Observations on Employee Ownership
The Sale of U.S. Sugar and ESOPs
May 2008In the spring of 2008, there was considerable national attention focused on a lawsuit by former participants in an ESOP (employee stock ownership plan) at U.S. Sugar over whether they had received too little for their shares. The employees had left the company and been paid out for their stock at an appraised price that did not reflect an undisclosed offer that included a substantial premium. Just a few weeks later, however, the State of Florida agreed to buy U.S. Sugar for $1.75 billion. The primary purpose of the purchase was to restore the Florida Everglades by turning over the land the company owns to the state for environmental restoration.
The price offered by the state was a considerable premium over a previous bid of $293 per share. The state bid amounted to about $350 per share. The roughly 1,700 U.S. Sugar employees own about 35% of the company through an ESOP, so they would have divided approximately $650 million between them.
By 2009, the deteriorating economy forced a reconsideration of the terms of the sale. The state renegotiated for a lower price for fewer acres of the Everglades. Meanwhile, a court dismissed the employee lawsuit. The court said that ESOP participants are not yet actually shareholders (the ESOP trust is) and thus are not owed fiduciary duties from board members under state corporate laws to report on unsolicited offers.
The new state offer has been accepted, but the state must obtain uncertain financing for it. The deal buys land from the company, but, for now, the company would continue to lease back the land to farm and mill the sugar.
How much each worker ultimately gets will be based on how many shares they have allocated to them in the ESOP. All ESOP participants will become fully vested when the transaction closes. In addition, hourly workers will receive 12 months of severance pay and salaried workers two years of severance pay.
ESOPs and the Sale of CompaniesWhen a buyer approaches an ESOP company, the bid first goes to the board, which must, as in any company, consider any bona fide offer that may benefit shareholders. Offers that do not appear serious, are inadequately financed, or otherwise problematic do not have to be considered.
If an offer is considered, the ESOP trustee, a legal fiduciary who oversees the plan for the benefit of employees (in the U.S. Sugar case, an independent outside firm) must decide how to represent employee interests. The law that governs ESOPs requires the fiduciary to support any offer that would increase the long-term value of plan assets. Employment issues cannot be a factor because ESOPs are part of U.S. retirement plan law, the Employee Retirement Income Security Act (ERISA), which was designed to ensure plan assets are only used for that purpose. An offer could provide a substantial premium over the current price, but the trustee might still reject it if it considered it to be less than what a future offer might provide or if the value of the company will grow fast enough to overcome the premium if it stays independent.
In public companies, employees can vote on the offer; in private companies, whether they can vote depends on how the offer is structured (an asset sale requires a vote; a stock sale can be put to a vote if the company voluntarily chooses to do so). The exact employee role in this transaction has not yet been disclosed in articles describing the sale and may, in any event, depend on how the final terms are worked out. The trustee is required to override the vote if the trustee determines that employees are not acting in their best interests as shareholders. That has only happened once in ESOP history, however. In fact, employees usually are eager to sell when offered terms such as are being offered here, as many will end up with very substantial payoffs, as well as severance.
The Sale and Prior Employee LawsuitsThe national publicity of the lawsuit came largely from an article in the New York Times (May 29, 2008) reporting that three former U.S. Sugar employees believed they were cashed out of the ESOP at a much lower price than they should have been (Sugar Workers, Given Shares, Wonder Why Price Is So Low). Their argument was based on two prior offers from a family-owned agricultural corporation's bid for the company in 2005 and 2007, both of which were as much as 50% higher than what the employees received. The employees also alleged that the former CEO of the company was replaced (and given a $10 million golden parachute) after he urged the board to accept the offer.
On the face of it, the article suggested the employees were cheated out of significant income. The situation is much more complex, however.
1. Should former participants have gotten the same price as prior offers?When someone buys a company, they pay a premium for a controlling block of shares. That's why shares in public companies often rise in price substantially when a takeover is expected. As an individual owner, you have no ability to control the company directly, but as a buyer of majority ownership, you would. That right is worth a lot of money.
