Castle v. Cohen

• Decision Date: 07 December 1987
• Docket Number: Civ. A. No. 87-1402.
• Citation: 676 F. Supp. 620
• Parties: Joseph L. CASTLE, II, Alan M. Feldman, Miguel A. Mora and Robert S. Seltzer, Trustees of the Psychiatric Hospitals of America, Inc., Employee Stock Ownership Plan, and Retirement Plan Committee of the Psychiatric Hospitals of America, Inc., Employee Stock Ownership Plan, and Psychiatric Hospitals of America, Inc. v. Robert M. COHEN, Hartsell, Inc., Cheyenne Corporation, and Roland M. Jermyn.
• Court: U.S. District Court — Eastern District of Pennsylvania

676 F. Supp. 620

Joseph L. CASTLE, II, Alan M. Feldman, Miguel A. Mora and Robert S. Seltzer, Trustees of the Psychiatric Hospitals of America, Inc., Employee Stock Ownership Plan, and Retirement Plan Committee of the Psychiatric Hospitals of America, Inc., Employee Stock Ownership Plan, and Psychiatric Hospitals of America, Inc. v. Robert M. COHEN, Hartsell, Inc., Cheyenne Corporation, and Roland M. Jermyn.

Civ. A. No. 87-1402.

United States District Court, E.D. Pennsylvania.

December 7, 1987.

COPYRIGHT MATERIAL OMITTED

Marc Durant, Robert M. Wolff, Karen S. Berger, Marc Durant & Associates, Philadelphia, Pa., William P. Frank, Jay S. Berke Skadden, Arps, Slate, Meagher & Flom, New York City, for trustees.

Harold E. Kohn, Robert A. Swift, Marguerite R. Goodman, Denis F. Sheils, Kohn, Savett, Klein & Graf, Philadelphia, Pa., for Cohen, Hartsell, and Cheyenne.

Gregory T. Magarity, James G. Wiles, Wolf, Block, Schorr & Solis-Cohen, Philadelphia, Pa., for Jermyn.

James J. Binns, Philadelphia, Pa., for Psychiatric Hosp.

J. Clayton Undercolfer, III, Saul, Ewing, Remick & Saul, Philadelphia, Pa., for counterclaim defendants Castle, Feldman, Mora and Seltzer, individually and as escrow agents.

MEMORANDUM OPINION

CAHN, District Judge.

This litigation involves complex issues related to the Employee Stock Option Plan ("ESOP") of Psychiatric Hospitals of America ("PHA").

I. Facts

On December 4, 1984, Robert M. Cohen pleaded guilty to Medicare fraud before the Honorable J. William Ditter, Jr. of this court. Because Cohen owned more than five percent of the stock in PHA, PHA would no longer be entitled to Medicare reimbursements after the imposition of sentence which was scheduled for February 1, 1985.¹ In order to ensure that PHA would continue to receive Medicare funds, Cohen and certain other stockholders (the "Cohen Group") transferred 56.2% of the outstanding shares in PHA to the trustees of the ESOP. The parties agree that the trustees of the ESOP are independent persons not controlled directly or indirectly by Cohen.

At the time the Cohen Group transferred the stock to the ESOP trustees acting as escrow agents, the Cohen Group and the trustees entered into a stock purchase agreement dated January 31, 1985. This agreement provides that the price the trustees are to pay to the Cohen Group for the 56.2% interest in PHA would be fair market value as determined through an appraisal process. The function of the appraisal process was to determine the fair market value of the 56.2% majority block of stock as of January 31, 1985.

The trustees were to begin the appraisal process by submitting an independent appraisal to the Cohen Group. If the Cohen Group was not satisfied with the value set by that appraisal, the Cohen Group could procure a second appraisal. If the value set by the second appraisal exceeded the value set by the first by more than 10 percent, then the ESOP trustees could, at their option, purchase the shares at the price determined by the Cohen Group's appraisal. Finally, if the trustees declined to purchase at that price, the Cohen Group could seek a third-party purchaser with the trustees retaining a right of first refusal.

The following events transpired with respect to the stock purchase agreement:

(a) The trustees obtained an appraisal from Marshall & Stevens setting the value for the 56.2% majority block of stock as of January 31, 1985, at $13,072,232;

(b) The Cohen Group obtained an appraisal from Poole and Associates setting the value of the 56.2% majority block of stock as of January 31, 1985, at $38,790,000;

(c) The Cohen Group entered into a purchase agreement dated February 27, 1987, wherein the 56.2% majority interest was to be sold to the Ramsay Hospital Corporation of Pennsylvania at a price of $28,015,000;²

(d) The ESOP trustees filed this suit against the Cohen Group seeking to enforce the trustees' rights under the stock purchase agreement.

