VINCENT L. BRICCETTI, District Judge.
Plaintiff Edward Hugler,
Before the Court are First Bankers's motion for summary judgment (Doc. #118) and the Secretary's cross-motion for partial summary judgment (Doc. #134).
For the reasons set forth below, both motions are DENIED.
The Court has subject matter jurisdiction pursuant to 28 U.S.C. § 1331.
The parties have submitted briefs, statements of material facts, and declarations with supporting exhibits, which reflect the following factual background.
In 2005, The Rembar Company Inc. ("Rembar") was a closely-held corporation located in Dobbs Ferry, New York. Rembar manufactured and distributed precision parts and components made from refractory metals, and distributed refractory metals in raw form to lowervolume producers.
First Bankers is a trust company based in Quincy, Illinois, that acts as trustee and custodian for employee benefit and personal trust accounts. In April 2005, Rembar retained First Bankers to serve as trustee for the Rembar ESOP in connection with a transaction in which the ESOP would purchase 100% of Rembar's stock from selling shareholders Frank Firor, Virginia Keilty, and Rosemary Brockett.
Prior to the 2005 ESOP transaction, Firor was Rembar's chief executive officer, chairman of the board of directors, president, and majority stockholder. Firor owned 81.88% of Rembar's then outstanding shares, Keilty owned 11.77%, and Brockett owned 6.35%.
In January 2005 after Firor became interested in selling his Rembar shares, Rembar engaged Corporate Solutions Group ("CSG"), an investment bank, to evaluate the feasibility of establishing an ESOP
At CSG's suggestion, Rembar established an ESOP formation committee to retain a valuation company to prepare a preliminary valuation. Firor participated in the formation committee's activities.
On February 8, 2005, the formation committee retained Empire Valuation Consultants, LLC ("Empire") to prepare a preliminary valuation of the fair market value of Rembar's stock. In connection with the preliminary valuation work Empire performed, it reviewed a confidential information memorandum prepared by CSG that contained historical and financial data concerning Rembar.
Empire and CSG engaged in discussions regarding the value of Rembar's stock before Empire issued its preliminary valuation. Terence Griswold, a managing director at Empire, testified that his firm initially proposed a valuation "in the high 13 millions, and [CSG] said 20 million." (Sullivan Decl. Ex. I, at 93:2-16). CSG urged Empire to increase its preliminary valuation conclusion, and specifically sought to persuade Empire to adjust valuation factors such as the discount rate. Empire and CSG ultimately agreed to a valuation of $15.5 million after Empire communicated to CSG, "We're not going any higher." (
Empire subsequently issued a preliminary valuation on March 4, 2005, to the Rembar formation committee c/o Walter Pastor (Pastor was a Rembar officer named to head the formation committee). The preliminary valuation was also shared with Firor. Empire's preliminary valuation concluded that as of February 15, 2005, for potential ESOP purposes, the fair market value of 100% of Rembar's common stock was $15.5 million, on a controlling interest basis. This valuation conclusion included the application of a 25% control premium and used a weighted average cost of capital discount rate that was calculated based on a capital structure of 50% debt and 50% equity.
On April 13, 2005, following the issuance of the preliminary valuation and at CSG's suggestion, Firor signed an engagement letter on behalf of Rembar appointing First Bankers to act as the ESOP's independent trustee in connection with the transaction.
Paragraph 9(a) of the FBTS engagement letter states:
(Sullivan Decl. Ex. B, at DOL0019924). Paragraph 11 then provides:
First Bankers's continued engagement as Trustee is contingent upon the following:
(
After the ESOP engaged First Bankers, CSG instructed Empire to send First Bankers an engagement letter. Empire complied and sent First Bankers an engagement letter dated April 5, 2005, which was countersigned by First Bankers and Rembar as of May 25, 2005. The letter specified that Empire was engaged to act as financial advisor to First Bankers in its capacity as trustee to the ESOP. It also stated that Empire would "express its updated opinion as to the fair market value of Rembar's common stock on, or before a date where [sic] Empire will present its conclusions to the Trustee" and "render a fairness opinion as of the Transaction Date with respect to the acquisition of the common stock by the ESOP." (Schnapp Decl. Ex. 3, at 1). The engagement letter further stated that Empire "will represent only the interests of the ESOP participants and beneficiaries." (
First Bankers also retained Brian Snarr, an attorney of the law firm Morrison Cohen LLP, as its legal counsel in connection with the 2005 ESOP transaction.
As part of its role as trustee, First Bankers formed an employee benefits committee (the "EB committee") to represent the ESOP's interests and vote on whether to approve the 2005 transaction. Such approval required the unanimous vote of the EB committee members. Among the eight First Bankers employees who served on the EB committee were certified public accountants, holders of masters of business administration degrees, and licensed attorneys. Specifically, the EB committee members included: First Bankers's president, Brian Ippensen; First Bankers's administrative trust officer, Kimberly Serbin; and First Bankers's business development officer, Merri Ash.
