Company's Lack of Merger Disclosure to ESOP Participant Not Fiduciary Breach

October 10, 2003 ( - Failure to notify an employee stock ownership plan (ESOP) participant of an impending merger at the time of the ESOP payout is not an Employee Retirement Income Security Act (ERISA) fiduciary breach.

ERISA did not preempt the claim due to the employee’s positing of his argument as a minority shareholder and not as a participant of the ESOP, the US 11th Circuit Court of Appeals found.   Reversing a lower court’s opinion, the appellate court ruled that the presence of an ERISA plan does not automatically require federal jurisdiction.

“In essence, [the participant] claims that he is entitled to the difference in the price he received for his ESOP shares and post-merger announcement price of the shares because the defendants, as the majority shareholder and officers/significant shareholders, had the fiduciary duty to inform him, as a minority shareholder, of the merger discussions … and they did not,” wrote Circuit Judge Stanley Birch Jr.

However, the participant “does not contendthat the valuation for the shares he received under the ESOP was improper under the terms of the ERISA plan. Rather, he hinges defendants’ liability on a failure to communicate material information to which he allegedly was entitled as a shareholder and affected his individual decision to resign and cash out his participant account of shares under the ESOP,” Birch added.

Thus, the appellate court determined the nature of the claim itself must be for benefits due under the plan, which the court characterized as essentially a contract claim, and for relief sufficiently related to that available under the applicable ERISA provisions; otherwise, a dangerous precedent might be set.   “Converting [the participant’s] state law claims derived from state law duties to an ERISA civil action subject to complete preemption would serve to insulate majority shareholders from minority shareholders seeking to exercise their rights by the coincidental nature in the means by which those minority shares were obtained, an ERISA plan,” the court said.

The appeals court sent the case back to the district court, instructing the trial judge to then send the case to the applicable state court.

Case History

Roger Ervast tendered his resignation from Flexible Products Co on October 4, 1999, with a scheduled separation date of October 15.   Immediately after his resignation, Ervast exercised his put options contained in his ESOP.   Under terms of the plan, Flexible was obligated to purchase Ervast’s company stock.  On October 12 Flexible remitted a check to Ervast in the amount of $448,648 for the stock purchase.

At the time of the ESOP option exercise, Flexible was in merger talks with Dow Chemical Co., about which Ervast was unaware.   The merger was consummated in June 2000.   After learning of the deal, Ervast filed suit in state court against Flexible, claiming failure to disclose the impending merger was a fiduciary breach, since such knowledge would have caused him to postpone the liquidation of his ESOP until after the announcement, resulting in a higher distribution amount. The employer had the case removed to federal court.

The case is Ervast v. Flexible Products Co., Eleventh Circuit Court of Appeals, Number 02-15769.