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    Former Employee Brings Complaint Against ESOP in North Carolina

    May 13, 2019, 09:21 PM

    In 2016, Choate Construction Company (“Choate”), a Georgia-based provider of “general contracting and construction management services,” retained CSG Partners to provide advice regarding the proposed sale of Choate to an ESOP; at that time, 100% of Choate’s stock was owned by the Selling Shareholders, including William Choate, who was Choate’s President. Around August 30, 2016, Choate’s Board of Directors engaged Argent Trust Company (“Argent”) and appointed Argent as Trustee of the to-be-formed ESOP. On December 9, 2016, Choate established the Choate Construction Company ESOP (the “Choate ESOP”), and the Choate ESOP purchased 80% (i.e., 8,000,000 shares) of Choate’s voting common stock from the Selling Shareholders for $198 million, or $24.75 per share (the “2016 Sale”); the purchase price consisted of $57 million in cash and $141 million in promissory notes issued to the Selling Shareholders. On December 14, 2016, Choate redeemed 2,000,000 shares of Choate’s voting common stock held by the Selling Shareholders, and, in exchange, Choate issued to the Selling Shareholders (i) 26,667 shares of non-voting common stock (i.e., 0.20% of Choate’s fully diluted equity); and (ii) warrants to acquire 5,306,667 shares of voting common stock (i.e., 39.80% of Choate’s fully diluted equity).

    Sharon Lee, a former employee of Choate, filed a class action complaint on April 17, 2019, alleging that, among other things, (i) Argent breached its fiduciary duty to the Choate ESOP by failing to “undertake an appropriate and independent investigation of the fair market value of the Choate stock before approving the 2016 Sale”; (ii) as of December 31, 2016 (i.e., less than one month after the 2016 Sale), the value of Choate’s stock was $8.10 per share (a decrease of over 67%), reflecting that the Choate ESOP paid more than fair market value for the shares of Choate’s stock and, as a result, the Selling Shareholders were “enriched by tens of millions of dollars at the expense of the [Choate] ESOP participants”; (iii) the valuation prepared in connection with the 2016 Sale that Argent used did not account for the fact that the Selling Shareholders’ warrants could ultimately dilute the Choate ESOP’s ownership of Choate from 80% to 60% and allowed the Selling Shareholders to “retain elements of control over” Choate; and (iv) the Selling Shareholders were responsible for retaining Argent, so the Selling Shareholders and Argent “were operating under significant conflicts of interest at the expense of the [Choate] ESOP participants.”1 The case is pending.

    Takeaways

    • Argent breached its fiduciary duty to the Choate ESOP by failing to independently investigate the fair market value of Choate before approving the 2016 Sale.
    • The Choate ESOP paid more than fair market value for Choate’s stock and, as a result, the Selling Shareholders were “enriched by tens of millions of dollars” at the Choate ESOP’s participants’ expense.
    • The valuation that Argent relied on did not account for the fact that the Selling Shareholders’ warrants could dilute the Choate ESOP’s ownership of Choate to 60%.
    • Argent and the Selling Shareholders operated under “significant conflicts of interest” during the 2016 Sale since Argent was retained by the Selling Shareholders.

    1 Class Action Complaint, Lee v. Argent Trust Company, No. 5:19-cv-00156 (E.D.N.C. Apr. 17, 2019), ECF No. 1.