Frequently Asked Questions

Employee Ownership FAQs

Common questions about employee stock ownership plans (ESOPs), employee ownership trusts (EOTs), and other forms of employee ownership, from the basics to technical topics.

This FAQ is written primarily for business owners, managers, and advisors involved in setting up or running an employee ownership plan. If you're an employee at an ESOP company looking to understand your own benefits and rights, see our articles on Working at an ESOP Company and The Rights of ESOP Participants.

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Can ESOP loans be refinanced?

ESOP loans can be refinanced, but this is a fiduciary issue. There are two common reasons for refinancing:

1, When an ESOP borrows money to buy out an owner, there is an external loan between the company and the lender (which can be a bank, the seller, a non-bank lender, or a combination) and an internal loan between the company and the ESOP for the same amount. The internal loan is essentially an accounting mechanism (the money to pay the loan comes from the company and goes back to the company) to release the shares in the ESOP over time. Sometimes companies want to extend the internal loan to spread out the allocation of shares more slowly.

2. Mature ESOPs may releverage an ESOP to buy shares from former employees and then allocate these repurchased shares over the course of the loan repayment rather than have them go back into accounts all at once.

Whatever the reason, the trustee should evaluate the terms to make sure the refinancing is favorable to participants. There are several ways to do this, including:

1. Dividend Make Whole. The use of a dividend make whole agreement is designed to compensate the trust as a whole for the amount of dividends used to repay an extended loan during the extended period. Obviously, if the company stock owned by the ESOP receives no cash dividends, this issue is unimportant. However, where cash dividends are paid on the company stock and these cash dividends are used to repay the ESOP loan, the longer the ESOP loan remains outstanding, the greater the dividends that are used to repay the ESOP loan. In other words, if the ESOP loan had not been refinanced, these dividends would

have been paid on company stock allocated to participants' accounts instead of

being used to repay the ESOP loan.

2. Event Protection. This is designed to protect the trust as a whole where a corporate sale of company stock from the loan suspense account occurs during the extended loan period; the proceeds from the shares which would have been allocated had no ESOP refinancing occurred would be lost unless the plan sponsor agrees that these proceeds will not be used to repay the ESOP loan. If the proceeds from the sale of company stock are used to repay the ESOP loan, the trust as a whole could be harmed when company stock which would have been

allocated had no refinancing occurred, is used to repay the ESOP loan. Therefore,

it is appropriate that the proceeds from unallocated shares which would have been

allocated but for the extension of the loan amortization will not be used to repay the ESOP loan.

3. Contribution Commitment. Where the plan sponsor has not previously committed

itself to make contributions, or reserves the right to amend or terminate the plan, it is appropriate for the fiduciary to negotiate for an enforceable legal obligation of the plan sponsor to make contributions necessary to fully amortize the loan and/or keep the trust whole (or better).

5. Other Enhancements. The quid pro quo approach may also focus on other issues

including, but not limited to, vesting liberalization, liberalized diversification rights, covenants that the matching contributions will not be reduced or that no further refinancings will occur unless negotiated with and approved by an independent corporate fiduciary and a commitment that no plan termination will occur before the ESOP loan is fully repaid. It is also possible that the additional benefit to the ESOP will be a negotiated amount that is to be contributed to the

ESOP over a negotiated period of time.

Link to this FAQ Topic: Financing an ESOP