Understanding the Duties of ESOP Board Members and Trustees
At the 2024 New England Spring Conference, Jennie Msall, Director at Ventura Trust Company, joined a panel of experts to explore the distinct yet interconnected roles of the Board of Directors and the ESOP Trustee in employee-owned companies. Her presentation offered a clear and practical overview of the legal and fiduciary responsibilities that guide these two essential governance bodies.
Corporate Governance in an ESOP Company
Corporate governance defines how a company is directed and controlled. In an ESOP-owned business, this framework includes the Board of Directors, the ESOP Trustee, and company officers. Once a company becomes 100% ESOP-owned, the Trustee becomes the sole shareholder and appoints the Board, which then oversees the management team.
The Role of the Board of Directors
The Board is responsible for setting the company’s strategic direction, evaluating and compensating the CEO, approving major decisions, managing risk, and planning for leadership succession. In an ESOP context, the Board also oversees the ESOP itself—adopting or amending the plan, determining contributions and distributions, and directing the Trustee in accordance with the plan document. The Board may also outsource these ESOP administrative tasks to a Plan Administrative Committee.
Best practices for board composition include having three to seven members with a mix of internal and independent directors, diverse backgrounds, and staggered terms. Regular performance evaluations are also encouraged.
Why Independent Directors Matter
Independent directors bring objectivity, reduce conflicts of interest, and offer broader perspectives and credibility with external stakeholders. However, they may face challenges such as limited familiarity with ESOPs or confidentiality constraints. Boards should aim to recruit directors whose skills complement those of the management team.
Legal and Fiduciary Responsibilities
Board members are bound by state law to uphold two core duties: the duty of care—being informed and diligent in decision-making—and the duty of loyalty—acting in the company’s best interest and avoiding conflicts. The business judgment rule protects directors who act in good faith and with reasonable care.
The ESOP Trustee’s Role
The Trustee is legally obligated to act solely in the interest of plan participants. This includes managing plan assets, making loan payments, overseeing distributions, determining the fair market value of shares, and voting as a shareholder on behalf of the ESOP. Trustees must meet ERISA’s fiduciary standards and act with the prudence of an expert.
How the ESOP Functions as a Shareholder
The ESOP, through its Trustee, is the legal shareholder of the company. In certain major corporate events—like mergers or asset sales—participants may have the right to vote directly. In most cases, however, the Trustee votes on shareholder issues on behalf of the plan.
Collaboration Between Board and Trustee
Effective governance relies on strong collaboration between the Board and the Trustee. This includes the Trustee attending board meetings as an observer, working together on the annual valuation update, participating in board elections, and working with the board on repurchase liability planning. While it’s the Board’s responsibility to respond to unsolicited offers, the ultimate decision to sell the company to a third party buyer will require Board and Trustee collaboration. The Trustee also ensures that the CEO evaluation process is properly conducted.
Real-World Scenarios
The presentation included case studies that highlighted the importance of communication and clearly defined roles. These scenarios covered topics such as adjusting executive compensation, addressing poor operational decisions, navigating company sales, and resolving valuation disputes.
Conclusion
Strong governance in an ESOP company depends on a clear understanding of roles and a commitment to communication and partnership. When the Board and Trustee work together effectively, they not only protect the interests of employee-owners but also help ensure the long-term success of the company.