Pension & Benefits News ESOP participant lacked standing to challenge leveraged purchase of allegedly overvalued company stock
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Thursday, November 14, 2019

ESOP participant lacked standing to challenge leveraged purchase of allegedly overvalued company stock

By Pension and Benefits Editorial Staff

An employee stock ownership plan (ESOP) participant lacked standing to challenge the process by which the stock of a privately held company was valued prior to purchase by the ESOP, according to a federal trial court in North Carolina. The post-transaction value of the company stock, although substantially less than the debt-financed purchase price, did not indicate that the ESOP overpaid for the stock or establish the injury necessary to find subject matter jurisdiction.

ESOP purchase of company stock. Choate Construction Company, a privately-held concern, created an ESOP in late 2016. Argent Trust Company served as the plan’s trustee. As the company’s stock was not publicly traded, Argent was subsequently charged with retaining an independent appraiser (Stout Risius Ross) to determine the value of Choate’s stock. In this capacity, Argent was responsible for overseeing the valuation process and ensuring that the ESOP did not pay more than fair market value for the Choate stock.

In December 2016, the ESOP purchased 8 million shares of Choate stock, representing 80 percent of the company, for $198 million. In order to finance the transaction, Choate borrowed $57 million from a bank and then loaned that amount to the ESOP for a portion of the purchase price. In financing the remaining $144 million of the purchase cost, the ESOP issued notes to the selling shareholders at a 4 percent annual rate.

Following the transaction, a former Choate employee who was fully vested in the ESOP, brought a class action suit alleging that the creation of the ESOP was not conducted in the best interests of the Choate employees. The participant’s multiple ERISA claims were based mainly on the fact that, less than one month after the creation of the ESOP, the Choate stock in the ESOP was valued at $64.8 million. According to the participant, the post-transaction value of the company stock indicated that the $198 million purchase price was excessive.

Argent, the Choate ESOP Committee, and various Choate officers and directors moved to dismiss the participant’s claims for lack of subject matter jurisdiction. The defendants charged that the participant lacked Article III standing to bring suit because she had not alleged any “concrete and particularized” injury. Moreover, the defendants maintained, the participant failed to plausibly allege an ERISA claim.

Lack of concrete and particularized injury negates standing. The participant averred that the fact that the per-share value of the company stock declined from $24.75 ($198 million divided by 8 million shares) to $8.10 in a short period of time indicated that the stock purchase price could not have represented fair market value. The court, however, dismissed the participant’s argument as reflecting a fundamental misunderstanding of the nature of the leveraged transaction that created the ESOP and Choate’s subsequent valuation.

Analogizing the transaction to the purchase of a mortgage-financed house, the court explained that the Choate ESOP obtained the company’s 8 million shares at a discount. The $64.8 million valuation at the end of December 2016, the court explained, reflected an appreciation in value of the Choate shares of nearly 33 percent in less than a month.

As the ESOP purchased the shares in 2016 at a discount and an immediate equitable benefit (of $64.8 million) inured to the ESOP and its participants, the participant could not plausibly allege a concrete and particularized injury. Stressing that the participant actually benefitted from the transaction, the court concluded that the mere allegation that the ESOP overpaid for the Choate shares was not sufficient to support standing.

Source: Lee v. Argent Trust Company (DC NC).

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