Whether or not an ESOP company is for sale, it needs to understand what should happen when offers are made or solicited. What board and fiduciary practices should be in place now so that ESOP companies can best control how they respond to offers? What are the legal requirements for boards and plan fiduciaries in vetting and negotiating offers? Where can an investment banker fit in? When a sale does occur, what administrative steps need to be taken? How should companies communicate with employees about their policies upon being acquired, as well as when an acquisition is in the works? This issue brief addresses these issues and also contains a step-by-step case study of the actual sale of an ESOP company. This expanded and updated second edition (the original brief was published in February 2011) adds two new articles and includes updates to existing material.
Also see our issue brief on the other side of this issue: Acquisition Strategies for ESOP Companies.
Table of Contents
- Fiduciary Issues and Practical Solutions for Boards of Directors in ESOP Companies When Responding to Acquisition Offers
- Basic Operative Principles for a Board of Directors: Sources of Law and an Overview of the State Statutes
The General Duties of a Board of Directors
The Business Judgment Rule
The Application of the Business Judgment Rule in the Sale of Business
Specific Issues for the Sale of an ESOP-Owned Company
- Responding to Unsolicited Offers to Purchase ESOP Companies: Issues for Plan Fiduciaries
- The Initial Response to an Acquisition Offer
Responding to an Offer: Step-by-Step
- Evaluating Offers to ESOP Companies: The Case for Engaging an Investment Banker
- Fiduciary Duties of the Board and Trustees
Getting Free Advice
The Competitive Process
Typical Engagement Timeline and Fees
Advantages of Dealing with a Licensed Investment Banking Firm
- Operational Issues Stemming from the Sale of an ESOP Company
- Sale of an ESOP Sponsor Company: Questions of Time, Money, People, and the Law
- First Steps When an Offer Comes In
Sale Structure, Letters of Intent, and Exclusivity Agreements
Cash, Stock, or Both?
The Fairness Opinion
Key Aspects of the Purchase Agreement for the ESOP
What Happens to the ESOP?
- Legal Considerations for Buyers and Sellers of ESOP Companies
- Representations and Warranties When Selling an ESOP Company
Indemnification and Related Topics
Stock vs. Asset Deal: Pass-Through Voting
- Employee Relations Issues in ESOP Company Sales
- Communicating Corporate Policy on Being Acquired
Communicating About a Possible Sale
Issues When the Sale Is Completed
- Bofors: A Case Study of an ESOP Sale
- Putting a Sale Together
The Payout and Beyond
- Appendix A: Sample Company Acquisition Policy
- Appendix B: Sample Questions to Ask Potential Acquirers
From "Responding to Unsolicited Offers to Purchase ESOP Companies: Issues for Plan Fiduciaries"
The structure of the sale normally determines the approval process for a sale of the company. Most buyers want to purchase assets and assume specific liabilities since this limits the risk against assuming all liabilities, especially those that are not on the balance sheet or otherwise identified. The sale of substantially all of the company assets will require participant voting on the transaction as it is one of seven transactions requiring "pass-through" voting to participants. Also, in almost all cases, as concerns the ESOP, there will be an additional tax on the transaction due to the sale of assets that would not exist if there were a stock sale. This requires that the price be sufficient to compensate for the additional tax.
The trustee is required to provide participants with sufficient information regarding the transaction to allow them to make an informed choice or intelligent decision when they vote shares allocated to their account. This information statement is usually prepared by the trustee and the trustee's legal advisor and reviewed by the company and its legal advisor. The trustee has the authority to determine the final document that is distributed to participants along with their voting instructions and directions. The document needs to be written so participants can understand it. Most information statements will include a factual explanation of the transaction; analysis of the transaction; recommendations by management, the board, and the trustee; current financial statements and a fairness opinion; and participants' rights to direct the trustee. Many trustees will meet with groups of participants to review and discuss the information statement and, more importantly, respond to their questions.
From "Evaluating Offers to ESOP Companies: The Case for Engaging an Investment Banker"
Potential buyers making unsolicited bids will often tell a company that if the company participates in an auction process, their offer is "off the table." My experience is that this is usually not the case. In fact, not only does the bidder typically participate in the process, they usually increase their bid as they learn more and get a sense that there is competition. When a potential buyer makes this kind of threat, you should step back and consider why the buyer is trying to create this sort of pressure. First, why do you think they do not want you to shop their offer? The potential buyer knows that if you go through a process you are likely to get a significantly better offer. Simply put, the buyer is trying to purchase the company at a discount to its true fair market value. Even if the offer price is at a significant premium to the annual valuation, that value may not include cost savings, revenue enhancements, and other strategic considerations (like the value to a potential buyer increasing market share, or just plain "fit"). If one bidder sees value at that price, others will usually also. Furthermore, although it may seem quicker and easier to deal with a single party, it usually turns out not to be the case. When a seller is dealing with a single buyer, that buyer has more leverage than they would have had in a competitive process; it is easier for that buyer to make demands on the seller, and such a buyer often "retrades" price and other terms after the seller is too far down the road to pursue other options.
Whether the ESOP is a minority or majority owner, the company's management, the board of directors, the ESOP trustee, and any other stakeholders (including warrant holders) should discuss an offer with a Financial Industry Regulatory Authority (FINRA)-licensed investment banking firm. Most of the time, the investment banking firm will meet with interested parties and provide a "free" assessment as part of their sales effort.
From "Legal Considerations for Buyers and Sellers of ESOP Companies"
Most ESOP trustees and their counsel take the position that the ESOP is permitted to indemnify the buyer, but indemnification claims will be capped and limited solely to amounts placed in escrow. An escrow is an amount deducted from the purchase price and held by a third party, who may use the escrow only for purposes of satisfying indemnity claims pursuant to a detailed escrow agreement. Most buyers insist on an escrow for the transaction so that there is a ready source of funds to satisfy any breaches of the representations and warranties, rather than relying solely on an unsecured promise to pay. If there is money left in the escrow account and no unresolved claims following a fixed period of time (typically 12 to 24 months following the closing of the transaction), then such funds will be returned to the sellers, typically in proportion to their ownership interests at the time of the sale or as provided in the applicable agreement. By requiring indemnity claims to be limited solely to amounts in escrow, the ESOP trustee is effectively capping the potential post-closing exposure so that the ESOP's participants and beneficiaries cannot be liable for any exposure beyond such amounts. This is another example of how selling an ESOP company is similar to selling a publicly traded company, since the shareholders in a publicly traded company have no post-closing exposure.
The purported reason why ESOP trustees claim that indemnification must be limited to amounts placed in escrow is due to the prohibited transaction rules of the Internal Revenue Code of 1986, as amended (the "Code") and the Employee Retirement Income Security Act of 1974, as amended (ERISA). The prohibited transaction rules prohibit, among other things, certain direct or indirect transactions between a plan and a "disqualified person" (the term used by the Code) or a "party in interest" (the term used by ERISA). Of relevance for indemnification, the Code and ERISA prohibit a direct or indirect lending of money or other extension of credit between the plan and a party in interest. The concern is that if indemnification permits a buyer to recover from the assets in the ESOP trust, then the buyer, who perhaps could be a party in interest, has extended credit to the ESOP trust or vice versa. Because of this risk, ESOP trustees flatly refuse to permit the buyer to seek indemnification from the ESOP trust.