or about $63 per share. The firm’s presentation noted that the benefits of an ESOP transaction included the key officers’ retention of their positions as officers and directors and supplemental incentive compensation for them.
The advisory financial firm revised its estimate to $74 per share on June 24; $84 per share on June 30; and $85 per share on July 11th.
Management worked on financing for the deal with a bank. On July 18 the bank advised management that its projections on which the financial advisory firm’s valuations were based were “very aggressive when compared to past performance” and observed that the “figures considerably exceed actual performance for each of the last 6 years.”
Four days later, the directors resigned as ESOP trustees and appointed an independent trustee to serve as the ESOP’s trustee, that was recommended by the financial advisory firm. The deal closed October 5, 2011 with the ESOP paying seller $39 million, or $85 per share.
The Department of Labor or DOL sued the independent trustee and the three officers, in their capacity as directors, for various ERISA violations. The three directors challenged the claims by way of summary judgment.
The DOL claims that the directors’ actions in the transaction amounted to a breach of their duties of loyalty and prudence to the ESOP; accusing the directors of being aware of evidence suggesting that the selling price was unreasonably high.
The DOL’s claims against the directors included allegations that the directors orchestrated an overpriced sale to the ESOP and failed to monitor the independent trustee’s behavior in the transaction.
The court reviewed the DOL’s detailed allegations and concluded that director liability could not be settled by summary judgment.
This case is referred to as Scalia v. Reliance Trust Company, No. 17-cv-4540 (SRN/ECW), United States District Court, D. Minnesota, (March 2, 2021).
The takeaway here is that an independent ESOP trustee may not insulate management from ERISA liability for an unreasonably overpriced deal. The red lights should have gone off in management’s heads when management provided unreasonably high projections for the transaction and when the 2011 purchase price of $85 per share was 2.5 times higher than any of the 2006 through 2010 ESOP valuations.
By John McCauley: I help people manage M&A legal risks.
Telephone: 714 273-6291
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