A new threat facing employers is an increase in complex and costly litigation over the handling of employee benefit plans. The potential liability can be substantial, as Occidental Petroleum recently discovered when it agreed to pay $25 million, plus another $3.5 million in attorneys’ fees and expenses, to settle such a dispute. The class action lawsuit was filed on behalf of employees of a former subsidiary of the oil company who alleged that the value of their shares in an employee stock ownership plan was improperly assessed when the business was sold. We’ll tell you how to avoid similar pitfalls.
Employer Establishes Employee Stock Ownership Plan
Occidental set up a stock plan for employees of a subsidiary, MidCon Corp., to help retain workers while Oxy tried to sell the subsidiary. Occidental created a special class of preferred shares that it assigned to the employee stock ownership plan (ESOP) when it was set up.
The company agreed that the employees’ shares would be worth half the value of MidCon for one year, increasing to a maximum of 70 percent of the value of the subsidiary after two more years.
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The ESOP outlined that the value of MidCon was to be determined by an independent third-party appraiser who would be selected by the ESOP’s trustee and paid by Occidental. If either the trustee or Occidental were dissatisfied with the appraisal, a second appraiser could be selected and under certain circumstances a third could be brought in.
A little over a year after starting the ESOP, Oxy sold MidCon for $3.9 billion. The ESOP participants received $258 million from the sale.
Plan Participants Sue
About 1,900 ESOP participants and beneficiaries sued Oxy in a federal court. They charged that Occidental grossly understated the value of their shares because it didn’t follow the proper valuation procedure, although Oxy led the employees to believe it had.
The employees claimed that an independent appraisal of ESOP shares was never made. They also asserted that Occidental had seriously underestimated the value of MidCon by improperly deducting costs it incurred in selling the subsidiary, failing to credit the ESOP for an initial cash contribution toward the purchase of the preferred shares, and not accounting for the buyer’s assumption of some of MidCon’s obligations.
Lawsuit Settled For $28.5 Million
After two years of litigation, the parties agreed to settle the lawsuit, although Oxy admitted no wrongdoing. The employees had claimed that MidCon’s value was understated by more than $200 million. But Lee Kaplan, a lawyer who represented the employees, told CEA he was happy with the settlement because the complex litigation could have lasted for years.
How To Safely Value ESOP Shares
The Occidental case illustrates that employers must take great care in assessing the value of shares assigned to an ESOP, an especially difficult task when shares aren’t publicly traded. You can minimize the risk of being sued by following these steps:
- Specify a valuation formula. You can avoid the uncertainty inherent in letting an appraiser come up with a valuation by including in the ESOP a formula specifying how the shares will be valued, says Robert A. Blum, a partner with the San Francisco firm of Hanson, Bridgett, Marcus, Vlahos & Rudy.
- Allow for alternative appraisers. If an appraiser is to be assigned to value shares, get as many appraisers as necessary to produce a valuation that is acceptable to both sides. The MidCon ESOP wisely called for up to three successive independent appraisers, though the company allegedly failed to stick with that plan.
- Give the appraiser plenty of latitude. Appraisers should have the leeway and resources to hire their own experts so they can produce an appraisal that is beyond reproach. Keep records of the procedures that were followed to prove that it was done right.
- Follow the plan to the letter. Kaplan advised that it’s absolutely critical to go back and read the stock ownership plan carefully to be sure what your obligations are in providing information to employees and preparing a final accounting of their interest.