The ESOP Litigation Tide Might Have Turned, But What Does It Mean?

As Andy Dzamba points out in a front-page article in the August Business Valuation Update, the tide appears to be turning in the ESOP litigation arena, as speakers at the recent ASA ESOP Virtual Conference report. In the recent Bowers¹ case, the court ruled very decisively against the Department of Labor (DOL) in an ESOP valuation case, stressing that the DOL failed to follow standard valuation practices. Also, recently, the DOL announced it was committed to moving forward with rule making with stakeholder input on the valuation of company shares to be bought by an ESOP.

As also noted in the BVU article, the DOL has for over a decade aggressively pursued litigation on ESOP compliance and had not, until the Bowers case, lost an ESOP valuation-related case. It should be noted that the IRS had carried the torch for the DOL on these valuation ESOP cases for a long period before the DOL took over. The court in Eyler v. Commissioner, TC Memo. 1995-123, highly criticized yours truly. I was engaged to provide my opinion as a valuation expert that the board followed the proposed regs on “adequate consideration,” defined in the regs as “‘adequate consideration’ is equal to ‘the fair market value determined in good faith (using objective standards) as of the date of the transaction and as reflected in written documentation of value.’”

Although I was not engaged to provide an opinion as to the value of the company, CTS, in Eyler, the Tax Court used that as its excuse not to accept my testimony as credible. There were other similar ESOP cases with the IRS leading the charge.  And, yes, the regulations the court in Eyler referred to are the ones that the IRS has been dragging its feet on for years.

So it is my hope that the Bowers case and the IRS announcement that it intends to move forward on the regulations will indeed be the turning point.

If indeed it is the turning point, it is good news for the ESOP community. Couple all of this with the attempts by the DOL to make valuators fiduciaries and you had an environment that was certainly heading toward one where the liability issues for valuators was forcing them out of providing valuations for ESOPs.

It has been a puzzle to me for many years, at least back to 1996, why the DOL and the IRS were so bent on making it difficult for valuation transactions in ESOPs to take place. Their public reasoning has been that they are protecting the employees, who are participants of the plans. However, the result of their behavior has been, as noted, to put a pall on the very existence of ESOPs.  

Putting aside the valuation issues with some of the decisions the courts rendered on ESOPs, one can still see that, as in the case of most Tax Court decisions, the cases the DOL selected for trial are often simply “winning cases” for the DOL and the IRS prior to that.² 

Congress put ESOPs into law to help employees become owners of their employed businesses, yet the bureaucracy has done its best, in my opinion, to thwart the intention.

 ¹ Walsh v. Bowers, 2021 U.S. Dist. LEXIS 177184 (Sept. 17, 2021); a case analysis and full opinion are available on the BVLaw platform.

² Jon Decatorsmith, “Test Your IRS Knowledge—A Short Quiz," July 28, 2016, theshortchicagotaxlawyer.com.