About the Journal

From the fall of 1989 to the fall of 2010, we published The Journal of Employee Ownership Law and Finance as a quarterly subscription-based periodical. Although at one time most of the material we published came through that journal, we had come to a point where it was no longer as relevant to us and our readership, due to the growth of our other publications. At this point we publish more than 60 books and issue briefs, some of them being general books on ESOPs or equity compensation and many others being devoted to a particular topic. However, there are times when we have interesting material that does not fit in the framework of our existing publications. We thus present here our Journal of Employee Ownership as a new publication to be issued on an irregular basis and sold by the issue, not by subscription.

About This Issue

The indemnification of ESOP fiduciaries is a very serious issue, and ERISA has been interpreted in various ways in evaluating if and when a fiduciary can be indemnified. For example, it is commonly stated that a fiduciary found liable for breaching an ERISA fiduciary duty cannot be indemnified. The article by Theodore Becker and Richard Pearl (pp. 3–46) takes an exhaustive look at multiple factors and concludes that while ERISA prohibits the plan itself from indemnifying ERISA fiduciaries found liable for breaching a fiduciary duty, that prohibition does not apply to other indemnitors, and that ERISA permits indemnification of ESOP fiduciaries by ESOP-owned company sponsors, including ESOP fiduciaries found liable for breaching a fiduciary duty. It is extensively documented, with more than 100 footnotes. Next, Kyle Wishing provides a useful discussion of the valuation treatment of the ESOP repurchase obligation, with multiple exhibits (pp. 47–70).

Product Details

PDF, 73 pages
(July 2020)
Available for immediate purchase

Table of Contents

Indemnification of ESOP Fiduciaries
Theodore M. Becker and Richard J. Pearl

I.    Introduction
II.    ERISA Section 410
III.    ERISA Legislative History
IV.    Department of Labor Guidance
V.    Other Federal Agency Guidance
VI.    State Guidance
VII.    Restatement (Second) of Trusts
VIII.    Principles of Statutory Construction Support Indemnification
IX.    Cases Interpreting ERISA Section 410(a) and Indemnification of ESOP Fiduciaries
X.    Conclusion

Valuation Treatment of the Repurchase Obligation Liability
Kyle J. Wishing


From "Indemnification of ESOP Fiduciaries" (footnotes omitted)

ERISA Section 410(a) prohibits agreements that purport to “relieve a fiduciary from responsibility or liability for any responsibility, obligation, or duty” under ERISA. This statutory provision has three clauses: (1) relieve a fiduciary; (2) from responsibility or liability; (3) for any responsibility, obligation, or duty under ERISA.

The concept of liability should not be confused with the separate question of whether a liable party may seek reimbursement or payment from a third party. Liability refers to one’s ultimate legal exposure, the idea that one can found legally responsible for breaching an obligation, rather than payment for that exposure. The language of ERISA Section 410(a) supports this interpretation. This statutory provision begins, “[e]xcept as provided in sections 1105(b)(1) and 1105(d),” meaning that sections 1105(b)(1) and 1105(d) are exceptions to the ERISA Section 410(a) prohibition on exculpatory agreements. ERISA Sections 1105(b)(1) and (d) are provisions that expressly state that certain trustees “shall not be liable” or “no trustee shall be liable” for certain conduct. These provisions are exceptions to the anti-exculpation provision in ERISA Section 410(a) because they are examples of exculpatory clauses; they do away with the very liability itself. ERISA Sections 1105(b)(1) and (d) provide that the trustee faces no liability in the first instance for the conduct set forth in these sections. That is the type of exculpation that ERISA Section 410(a) otherwise prohibits, and it is not the same as indemnification.

The prohibition in ERISA Section 410(a) against relieving a fiduciary of “responsibility” under ERISA does not prohibit an arrangement to satisfy the fiduciary’s liability. Provisions in ERISA indicate that when Congress used the word “responsibility” in the statute, it meant to refer to the duties or burdens that ERISA imposes. For example, ERISA Section 1105 refers to allocating responsibilities among fiduciaries. That section clearly uses the word “responsibilities” to refer to various obligations that can be delegated among multiple fiduciaries, not to the concept of satisfying liability. ERISA Section 1136 grants the Secretary of Labor the “responsibility” to detect and investigate civil and criminal violations. That context supports the interpretation of “responsibility” as referring to the obligation to perform some act. ERISA’s civil-enforcement section, found in ERISA Section 502, authorizes civil penalties against a fiduciary for “any breach of fiduciary responsibility . . .” This section clearly distinguishes a fiduciary responsibility, meaning the obligations ERISA imposes on fiduciaries, from the penalties or consequences of breaching a responsibility.

An indemnification agreement addresses payment for liability but does not “relieve” the liability itself. The word “relieve” means “To lessen or alleviate ... [t]o free from a specified duty or obligation, esp[ecially] by providing a substitute.” Similarly, Webster’s Dictionary defines the term “relieve” as “to set free from a burden” and “to set free from duty or work by replacing.” A private agreement entitling the fiduciary to indemnification from a third party has no bearing on the fiduciary’s liability.

ERISA Section 410(b) also confirms that the “liability” that cannot be relieved is not the same as the act of paying for that liability. It allows insurance to “cover liability” or “potential liability,” distinguishing between the liability and the payment. An insurance policy does not absolve a fiduciary from liability. The liability remains, but a third party is contractually obligated to indemnify the fiduciary for that liability. This interpretation is consistent with the DOL Interpretive Bulletin, which distinguishes between liability and satisfaction of liability. The DOL interpreted ERISA Section 410(a) as allowing indemnification arrangements that leave the fiduciary fully liable but merely permit another party to satisfy that liability in the same manner as insurance.

From "Valuation Treatment of the Repurchase Obligation Liability" (exhibits omitted)

The ESOP-hybrid FMV interpretation considers the repurchase obligation only to the extent that the repurchase obligation provides liquidity (therefore decreasing the lack of marketability) for the subject shares. The repurchase obligation “liability” does not directly affect the share value conclusion, under the rationale that the repurchase obligation liability would cease to exist if the ESOP sold its interest to a non-ESOP third party. Analysts may increase or decrease the discount for lack of marketability based on the sponsor company’s ability to meet its repurchase obligation.

While these assumptions are valid, they may have unintended consequences for the ESOP sponsor company. A higher share price under this FMV interpretation due to normalizing retirement expenses also increases the repurchase obligation.

Depending on the sponsor company’s cash flow, balance sheet sources of liquidity, and funded status of the ESOP, this could cause the sponsor company to be cash-constrained.

The hypothetical sale transaction assumed under the ESOP-hybrid interpretation may ultimately lead the sponsor company shareholders to enter into an actual sale transaction to eliminate the repurchase obligation.

There are various financial planning and ESOP structural measures that can reduce the financial burden related to the repurchase obligation.

Exhibits 2a and 2b present the PSF adjusted historical financial fundamentals and projected income statements respectively under the ESOP-hybrid FMV interpretation.

As presented in exhibit 2a, ESOP contribution expense ranged from 74.4% to 115.8% of adjusted earnings before interest, taxes, depreciation, and amortization (EBITDA) over the five years ended December 31, 2019.

As presented in exhibit 2b, ESOP contribution expense is expected to range from $2.38 million (or 78.0% of adjusted EBITDA) in 2020 to $2.51 million (or 74.7% of adjusted EBITDA) in 2022.