Mullins v. Testamerica, Inc.

• Citation: 564 F.3d 386
• Decision Date: 30 March 2009
• Docket Number: No. 08-11224.,08-11224.
• Parties: Billy J. MULLINS, Jr.; Faraway Enterprises, Plaintiffs-Appellees-Cross-Appellants, v. TESTAMERICA, INC.; Sagaponack Partners LP, Defendants-Appellants-Cross-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (5th Circuit)

564 F.3d 386

Billy J. MULLINS, Jr.; Faraway Enterprises, Plaintiffs-Appellees-Cross-Appellants, v. TESTAMERICA, INC.; Sagaponack Partners LP, Defendants-Appellants-Cross-Appellees.

No. 08-11224.

United States Court of Appeals, Fifth Circuit.

March 30, 2009.

J. Stephen Hunnicutt, Hunnicutt Law Firm, Dallas, TX, for Faraway Enterprises, Mullins.

Gregory Scott Coleman, Marc S. Tabolsky, Yetter, Warden & Coleman LLP, Michael P. Lynn, Lynn, Tillotson, Pinker & Cox, LLP, Dallas, TX, for TestAmerica, Inc., Sagaponack Partners, LP.

Appeal from the United States District Court for the Northern District of Texas.

Before KING, HIGGINBOTHAM, and WIENER, Circuit Judges.

KING, Circuit Judge:

In 1998, Plaintiff Billy Mullins sold all the assets of his company to Defendant TestAmerica, Inc. in exchange for cash and an unsecured promissory note payable to Mullins's company, renamed Faraway Enterprises. TestAmerica's obligation to pay the note was subordinated and subject to the prior payment in full of all of TestAmerica's "debt facilities." TestAmerica fell on hard times, winding up with approximately $50 million in debt. In 2003, TestAmerica sold all of its assets to a third party in exchange for $33.5 million. Secured and senior debt was paid, and at the direction of the secured creditor, approximately $3 million due it was paid to retire part of TestAmerica's debt to Sagaponack Partners LP, the majority shareholder of TestAmerica. Faraway's note and the balance of Sagaponack's debt remain unpaid. Mullins and Faraway filed suit against TestAmerica claiming breach of contract and fraud and against TestAmerica and Sagaponack alleging a violation of the Texas Uniform Fraudulent Transfer Act. The jury found that the contract was breached, that TestAmerica defrauded Faraway, and that TestAmerica and Sagaponack violated TUFTA. The jury awarded no actual damages but imposed punitive damages against TestAmerica and Sagaponack. In large part, we reverse.

I. Factual Background

A. The 1998 sale of METCO to TestAmerica

Plaintiff Billy Mullins, a resident of Texas, owned Mullins Environmental Testing Co., Inc. ("METCO"), a Texas company that specialized in testing air from smokestacks. Early in 1998, Mullins began marketing his company to potential buyers. A business broker put Mullins in touch with TestAmerica, Inc. ("TestAmerica"), then known as Hydrologic, an environmental testing company based in North Carolina that was seeking to expand the scope of its business. Thomas Barr served as TestAmerica's President, as its CEO, and as one of five directors on its board. Of TestAmerica's four other directors, two — Barry Rosenstein and Defendant Marc Weisman ("Weisman")—were also limited partners in Sagaponack Partners LP ("Sagaponack"), a private equity group, a third was chosen by Barr from a slate of individuals proposed by Sagaponack, and the fourth was unaffiliated with Sagaponack.¹

On December 18, 1998, TestAmerica purchased METCO and two other companies. TestAmerica financed these acquisitions by issuing both debt and equity. First, Fleet Capital Corporation ("Fleet"), both as a lender and as agent for a syndicate of other lenders, agreed to make available to TestAmerica a "Total Credit Facility" of $37 million consisting of revolving credit loans, letters of credit, and term loans. These loans were secured by all of TestAmerica's assets. Key Mezzanine Capital, L.L.C. ("Key") and Regis Capital Partners, L.P. ("Regis") also provided a total of $7 million in mezzanine financing, a hybrid of debt and equity financing. By agreement, Fleet's loan had priority in right of payment over that of Key and Regis.

TestAmerica also issued three "amended and restated" promissory notes totaling $555,000, and three "earnout" promissory notes totaling $350,000 to Louis, Rami, and Firas Mishu (the "Mishus").² The Mishu notes were secured by approximately $2 million of equipment belonging to Geotek Drilling Company, Inc., one of TestAmerica's existing subsidiaries.

Sagaponack, under a "Second Securities Purchase and Loan Agreement," contributed $3,700,000 in cash and agreed to cancel two prior notes from January 13, 1998, in exchange for a bridge note of $3,000,000, a term note of $700,000, and a replacement note of $5,311,094. Sagaponack also received enough shares of TestAmerica's common stock to become the majority shareholder of TestAmerica. Significantly, the agreement included a change of control provision that prohibited TestAmerica from selling its assets without Sagaponack's approval.

