Things Not to Do in an ESOP

We have just started work on a book of things not to do in an ESOP. We'll be covering a whole range of bad choices, from the imprudent to the ill-considered to the illegal, in each case basing a general principle on one or more brief case histories (often anonymous). We would welcome any stories you might want to share.

One recent "don't do that" story involved an S corporation ESOP that did not have enough cash in the accounts of eligible participants to handle current distributions. There was, however, cash in the accounts of two ineligible participants—ineligible because they had sold their stock to the ESOP when the company was a C corporation and taken a tax deferral. They were thus not eligible to have any of those shares allocated to them. But there was cash in their accounts, and the company's lawyer advised the company it could borrow that cash to make the payments, then pay it back just to the two participants, with no interest, through future ESOP contributions.

That raised a whole raft of problems. First, where did the cash come from? If it was a "make-up" contribution for their not getting shares, that is a plan violation. If contributions are made to the ESOP, they cannot be made to specific people. The company cannot borrow money from the ESOP, and, if it could, couldn't repay it at zero interest.