ESOP Repurchase Obligation Liability
Section 409(h) of the Internal Revenue Code provides that when ESOP participants at a closely held employer receive company stock in an ESOP distribution, they have the right to require the employer to repurchase them at fair market value. This requirement gives these employees a put option on stock distributed to them and creates what is known as the ESOP repurchase obligation, repurchase liability, or ESOP repurchase obligation liability.
The put option requirement exists because otherwise, employees receiving closely held company stock would likely be stuck with it or at best might sell it at a discount, thus frustrating a prime purpose of having ESOPs in the first place: to spread the benefits of ownership to employees.
In many cases, the ESOP, not the company itself, repurchases the shares. This is a common practice, but the company may not force the ESOP to do so.
Due to the financial impact of repurchasing shares, it is important to forecast the repurchase obligation. There are several ways to finance it, such as prefunding it, paying dividends, and so on, and repurchased shares can be redeemed by the company or recirculated in the ESOP. There are specific legal requirements affecting repurchases, such as distribution and diversification requirements, account segregation, and valuation.
These and other issues are discussed in The ESOP Repurchase Obligation Handbook, 5th Ed. You also can delve deeply into our survey data on how companies are dealing with the repurchase obligation (discussed in a chapter in the book) by obtaining our repurchase obligation survey report. And if you're an NCEO member, watch our live and replay webinars on the repurchase obligation and related topics. If you're not a member, consider joining.
Naturally, repurchase obligations come up for discussion in our other publications, from general ESOP overviews like Understanding ESOPs to specialized books like Sustainable ESOPs and The Fiduciary's Guide to ESOP Valuation, where the repurchase obligation is one of the factors affecting the topic at hand.