Explore a case study where an ESOP purchase price came under legal scrutiny. Learn valuable lessons for business owners considering Employee Stock Ownership Plans (ESOPs).
M&A Stories
February 7, 2019
In a notable case, the owners of a Hawaii architectural firm sold their business to employees through an Employee Stock Ownership Plan (ESOP) in December 2012. ESOPs allow employees to become business owners, similar to a retirement plan where employees receive company shares instead of cash.
However, in 2018, the U.S. Department of Labor filed a lawsuit, alleging that the ESOP Trustee and owners had overvalued the business when the ESOP purchased it. The Department of Labor claimed that the valuation report was flawed and used unrealistic revenue projections.
The owners initially stated that the firm’s value was $40 million. After negotiations, they sold it to the ESOP for $40 million, payable over 25 years at 7% interest. The Department of Labor argued that this price was too high, considering the flawed valuation.
The Department of Labor accused the owners and the ESOP Trustee of failing to carry out a proper review of the valuation report, providing inaccurate revenue projections, and not ensuring the ESOP Trustee acted in the employees’ best interests.
As a result, the Department of Labor claimed that the owners and the ESOP Trustee breached their fiduciary duties under federal law (ERISA) and sought to reverse the transaction.
In response, the owners argued that the ESOP Trustee alone was responsible for overpayment, as they had no fiduciary duty to the ESOP. However, the court disagreed.
The court ruled that the owners, as primary decision-makers, owed a duty to their employees to protect their ESOP retirement assets. These duties included loyalty, care, and a prohibition against self-dealing. If the Department of Labor’s allegations were true, the owners breached their duty by allowing the ESOP Trustee to accept an inflated purchase price.
Lesson:
Selling your company to an ESOP can be a viable exit strategy, but it must be done correctly. Business owners should consider hiring experienced ESOP lawyers and selecting trustworthy ESOP Trustees to ensure fair purchase prices and reasonable projections.
ably have resulted in a reasonable purchase price and would probably not risk the deal being unwound.
Case Reference:
Acosta v. Saakvitne, Civ. No. 18-00155 SOM-RLP, United States District Court, D. Hawaii, (January 18, 2019).
By John McCauley: I help people start, grow, buy and sell their businesses.
Email: jmccauley@mk-law.com
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Check out my book: Buying Assets of a Small Business: Problems Taken From Recent Legal Battles
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