Brundle ex rel. Constellis Emp. Stock Ownership Plan & v. Wilmington Trust N.A.

Decision Date13 March 2017
Docket Number1:15–cv–1494(LMB,IDD)
Citation241 F.Supp.3d 610
CourtU.S. District Court — Eastern District of Virginia
Parties Tim P. BRUNDLE, ON BEHALF OF the CONSTELLIS EMPLOYEE STOCK OWNERSHIP PLAN and a class of other individuals similarly situated, Plaintiff v. WILMINGTON TRUST N.A., as successor to Wilmington Trust Retirement and Institutional Services Company, Defendant.

Gregory Yann Porter, Bailey & Glasser LLP, Washington, DC, for Plaintiff.

James Patrick McElligott, Jr., Summer Laine Speight, McGuireWoods LLP, Richmond, VA, John Edward Thomas, Jr., Nicholas DelVecchio SanFilippo, McGuireWoods LLP, McLean, VA, Sarah Aiman Belger, Odin Feldman & Pittleman PC, Reston, VA, for Defendant.

MEMORANDUM OPINION

Leonie M. Brinkema, United States District Judge

Plaintiff Tim P. Brundle ("plaintiff" or "Brundle") is a former employee of Constellis Group, Inc. ("Constellis"), and a former participant in an Employee Stock Ownership Plan ("ESOP") sponsored by Constellis. Defendant Wilmington Trust N.A. ("Wilmington") was the trustee for the ESOP in connection with Constellis' creation of the ESOP. Creating the ESOP involved purchasing 100% of Constellis' voting stock in December 2013 (the "2013 Purchase"). Less than a year after the ESOP was created, all its stock was sold (the "2014 Sale"). Plaintiff alleges that the 2013 Purchase involved transactions and payments prohibited by the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1106, resulting in the ESOP paying an inflated price for the Constellis stock. Specifically, plaintiff alleges that the $4,235 per share paid in 2013 was not the fair market value of such stock, resulting in the ESOP overpaying for the stock by $103,862,000, see PTX1 512, which plaintiff seeks to recover for the ESOP. Following a bench trial, and for the reasons that follow, the Court holds that Wilmington is liable for violating § 1106(a)(1)(A), causing $29,773,250 in damage to the ESOP, but not liable for violating § 1106(a)(1)(B) or § 1106(b).2

I. FINDINGS OF FACT

An ESOP is a form of employee retirement benefit plan "designed to invest primarily in securities issued by its sponsoring company." Donovan v. Cunningham. 716 F.2d 1455, 1458 (5th Cir. 1983). Under the terms of the Plan Document ("Plan") governing Constellis' ESOP, the participant employees would not immediately own the stock purchased by the ESOP. Rather, the stock would be held by a trust and allocated to employees over time, as an incentive to remain with Constellis. The Plan defines a year of service as 1,000 hours. DTX 120 at 28, 13. An employee begins to become vested in his shares at the completion of the second year of service, an amount that increases 20% per year until reaching 100% in the sixth year. Id. Alternatively, the employee would become fully vested upon reaching the designated retirement age while employed by Constellis. Id.

A. Constellis Background

Thomas Katis ("Katis") and Matthew Mann ("Mann") founded Constellis' predecessor, Triple Canopy, Inc. ("Triple Canopy"), as a private security firm in the fall of 2003. Tr. at 1091:5–8. Troubled by the unsavory reputation of the private security industry at that time, they hoped to build Triple Canopy into a company that would be a source of pride for its employees, who were primarily retired members of the U.S. Armed Forces. Id. at 1095:20–22. Although the founders had a significant operational role at the outset, they began to step back in the spring of 2004, naming Ignacio Balderas ("Balderas") as Chief Executive Officer ("CEO"). Id. at 1092:8–14. Triple Canopy's primary clients were the U.S. Department of State ("DoS") and U.S. Department of Defense ("DoD"). Id. at 1094:23–24. Over the next several years, the company experienced steady growth, id. at 1095:13–14, landing a series of large contracts to provide security both for physical locations, known as "fixed site security," and for key personnel, known as "personal security," Tr. at 19:14–19. Triple Canopy also began to acquire other security firms. See id. at 1093:17–1094:3. These acquisitions led the company to reorganize itself into Constellis, which became the parent company, with Triple Canopy being its largest subsidiary. See id.