Prior to its appointment as trustee of the Rembar ESOP, the EB committee conducted a pre-acceptance review process to determine the feasibility of the proposed transaction. This review process involved an examination of Rembar and its business (including its performance and financial history), and a review of the proposed transaction structure.
One of the agreements entered into as part of the Rembar ESOP transaction was a limitation agreement dated as of June 17, 2005, among Rembar, First Bankers as the ESOP's trustee, and the selling shareholders. The recitals of the limitation agreement provide,
(Schnapp Decl. Ex. 15, at DOL0016293).
Section 3.2(d) of the limitation agreement contains a covenant of First Bankers as trustee, which provides:
(Schnapp Decl. Ex. D, at 6).
Other key provisions of the limitation agreement include Section 3.1(a), which limits Firor's annual compensation from Rembar for the following five fiscal years to $75,000 per year, and Section 3.1(c), which requires Rembar to distribute the company's annual net earnings as a shareholder dividend, unless the board of directors exercises its discretion to retain up to $100,000 of its net earnings each year.
On April 12, 2005, First Bankers's counsel, Snarr, sent a request for due diligence materials to Rembar's counsel, Stanley Bulua, asking for numerous documents related to Rembar's corporate formation, business matters, risk factors, financials, and tax information, among other things. (Schnapp Decl. Ex. 6). Snarr also prepared a due diligence memorandum, a draft of which was circulated to Bulua on May 17, 2005, identifying various issues relating to the proposed ESOP transaction, including issues with Rembar's financial statements, and documentation that Rembar had not yet provided. Before it approved the transaction, First Bankers also received an "ESOP Transaction Memorandum" prepared by Bulua, along with a due diligence report prepared by Snarr. First Bankers performed its own due diligence by,
First Bankers claims it reviewed Empire's final valuation in draft form to ensure the completeness of its information, scrutinize and understand the methodologies used, and formulate any questions it may have based on the information it contained. The Secretary disputes whether First Bankers actually engaged in such a review of Empire's report, pointing out that much of Ippensen's testimony that First Bankers relies on discusses how First Bankers
The parties also dispute whether and the extent to which First Bankers and Empire engaged in discussions regarding Empire's valuation ahead of the June 13, 2005, EB committee meeting.
According to the Secretary, the
First Bankers claims it used the information it obtained from its initial due diligence process to test the reasonableness of Empire's final valuation. But, again, the Secretary points out that the Ippensen testimony upon which First Bankers relies in making this statement discusses what First Bankers
On June 13, 2005, the EB committee held a meeting to consider whether to approve the Rembar ESOP transaction.
Consistent with Eckl's presentation at the EB committee meeting, Empire's final valuation report dated June 16, 2005, concludes:
(Sullivan Decl. Ex. L, at 53).
In reaching its valuation conclusion, Empire analyzed and relied on Rembar's reviewed financial statements for the five years ended May 31, 2000 through 2004, internally prepared results for the eleven months ended April 30, 2005, and financial projections provided by Rembar's management.
On June 17, 2005, the ESOP purchased 100% of the 100,000 issued and outstanding shares of Rembar from the selling shareholders for $15.5 million (representing $155 per share). In order to finance the stock purchase, the ESOP borrowed $15.5 million from Rembar, to be paid back over a 26-year term at an annual interest rate of 4.83%. The ESOP loan was secured by the shares purchased from the selling shareholders. Rembar, in turn, financed the ESOP loan with $4 million cash on hand, $5 million bank term loans, and a $6 million one-day loan. Rembar also borrowed $6.5 million from the selling shareholders in exchange for subordinated notes, which Rembar then used to pay back the $6 million one-day loan.
Following the consummation of the 2005 ESOP transaction, Rembar made payment on its debt obligations until 2009, when it became unable to service its debts as they became due. On July 30, 2009, as part of a restructuring, the ESOP surrendered the unallocated Rembar shares to Rembar, and Rembar purchased the allocated shares held by the ESOP for $15,500 (representing $1.0075 per share), cancelled the ESOP loan, and terminated the ESOP. (Schnapp Decl. Ex. 16; Sullivan Opp'n Decl. Ex. EE). The selling shareholders also cancelled the outstanding debt Rembar owed them pursuant to the subordinated notes. (Schnapp Decl. Ex. 18, at 5).
