Navigating Internal Trustee Waters in Rough Seas September 17, 2015

Transcription

1 Navigating Internal Trustee Waters in Rough Seas September 17, 2015

2 Agenda Introductions Brief Background Case Studies Board Bypasses Trustee in Election Trustee Disagrees with Choice of Board Nominee Purchase Proposal for Updated Valuation Distressed Company Cannot Satisfy Benefit Payments Co-Trustee Disagreements re Valuation 2

3 Introductions Bret Keisling - Capital Trustees bret@captrustees.com Edward C. Renenger Stevens & Lee, P.C ecr@stevenslee.com 3

4 Background Fiduciary duty requires trustee to discharge his or her duties solely in the interest of the participants and beneficiaries: For the exclusive purpose of providing benefits and defraying reasonable expenses of administering the plan With the care, skill, prudence (ESOP exception), and diligence under the circumstances that a prudent person acting in like capacity and familiar with such matters would use By diversifying the investments of the plan so as to minimize the risk of large losses unless it is clearly not prudent to do so (ESOP exception) In accordance with the documents and instruments governing the plan to the extent they are consistent with ERISA Note: the ESOP exception noted above only states that diversification or prudence (only to the extent it requires diversification) do not apply to the holding of employer securities Potential for personal liability 4

5 Case Study 1 Fact Pattern Minutes from last Board meeting indicate that Board re-elected itself to new term Trustee was not aware of election and did not have opportunity to vote How should this be handled? 5

6 Case Study 1 (cont d) IF Trustee agrees with slate of candidates, Trustee should vote its shares Board vote is a non-event Board does not have power to elect itself in the ordinary course Filling a temporary vacancy is typically permissible under bylaws, but that is different than re-electing entire Board As such, only shareholders have the power to vote for Board members ESOP s vote is proportional to percentage of ownership Bylaws Describes procedures for nominating and voting If procedures are not followed, vote is typically not valid Other stakeholders Although shareholders elect directors, sometimes shareholders will precommit seats to other stakeholders Common example: subordinate note holder may have a right to appoint a board member 6

7 Case Study 1 (cont d) Fulfilling Fiduciary Duty Follow applicable procedures Determine suitability of nominees Review background and qualifications Obtain bio in writing Web searches Interviews? Document the process Keep record of all documentation Keep record of minutes Keep record of deliberations this record should show that the trustees considered all of the facts and circumstances and made a determination Pass-through vote? 7

8 Case Study 2 Fact Pattern Board follows nominating procedure for upcoming shareholder vote of Board members Trustee completes due diligence to determine suitability of nominees Trustee weighs facts and circumstances and determines that one of the nominees should not be elected What should trustee do? What if this is the trustee s superior from a corporate management perspective? Does it matter the reason why as long as determination was made in good faith? 8

9 Case Study 2 (cont d) Trustee cannot vote for election of candidate it does not support The reason does not matter: if the Trustee does not believe that the election of the board member is in the best interest of the ESOP s participants and beneficiaries, the Trustee cannot support Best practices Communicate with relevant stakeholders about decision Discuss informally with other board members Discussion will often lead to Board withdrawing nominee from consideration without Trustee needing to cast a single vote If Board insists on proceeding with nominee, much larger problem than simply a disagreement on Board member 9

10 Case Study 3 Fact Pattern Company is owned 40% by ESOP and 30% by two different minority shareholders Enterprise value of company is $20MM based on last December 31 valuation In March, one of the minority shareholders proposes to buy 100% of the outstanding shares for whatever appraiser determines is the updated enterprise value of the company assume $22MM What should an internal trustee do? Should an internal trustee accept offer? How does a trustee determine that the offer is credible enough to retain counsel and a financial advisor (valuator)? Should an internal trustee engage an independent fiduciary? If so, when is an offer serious enough to warrant engaging advisors? Is the price being proposed sufficient? 10

11 Case Study 3 (cont d) What if the ownership was 40% ESOP and 60% majority owner and majority owner wanted to pay current valuation? Engaging a third-party special fiduciary for the transaction transfers the fiduciary risk from internal trustees to external fiduciary External fiduciary typically will require company to indemnify fiduciary, but this indemnification cannot, by law, extend to breaches of fiduciary duty Required to engage third-party fiduciary? No, but how does an internal trustee remain objective when They are likely a participant? Their job security could be impacted? They could be getting pressure from senior management? 11

12 Case Study 3 (cont d) Why can t the buyer just pay the amount determined on the updated valuation ($22MM)? Is there a difference between a transaction value and updated valuation? If minority shareholder is purchasing control, then price should reflect control updated valuation likely does not Does an updated valuation accurately reflect the anticipated share value in five years? In ten years? Trustee does not share transaction valuation with buyer or company 12

