The Legal Framework for Repurchase Obligations

1. The Legal Framework for Repurchase Obligations Presented To: Ohio Employee Ownership Center By: John M. Wirtshafter McDonald Hopkins Co., LPA (216) 348-5833 Jwirtshafter@mcdonaldhopkins.com Friday, April 21, 2006

2. Legal Framework or Requirements Underlying Repurchase Liability • Requirements come from four sources • Distribution requirements for qualified retirement plans, generally. • Distribution requirements unique to ESOPs. • Requirements that ESOPs permit diversification. • Unique distribution requirements included in the ESOP document.

3. Distribution Requirements for Qualified Retirement Plans • Section 206(a) of ERISA • Payments to participants shall begin not later than 60 days after the end of the plan year in which the later of the following events occur: • Date the participant attains age 65 or the normal retirement age specified in the plan (if earlier than 65), • The tenth anniversary of the year the participant began participating in the plan, or • The participant terminates from service.

4. Distribution Requirements for Qualified Retirement Plans • Section 401(a)(9) requires that a qualified retirement plan provide the entire interest of an employee to be distributed by the “required beginning date” or in installments not exceeding the life expectancy of the employee and a designated beneficiary commencing on the required beginning date.

5. Unique Distribution Requirements for ESOPs • Section 409(o): Distributions begin to a participant (subject to the participant’s consent) not later than one year after the close of the plan year: • In which the participant separates from service by reason of attainment of normal retirement age, death or disability; or • In which the fifth plan year following the plan year in which the participant separates from service.

6. Unique Distribution Requirementsfor ESOPs • Section 409(o): Distributions may be delayed with respect to employer stock held in a participant’s account which were acquired with the proceeds of an ESOP loan until the end of the plan year in which the ESOP loan is paid.

7. Unique Distribution Requirementsfor ESOPs • Section 409(o): ESOP must provide that, unless a participant elects otherwise, payments must be made in equal periodic payments (not less frequently than annually) over a period not longer than the greater of: • Five years, or • For participants with balances greater than $875,000 (for 2006, as adjusted) – five years plus one year for each $175,000 or fraction thereof by which the balance exceeds $875,000.

8. Unique Distribution Requirementsfor ESOPs • Section 409(h): A participant who is entitled to a distribution has the right to receive his/her benefit in employer stock (unless the Company limited ownership because Company is an S Corp or if the articles of incorporation or bylaws substantially restrict stock ownership to employees or a qualified plan).

9. Unique Distribution Requirementsfor ESOPs • Section 409(h)(4): If no public market exists for the stock, a participant who receives securities has the right to sell them back to the Company. This “put option” is exercisable at a minimum during two separate 60-day periods. • Obligation is on the Company, not the ESOP.

10. Diversification Requirements Creating Repurchase Liability • Section 401(a)(28): Requires an ESOP to permit participants who are age 55 and have completed 10 years of participation in the ESOP to diversify a portion of their account balances. • 25% of account for first 5 plan years • 50% of account for the 6th plan year • Right is exercisable during 90-day period following close of each of five plan years following participant’s eligibility to diversify.

11. Fiduciary Issues in Handling Repurchase Liability • Repurchase liability is an obligation and duty of the Corporation, not of the ESOP. • Nonetheless, ESOP Trustee/Committee may need to review issues and concerns regarding repurchase liability. • Duties often derive from the terms of the Plan and from the general fiduciary responsibilities of all plan fiduciaries under ERISA (e.g. reasonableness, prudence, etc.)

12. Trustee’s Duties • In addition, ESOP Trustee/Committee often have multiple roles which may result in their having conflicting corporate and trust fiduciary issues • Consider using independent trustee. • May want to or need to assist ESOP sponsor in considering options that minimize repurchase obligations. • May have a fiduciary responsibility on behalf of plan participants and beneficiaries to ensure that the Company has sufficient cash flow to meet its debt obligations.

13. Company/Trustee’s Duties • Options for sponsor/trustee to minimize repurchase obligation pressure: • Adoption of statutory delay period. • Distribution of ESOP accounts to non-retiree terminated participants. • Distribution of ESOP accounts in a lump sum in stock and pay put option over five years. • Distribute ESOP accounts over five plus year installments. • Convert the account of terminated employees to cash immediately after termination.

14. Repurchase Liability Study • Trustee cannot request formal repurchase obligation study or make internal estimate. • Trustee purchasing stock has a fiduciary duty to assess whether the Company is able to repurchase stock. • If the trustee determines that the Company cannot meet its obligation, can not follow through with sale, require Company or selling shareholder to find a guarantor or renegotiate terms with the sellers.

15. Monitoring Repurchase Obligations • No specific requirement to perform periodic repurchase liability studies. • Trustee guided by general obligations under ERISA.

16. Thank You