Even as Mercedes Homes has systematically gained creditor approval for a reorganization plan that would pull it out of Chapter 11 bankruptcy, there remains a group of creditors with disgruntled members: the builders’ past and current employees.

If Mercedes' plan is approved, these employee-investors stand to lose all their equity in the Employee Stock Ownership Plan (ESOP). Meanwhile, the Buescher family, which owns 44% of the ESOP shares, will receive 100% of the new company’s stock, because in recent years, the Bueschers have converted much of their stock in Mercedes into debt owed to them by the company due to changing tax laws.

The situation angers former Mercedes employee James Atkinson.

"They get their asset back, and the rest of us are sitting on the sidelines," said Atkinson, a computer-aided design manager who left Mercedes three years ago after working there for 10 years and who has roughly $250,000 worth of ESOP stock. "I spent a lot of time investing and believing in their system," he added.

Mercedes said employees were given, not sold, their shares in the home building firm. The company did not answer other questions posed by BIG BUILDER regarding the ESOP before the publication’s Monday deadline.

Unfortunately for Mercedes employees, there is nothing unusual about ESOP owners losing everything in bankruptcies. Like ordinary stockholders, they are last in line for consideration under reorganization and liquidation plans. What is unusual in Mercedes' case is how the company's founders, who just a few years ago also would have lost everything, will still end up with ownership and control of the Melbourne, Fla.-based builder.

The situation wasn't planned, Mercedes said in bankruptcy documents. Rather, the moves the company said it made over the past eight years to avoid taxes have, in effect, boosted the Buescher family from the bottom of the bankruptcy creditors' ladder to one rung from the top in a position that would keep the company under the family's control, albeit with considerable debt remaining.

Recent Developments
On Friday, July, 17, Mercedes announced that it had reached approval with the majority of its creditors for a reorganization plan that would pull the company out of bankruptcy within eight months of filing for protection under Chapter 11 of the U.S. bankruptcy code.

What it didn't say at the time in the release is that the Buescher family and some of the company's senior managers are the owners of the company's second most senior creditor, Real Estate Investment Ventures (REIV), which is owed $70 million by Mercedes.

Under the company's reorganization plan as currently proposed, the company's top creditor, a consortium of banks managed by Bank of America, has agreed to rewrite and reduce the total loans owed by Mercedes to $140 million, 90% of what it is owed now.

Real Estate Investment Ventures, the second creditor in line, would get all the new stock in the reorganized company after dissolving the company's existing stock, which is in the ESOP.

That situation did cause the company's unsecured creditors to question the plan. Documents filed by the unsecured creditors' committee allege that the movements of cash in and out of REIV had the effect of "camouflaging" what was unsecured equity as secured debt, putting it ahead of the unsecured creditors for reimbursement. It also alleged that there were wrongful transfers of assets out of Mercedes within the year before filing for bankruptcy into REIV.

Mercedes was prepared for the REIV situation to cause complaints. It said in court documents that, even before filing for bankruptcy protection, it put in place an independent special committee to review the related-party transactions, particularly regarding REIV. In the end, the committee found there were no improprieties.

In the documents, Mercedes detailed the contortions it undertook to keep from paying taxes on the company's earnings and how that led to position REIV as a creditor rather than shareholder.

Mercedes’ History as an Employee-Stock Ownership Plan (ESOP) Company
In 1982, Mercedes created its ESOP as a defined contribution retirement plan and trust for its employees. At the time, Mercedes Homes contributed money to allow the ESOP to buy the company's stock. There were considerable tax advantages to doing so; because the ESOP was a tax-qualified retirement plan, it paid no taxes.

Then in 2001, the tax law was changed to apply an excise tax to "disqualified persons" who owned directly or indirectly 50% or more in the ESOP stock. That year, members of the Buescher family owned 46% of the company's common stock. When that was added to the Bueschers’ ESOP stock, these family members accounted for more than 70% of the company's ownership. To avoid paying taxes on the company's earnings because the Bueschers were "disqualified persons" under the tax law changes, the company's board was advised that the Bueschers’ company stock must be purchased or redeemed.

So the company bought the Buescher family's stock for about $42 million on Dec. 17, 2001, to avoid the taxes on corporate earnings.  But Mercedes didn't pay the Bueschers cash. Instead, it issued "Stock Redemption Notes" totaling $42 million to the family. The notes were collateralized by a pledge of stock certificates that Mercedes held in escrow. The purchase price was based on a valuation by Standard & Poor's Corporate Value Consulting arm.

The Mercedes board realized at the time that the transaction might be looked at with suspicion. After all, the Buescher family, which owned the stock, also were members of the board, managing the company, and trustees of the ESOP. So it had Howard Buescher and Jon Buescher resign as trustees of the ESOP and appointed James Lane as sole and independent trustee of the ESOP. Lane was instructed to review the transaction.

Mercedes said that an accountant issued a letter at the time stating that the consideration paid for the common stock did not exceed the fair market price of the shares and that the Stock Redemption Note terms were fair and comparable to loans that would have resulted from arm's-length negotiations between unrelated parties.

More Changes to Tax Laws and ESOPs
Fast-forward to December 2004, when the tax laws governing ESOPs again changed, threatening the tax-exempt status of the Mercedes ESOP. This time, tax law said it counted "synthetic equity," the right to acquire or receive stock of an S-corporation in the future, toward whether someone was a "disqualified person."

Advisors told Mercedes the Stock Redemption Notes it had been issued in 2001 likely qualified as synthetic equity and would push the ownership of the company by disqualified persons to 54.22% as of February 2005. It was suggested that Mercedes could avoid paying a potential $21.6 million tax penalty by paying off the Stock Redemption Notes, which were valued at $128 million at the time.

Mercedes agreed to pay off the Stock Redemption Notes on the caveat that the Bueschers would take the money and loan it back to the company with loans secured by the assets of the company. So the Bueschers and other senior management in the company created REIV on Jan. 6, 2005. At the time, the Bueschers were owed $53 million on the notes for deferred compensation claims, stock options, and some notes payable. Mercedes paid cash to the Bueschers, who put it into REIV. Then Mercedes borrowed $42 million back from REIV. On Jan. 31, 2005, Mercedes gave REIV a promissory note for $50 million. A year later, REIV increased the loan to Mercedes to $125 million.

Reorganization Plan Pending
The law firm representing the unsecured creditors' committee did not return BIG BUILDER’s telephone calls last week to discuss its earlier objections to the transfers of Mercedes assets into REIV and whether the committee has since decided to support the reorganization plan.

Under the current plan, the company's general unsecured creditors would receive between 12% and 15% of the $40 million to $50 million they are owed.

That is more than the general unsecured creditors would be entitled to receive under normal circumstances, Mercedes pointed out in court documents. The company stressed that if its plan for reorganization is not approved and the company is forced into liquidation under Chapter 7, there would be nothing left for the general unsecured creditors "because the combined value of the secured claims of the First Lien Lenders and REIV are greater than the total enterprise value of the Debtors."

Teresa Burney is a senior editor at BIG BUILDER and BUILDER magazines.

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