ESOP Participants’ Breach Claims Not Supported

Participants in an ESOP that purchased shares with a loan from the sponsoring employer made allegations that were not backed by evidence, a court found.

A federal judge dismissed a lawsuit brought by participants in the Personal-Touch Home Care Employee Stock Ownership Plan (ESOP) for failure to state a claim.

U.S. District Judge James B. Zagel of the U.S. District Court for the Northern District of Illinois rejected the participants’ first claim that GreatBanc trust, in its role as fiduciary, breached its fiduciary duty under the Employee Retirement Income Security Act (ERISA) by arranging for the ESOP to purchase Personal-Touch shares above value, financed with an unreasonable loan rate. The participants said the ESOP paid too much for the Personal-Touch shares that it purchased because the price went down after the transaction, and it borrowed money to fund this purchase at a rate higher than the market rate—without providing any supporting detail.

Citing Bell Atlantic Corp. v. Twombly, Zagel found that without additional facts, the participants’ allegations are “merely consistent with” a breach, and they fail to nudge their claim “across the line from conceivable to plausible.” He found that the value of Personal-Touch stock years after the transaction does not speak directly to GreatBanc’s duty “under the circumstances then prevailing” at the time of the purchase. It is not necessarily indicative of the fair market value before the purchase.

In addition, citing the Supreme Court decision in Fifth Third Bancorp v. Dudenhoeffer, Zagel said that “absent an allegation of special circumstances regarding, for example, a specific risk a fiduciary failed to properly assess, any fiduciary would be liable for at least discovery costs when the value of an asset declines. Such a circumstance cannot be the intention of Rule 8(a), or Dudenhoeffer. An allegation of a special circumstance is missing in this case—in fact, we know absolutely nothing about the financial situation of Personal-Touch.”

Regarding the participants’ argument that the loan rate was higher than market rate, Zagel again found they had no evidence to support the claim. A reasonable rate is determined from all relevant factors, he said, including the amount and duration of the loan, the security involved, the credit standing of the ESOP, and the interest rate prevailing for comparable loans. While the participants offered up the interest rate for comparable loans, Zagel determined this only raises a possibility that the rate was unreasonable, while a dearth of other facts makes it impossible to draw a plausible inference that the mismatched rates were due to a breach of fiduciary duty.

NEXT: Did prohibited transactions occur?

Zagel also rejected the participants’ other claim that GreatBanc caused the ESOP to engage in prohibited transactions under ERISA when the ESOP both bought stock and received a loan from a “party in interest.” Personal-Touch is a party in interest because it is an employer whose employees are covered by the ESOP. Zagel noted that ERISA statute categorically prohibits almost any transaction between an ESOP and a party in interest, but then provides a long list of exemptions. 

A purchase of shares by an ESOP from a party in interest is exempted from being a prohibited transaction if the shares are purchased for “adequate consideration,” defined, for a security with no generally recognized market, as “the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan and in accordance with regulations promulgated by the Secretary.” According to Zagel, under 7th U.S. Circuit Court of Appeals case law, this provision creates a two-part test that the ESOP paid no more than fair market value, and the fair market value was determined in good faith. As he found earlier in his opinion, the participants did not successfully plead that the ESOP paid more than fair market value for the Personal-Touch shares. 

Zagel noted that an extension of credit from a party in interest to an ESOP is a prohibited transaction unless the loan is primarily for the benefit of the plan participants and “such loan is at an interest rate which is not in excess of a reasonable rate.” Again, participants did not successfully plead that the loan interest rate was unreasonable. 

The plaintiffs in the case were participants in the ESOP when it purchased an unknown percentage of Personal-Touch shares for $60 million on December 9, 2010. The transaction was funded by a $60 million loan from Personal-Touch (and/or its principal shareholders) to the ESOP, payable over 30 years with 6.25% annual interest. 

According to the participants, the value of ESOP’s Personal-Touch shares was only 78% of the purchase price about one month after the transaction, 50% by the end of 2011, and 45% by the end of 2013. They also allege that the market rate for a loan similar to the one extended to the ESOP is 4.25%, significantly lower than the rate the ESOP received. 

The opinion in Allen v. GreatBanc Trust Co. is here.