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ASA Files Amicus Brief in ESOP Case

by Jessica Wilhelmy | Jun 16, 2020

ASA Files Amicus Brief in ESOP Litigation
Seeks to Distinguish Between ESOP and Private Equity Valuations

On June 9, 2020, ASA filed an amicus brief on behalf of the defendants in an ongoing employee stock ownership plan (ESOP) case, Lee v. Argent Trust. The case, which is pending in the United States Court of Appeals for the Fourth Circuit, involves the valuation of a company for purposes of an ESOP transaction, and the appropriate valuation approaches, methods, and techniques to be considered in the ESOP appraisal.

In an amicus brief filed in support of the plaintiff, the Pension Rights Center argues that ESOPs should be valued similarly to the way private equity (PE) buyers value target companies when deciding whether to engage in a leveraged buyout transaction. However, as ASA’s brief points out, typical PE buyers focus on shorter time horizons and, as a result, seek to realize a higher rate of return on the asset from the time it is acquired until it is subsequently sold or taken public. PE buyers commonly are general partners of their funds and provide management services, and the valuations of PE buyers are subjective and tailored to their specific financing arrangements, time horizons, exit strategies, and desired outcomes.

ASA argues in its amicus brief that the “investment value” (typically relied on by a PE buyer) is the wrong standard of value for ESOP valuations, and that Congress required fair market value (FMV) as the standard of value for ESOP transactions. FMV, as understood through Revenue Ruling 59-60, numerous treatises, and common practice, looks at how hypothetical buyers and sellers would value an asset at arm’s length, when neither are under the compulsion to buy or sell, assuming both seek the best possible price.

ASA’s brief goes on to address additional points of contention:

First, the fact that post-transaction ESOP stock values are typically lower than company equity value at the time of the formation transaction is not, as plaintiff argues, evidence that the formation/transaction value was inflated. Rather, the brief emphasizes that the lower equity value after the transaction reflects the impact of the financing used to complete the ESOP transaction;

Second, the nature of the deal financing, and specifically the use of warrants as a means to alleviate fixed financing costs by offering reduced interest rates on subordinated debt, does not impact the FMV of the stock being sold to the ESOP, as FMV assumes a cash equivalent deal at the time of transaction, ignoring the financing structure utilized in the transaction;

Third, the consideration of whether a control adjustment is permissible in an ESOP transaction (e.g. a control premium or discount for lack of control) requires review of the rights ESOPs obtain. ESOPs commonly obtain certain “indicia of control,” most notably the ability to approve or reject a sale, merger, or recapitalization of the company;

Fourth, the absence of a traditional market for the company stock being sold to the ESOP does not suggest that the sellers or company had improper motives in pursuing an ESOP; in fact, when Congress passed ERISA, it specifically intended for ESOPs to be used by privately held companies and their shareholders if no other market existed for the stock, and considered the creation of a market to be a beneficial feature of ESOPs;

Fifth, Congress intended for ESOPs to be used by sponsor companies as a financing vehicle, especially companies that cannot readily raise capital through public stock offerings; and

Sixth, an ESOP transaction does not violate ERISA if the ESOP pays no more than fair market value, pursuant to generally accepted appraisal principles. The fiduciary standards applied to ESOP plan trustees, and the requirement that the trustees exercise “good faith” when obtaining an independent opinion of FMV, is meant to prevent the kinds of self-dealing and abuse alleged by plaintiffs, and the Court should not impose upon ESOP trustees the obligation to act like a PE buyer.

ASA was pleased to be represented in its amicus brief by attorneys Theodore M. Becker, J. Christian Nemeth, and Richard J. Pearl of the firm McDermott Will & Emery. ASA also wishes to acknowledge the contributions of Ken Pia and Patrice Radogna in helping to develop the brief. To read ASA’s amicus brief, click here.