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The Employee Ownership Report

NewsletterConcisely written for leaders in employee ownership companies and for service providers in the field, the NCEO's bimonthly newsletter, the Employee Ownership Report, is the most efficient way to stay informed about legal issues, current events, best practices, breaking research, management approaches, and communications ideas for employee ownership companies.

Available exclusively to NCEO members, the Employee Ownership Report is delivered in hard copy and all issues back to 1997 are available in the members-only area of the Web site.

Nonmembers are invited to read the sample article below from the current issue of the newsletter. Every time a new issue appears, the sample article on this page will be replaced by one from the new issue. Join online for only $90 to receive the Employee Ownership Report and all our other membership benefits.

Read a sample issue of the entire newsletter (September-October 2015).

Sample Article from the January-February 2017 Issue:

Can ESOP Participants Say No to a Takeover Offer?

If an ESOP company receives an offer to purchase substantially all its assets or stock and the directors are in favor of accepting the offer, then the ESOP trustee is required under ERISA to exercise its fiduciary duty in deciding whether to vote the ESOP shares in favor of or against the proposed transaction. In certain circumstances, ESOP participants have a right to vote on the transaction. Can they vote "no" and force the trustee to vote "no" as well? Under current law and practice, the answer is unclear.

Do Trustees Need to Follow the Participants' Vote?

The answer depends on the circumstances. If there are unallocated shares, the trustee will vote those shares. If the plan document requires mirror voting of unallocated shares based on participants' votes of allocated shares, the trustee does not necessarily have to follow this direction. Even if the ESOP participants are allowed to vote a controlling number of shares on a proposed offer, the trustee may need to override the participants' vote if the trustee believes it would be a breach of fiduciary duty under ERISA to follow the participants' vote. That could happen, for instance, if the participants voted "no" on an offer with a very large premium from a buyer that would lay off employees, relocate operations, or offer continued employment but for lower compensation. Employees could be put in the difficult situation of losing their jobs or working for less pay, in return for a relatively small amount of money for their stock.

In Herman v. NationsBank of Georgia, N.A., a case concerning a hostile takeover bid for Polaroid, the Department of Labor took the position that the ESOP trustee must essentially ignore participant directions if it concludes that the offer would substantially increase the value of plan assets. In a 1995 letter to the AFL-CIO, Olena Berg, the Assistant Secretary of Labor at the time, said that trustees cannot "automatically assume that following plan provisions [providing for participant voting] in every case will come out with a result that is prudent under ERISA." But in those cases where a trustee does not follow the participants' vote, the trustee needs to show in writing why it followed its own course. Trustees ordinarily should give deference to the participants' vote, but can still override it if the trustee believes the participants' decision is inconsistent with ERISA requirements. This effectively expands the range of acceptable offers. Some offers that the trustee normally might accept could be rejected, but higher offers could not be rejected if doing so would be a breach of fiduciary duty. In the absence of clear guidance, however, trustees may be more likely to err on the side of caution.

Providing the Vote

If the offer is structured as an asset purchase, the law entitles ESOP participants to pass-through voting. If the offer is to purchase stock, however, pass-through is not required by ERISA, but a company can choose to include pass-through voting in its plan documents. If a company does so, participants must be given adequate disclosure materials to make their choice. The trustee (not the company) should hire an advisory firm to prepare detailed material on the offer, explaining the risks and considerations in language ordinary participants can understand. Company management needs to be exceptionally cautious to play a neutral role in this process. Management should, however, make sure that employees understand how ERISA works in acquisitions, ideally by bringing in an independent third party. Acquirers need to be told in advance, in detail, what this process will involve and how much it might cost in dollars and time.

Employee Voting Still Makes a Difference

Requiring a pass-through vote by ESOP participants may, in itself, discourage potential buyers who are not comfortable with the prospect of going through a long, expensive process of making an offer in the face of an uncertain election. Even the possibility of a "no" vote could be perceived by a potential buyer as making the acquisition of an ESOP company more expensive than a company without an ESOP.

Should You Allow Employees to Vote?

Most ESOPs do not provide more than the mandatory minimum voting rights on acquisition offers, presumably because management and boards want to have more control over that decision. In practice, however, we know of only a few cases where employees and management have gone different ways on a vote, and these cases sometimes presented unusual scenarios, such as feuding family members serving on boards and ESOP trust committees.

The NCEO thanks Theodore Becker of Drinker Biddle & Reath LLP for his input on this article. Any conclusions and errors are the NCEO's, not his.