Farnum Redux

Several years ago, the Department of Labor initiated a legal action against Wardwell Braiding Company (the so-called "Farnum" case) accusing the ESOP of overpaying for the shares. The ESOP had borrowed money to buy ownership in Wardwell and, as is usually the case, the share value dropped after the transaction to reflect the debt the ESOP had taken on to make the purchase. The DOL argued that the ESOP should only have paid the post-transaction value.

ESOP advocates pointed out that this hardly made sense. If someone were to sell a house worth $200,000, they would not agree to sell it to someone borrowing money to buy the house for $40,000, on the argument that the buyer's post-transaction equity interest would only be worth that much if the buyer borrowed 80% of the house's value. If the Farnum view prevailed, no one would sell to an ESOP.

Apparently recognizing the absurdity of the position, the DOL withdrew from the case. Now comes word that the IRS is auditing a number of ESOPs on the same theory, and that the DOL may be ready to revive it. In a coming column on this site, Ronald Ludwig, a prominent ESOP attorney, will talk about an approach that might satisfy the government, the seller, and the ESOP.