On November 28, 2012, the Secretary filed its initial complaint against Firor, First Bankers, and the ESOP. (Doc. #1). Firor moved to dismiss pursuant to Rule 12(b)(6), and the Secretary filed an amended complaint on May 3, 2013. (Doc. #15). The amended complaint alleges that in connection with the 2005 ESOP transaction, (i) First Bankers and Firor breached their fiduciary duties to the ESOP in violation of ERISA § 404(a)(1)(A), (B) & (D), 29 U.S.C. § 1104(a)(1)(A) & (B); (ii) First Bankers caused the ESOP to engage in a prohibited transaction in violation of ERISA § 406(a)(1)(A) & (D), 29 U.S.C. § 1106(a)(1)(A) & (D); and (iii) Firor was subject to equitable relief, including disgorgement.
On June 17, 2013, Firor again moved to dismiss (Doc. #21); the Court denied that motion on January 13, 2014 (Doc. #28).
Following a lengthy and contentious discovery period, the parties participated in the Court-annexed Mediation Program, which resulted in a settlement agreement between the Secretary and Firor. On May 3, 2016, the Court entered a Consent Partial Judgment and Order pursuant to which,
On August 12, 2016, First Bankers moved for summary judgment (Doc. #118), and on November 21, 2016, the Secretary cross-moved for partial summary judgment (Doc. #134).
The Court must grant a motion for summary judgment if the pleadings, discovery materials before the Court, and any affidavits show there is no genuine issue as to any material fact and it is clear the moving party is entitled to judgment as a matter of law. Fed. R. Civ. P. 56(c);
A fact is material when it "might affect the outcome of the suit under the governing law . . . . Factual disputes that are irrelevant or unnecessary" are not material and thus cannot preclude summary judgment.
A dispute about a material fact is genuine if there is sufficient evidence upon which a reasonable jury could return a verdict for the non-moving party.
If the non-moving party has failed to make a sufficient showing on an essential element of her case on which he has the burden of proof, then summary judgment is appropriate.
On summary judgment, the Court construes the facts, resolves all ambiguities, and draws all permissible factual inferences in favor of the non-moving party.
In deciding a motion for summary judgment, the Court need only consider admissible evidence.
As an initial matter, First Bankers argues the Secretary's claims should be dismissed as untimely under Section 413 of ERISA. Section 413(1) of ERISA provides:
29 U.S.C. § 1113. According to First Bankers, the last action which constituted a part of the alleged breach or violation occurred when the Rembar ESOP transaction closed on June 16, 2005. The Secretary commenced this action by filing its initial complaint on November 28, 2012, which is well after the expiration of the six-year statutory period specified in Section 413(1).
The Secretary argues First Bankers has waived its affirmative defense that the Secretary's claims are time-barred under Section 413(1) because First Bankers signed three agreements in which it agreed not to raise a timeliness defense in exchange for the Secretary's agreement to delay filing this action. First Bankers does not dispute that it entered into these agreements. Instead, it argues that because the six-year limitation contained in Section 413(1) is a statute of repose, and not a statute of limitations, it is an absolute barrier to an untimely suit that is not subject to equitable tolling principles.
First Bankers's argument is not persuasive.
First Bankers is correct that "[s]tatutes of limitations, but not statutes of repose, are subject to equitable tolling, a doctrine that `pauses the running of, or tolls, a statute of limitations when a litigant has pursued his rights diligently but some extraordinary circumstance prevents him from bringing a timely action.'"
Equitable tolling, however, is not at issue here. Instead, the timeliness of the Secretary's suit turns on whether Section 413(1) may be tolled by express agreement of the parties.
First Bankers points to
But the issue before the
First Bankers also urges this Court to consider the Second Circuit's decision in
In concluding that the Securities Act's statute of repose is not tolled by the filing of a class action complaint, the Second Circuit emphasized that statutes of repose "`create a
This Court concludes that "no public policy would be offended by permitting a private party like [First Bankers] to contract out of [ERISA]'s statute of repose with a particular litigant. In fact, a very important public interest may be served by doing so."
Accordingly, this Court rejects First Bankers's argument that the Secretary's claims should be dismissed as untimely.
ERISA is a remedial statute designed to protect beneficiaries of employee benefit plans.
In addition to the general fiduciary obligations set forth in Section 404 of ERISA, Section 406 prohibits "certain categories of transactions believed to pose a high risk of fiduciary self-dealing."
Because Firor was chairman of the board of directors, chief executive officer, president, and 82% shareholder of Rembar, there is no dispute that the June 16, 2015, sale of 100% of Rembar's shares to the ESOP, was a prohibited transaction under Section 406.
However, to encourage employees' ownership of their employer company, Section 408(e) permits the sale of employer stock by a party in interest to an ESOP if the purchase is made for "adequate consideration." 29 U.S.C. § 1108(e). "In transactions involving securities with no known market value, as is the case here, ERISA defines `adequate consideration' as `the fair market value of the asset as determined in good faith by the trustee or named fiduciary pursuant to the terms of the plan."
