The Employee Ownership Update
July 12, 1996
Avis Agrees to Be SoldThe Board of Directors of Avis has agreed to sell the company to HFS, Inc., a major franchise operator, for an estimated $800 million. Analysts estimate HFS will pay about $35 per share to buy the company, whose stock was most recently valued at about $12.50. The Avis ESOP owns 71% of the total common stock in the company, with General Motors owning 29%. In addition, senior management owns preferred stock, stock appreciation rights, and phantom stock valued at approximately $73 million. Based on very rough calculations, the ESOP will end up with about $35,000 per participant if the sale goes through. Because of wide variations in whether employees participate in the plan, how senior they are, and pay, however, the amount for each employee will vary from a few thousand dollars to several hundred thousand dollars.
According to the company, the HFS offer was unsolicited. News reports have indicated that Avis welcomed the offer as a way to deal with its repurchase obligation, but that seems doubtful given the fact that Avis could have gone public instead, and was considering doing that at some point in the future. A more likely explanation, and the one company insiders provide, is that the HFS offer is simply too good to turn down. Avis stock has gone from about $5.50 when the ESOP was first started to as high as $22. Recently, it fell back to $9, rising to $12.50 last year. Like the rest of the car rental industry, Avis has suffered from increased fleet prices and softness in rental prices. Despite a couple of recent bad years, however, Avis has now returned to solid profitability and has outperformed most competitors.
The next step in the sale process will be for the ESOP trustee (U.S. Trust) to consider the offer. Currently, the ESOP owns 24 million shares, of which 10 million are allocated (the Avis ESOP has an unusually long loan term). The trustee votes the unallocated shares, with the caveat that the employees' decision must be consistent with the constraints of ERISA. General Motors has already agreed to the sale, so the trustee ultimately will have the deciding say in the sale. Given the large premium, however, opposition is unlikely.
One of the key issues that will need to be resolved is how to deal with unallocated shares. When the unallocated shares are sold, proceeds will be used to pay the remaining debt, but there will be a considerable amount left over. Originally, it appeared that this excess value would not go to current participants, but, after the Teamsters Union wrote Avis management on this issue, the company quickly agreed that these proceeds should go to current participants.
Under recent IRS rulings, it is appropriate to do this. Indeed, the ESOP legal community is virtually unanimous in arguing excess proceeds must go to plan participants. The IRS, however, says that the excess remaining amounts paid to participants after the loan is paid cannot exceed the "section 415" limits of, generally, 25% of pay per participant per year. The IRS does not say what to do with what is left over after those limits have been met, however. Presumably, they would remain with the acquiring company to be paid to future employee benefit plans. It appears that Avis and HFS have agreed to find a way to get around this issue. Just how that will be done is not yet clear, nor is it clear whether the IRS will object. Some companies have gotten IRS approval to pay out the excess amounts, despite the previous private letter ruling.
However this issue is resolved, all current ESOP participants will be become 100% vested and receive full payment for their allocated shares. That, plus whatever payment for unallocated shares is received, can be put into a special rollover retirement fund or paid out and taxed as income, with a 10% early distribution penalty.
The Avis sale comes as a disappointment to those who touted the company as a visible and successful example of employee ownership. On the other hand, the sale does represent a major financial benefit for employees who, in a conventional company, would get nothing at all from a transaction such as this.
Senate Allows ESOPs in Subchapter S Companies, Eliminates Section 133 LoansThe Senate has agreed to legislation that would allow Subchapter S companies to have ESOPs. The same bill would also eliminate section 133 of the Internal Revenue Code, a provision allowing lenders to exclude 50% of the interest income they receive from loans to ESOPs owning over 50% of the company's stock and passing through full voting rights on shares acquired by the loan.
The legislation was passed as part of the bill to increase the minimum wage. The House has already passed its version of the legislation. It also eliminates section 133, but its effective date is October 1995; the Senate version would be effective in June 1996. The Subchapter S provision, which would become effective at the start of 1998. The House bill does not allow Subchapter S companies to have ESOPs.
These differences would have to be ironed out in a conference committee of the two houses. At this point, it is not possible to say which side is likely to prevail. Because the bill is attached to the minimum wage bill, it appear likely that some action will be taken, however.
The section 133 provision has been used only rarely in the 1990s. Until 1989, it was available to all ESOPs, and was very popular, especially in large public firms. Because of the costs it incurred, Congress limited its application in 1989. Since then, only a handful of transactions have used it each year. The Subchapter S change may also have a limited effect.
The Senate proposal would allow "S" companies to have ESOPs, but would be tax-neutral. "S" corporations do not pay tax; their owners pay tax on an allocated share of earnings. The ESOP trust is normally non-taxable, however. The legislation would require the ESOP to pay its share of taxes, presumably through additional contributions the company would make (and that would also count as allocations to employees). In addition, Subchapter "S" ESOPs would not be eligible for the "ESOP rollover" in sales to an ESOP, would not be allowed to deduct dividends paid to employees, and would have to count interest on a loan when calculating the contribution amount for annual limitations on contributions to employees. As a result, ESOPs would have limited applicability in "S" companies.
Boxer Bill Would Limit Stock Ownership in 401(k) PlansLegislation introduced by Senate Barbara Boxer (D-CA) would limit the amount of employer stock that could be held in a 401(k) plan to 10% of the amount employees contribute and would require that employees be able to reallocate employer 401(k) matches in the form of company stock to other accounts.
Similar limits would be placed on other assets owned by the company. The legislation follows some well-publicized scandals in some 401(k) plans that invested heavily in employer-controlled assets (although not stock) that ended up having no value. The bill's future is uncertain, but concern with undiversified investments in 401(k) plans has become an issue of growing importance.