The first form of deferred compensation Constellis offered to its employees was an employee stock option program. See Tr. at 1099:5–13. Driven in part by a desire to monetize that program for the employees, in the fall of 2007 Constellis began considering an offer from Cerberus Capital Management to purchase the company. Id. Although the parties engaged in extensive negotiations, the deal fell through. In 2010, with no prospective sale on the horizon, Constellis cashed out its employee stock option plan as part of a restructuring and replaced it with a profit sharing plan that used Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA") as its benchmark. Tr. at 318:14–20.3

The next serious offer to buy Constellis came in 2012, when the investment banking firm Teneo Holdings, Inc., attempted to broker a deal in which a private equity firm, Vestar Capital Partners ("Vestar"), would be the buyer. Although Vestar initially offered a price in the range of $340 to $350 million, it reduced its offer to $275 million as the closing date approached. Tr. at 1136:8–9. The deal fell through because of this last minute reduction, which Katis characterized as a "classic private equity move." Id. at 1100:6–12

By the end of 2013, Katis owned 31.1% of Constellis' outstanding stock, Mann owned 29.2%, Howard Acheson ("Acheson") owned 11.1%, John Peters ("Peters") owned 5.6%, and "other minority shareholders" held the remaining shares. PTX 2 at 14. Collectively, Katis, Mann, Acheson, and Peters are known as the "Sellers."4

B. Considering an ESOP

In June of 2013, Constellis board member Simon Crane ("Crane") approached its general counsel Juliet Protas ("Protas") about the possibility of forming an ESOP. Tr. at 1417:9–14. Several factors motivated Crane and the Sellers to consider this option. Katis believed that an ESOP provided him an "exit strategy" while being consistent with his vision of Constellis as a company focusing on taking care of its employees. Id. at 1418:16–22. Creating an ESOP is often driven by the shareholders' desire for liquidity, id. at 945:10–11, although Katis testified that he had no urgent need for liquidity when the Constellis ESOP was formed, id. at 1184:3.

Protas was receptive to the idea of an ESOP, in part because she had participated in a panel discussion with ESOP specialist Scott Meza of Greenburg Traurig LLP ("GT") a month earlier. Tr. at 1417:18–19. She took Crane's suggestion to Balderas, who authorized her to explore the idea. Id. at 1418:3–7. At GT's recommendation, Protas retained investment bankers CSG International ("CSG"), including managing partner George Thacker ("Thacker"), to advise Constellis on the prospect of an ESOP. Id. at 1421:9–11.

CSG prepared a series of PowerPoint presentations for the Sellers and Constellis management about what an ESOP is and how to go about forming one. See PTX 626, 628. The first, titled "Preliminary ESOP Structural Analytics" and dated September 25, 2013, explained that the "Status Quo" left the shareholders with "no exit strategy" and that they were "limited to dividends for liquidity." PTX 626 at 6. Under those circumstances, CSG reported that an ESOP "optimizes results for all parties. " Id. at 9 (emphasis in original). For the Sellers, this meant creating an "attractive liquidity structure," optimizing "after-tax cash flow," receiving "$307.8MM net of taxes over 6 years," retaining "control until fully paid," and participating "in future growth/[mergers and acquisitions] opportunities." Id. (emphasis in original). CSG also pointed out that by selling their shares to an ESOP, the Sellers would be able to roll over capital gains taxes, saving 23.8% on federal taxes. Id. at 18. Employees would benefit through a management incentive program and by obtaining equity in the ESOP. Id. at 9. Creating an ESOP in 2013 would result in Constellis becoming a "tax-free business" beginning in 2014 and receiving approximately $30 million through a tax refund for taxes paid in 2013; however, to fully realize these tax benefits, an ESOP had to own 100% of the company's stock. Id.

CSG did not recommend a "traditional 100% ESOP." PTX 626 at 17. Instead, it proposed "a more advanced 100% structure that CSG developed." Id. In this "more advanced" ESOP structure, the Sellers would sell the ESOP 90% of their shares, and exchange the remaining 10% for warrants, id. , which Katis described as "equity-like," Tr. at 1173:15. The warrants would be financial instruments entitling the Sellers to buy back equity in Constellis at a designated price, known as the "strike price," during a certain period of time. See id. at 1173:19–21. Under CSG's proposed structure, the Sellers as warrant holders would retain significant elements of control over the company, most notably the ability to appoint a majority of the board of directors. Id. at 1603:21–22. Although the warrants would not create immediate value for the Sellers, eventually the sellers would be able to capture the warrants' value "by (1) selling the warrants back ... in the future, or (2) selling the company." PTX 626 at 17. Under CSG's proposal, the Sellers would "control the company post transaction," giving them the "flexibility" to follow through on these options. Id.

In addition, because an ESOP rarely, if ever, begins its life with substantial assets, it is created by a heavily leveraged transaction in which the ESOP borrows the funds with which it buys the stock. Under the plan proposed by CSG, the Constellis ESOP was to borrow from the Sellers to buy their stock, meaning that the Sellers would also become the company's creditors. CSG pointed out that because the Sellers would "control the [b]oard," they would also "control the timing of payment" on that...

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