Whether a fiduciary has made a proper determination of "fair market value" depends on whether the parties "are well-informed about the asset and the market for that asset."
The role of courts in reviewing the adequacy of consideration in an ERISA case is to determine whether the fiduciary can show that the price paid represented a good faith determination of the fair market value of the asset at the time the challenged transaction was consummated, "not to redetermine the appropriate amount for itself
Under ERISA, the fiduciary bears the burden of proving by a preponderance of the evidence that the ESOP received "adequate consideration" for its purchase of company stock.
The Secretary's case centers on its claim that First Bankers approved the ESOP's purchase of Rembar's stock from the selling shareholders for more than adequate consideration. The alleged Section 406 violation can be established only if the "adequate consideration" exemption from Section 406 is not applicable. Similarly, the Secretary's claim that First Bankers's conduct violated its general duties of prudence under Section 404 is based on its view that First Bankers authorized the ESOP to pay too much for the stock. The Secretary does not contend the Rembar stock purchase was not undertaken "solely in the interest of the participants" of the ESOP or for any other improper reason, nor does it contend the purchase of Rembar stock, if made for adequate consideration, would have been imprudent for some other reason. Thus, although payment of adequate consideration is a statutory defense only to a violation of Section 406, and not of Section 404, under the Secretary's theory of this particular case, the Court's inquiry will substantially be the same.
First Bankers contends its conduct and internal procedures demonstrate that it thoroughly investigated the 2005 Rembar ESOP transaction and Empire's valuation report with "ample due diligence to more than satisfy its duties" under Sections 404 and 406. (Def.'s Br. at 22).
Specifically, First Bankers argues the record demonstrates: (i) it confirmed Empire used complete and accurate information in performing its valuation of Rembar's stock; (ii) Empire was qualified, experienced, and justifiably had First Bankers's full confidence with regard to its advisory and valuation capabilities; (iii) First Bankers conducted its own due diligence before agreeing to be engaged as the Rembar ESOP's trustee; (iv) First Bankers's due diligence prior to approving the 2005 transaction included (a) an on-site visit at Rembar, (b) review of Rembar's financial information, (c) the engagement of Empire as its independent financial advisor, (d) review and analysis of Empire's valuation report, (e) and review of legal due diligence reports; and (v) First Bankers engaged in an active dialogue with its advisors and had at least one EB committee meeting in which its independent financial and legal advisors participated, prior to approving the transaction. Additionally, First Bankers argues it is entitled to summary judgment because the Secretary cannot show the ESOP has sustained an actual economic loss.
In turn, the Secretary contends that it is entitled to partial summary judgment because the record demonstrates First Bankers failed to determine the fair market value of Rembar in good faith by (i) failing to investigate Empire's independence as a financial advisor prior to relying on its valuation; (ii) failing to review Empire's valuation with sufficient scrutiny and thus failing to ascertain that the discount rate and control premium conclusions were unfounded; and (iii) failing to negotiate the price the ESOP paid for Rembar's stock.
According to the Secretary, First Bankers's reliance on Empire's valuation was imprudent because Empire was not truly independent. The Secretary's contention rests on three principal arguments. First, the Secretary contends that because First Bankers's engagement as the Rembar ESOP trustee was contingent on hiring Empire as its financial advisor, First Bankers was not actually free to select its own independent financial advisor. Second, because Empire had already performed preliminary valuation work that was shared with Firor—the principal selling shareholder—Empire's valuation work for First Bankers was conflicted by its prior engagement. Third, the Secretary claims Empire's valuation conclusions were not based entirely on Empire's view of Rembar's financials, but instead were the result of negotiations with the sellers' agents prior to First Bankers's involvement in the ESOP transaction.
Securing an independent assessment from a financial advisor or legal counsel is evidence of a thorough investigation, but it is not a complete defense against a claim of imprudence.
Moreover, "[o]ne extremely important factor" courts consider "is whether the expert advisor truly offers independent and impartial advice."
The record here raises questions regarding Empire's independence and First Bankers's investigation into Empire's independence. According to Ippensen's declaration, Empire's performance of both preliminary valuation work for the Rembar ESOP formation committee and "independent" valuation work for the ESOP trustee, was consistent with customary practice in the ESOP industry. (Schnapp Decl. Ex. 5 ¶ 18). But it is not clear that this statement takes into account the fact that Firor participated in the formation committee's activities and received Empire's preliminary valuation.
