The Labor Department, seeking to curb what it sees as abuses of a generous tax break, has fired a volley of lawsuits in recent months that is rattling windows in small and medium-size corporations across the country.

Executives, lawyers and employee benefits experts say that if the department wins in court, an important mechanism for spreading corporate ownership among American workers will be sharply curtailed. For its part, however, the department, as indicated by the suits it has filed, believes it is heading off a major abuse of employee benefit funds.

At issue is a legal device known as a "leveraged employee stock ownership plan," or leveraged ESOP, under which a company's employees borrow money through a trust to buy stock in their employer. The stock is held by the trust, and the employer makes annual tax-deductible contributions to the trust so that it can pay off the loan.

ESOPs are increasingly popular. They are usually used to fund pension plans, but they can also fund other benefits such as retiree health care coverage. This puts them in a special legal category that allows special tax benefits but also carries strict requirements to protect the rights of employees.

In the case of small, closely held businesses, they provide a way for the owner or the owner's family to pass on the business to its employees when the owner steps down or dies.

Some 11,000 companies, with 11 million workers, now have ESOPs.

But ESOPs can be abused. Owners of companies whose stock is not traded publicly have been known to arrange for the ESOP to pay too much for its shares, resulting in a windfall for the owners.

The 1974 law that promoted ESOPs requires that the trust pay "adequate consideration" for stock that it acquires, and adequate consideration is defined as "the fair market value ... as determined in good faith by the trustee" or other responsible person.

However, it took the Labor Department 14 years to draft regulations covering the adequate consideration requirement, and those rules, published in 1988, are still not final. In the meantime, the department and ESOP sponsors have clashed repeatedly over what is permissible and what is not.

Over the years, the department compelled a number of sponsors to modify or drop their ESOP plans on the grounds that the employees would be paying too much.

Two current cases carry this dispute a step further.

In one, the ESOP participated in a leveraged buyout and paid nearly five times as much per share as did the management officials and outside investors who also bought into the firm. The Labor Department contends that the ESOP should have paid the same price as other investors. The firm, Kroy Inc., a Scottsdale, Ariz., maker of lettering devices for graphic arts, is now in bankruptcy proceedings.

In the second case, an ESOP purchased a block of stock from the estate of the company's founder. The company, Wardwell Braiding Machine Co. of Central Falls, R.I., borrowed $5.4 million and lent that money to the ESOP to buy the stock. The Labor Department argues that the price paid was too high because it failed to take into account the debt, which it contends makes the company less valuable.

ESOP experts view both cases as disturbing, but find the Wardwell one particularly so because borrowing would always lower the value of a company. Under the Labor Department's theory, according to the critics, a leveraged ESOP would always have to pay less than another buyer who also had to borrow money to complete the deal.

If the department prevails, "it would be the end of the leveraged ESOP, clearly. What shareholder is going to sell" to an ESOP when he could get more from an outside buyer, asked Edwin G. Torrance of the law firm of Hinckley, Allen Snyder & Comen in Providence, which represents Wardwell.

David Binns, executive director of the ESOP Association, a trade group, called the case "a bolt from the blue."

Labor Department officials refused to discuss the case. In their eight-page complaint in U.S. District Court in Rhode Island, they charged that the ESOP administrators "failed to make a good faith determination of the fair market value of the {Wardwell} stock ... , and caused the ESOP to pay more than 'adequate consideration' for the stock. ..."

The administrators did this "by failing to take into account the cash drain on Wardwell represented by the company's anticipated contributions to the ESOP, and the requirement that it repay" the debt undertaken in connection with the ESOP, the department charged.

Washington attorney Luis Granados agreed that if the department succeeds in the Wardwell case, it will be very difficult to do a leveraged ESOP. He added that ESOP trustees around the country are alarmed at the case because "there have been billions of dollars of deals done, all of them based on standard business appraisal practice, which the department now says was all wrong."

Jonathan Farnum, who currently heads Wardwell, said, "We're mystified by all this. We set this all up exactly as {the firm's accountants} told us to." He said the stock price did go down initially, but "it's now way higher than when we started and we can't see why anybody would question the transaction."

The Kroy case raises a different issue, and attorneys said that how disruptive it is will depend on how the case is decided. Several said the department could win on procedural grounds and cause few problems for other ESOPs. But if the New York federal court chooses to rule in broad terms, leveraged ESOPs involving outside investors could be made much harder to set up.