WHAT IS A REPURCHASE OBLIGATION?
WHAT IS A REPURCHASE OBLIGATION? by Edward (Ed) Wilusz an ESOP Advisor.
The repurchase obligation (or repurchase liability) is the legal obligation of a privately-held ESOP company to buy back shares of company stock from participants upon a Distributable Event. Unlike other retirement plans, which invest in a diversified portfolio of assets, an ESOP invests primarily in the sponsoring company’s stock. For publicly traded corporations, shares of company stock can be sold in the marketplace, if necessary, to fund a participant’s distribution upon a Distributable Event. Privately-held companies that are not traded on a stock exchange (the vast majority of all ESOP companies) are required to repurchase a participant's ESOP shares when a Distributable Event occurs.
The legal requirement to repurchase the shares, which is found in the Code and ERISA, provides the employee participants with the right to put the shares to the company upon a Distributable Event. Some ESOP companies, however, do not distribute stock; rather, a company may fund the repurchase obligation created by the put option with cash contributions to the ESOP, a promissory note or a related party’s purchase of the shares. No matter the approach selected, ESOP companies remain legally required to create liquidity for its ESOP’s stock, provided it is not prohibited by other federal or state law, such as bankruptcy or receivership.
Additionally, ESOP companies are legally required to provide sufficient cash (commonly referred to as adequate security) to the ESOP to meet the distribution and diversification requirements of the ESOP. Upon a Distributable Event, it is not the ESOP, but the company that is ultimately responsible for providing enough cash to the ESOP to fund the value of the company shares held in a participant’s account.
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