In his deposition, Ippensen testified that the experience Empire had with Rembar was one of the reasons First Bankers retained Empire as its financial consultant, and that he understood Empire "would have shared [its preliminary valuation] with a Rembar Formation Committee." (Sullivan Decl. Ex. Y, 49:16-22). But Ippensen also testified he was not aware whether or not Empire's preliminary valuation had been shared with the selling shareholders or their agents. Moreover, he testified that had he known Empire's preliminary valuation had been shared with the selling shareholders, that would "raise . . . issues for First Bankers in deciding whether to be trustee." (
Next, the Secretary argues a prudent inquiry into Empire and the preliminary work it did for the Rembar formation committee would have revealed that Empire's final valuation was almost exactly the same as its preliminary valuation, and that Empire's valuation conclusion was not based entirely on Empire's view of Rembar's financials, but instead was the result of negotiations with CSG.
The record supports the Secretary's contention that CSG and Empire negotiated the value of Rembar's stock before Empire issued its preliminary valuation.
(Sullivan Decl. Ex. M). Firor replied to Meshechok:
Furthermore, First Bankers's appointment as the Rembar ESOP's trustee was expressly contingent on engaging Empire as First Bankers's financial advisor, which casts further doubt on Empire's independence and First Bankers's "care and impartial investigation" into Empire.
Additionally, the notes from the June 13, 2005, EB committee meeting indicate only one question was asked regarding Empire's valuation: "Ippensen asked [Eckl] if he knew how Rembar had previously come up with their number. [Eckl] said he did not know. He pointed out that Empire ha[d] been engaged by the company and will be working for the Trustees." (Sullivan Decl., Ex. C). The record does not contain any contemporaneous evidence demonstrating that any follow up questions were asked, or that First Bankers undertook any further investigation into how the preliminary valuation number was derived.
As a whole, this record raises doubts—and questions of fact—regarding Empire's independence as a financial advisor and valuation consultant for First Bankers in connection with the 2005 transaction, and regarding First Bankers's inquiry into Empire's independence.
The Secretary also argues it is entitled to summary judgment because First Bankers breached its fiduciary duties by not negotiating the purchase price the ESOP paid for Rembar's stock.
First Bankers, on the other hand, contends it negotiated the stock price, ESOP note terms, flow of funds, the seller finance notes, the limitation agreement, and the plan and trust documents, in connection with the 2005 transaction. However, the evidence First Bankers relies on in support of this contention is less than clear.
Initially, Ippensen testified "the list [of what First Bankers negotiated] would have been price, obviously the price of the stock. It would have been ESOP note terms, which would have been length of the notes and the interest rate on that note. The flow of funds . . . [, t]he seller finance notes, would have been part of that negotiation process. The Limitation Agreement was part of that negotiation process. The plan and trust document would have been a part of that negotiation process. That's the only ones that I can think of." (Schnapp Decl. Ex. 24, at 123:1-14).
Ippensen later testified, however, that the stock purchase price was effectively not negotiated—the sellers made an offer to the buyers, and the ESOP never made a counteroffer. (Sullivan Decl. Ex. Y, at 205:5-15). Serbin testified that she did not recall the price negotiations for the 2005 transaction, but that First Bankers typically negotiates ESOP transactions through its counsel. (
First Bankers maintains it did in fact negotiate the price of Rembar's stock, highlighting the fact that Empire ultimately valued 100% of Rembar's stock at $16 million, while the transaction closed at $15.5 million. Moreover, First Bankers emphasizes that Griswold, a managing director at Empire, testified that prior to closing, CSG called Empire seeking to persuade Empire to increase its valuation to $18.5 million.
Courts have relied on the failure to negotiate the purchase price to support a finding that the fiduciary did not act in good faith on behalf of the ESOP.
While it appears from the record that First Bankers engaged in less-than-vigorous negotiations on behalf of the ESOP, that factor alone is insufficient to find, as a matter of law, that First Bankers did not act in good faith. Moreover, the extent to which First Bankers negotiated the 2005 transaction generally and the stock purchase price specifically, is a question of fact that has not been established by either party.
The Secretary also argues the Rembar ESOP paid more than fair market value for the Rembar stock because it paid a control premium despite agreeing to forfeit the ESOP's control of the Rembar board by entering into the voting covenant contained in Section 3.2(d) of the limitation agreement.