Closing occurred at the offices of Fleet's attorneys in New York City. Mullins, who signed the documents in Texas and sent them to the closing, executed five contracts with TestAmerica governing the sale of METCO: (1) an employment agreement under which Mullins would serve for three years as President of the new METCO entity, METCO Environmental, Inc. ("METCO Environmental") and receive a yearly salary of $150,000; (2) a non-compete agreement; (3) an asset purchase agreement (the "Purchase Agreement"); (4) an "8% subordinate convertible note" (the "Note"); and (5) a subordination agreement (the "Subordination Agreement"). After the sale of its assets, METCO changed its name to Faraway Enterprises ("Faraway"), a Texas corporation wholly owned and controlled by Mullins with its principal place of business in Texas. The parties' dispute centers around the payment and priority terms in the Note, Purchase Agreement, and Subordination Agreement (collectively, the "Agreements").

As required by the Purchase Agreement, TestAmerica paid Mullins $8.25 million in cash at closing. TestAmerica's obligation to pay the balance of the purchase price for METCO's assets was evidenced by the Note. Pursuant to a formula based on METCO Environmental's profits over the following three-year period, the Note's initial principal amount of $2 million would be adjusted to an amount between $1 million and $6.75 million. This calculation was to be provided to Faraway in a "Period Income Statement" within 90 days of December 31, 2001, i.e., on or before March 31, 2002. The Note also required TestAmerica to make annual interest payments of $160,000 starting on December 31, 2000, and three annual principal payments starting on December 31, 2001. Both the Note and Purchase Agreement included Texas choice of law provisions and provided for exclusive venue and jurisdiction in Dallas County, Texas.

Faraway's priority in payment in relation to TestAmerica's other creditors is defined by several provisions in the Agreements. According to the Purchase Agreement, the Note shall be subordinated and subject in right of payment to the prior payment by [TestAmerica] in full of all of [TestAmerica's] debt facilities. The indebtedness evidenced by the . . . Note shall be expressly subordinated to the extent and the manner set forth in the Subordination Agreement dated December 18, 1998 among TestAmerica Incorporated ("TAI"), Key Mezzanine Capital L.L.C. ("KMC"), Regis Capital Partners, L.P[.] ("Regis"), [and] Fleet Capital Corporation ("Fleet"). . . .³

The Subordination Agreement, which was drafted by the attorneys for Key and Regis, delineates two categories of creditors: (1) "Senior Creditors" Fleet, Key, and Regis (the "Senior Creditors"), and (2) "Subordinated Creditors," defined as "the parties signing below as Subordinated Creditors." During the course of litigation, the parties disputed which of two versions of the Subordination Agreement is the operative agreement. The day before closing, Mullins signed a copy of the agreement, which Mullins's counsel sent to TestAmerica's counsel in New York City. That document is labeled in the footer as "v.6" ("Version 6"), and the only signature reflected on the signature page is that of Mullins, as a "Subordinated Creditor." The version that surfaced later during the course of litigation, however, is identified in the footer as "v.7" ("Version 7"). The footer on the two signature pages to Version 7, however, indicates that they are from Version 6. The first of these pages includes the signatures of the Senior Creditors; Thomas Barr for TestAmerica; and, as a "Subordinated Creditor," Robert Juneja, the authorized signatory for Sagaponack. The second signature page contains only Mullins's signature. According to Mullins, he neither authorized anyone to attach his signature to Version 7, nor anticipated that it would be so attached. Although several witnesses suggested that Version 7 was assembled by counsel to one of the lenders, at trial no one definitively identified the responsible lender.

Both versions of the Subordination Agreement establish the priority of TestAmerica's debts to the Senior Creditors ("Senior Debt") over all "Subordinated Debt" but permit certain payments on Subordinated Debt while the Senior Debt remains outstanding so long as other conditions within the agreement are satisfied:

2. Subordinated Debt Subordinated to Senior Debt

(a) Notwithstanding any contrary provisions of any instruments or agreements evidencing or relating to Subordinated Debt, [TestAmerica] covenants and agrees, and each holder of Subordinated Debt by its signature hereon likewise covenants and agrees, for the benefit of the holders from time to time of Senior Debt, that all payments of Obligations and Claims in respect of Subordinated Debt shall be subject and subordinate in right of payment . . . to the prior payment in full in cash of all Obligations in respect of (1) Designated Senior Debt [i.e., debt to Fleet] and (2) other Senior Debt. . . .

(b) Unless and until all Obligations in respect of the Senior Debt have been finally paid in full in cash, and subject to the provisions of this Agreement, including without limitation Section 3, 4, and 5, no direct or indirect payments shall be made on, under or with respect to any Obligations or Claims under, relating to or in respect of any Subordinated Debt except for the payments set forth as...