Defazio v. Hollister, Inc.

Decision Date29 June 2009
Docket NumberNo. 05-1726 WBS GGH.,No. CIV. 04-1358 WBS GGH.,No. 05-0559 WBS GGH.,CIV. 04-1358 WBS GGH.,05-0559 WBS GGH.,05-1726 WBS GGH.
Citation636 F.Supp.2d 1045
PartiesJames P. DeFAZIO, et al., Plaintiffs, v. HOLLISTER, INC., et al., Defendants.
CourtU.S. District Court — Eastern District of California

Scottlynn J. Hubbard IV, Lynn Hubbard III, Law Offices of Lynn Hubbard, Chico, CA, James M. Crawford, Jr., Crawford Law Office, P.A., The Woodlands, TX, Daniel E. Wilcoxen, Wilcoxen Callahan Montgomery and Deacon, Russell Glenn Porter, Martin Niels Jensen, Porter Scott, Sacramento, CA, for Plaintiffs.

Michael B. Roche, PHV, L. Andrew Brehm, PHV, Schuyler Roche and Zwirner, James W. Ducayet, PHV, Mike Bartolic, PHV, William F. Conlon, PHV, Sidley Austin LLP, Chicago, IL, James D. Adducci, Marshall L. Blankenship, Adducci Dorf Lehner Mitchell and Blankenship, William A. Gould, Jr., Daniel Lawrence Baxter, Wilke Fleury Hoffelt Gould and Birney, Sacramento, CA, for Defendants.


WILLIAM B. SHUBB, District Judge.

Plaintiffs James P. DeFazio, Theresa Beetham, Brenda DiMaro, DeLane Humphries, Hallie Lavick, Michael McNair, Sonya Pace, Judy Seay, Nancy Russell Stanton, Cindy Worth, and Kathleen Ellis filed these consolidated actions against defendants Hollister, Inc. ("Hollister"), Hollister Employee Share Ownership Trust ("HolliShare"), The Firm of John Dickinson Schneider, Inc. ("JDS"), Samuel Brilliant, Richard I. Fremgen, Donald K. Groneberg, Charles H. Gunderson, Alan F. Herbert, James A. Karlovsky, Lori Kelleher, James J. McCormack, Charles C. Schellentrager, Loretta L. Stempinski, Michael C. Winn, and Richard T. Zwirner alleging violations of the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. §§ 1001-1144. Presently before the court are plaintiffs' and defendants' cross-motions for partial summary judgment, defendants' motion to strike class action allegations, and plaintiffs' motion to remove the plan trustees.

I. Factual and Procedural Background1

In a fourteen-month period between 2004 and 2005, three groups of the current makeup of plaintiffs—former participants and beneficiaries of HolliShare, a defined contribution plan2 established by Hollister (see 1st Zwirner Decl. (Docket No. 399) ¶ 7)—independently filed complaints against defendants Hollister, its parent company JDS, the HolliShare trustees, and various members of the boards of directors of both companies. The cases were consolidated by court order on May 25, 2006. (Docket No. 87.) Currently, the plaintiffs are divided into two groups based upon the two operative complaints in this litigation. Ten of the plaintiffs ("DeFazio/DiMaro plaintiffs") are represented by the same counsel and filed their Fifth Amended Complaint ("HAC") on July 22, 2008. (See Docket No. 368.) Ellis, the only plaintiff represented by separate counsel, filed her Fourth Amended Complaint ("FAC") on January 23, 2008.3 (See Docket No. 314.) Though they differ in some respects—most notably, the HAC contains class action allegations while the FAC does not—the allegations asserted against defendants are substantially similar in both the HAC and FAC.

The claims in this case are based upon the alleged misconduct by the fiduciaries of HolliShare. HolliShare is funded through contributions by Hollister from the company's profits; participants are not permitted to make personal contributions. (See Defs.' 1st App'x (Docket Nos. 486-488) Ex. 1 ("Trust Instrument") §§ 6.01, 6.02.) Hollister is a privately-held Illinois corporation that manufactures and markets healthcare products. (1st Zwirner Decl. (Docket No. 399) ¶¶ 4, 8.) It is the operating subsidiary of JDS, an Illinois corporation that holds all of Hollister's capital stock.4 (Id. ¶ 5.) Consistent with the terms of the HolliShare Trust Instrument, the plan's principal investment is common shares of JDS.5 (Trust Instrument § 11.01(1); 2d Zwirner Decl. (Docket No. 494) ¶ 8.)

In their papers on the instant motions, the parties have divided plaintiffs' claims into three rough categories according to the three primary factual bases upon which they are premised: the prohibited transactions between HolliShare and JDS, the 1999 Transaction (a series of events culminating in the transfer of all of the preferred shares of JDS to a new trust), and the DeFazio-Ellis divorce proceedings.6 Though these categorizations overlap in certain areas, given the complexity of the factual issues in this case, the court will follow the convention adopted by the parties.