On May 18, 2005, Snarr emailed Bulua and others at Rembar, CSG, and First Bankers, a draft of the limitation agreement, which contained the Section 3.2(d) voting covenant. (Sullivan Decl. Ex. Q, at 6). Snarr explained to First Bankers that the reason for the voting covenant was because Firor "did not want to go forward with the transaction absent the ability to have effective control of the board while his notes were outstanding." (
Bulua testified that he considered the voting covenant "belt and suspenders because in an ESOP transaction the owner of the company or the Board usually directs the ESOP as to who to vote for on the Board anyway." (Schnapp Decl. Ex. 29, at 82:19-83:1). The Secretary, however, disputes that Section 3.2(d) provided Firor with rights that he would have had anyway in the absence of this provision, and First Bankers points to no other evidence that corroborates Bulua's testimony. Ippensen, for example, testified that the Rembar board could not direct First Bankers as to how to vote the shares held by the ESOP. (Sullivan Opp'n Decl. Ex. Y, at 148:4-7). Moreover, Griswold testified that he had not seen a provision like the Section 3.2(d) covenant in any ESOP transaction prior or subsequent to the Rembar transaction. (Schnapp Decl. Ex. 31, at 146:3-11).
The parties also dispute the extent to which First Bankers negotiated the terms of the limitation agreement. First Bankers relies on Ippensen's testimony regarding how First Bankers
Ash is the EB committee member who signed the limitation agreement on behalf of First Bankers as the ESOP's trustee. In her deposition, Ash testified that she
In the context of discussing a proposed non-compete covenant agreed to by Firor, an email from Bulua to Snarr dated June 8, 2015, frames Snarr's position that "since Frank [Firor] would be in control of Rembar he should not get out of the covenant [not to compete] if he has control over whether he is being paid on his note." (Sullivan Decl. Ex. T). Snarr responded to Bulua's email on June 9, 2015, copying Ash and Serbin of First Bankers, and further explaining his position regarding Firor's non-compete agreement. Thus, arguably, Ash and Serbin were on notice that Snarr believed Firor would continue to effectively control Rembar following the consummation of the 2005 transaction.
Snarr testified that if First Bankers concluded that appointing Firor's director choices would violate ERISA, "the trustee always had the ability to choose to breach the agreement and honor its obligations under ERISA . . . if it thought that was the more prudent decision." (Sullivan Decl. Ex. N, at 88:8-18). Bulua, on the other hand, testified that Section 3.2(d) required that the trust vote a certain way. (
But Snarr and Bulua's opinion that First Bankers could breach the limitation agreement rather than vote for candidates they felt were imprudent is inconsistent with Ippensen and Ash's position that the provision did not require them to vote for Firor's candidates in the first place.
Moreover, even if First Bankers could choose to breach the voting covenant rather than vote for imprudent board members, the Secretary disputes that this is relevant to its claim that Section 3.2(d) is a limitation on the ESOP's control of the company and thus should have impacted the control premium paid by the ESOP. The Secretary also disputes that members of First Bankers's EB committee discussed the individuals' interpretations of what Section 3.2(d) required them to do prior to approving the 2005 transaction. Specifically, the Secretary disputes that First Bankers ever contemporaneously discussed, amongst the EB committee members or with counsel, whether the limitation agreement permitted First Bankers to retain the ability to accept or remove the directors nominated by Firor. According to the Secretary, this view of the limitation agreement is not reflected in any contemporaneous documents, including the notes from the June 13, 2005, EB committee meeting during which First Bankers approved the transaction. Serbin testified she does not recall seeking legal advice with respect to the meaning of Section 3.2(d). (Sullivan Decl. Ex. Z, at 94:20-95:2). Ippensen also testified he does not recall whether the EB committee discussed his asserted understanding of the limitation agreement with regard to voting for board members.
Moreover, Empire's final valuation does not specifically mention Section 3.2(d) of the limitation agreement or explain whether the voting covenant it contains was factored into Empire's analysis.
Section G of the final valuation under the heading, "Issues of Control: Enterprise Value" states:
(Sullivan Decl. Ex. L at 46-47).
First Bankers contends the voting covenant was in fact considered by Empire, pointing to Ippensen's testimony that, "We talked about the control premium that they put on to the value and what was in the Limitation Agreement." (Schnapp Decl. Ex. 24, at 67:17-19). Ippensen further testified that Empire incorporated the effect of [the voting covenant] into its valuation as part of the control premium." (
The Secretary, on the other hand, maintains that Empire and First Bankers did not consider the effect of the voting covenant on the valuation, and that Empire did not advise First Bankers as to the effect of the covenant on the valuation. The Secretary emphasizes that the percentage control premium applied by Empire did not change between its preliminary and final valuations, even though the limitation agreement had not yet been contemplated at the time of the preliminary valuation. Furthermore, Ippensen further testified that the control premium "matched our understanding of buying 100 percent of the company . . . the question becomes why would there be a control premium applied? Pretty simple, we bought 100 percent of the company in the Rembar transaction." (Sullivan Opp'n Decl. Ex. Y, at 117:8-16, 120:18-21).