II. Procedural History

The claims of the trustees are based upon the Employee Retirement Income Security Act of 1974 ("ERISA") 29 U.S.C. §§ 1001-1461 (1982 & Supp. I 1983 & Supp. II 1984 & Supp. III 1985), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982), common law fraud and breach of contract. The defendants filed counterclaims including claims based upon the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. §§ 1961-1968 (1982 & Supp. III 1985 & Supp. IV 1986), Section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982) and various common law causes of action.

The parties are interested in a prompt disposition of the controversy. A number of minority shareholders have filed suits assigned to my docket based upon allegations of securities fraud, RICO, and common law causes of action.

After extensive pretrial conferences and pretrial motion practice, I submitted three issues concerning the basic contract dispute to a jury. These issues were set forth in written interrogatories.³ For the reasons that follow, the interrogatories were structured sequentially. If the trustees fail to prove that the Poole appraisal was invalid, then their claim is defeated because they declined the opportunity to purchase the stock at the price set by that appraisal. However, if the trustees were able to prove that the Poole appraisal was invalid and that the Marshall & Stevens appraisal was valid, then they would be entitled to a decree enforcing the terms of the contract. The Cohen Group, in effect, would have declined the opportunity to submit a valid appraisal and the trustees would have the right to purchase the stock at the price set by the Marshall & Stevens appraisal. Only if both the Poole appraisal and the Marshall & Stevens appraisal were invalid would it be necessary for the jury to determine the fair market value of the stock as of January 31, 1985, in order to enforce the terms of the contract as contemplated by the parties.

After three weeks of testimony and several days of deliberation, the jury answered "Yes" to interrogatory number 1, "No" to interrogatory number 2, and determined the fair market value of the 56.2% majority interest as of January 31, 1985, to be $15,800,000.

After the jury verdict and after extensive discussion on the record with the lawyers, I entered a final order which declared the Poole appraisal to be invalid, declared the Marshall & Stevens appraisal to be invalid, and set the fair market value of the Cohen Group's stock as of January 31, 1985, at $15,800,000. In addition, the final order dismissed all of the other claims with prejudice. A copy of this order is attached to this Memorandum Opinion as Addendum "A".

The defendants appealed from this order and filed a motion before the United States Court of Appeals for the Third Circuit seeking injunctive relief pending the outcome of the appeal. Following a hearing before an emergency panel of the Court of Appeals, at which defendants' motion was denied, the defendants made an application for similar relief in this court in the form of a Motion to Alter, Amend or Grant Relief from Judgment. In addition to repeating arguments previously rejected, the motion requested that I permit the Cohen Group to sell their stock to the Ramsay Group unless the plaintiffs tendered payment by October 10, 1987. I held hearings on this motion on October 9 and October 21, 1987, during which counsel set forth their respective positions.

The trustees argued that they should not effectively be denied the benefits of the judgment and the jury verdict and that they were entitled to a reasonable time period within which to exercise their rights under the contract. They suggested that it would be reasonable to expect them to secure the necessary financing within three to four months after the appeal process was completed. The defendants argued that if the Ramsay offer were allowed to lapse they might be irreparably injured and therefore asked this court to set a date after which, if the trustees have not tendered payment, they can sell their shares to a third party. The defendants suggested that it would be reasonable to require the trustees to tender payment by November 6, 1987, or at the latest, sometime in December, 1987.

The concerns of both parties were well taken. I therefore entered a final order on October 26, 1987, modifying my earlier order and setting a date certain of March 31, 1988, after which, if the trustees have not consummated the purchase of the 56.2% majority block of stock, the Cohen Group may sell their stock to a third party. For the protection of the beneficiaries of the ESOP, my October 26, 1987, order contained two additional requirements: first, that any sale to a third party be for an amount greater than $15,800,000 plus applicable interest from January 31, 1985, and second, that from the proceeds of any sale to a third party, $15,800,000 plus applicable interest from January 31, 1985, be put in escrow pending a final resolution of this case.⁴ A copy of this order is attached to this Memorandum Opinion as Addendum "B".

Ordinarily, extensive post-trial motion practice would have occurred in litigation of this type. However, the Cohen Group is concerned that the Ramsay Hospital Corporation of Pennsylvania will withdraw its offer to purchase in the near future. Therefore, I felt it advisable to enter a final order promptly. This Memorandum Opinion is filed for the purposes of explaining my reasoning in regard to the legal and equitable issues in this case.

III. Jurisdiction

Diversity of citizenship between the plaintiffs and the defendants in this case is not complete. Jurisdiction is proper, however, based upon this court's jurisdiction over federal questions, 28 U.S.C. § 1331 (1982), as well as upon Section 502 of ERISA, 29 U.S.C. § 1132(e) (1982). The trustees' complaint contained allegations of violations of the federal securities laws and ERISA requirements. Although the issues...