A. Prohibited Transactions

JDS has two classes of shares, preferred and common, neither of which has a generally recognized public market. (2d Zwirner Decl. ¶¶ 10-11.) The JDS Articles of Incorporation ("JDS Articles") provide several restrictions on JDS shares relevant to this case.7 First, pursuant to article five paragraph II.C ("paragraph II.C"), only certain persons and entities are entitled to own JDS shares, including holders of shares as of May 5, 1978, employees of JDS and/or Hollister, and any deferred benefit plan maintained by JDS and/or Hollister.8 (Defs.' 1st App'x Ex. 4 ("JDS Articles") 9.)

Second, article five, paragraph II.D ("paragraph II.D") restricts the manner in which holders of JDS stock may transfer ownership. Specifically, paragraph II.D.2 gives JDS a first right of refusal by requiring that any holder of JDS stock who intends to transfer one or more shares to another must first offer to sell those shares to JDS. (JDS Articles 10.) Paragraph II.D.3 further provides that the price paid for any common share purchased by JDS "shall be its book value as of the end of the calendar month in which the Repurchase Date occurs.... The book value of each common share shall be computed in accordance with generally accepted accounting principles...."9 (Id. 12.) Despite these requirements, paragraph II. D.7 provides that:

"Under exceptional circumstances and in the discretion of the Corporation's Board of Directors, shares may be repurchased by the Corporation at such other times, upon such other terms, in such other manners, over such other periods of time, or on such other conditions as the Corporation and the owner or holder of such shares may from time to time agree."

(JDS Articles 15.)

JDS common shares are HolliShare's primary investment, and HolliShare must sell those shares in order to raise the cash needed to pay benefits to participants and beneficiaries. (3d Zwirner Decl. (Docket No. 515) ¶ 7.) Since the mid-1980s, HolliShare has sold its holdings of JDS common shares to JDS pursuant to the "exceptional circumstances" provision of paragraph II. D.7, not the first right of refusal embodied in paragraph II.D.2. (Pls.' Stmt. of Undisputed Facts Ex. B ("Zwirner Dep.") 237:19-238:8; 3d Zwirner Decl. ¶¶ 9, 16, 18.) Defendants contend that HolliShare and JDS entered into an agreement ("mid-80s buy-back agreement") that has since governed JDS's repurchase of common shares from HolliShare in order to avoid certain complications. (See 3d Zwirner Decl. ¶ 16.)

The JDS Articles provide that when JDS repurchases shares pursuant to the first right of refusal, it is obligated to pay a only minimal amount in cash (set originally at $5,000 and then increased to $250,000 in 1999) and can pay the remainder with a promissory note. (JDS Articles 12, 44.) Because HolliShare, as an ERISA plan, is prohibited from accepting a promissory note as payment from an employer, see 29 U.S.C. § 1106(a)(1)(B), and HolliShare's cash needs often exceeded the $5,000 and $250,000 minimums, HolliShare could not have sold its shares to JDS under the terms of that provision. (3d Zwirner Decl. ¶ 15.) If JDS did not waive its right of refusal, HolliShare would thus have been unable to sell its JDS stock to anyone pursuant to paragraph II.D.2. (Id.)

To avoid this problem, and to allow JDS to plan ahead for its cash flow needs, HolliShare and JDS agreed in the mid-1980s that: 1) JDS would repurchase HolliShare's common shares entirely for cash (i.e., would not tender promissory notes); 2) the price employed would be the most recent audited December 31 per share book value rather than the month-end book value from the date of the transaction, as provided in paragraph II.D.3; and 3) such transactions would take place only once a year. (3d Zwirner Decl. ¶ 16.)

Plaintiffs contend that these repurchases of JDS common shares from HolliShare using book value violated defendants' statutory duties under ERISA. Particularly in light of evidence that JDS common shares may have had a value in the "outside world" of up to three-times book value (Pls.' Stmt. Disputed Facts Ex. F ("Winn Dep.") 91:15-92:13), plaintiffs assert that defendants breached their fiduciary duties, 29 U.S.C. 1104(a)(1)(B), and violated the provision on prohibited transactions, id. § 1106(a)(1)(A).10

B. 1999 Transaction

HolliShare does not invest in JDS preferred shares. John Schneider, the founder of JDS, owned a majority of the outstanding preferred shares until he placed all of his holdings into a trust in 1977 ("1977 Schneider Trust"). (2d Zwirner Decl. ¶ 24; Defs.' 1st App'x Ex. 3 at 2-3.) Because those shares comprised a controlling interest in JDS, the 1977 Schneider Trust, through its trustees, effectively controlled JDS.11 (2d Zwirner Decl. ¶ 24.) After 1981, defendants Winn, Stempinski, and Zwirner became trustees of the trust. (Id. ¶ 29.)

The terms of the 1977 Schneider Trust provided that it would expire on April 21, 2001. (Defs.' 1st App'x Ex. 3 at 11.) Upon its expiration, the trust called for its corpus of preferred shares to be distributed to employees of Hollister who then owned common shares and agreed to abide by certain principles in governing JDS.12 (Id.) These employee-beneficiaries would have received a number of...

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