Enterprise Services, Inc. Business Transitions and Valuations
ESOP Articles

Valuation Issues in ESOP Court Cases: Eyler v. Commissioner
Written by Scott Miller, CPA/ABV, CVA

Originally published in The Valuation Examiner by the National Association of Certified Valuation Analysts, October/December 1999.

The court case of Eyler v. Commissioner is based in part on valuation issues as they relate to the common stock in a closely held company for the purposes of an Employee Stock Ownership Plan and Trust ("ESOP"). The case is also significant in that a number of issues relating to the duties of an ESOP trustee are also decided. This case is an important decision regarding ESOPs because of the substantial penalty imposed on the defendant, Gary Eyler, and the emphasis placed on fiduciary duties surrounding an ESOP transaction.

Since this article is part of a series, it is important to note that ESOP court cases often are very complex. The added level of complexity is introduced because ESOPs come under the regulatory authority of both the Internal Revenue Service ("IRS") and the Department of Labor ("DOL"). The landmark legislation, Employee Retirement Income Security Act of 1974 as amended ("ERISA"), officially introduced the concept of ESOPs in Federal tax statutes and in qualified retirement plans. ERISA legislation is often very general by design, and it is left to the courts to determine many points of interpretation. It is appropriate to place the ERISA legislation in perspective. ERISA is intended to safeguard the retirement system of the United States, and its enforcement provisions are very strong and must be carefully considered. This is a significant mandate, and the penalties for violation of the regulations may be severe.

The standard of value in ESOP valuations is "fair market value". The definition of fair market value is most clearly defined by the IRS in Revenue Ruling 59-60. The DOL substantially embraces all of the aspects of fair market value as defined in Revenue Ruling 59-60, but the ERISA legislation imposes additional considerations. ERISA mandates that all qualified plans have a trustee, and the trustee has to act in the best interests of the plan participants. ERISA imposes fiduciary responsibilities on all of the trustees. Fiduciary responsibilities are often at the center of ESOP based valuation litigation. This case is a good example of contested fiduciary responsibilities and valuation issues. It is specifically noted, this article is only a summary of significant issues and events relating to the case that have been deemed to be of interest to valuation professionals.

Court Case: Eyler v. Commissioner

This case, Gary L. Eyler v. Commissioner, 69 TCM 1995-123, CCH Decision 50,538M, is one where entering into a "prohibited transaction" for the purposes of an ESOP proved to be a devastating lesson for Gary Eyler. This article attempts to summarize the most significant factors in the case of interest to valuation professionals. The facts of this particular case are reasonably complex, and the more significant items are mentioned.

Fiduciary compliance with adequate consideration guidelines, in proposed regulations by the DOL, requires that the value of the stock for the purposes of an ESOP has a two part test. First, the price cannot exceed fair market value, and second, fair market value must be determined in good faith. These guidelines were not followed in this case.

Background Information

Mr. Eyler was the majority shareholder, Chairman, and Chief Executive Officer of Continental Training Services, Inc. ("CTS" or the "Company"). The Company operated a series of vocational schools to train truck drivers and operators of industrial equipment. The Company enjoyed significant growth, and in 1986 Mr. Eyler decided to pursue an initial public offering ("IPO") for the firm. In preparation for the IPO, the Company retained both Prudential-Bache Securities ("Prudential") and Raffensperger, Hughs & Co. ("Raffensperger") as underwriters. The underwriters conducted a due-diligence investigation of CTS and determined that an estimated price for the IPO would be between $13 and $16 per share. Once the offering price range had been established by the underwriters, they attempted to determine the level of investor interest by marketing the stock at that price range. The underwriters concluded that the level of interest was minimal at that time. The underwriters did not encourage the IPO at this point. The option was to wait for more preferential market conditions.

Rather than consider lowering the price range for the IPO, Mr. Eyler decided to sell a portion of his stock to an ESOP in 1986. In December, 1986, the CTS Board of Directors adopted the ESOP. The Directors named the CTS Vice President of Human Resources as the ESOP trustee, and appointed several insiders, including Mr. Eyler, to serve as the ESOP plan committee. Neither the ESOP trustee or the ESOP plan committee was involved in the decision to sell CTS stock to the ESOP. The Board of Directors decided to have the ESOP purchase stock from Mr. Eyler. They authorized the ESOP to borrow approximately $10,000,000 for the transaction, which was guaranteed by both CTS and Mr. Eyler. Mr. Eyler did not participate in the Board's discussion and decision to have the ESOP purchase his stock, although he did serve as the Board's Chairman, and was the controlling shareholder in the Company.

