Recent ESOP Ruling Changes the Game

Walsh v. Bowers, 2021 U.S. Dist. LEXIS 177184 

As we have reported on in the Business Valuation Update, BVWire, and the Business Valuation Law Alert, several court decisions have found sponsors and trustees of ESOPs liable for fiduciary failures. One of the most prominent of these is Brundle v. Wilmington Trust N.A. (I), 2017 U.S. Dist. LEXIS 35811, and Brundle v. Wilmington Trust N.A. (II), 2017 U.S. Dist. LEXIS 97752, where the trustee was held liable for overpayment of company shares by the ESOP.

Recently, however, a district court in Hawaii has ruled in favor of the trustees and sponsors in a case that is getting a lot of attention, Walsh v. Bowers, 2021 U.S. Dist. LEXIS 177184 (Sept. 17, 2021). The Department of Labor sued the defendants, which included two individual owners, Bowers & Kubota Consulting Inc., and the Bowers & Kubota ESOP, alleging that the defendants had violated ERISA laws by manipulating data to induce the ESOP to pay $40 million for the shares of the individual shareholders, which the DOL claimed was in excess of the fair market value of the shares. After extensive testimony from valuation experts and analysis of the facts of the case, the court determined that no ERISA violations have been established. The trustee was also sued in this matter but settled prior to the conduct of the trial in this case.

Kenneth Pia (Marcum), an expert for the defense in this case, helped the court in deciding that the price the ESOP paid was within the range of the FMV of the company. Pia both arrived at his own value that was higher than the value the ESOP paid and also opined that the value the trustee’s valuation advisor provided was within the range of FMV. Finally, Pia helped the court in deciding that the valuation the government’s witness provided “significantly and unreasonably undervalued the company.” Get Ken’s insights on this case in his upcoming webinar.

For many, this case was a breath of fresh air. The government, specifically the DOL, has been aggressive in going after ESOP transactions, so much so that many trustees and valuators are having second thoughts about performing work for ESOPs. Within the Walsh v Bowers opinion is a very interesting statement by the court. The court said that, “[i]n December 2014, Michael Wen of the Department of Labor was told by his supervisor to ‘find some ESOP cases in Hawaii.’" It is not clear from the opinion whether this statement to Wen was related to the DOL’s investigation of the trustee for the Bowers ESOP, Saakvitne, or is a reference simply to a fishing expedition on the part of the DOL. In either event, the Bowers ESOP was “discovered” as a potential violator as a result of this order to Wen. It implies that the DOL is ESOP hunting. This is even more alarming for ESOP trustees and valuators. 

But the DOL is not alone in going after fiduciaries. In a blog post by Cooley M&A entitled, “Pleading bad faith against Special Committee members: A new trend?" the authors pointed out that the Delaware Court of Chancery, in two separate decisions this year (In Re Pattern Energy Group Inc. Stockholders Litigation and The MH Haberkorn 2006 Trust, et al. v Empire Resorts, Inc., et al.), allowed bad-faith claims against special committee members to survive a motion to dismiss. The claims included a number of issues that the court found problematic, but, in both cases, there were issues of potential bad faith on the part of the Special Committee members including “allow[ing] interests other than obtaining the best value reasonably available for [the company’s] stockholders to influence [director] decisions during the sales process, given that they made decisions falling outside the range of reasonableness.”

In both of these decisions, financial advisors were involved in the process, and there were questions regarding projections and oversight of those projections by the Special Committee members. 

In summary, it is becoming more risky to serve as a fiduciary or on a Special Committee in these corporate matters that often involve transactions impacting minority shareholders. Providing financial advice to such fiduciaries or Special Committees is also riskier. When I was performing ESOP valuations, I always thought that the simple numbers game made ESOP valuations riskier, i.e., ESOPs generally had a large number of shareholders thus providing a larger pool of potential litigants.