The buyer also may be offering a price that reflects synergistic (or strategic) value. If a strategic buyer believes that U.S. Sugar would be more profitable as part of the buyer than a stand-alone entity, then U.S. Sugar is worth more per share to that buyer than a financial buyer, who does not capture these synergies.
Let's now imagine an ESOP company that has rejected a bid from a synergistic buyer. (If the offer was accepted, the ESOP participants' shares would have been sold at the same price as any other shares.) If the ESOP trustee agreed that the price offered to departing employees should be the same as the synergistic buyer's price, that would mean profits were being drained to pay off current retirees, harming the interests of continuing and future employees. The law is explicit in preventing ESOPs from paying a synergistic price. That also protects employees when the ESOP buys shares from outside owners. Paying a synergistic price would clearly harm the interests of participants in that case only for the benefit of non-ESOP owners.
A control price presents a similar issue. If the ESOP does not own a majority of the stock (as it does not at U.S. Sugar) but pays for a right it does not have, who is hurt and who gains? Outside sellers clearly gain a lot. So do early departees. But long-term employees see their stock decline as a result, and the extra cost can even imperil the company's financial stability. In fact, the most common cause of lawsuits by participants against trustees in an ESOP is approving a price that is too high as the basis for an ESOP purchase of shares from outside shareholders, often because of an incorrect assumption of control or synergies.
By law, in all ESOP-related transactions in private companies, the share price must be determined by the trustee based on an appraisal that in turn is based on what an outside financial buyer would pay. The employees cannot get one price and other people another (higher) price. Consequently, just because the employees did not get the price offered by the outside buyer does not mean they got an unfair value.
2. Should the trustee have pushed for a sale of the company earlier?There are two issues here. The first is the decision to reject the prior offers. If the ESOP trustee concluded an offer was in the long-term interests of ESOP participants as shareholders, it should have urged the board to accept the offer. The trustee would have had to evaluate the strength of the offer versus the long-term prospects for company stock if the offer were not accepted. As a minority shareholder, the trustee could not have forced the sale, but it could perhaps have initiated a lawsuit to try to do so. The viability of that suit would depend on the laws of the state of incorporation, the bylaws of the company, and the specific provisions of the two offers.
Second, the trustee could sue over the board's handling of the former CEO, arguing that there was a waste of corporate assets and mismanagement of the firm. At this point, only a court can decide on these facts; there is not enough pubic information for anyone to make an informed judgment.
3. Was the ESOP a "raw deal" for participants?Former employees argued that they should have been paid what the offeror paid. With this even higher offer now being accepted, they will argue that this only proves their point that they were badly treated. First, it is important to remember that employees did not buy these shares; they were an employer-provided benefit. The company also offered an additional diversified plan alongside the ESOP. The departing employees in the suit had larger distributions from their ESOP accounts (around $100,000) than most similar employees would accumulate at their ages in 401(k) plans alone, based on national data. Whether the valuation for their shares should have been higher prior to these offers is for a court to decide and is not possible to discern from facts available. It is not unusual, however, a buyer purchasing to control to offer a premium over 50%, and even 100% of a company's non-control price. Thus, none of these other offers, per se, proves that the prior valuation was incorrect.
4. Are ESOPs generally a good deal for employees?As with any large phenomenon, there is a wide range of experience with employee ownership. Overall, however, several academic studies of how participants fare in ESOPs show that they have about three times the total retirement assets of comparable employees in non-ESOP companies, and their diversified retirement assets alone are about the same size. That result, in turn, is because ESOP companies perform much better than non-ESOP companies, making it possible for them to provide more overall employee compensation.
To be sure, there have been ESOPs that have been abusive and ESOPs that, despite good intentions, did not work out well. That is true of any form of corporate organization. But for the 11 million ESOP participants in the U.S., on the whole, they provide a great deal more financial security than would be the case if there were no ESOPs.