The ESOP fiduciaries did not engage an independent appraiser to advise them on the value of the stock for the ESOP transaction. Supporting the ESOP transaction price of $14.50 per share, the CTS Board of Directors relied on a statement by the Company's Chief Financial Officer who decided that the price was fair. The Company's Chief Financial Officer was previously employed in a major brokerage firm. The price determined by the Board of Directors was within the IPO range, but the figure actually used was not determined by an independent appraiser for the purposes of an ESOP.

In 1987 after the purchase of the stock by the ESOP, CTS acquired a public trucking company. The acquisition of the public trucking company proved to be a significant mistake. CTS experienced financial difficulties following the acquisition, and filed for bankruptcy in 1989. Upon the failure of CTS, the circumstances of the ESOP installation came under review.

The IRS determined that Mr. Eyler engaged in a prohibited transaction when he sold his stock to the ESOP for more than fair market value. Selling stock to the ESOP for more than fair market value may lead to the conclusion that the transaction is prohibited, but the circumstances of each case will determine if the transaction is prohibited under the regulations and subject to potentially severe penalties. Mr. Eyler responded that the transaction is not prohibited because the ESOP purchased the stock for adequate consideration (fair market value determined in good faith), and the Board of Directors acted in good faith in determining the share price.

Court Decision

The court decided that Mr. Eyler did engage in a prohibited transaction because the ESOP paid more than adequate consideration for his stock. The ESOP failed to obtain the services of an independent appraiser to determine the specific fair market value of the stock at the date of the stock transaction. Mr. Eyler and CTS relied on a range of prices determined for a proposed IPO several months prior to the ESOP transaction. The range of prices was not established for the purposes of an ESOP.

The ESOP fiduciaries did not question the transaction price, and substantially failed to conduct any additional due-diligence to determine if the price was appropriate in light of known facts. The ESOP fiduciaries should have questioned the price when the IPO was unsuccessful.

The court rejected Mr. Eyler's argument that the standards of establishing fair market value were met by the ESOP fiduciaries. The price range cited by Mr. Eyler as support for the actual ESOP transaction price of $14.50 was originally developed for an IPO. The court noted that the price range for the IPO assumed the Company was going public, and a market for the stock was going to be established. A marketability discount should have been applied to the range of IPO prices for a closely held firm. Under the Company ownership structure including an ESOP, the Company remains closely held with no established public market for the stock. The court noted a market making mandate for the Company according to ESOP regulations, generally referred to as the repurchase obligation, but it still noted that a lack of marketability discount is appropriate.

Additionally, the court determined the range of value developed for the IPO was inappropriate because the financial strength of the Company was not considered, including the impact of ESOP related debt. Under the assumed IPO, the Company was to receive additional capital without incurring any debt, and the range of prices reflected this financial position. When the ESOP was installed, the Company increased its debt significantly. By accepting the debt the Company was now under the restrictions of the bank loan covenants that place a number of significant constraints on corporate actions. The loan covenant restrictions were not considered in the IPO range of value.

The court determined that Mr. Eyler failed in his responsibilities when selling his stock to the ESOP. The ESOP paid more than adequate consideration for his stock, thereby creating a prohibited transaction. More significantly, the court upheld the position of the IRS that a good faith attempt was not made to determine the fair market value of the stock.

Due to the determination that a prohibited transaction occurred, the IRS imposed first tier excise taxes (5% annually on the amount of the prohibited transaction), and second tier excise taxes (100% of the amount of the prohibited transaction). In total, the excise taxes imposed on Mr. Eyler amounted to approximately $12,500,000. Additionally, the $10,000,000 ESOP transaction was voided, and Mr. Eyler was ordered to restore the funds to the ESOP. Ultimately, Mr. Eyler incurred a financial reversal approaching $23,000,000 for his failures in the ESOP transaction. The sentence is harsh, but the intent of the legislation is to send a clear message that the fiduciary responsibilities must be taken seriously.

The court ruled that the ESOP paid more than adequate consideration for the stock. The court noted the many errors that were made when the transaction price was determined. Significantly, the court did not say what the ESOP transaction price should have been. No attempt was made by the court to provide a preferred transaction price, only that the price used was improper.


This decision is a Tax Court Memorandum case and they often do not have the same legal impact as a decision from a federal or appellate court. The decision is still significant for a number of reasons. Mr. Eyler failed to determine fair market value in good faith for the stock he sold to the ESOP. The assessment of stock value was critically flawed on several accounts. The assessment of value was originally developed for a different purpose, an IPO, and not for an ESOP. The value should have been questioned when the IPO was not successful. The eventual transaction price was developed by an individual that was not a qualified independent advisor to the ESOP. The assessment of value did not consider a lack of marketability discount. Finally, the excise tax penalties imposed by the IRS in this case serve as a clear signal that fiduciary responsibilities in ESOP transactions are to be taken seriously.

Enterprise Services, Inc. Business Transitions and Valuations
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