13 Case Study 4 Fact Pattern Company is financially distressed Accounts-receivable are delayed Vendors are not being paid on time Management believes that Company is viable, but recovery will take time and a lot of work A group of participants are eligible for distributions but Company does not have the cash to satisfy distribution requests Is this a trustee issue? If so, what should a trustee do? Can a trustee favor some classes of participants (e.g., active participants, those nearing retirement) over others (e.g., terminated employees)? Could a trustee determine that insolvency is the appropriate response? Can a trustee withhold distributions if making distributions will jeopardize financial viability of Company? 13

14 Case Study 4 (cont d) Yes it is a trustee issue a trustee has an obligation to administer the ESOP in accordance with its terms The trustee has a duty of impartiality to all plan participants But trustee may appropriately balance interests of different classes of participants In doing so, trustee must give due consideration to all classes of participants Trustee does not owe obligation to employees as employees only obligation is to ESOP s participants and beneficiaries Responsibility is to do what a prudent person would do while acting in best interest of participants and beneficiaries Trustee could determine that insolvency or bankruptcy is the right decision Weighs facts and considerations and concludes that there is a chance to get something in bankruptcy whereas nothing may be paid if Company continues its current course In other words, trustee has no obligation to avoid bankruptcy Benefit: all participants and beneficiaries are treated equally 14

15 Case Study 4 (cont d) Trustee could also determine that it is better to remain out of bankruptcy Trustee agrees with management s belief that Company will recover and recovery will be more advantageous for participants and beneficiaries than payments in bankruptcy But, trustee does not have ability to authorize that payments are not made to participants even if those payments would jeopardize company s viability Bottom line: if company cannot satisfy liabilities, it is not viable. Hypothetical is a bit of a trick Also consider: Code permits employer to repay purchase of employer securities over 5-year period But adequate security and interest must be provided to take advantage of this Also consider value of stock should reflect honest assessment of Company s financial viability 15

16 Case Study 4 (cont d) How does an internal trustee remain objective when They are likely a participant? Their job security could be impacted? They could be getting pressure from senior management? Or from their spouse? 16

17 Case Study 5 Fact pattern Group of three internal co-trustees: CEO, CFO and Head of HR CEO and CFO want to accept value determined by appraiser but Head of HR, who is somewhat new to the role of co-trustee, wants to get a peer review of the draft valuation They have discussed internally among themselves and no one has changed their mind They take a formal vote to accept the value, which results in a 2-1 vote, with the Head of HR voting no What should the Head of HR do? What should the CEO and/or CFO do? 17

18 Case Study 5 (cont d) No correct answer On one hand, majority vote overruled co-trustee But co-trustee has an obligation to make sure that they fulfill fiduciary duty and simply accepting majority vote may not be adequate If Head of HR really believes that acceptance of appraisal was not correct, should take steps to remedy this problem Possible routes of resolution Report to Board it is Board s responsibility to monitor whether trustees are fulfilling fiduciary responsibility. Board can replace trustee if they determine that is appropriate Seek peer review notwithstanding vote of CEO and CFO. Raises issue of cost may require discussion with Board or CEO before doing so or willingness to pay cost and seek reimbursement Recuse yourself probably does not insulate from fiduciary risk Seek advice from legal counsel Unfair hypo: in situation where other trustees are not willing to seek a peer review, much bigger issues of communication/relations 18

19 Case Study 6 Fact Pattern Same co-trustee setup as Case Study 5, except that Head of HR has been a co-trustee for several years and has much experience in reviewing appraisal reports CEO and CFO have synthetic equity compensation that will get paid in an amount tied to ESOP valuation (higher value is better) Head of HR has no synthetic equity In reviewing draft valuation, Head of HR notices that projection of revenue growth in future years is more robust than historical past What should Head of HR do? What should CEO and CFO do? 19

20 Case Study 6 (cont d) Head of HR should question appraiser as to whether projections are reasonable or whether adjustments should be made CEO and CFO should recuse themselves from determination of value Head of HR may still feel conflicted as subordinate to CEO and CFO depending upon the facts may decide that professional help may be necessary. Options? Peer review Another co-trustee (perhaps external board member) Ask appraiser to act as a fiduciary in making determination of value (not required under proposed fiduciary regs, but is permitted) 20

21 For more information, contact: Bret Keisling - Capital Trustees bret@capitaltrustees.com Edward C. Renenger Stevens & Lee, P.C ecr@stevenslee.com