The Secretary's position is that the voting covenant limited the control the ESOP actually had over Rembar. In that regard, Eckl testified that he believed the ESOP's ability to challenge the voting covenant was "a legal question more than a valuation question." (Sullivan Opp'n Decl. Ex. V2, at 180:8-16). Eckl further testified that Firor's ability to name the majority of the Board "was a short-term thing." (
The report of Bradley Van Horn, First Bankers's expert, states: "One of the effects of the Limitation Agreement is that full control over the Company's Board of Directors will not pass to the Trustee until the Seller Subordinated Note is paid in full, which is expected to occur several years subsequent to the transaction date." (Sullivan Decl. Ex. X at 55). Accordingly, Van Horn concludes that for his own valuation of Rembar:
(Sullivan Decl. Ex. X, at 55). James Krillenberger, the Secretary's valuation expert, applied a control premium of 12.5% to the value of Rembar's stock. (
On this record, the Court concludes the Secretary has raised a triable question of fact regarding whether First Bankers acted prudently in understanding the limitation agreement and voting covenant, and whether it properly ensured the control premium paid by the ESOP was fair.
The Secretary also argues First Bankers breached its fiduciary duties by accepting the flawed discount rate Empire applied in determining Rembar's value.
In preparing its final valuation of Rembar, Empire utilized and evenly weighted two valuation methodologies: (i) the debt-free discounted cash flow method ("DCF"); and (ii) the capitalization of debt-free cash flow method. Empire's DCF analysis used forecasts of Rembar's future cash flows together with a required rate of return by which to discount the projected cash flows back to their present value. In order to estimate the required rate of return, Empire calculated Rembar's weighted average cost of capital ("WACC"). The development of the WACC requires Rembar's cost of debt and cost of equity to be determined separately. As explained by First Bankers's expert Van Horn, "the discount rate is a measure of the riskiness of a company, so the higher the discount rate, the lower the valuation conclusion, and the lower the discount rate, the higher the valuation conclusion." (Sullivan Decl. Ex. CC, 64:5-9). The discount rate Empire used in both its preliminary and final valuations, relied on an assumed capital structure of 50% equity and 50% debt. Empire's final valuation report explains that this assumed capital structure "takes into account Rembar's lack of debt historically, expected future debt levels that in the short term will be uncharacteristically high, and the asset base which can be leveraged against." (Sullivan Decl. Ex. L, at 39).
Krillenberger, the Secretary's expert, opined that Empire's valuation conclusion was:
(Sullivan Decl. Ex. W, at 14-15). Krillenberger concluded that a capital structure of 75% equity and 25% debt represented the appropriate normalized capital structure for Rembar, "[b]ased on Rembar's lack of debt historically, the expectation that Rembar's uncharacteristically high debt levels after the Rembar ESOP transaction [would] not represent a long term capital structure, and with consideration of the comparable companies in Rembar's industry." (
First Bankers's valuation expert also opined that a capital structure of 75% equity and 25% debt was the appropriate ratio to calculate Rembar's WACC, but reached a different overall valuation conclusion that the Secretary's expert. (Sullivan Decl. Ex. CC, at 64:12-65:12).
Whether the discount rate Empire applied in its valuation was reasonable is a disputed question of fact. Additionally, whether First Bankers's reliance on Empire's assumptions and calculations satisfied its fiduciary duties, is also a question of fact. Accordingly, summary judgment is not warranted.
Lastly, First Bankers argues it is entitled to summary judgment because even if it breached its fiduciary duties when it authorized the 2005 transaction, the Secretary has failed to establish that the ESOP suffered an actual economic loss.
The Court disagrees.
First, in making its economic loss argument, First Bankers misconstrues the
The first Second Circuit decision in
On appeal, the fiduciary argued the district court's award of damages and prejudgment interest "greatly exceed[ed] the ESOP's actual economic loss and thereby result[ed] in a windfall."
Second, appellants argued that to the extent the ESOP suffered any economic loss, the ESOP may have already been fully compensated because the stock purchase agreement between the sellers and the ESOP provided that if the Internal Revenue Service, Department of Labor, or a court made a final determination that the ESOP paid more than fair market value for the purchased CommutAir shares, the sellers must pay the ESOP an amount equal to the difference between the purchase price and the fair market value of the shares, plus reasonable interest. Under this agreement, the sellers were permitted to satisfy the difference in cash or in the form of additional shares. In February 2004, after the district court found that the IRS had made a final determination that the ESOP had overpaid for its CommutAir stock, the sellers executed the stock purchase agreement remedy and agreed to provide the ESOP the additional CommutAir shares it was entitled to as of March 15, 1994. The fiduciary argued that even if the ESOP did overpay for the CommutAir stock, the remedial payment of additional shares restored the ESOP to the position it would have occupied absent any overpayment, and thus constituted a complete remedy. As such, any further recovery would amount to a prohibited windfall.
