District Court Dismissal in Lee v. Argent Trust Company Upheld in Appeals Court

Employee Stock Ownership Plans (“ESOPs”) can be a useful tool allowing business owners to facilitate succession planning while simultaneously providing retirement assets to their employees. The Employee Retirement Income Security Act of 1974 (“ERISA”) sets standards governing ESOPs which are enforced by the U.S. Department of Labor (“DOL”). One goal of ERISA is to protect ESOP participants and beneficiaries, while minimizing reasonable expenses of administering the plans.

ESOPs have come under increased scrutiny in recent years, mainly through DOL audits or lawsuits against plan fiduciaries filed by owner-employees. Owner-employees, and/or the DOL, may argue that an ESOP was not created with the best interests of the plan participants/owner-employees in mind. Specifically, the claims often state that the ESOP acquired its shares for more than the stock was actually worth, which can negatively impact the future retirement assets for the owner-employees. One such recent case, Lee v. Argent Trust Company, is described below.

Ms. Sharon Lee alleged that the creation of the Choate Construction Company (“Choate” or the “Company’s”) employee stock ownership plan (“ESOP”) was not conducted in the best interest of its owner-employees, including herself.

The Choate ESOP was formed in mid-December 2016 in a transaction where the ESOP paid $198 million for an 80% ownership interest in the company (the “Transaction”). The ESOP financed the Transaction by issuing $141 million in notes to the selling shareholders, and taking out a bank loan to cover the remaining $57 million balance.

However, Ms. Lee claimed that the value determined by an independent appraiser as of December 31, 2016 provided proof that the $198 million price paid by the ESOP to acquire its shares earlier that month was excessive. Specifically, Ms. Lee relied upon a valuation performed on behalf of the ESOP’s trustee, Argent Trust Company (“Argent”), by Stout Risius and Ross (“Stout”) who also performed the initial valuation upon which the Transaction price was based.

Stout valued the ESOP’s shares at $64.8 million as of December 31, 2016. Ms. Lee claimed that this $64.8 million valuation was proof that the $198 million price paid by the ESOP for its shares earlier that month was excessive.

The district court concluded that Ms. Lee had in fact benefited from the initial Transaction and was essentially ignoring the debt financing required.  That is, the value of an 80% interest in the Company before the transaction would have been $198 million.  However, after deducting the $198 million of debt, the value of the interest was now $0 (i.e., $198 million value less $198 million of debt owed).  The court equated it to purchasing a $200,000 house with a $200,000 mortgage.  The underlying value of the house would remain the same, but the owner’s equity in the house would be $0.

Therefore, the $64.8 million value of the ESOP shares determined weeks later actually represented a significant increase in value from the Transaction price. Argent was granted a motion of dismissal, which was upheld by the 4^th Circuit Court of Appeals.

This case demonstrates why it is important to understand valuation concepts, at least from a high level, when considering submitting a claim challenging an ESOP valuation. When unsure, it is wise to consult with a valuation specialist to clarify the situation. Although the details are unknown, it is clear that time and money could have been saved on both sides of this case if Ms. Lee had first consulted with a qualified valuation specialist before making her claim.

Schneider Downs has significant experience in preparing business valuations for shareholder disputes, gift and estate tax, financial reporting, buying/selling and a range of other purposes. Please contact Steve Thimons (412-697-5281; [email protected]) or Thomas D. Pratt (412-697-5615; [email protected]) for more information about Schneider Downs’  business valuation services.