Court Says Participant Misunderstood Valuation for ESOP Purchase

In a very concise decision, a federal district court judge found a participant in an employee stock ownership plan (ESOP) did not have standing to sue regarding the valuation of stock price for the setup of the ESOP because she did not prove she suffered any harm.

In late 2016, Choate Construction Company created its ESOP. The Choate ESOP purchased 8 million shares of Choate stock for $198 million. These 8 million shares represented 80% of Choate. According to the court’s opinion, Choate’s employees did not pay the company $198 million for the shares. Instead, Choate borrowed $57 million from a bank and then turned around and loaned that $57 million to the Choate ESOP for part of the purchase. To finance the remainder of the purchase, the Choate ESOP issued notes to the selling shareholders for the remaining $141 million at a 4% annual rate. Argent Trust, named in the lawsuit along with Choate defendants, as trustee of the Choate ESOP, oversaw and approved the transactions.

The plaintiff, a former Choate employee who worked for the company from April 2007 to April 2017, was “fully vested in the ESOP when her employment ended. She alleges, on behalf of herself and similarly situated current and former Choate employees, that the “creation of the Choate ESOP … was not conducted in the best interests of the employees.” In particular, she relies on a $64.8 million valuation of the Choate ESOP’s stock on December 31, 2016—less than one month after the creation of the ESOP—as evidence in support of her contention that the $198 million that the ESOP paid for Choate stock was excessive.

“Plaintiff, however, fundamentally misunderstands the nature of the December 2016 transaction that created the Choate ESOP and Choate’s subsequent valuation,” Chief U.S. District Judge Terrence W. Boyle of the U.S. District Court for the Eastern District of North Carolina wrote in his opinion.

He compared the ESOP purchase to the purchase of a mortgage-financed house. Boyle explains that a buyer of a house for $198,000 that gets a mortgage for the entire value has taken on a $198,000 debt (the mortgage) and, in return, obtained a $198,000 asset (the home), resulting in her asset and her corresponding obligation creating $0 in new equity. When the value of the home increases to $262,800, if the buyer sells her house at that value, after paying off her mortgage, she would be left with a profit of $64,800.

Likewise, Boyle says, the Choate ESOP obtained its 8 million shares of Choate at a price of $198 million, and the Choate ESOP took on $198 million in debt to obtain the stock. The $64.8 million valuation at the end of December 2016 reflects the fact that the Choate ESOP, like the hypothetical home buyer, realized an immediate equitable benefit. He notes that the benefit has only grown since, as the Choate ESOP’s value was pegged at $107.2 million by the end of 2017.

“As the Choate ESOP actually purchased the 8 million shares in 2016 at a discount, and an immediate equitable benefit inured to the Choate ESOP and its members, plaintiff has not plausibly alleged that she suffered any concrete and particularized injury,” Boyle wrote in his opinion.