Because "[t]he aim of ERISA is `to make the plaintiffs whole, but not to give them a windfall,'" the Second Circuit remanded the case to the district court to determine whether plaintiff-appellees were entitled to recover damages and, if so, to explain why those damages did not result in a windfall to the ESOP.
Meanwhile, in February 2006 during the pendency of the first
Following the 2006 remand from the Second Circuit, the district court found that even if ERISA violations occurred, the plaintiff beneficiaries suffered no damages.
The Second Circuit overturned the district court's conclusion, explaining:
Here, First Bankers argues that the 2009 "forgiveness" of the debt incurred by Rembar and the ESOP in connection with the 2005 transaction should be construed as a downward adjustment to the purchase price paid by the ESOP for the Rembar stock. Specifically, First Bankers claims "[t]he $6.5 million forgiveness of the Seller Notes resulted in a purchase price of $9 million, which is $1.5 million less than the $10.5 million fair market value claimed by the Secretary." (Def.'s Br. at 35). Thus, even if the $15.5 million purchase price in 2005 was an overpayment, the Rembar ESOP was made whole by the 2009 debt "forgiveness."
First Bankers is plainly wrong.
It is undisputed that in 2005, the Rembar ESOP purchased 100% of Rembar's stock (100,000 shares) for a total purchase price of $15.5 million (representing $155 per share). The ESOP's purchase was financed by a loan for $15.5 million from Rembar. Rembar, in turn, financed $11.5 million of that amount, including $6.5 million from the selling shareholders in exchange for subordinated notes. However, the ESOP was not a party to any of the debt Rembar incurred in connection with the 2005 transaction. Accordingly, the 2009 forgiveness of the subordinated seller notes had no impact whatsoever on the price the ESOP paid for Rembar's stock in 2005.
Furthermore, according to the Secretary, following the 2005 transaction, part of the ESOP's employee beneficiaries' compensation was retirement contributions Rembar made to the ESOP. (Pl.'s Br. at 22). The ESOP used these contributions to repay the $15.5 million loan (and its attendant interest) to Rembar. Each time the ESOP paid off some of the money it had borrowed from Rembar, it released shares in individual employee beneficiaries' retirement accounts. By 2009, the ESOP had made four years of payments on its $15.5 million loan in exchange for the allocation of approximately 15% of Rembar's shares.
At the time of Rembar's 2009 restructuring, Rembar, the ESOP, and Firor entered into a stock redemption agreement. According to that agreement, as of July 30, 2009, the ESOP owned 100,000 shares of Rembar's common stock, of which 15,384.615 shares were allocated to the accounts of the ESOP's participants, and $13,834,474.26 of the loan from Rembar to the ESOP remained outstanding. Pursuant to the stock redemption agreement, Rembar purchased the allocated shares for $15,500 (representing $1.0075 per share), the ESOP surrendered the unallocated shares, and Rembar cancelled the then-outstanding balance of the loan from Rembar to the ESOP.
Citing the 2009 stock redemption agreement, First Bankers baldly asserts "[t]he 2009 agreement to forgive the entire amount of indebtedness did
Here too, when the Rembar ESOP purchased Rembar shares in 2005 for $15.5 million, financed by incurring debt, and then in 2009 sold those shares in exchange for $15,500 plus forgiveness of $13,834,474.26 in debt, "the result was not a decrease in the price paid in [2005], but rather the realization of a substantial loss on that investment."
First Bankers has not established that a
Furthermore, First Bankers's argument that the Rembar ESOP did not actually suffer an economic loss, does not account for the fact that the assumption of indebtedness itself may well have constituted a loss to the ESOP.
Finally, the question of whether or not the Rembar ESOP ultimately was overcharged— and thus suffered an actual economic loss—"depends not only on the purchased shares' price, but also on their value."
Because at this time and on this record, (i) the Court is unable to determine the fair market value of the shares the Rembar ESOP acquired pursuant to the 2005 transaction; and (ii) First Bankers has failed to establish, as a matter of law, that the $15.5 million price paid in 2005 should be adjusted downward based on subsequent events, First Bankers is not entitled to summary judgment on its economic loss argument.
First Bankers's motion for summary judgment is DENIED.
The Secretary's cross-motion for partial summary judgment is DENIED.
Counsel are directed to appear at a case management conference on May 10, 2017, at 2:30 p.m., at which time the Court expects to set a trial date.
By May 3, 2017, the parties shall submit a Joint Pretrial Order in accordance with the Court's Individual Practices.
The Clerk is instructed to terminate the motions. (Docs. ##118, 134).
SO ORDERED.
(Sullivan Opp'n Decl. Ex. I, at 93:9-95:17).
