Newsletter Article
April 2020

Handling Repurchase in Difficult Times: Interim Valuation and Repurchase Delay Options

A critical question we are being asked is whether you can or should get an interim valuation in response to changed economic circumstances, and if so, how 
is it done.

We asked a number of experts about this, and they agreed that this is possible and supportable by the court decisions. Some advisors suggest it is possibly even required as a prudent exercise. If you do decide to have an interim valuation, one suggested approach is for the board of directors to amend the plan document (unless it already provides for this) to allow for an interim valuation to be done by the trustee. The Board might also consider amending the plan to require an interim valuation, so that this is not an exercise of fiduciary decision, and less subject to challenge under ERISA. You should consult with counsel about these alternatives. A decision also needs to be made as to whether this is a full-scale valuation with a full report or a modification of the existing valuation.

If your plan provides that you will be paying people out in 2020 based on the most recent year-end valuation, that price may be difficult to afford. The argument can be made that you have to do an updated valuation that incorporates some of the impact of the COVID outbreak in order to protect the value of plan assets for existing participants. The size of your obligation due in 2020 may influence whether you can manage to use the 2019 year-end value. There is also a question of what date in 2020 to use for the interim valuation, given the rapidly changing situation On the other hand, if you pay current distributions out at a lower price, the recipients might argue that you are taking away a benefit they are already entitled to or just deserve. This is the issue that will need management by communications and proper handling of the legal and appraisal details.

Matt Keene, an NCEO board member, recruited colleagues at Chartwell to answer a number of specific questions.

What impact are current economic conditions and COVID-19 having on December 31, 2019 valuations?

The simple answer is that current world events have no impact on December 31, 2019 valuations. December 31, 2019 valuations will not include the impacts the COVID-19 pandemic are currently having on the economy, a company’s industry, the capital and equity markets, and the specific company being appraised. Appraisal standards require that opinions of fair market value only incorporate what was known or knowable as of the Valuation Date. While this valuation position is not in question, it will likely create a challenge in the execution of many December 31, 2019 valuations that have not yet been completed or even initiated. Management will be asked to discuss the state of the company’s business at year-end 2019 and generate projections without being influenced by what they now know to be the initial impact of COVID-19.

My business has been materially impacted by COVID-19 and I believe that the value of my company is significantly different than it was as of December 31, 2019. How do I address this situation before paying terminated participants?

Assuming that a company’s value has been significantly impaired by the pandemic, an interim valuation may be considered (as outlined above). A careful review of other options and an understanding of the actual magnitude of the potential difference in value and impact on repurchase obligation is critical. The ultimate decision on whether an interim valuation is considered prudent will ultimately depend on ESOP plan document provisions and analysis by the ESOP plan administrator, and ESOP trustee, and legal counsel.

I think I want an interim valuation. What is involved?

An interim valuation is not much different than the customary year-end valuation. The valuation must include current financial statements, a new forecast that considers near and long-term impacts of COVID-19 (and any other specific factors that influence the company’s expected performance, positive or negative), current industry research, an update of guideline public company and merger and acquisition analysis, and a discussion regarding the current state of the company allowing an appraiser to accurately assess all 
of a company’s individual risks. In addition, most trustees require a full appraisal report for an event this significant versus any type of summary or limited valuation document. 

When should I get the interim valuation done?

Unfortunately, no one knows right now. The only definitive answer is that it should be done before any 2020 distributions are processed. While the near term impacts of COVID-19 may be clear, the lack of clarity on the long-term impacts of COVID-19 on the economy, various industries, the capital and equity markets, and the specific company being appraised result in challenging forecasts and ultimately challenging valuations. To the extent possible, ESOP companies may choose to delay conducting an interim valuation which could result in better clarity on future performance. 

John Prodoehl of Principal Financial added “You may be able to alter your distribution provisions to lower the amount you are required to pay out. For example, if your plan states distributions will be paid in a lump sum, amending the plan to change to installment distributions could reduce the amount required to be paid by up to 80%. In addition, you can amend the plan to not force out distributions less than $5,000 or less than $1,000.”

“What is a bit more of a grey issue is whether or not you can change the timing of when a distribution begins. Most practitioners say this is not allowed because it is an anti-cutback issue.”