In 2012, Iowa-based Dahl’s Foods Inc. was ranked in the Top 100 of the largest majority employee-owned companies in the United States. Two years later, it filed for Chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Southern District of Iowa. At the time of its bankruptcy filing, Dahl’s was 97% owned by its Employee Stock Ownership Plan (“ESOP”).
In its bankruptcy, Dahl’s sold substantially all of its assets and used the proceeds to fund its Chapter 11 plan of reorganization. At the time it filed its plan of reorganization (August 17, 2015), it had approximately $1 million available to distribute to approximately 900 participants in its ESOP – an average recovery of $1,000 per participant.
The Dahl’s case is remarkable for yielding even a modest financial recovery for ESOP participants. Unfortunately, recoveries in situations like these are the exception rather than the rule. In the vast majority of instances, a distressed company’s stock loses most, if not all, value post-bankruptcy. So, equity holders, such as ESOP participants, receive little or, most likely, no recovery on their ownership interests due to the absolute priority rule in bankruptcy, which provides that equity is last in line to get paid in bankruptcy.
As a consequence, employees of failing or bankrupt ESOP companies are left holding the proverbial “empty bag.” These irate employees often seek recourse by commencing Employee Retirement Income Security Act (“ERISA”) fiduciary breach litigation against plan administrators, company officers and directors and other fiduciaries of the ESOP. As discussed infra, ESOP fiduciaries now have a new weapon in their arsenal to help prevent or defend against ERISA fiduciary breach litigation.
This article discusses ESOPs in general; the U.S. Supreme Court’s unanimous decision in Fifth Third Bancorp v. Dudenhoeffer, which held that fiduciaries of ESOPs are not entitled to a “presumption of prudence” when deciding whether to buy, sell, or hold company stock; recent ESOP litigation against bankrupt companies; and a new ESOP protection trust designed to protect both employees and fiduciaries in the event of a catastrophic decline in the value of company stock, the primary trigger of ERISA “stock drop” litigation.