DeFazio v. Hollister, Inc.

• Citation: 53 Employee Benefits Cas. 2658,854 F.Supp.2d 770
• Decision Date: 06 April 2012
• Docket Number: Nos. CIV. 2:04–1358 WBS GGH, 2:05–0559 WBS GGH, 2:05–1726 WBS GGH.,s. CIV. 2:04–1358 WBS GGH, 2:05–0559 WBS GGH, 2:05–1726 WBS GGH.
• Parties: James P. DeFAZIO, et al., Plaintiffs, v. HOLLISTER, INC., et al., Defendants.
• Court: United States District Courts. 9th Circuit. United States District Courts. 9th Circuit. Eastern District of California

854 F.Supp.2d 770

53 Employee Benefits Cas. 2658

James P. DeFAZIO, et al., Plaintiffs,

v.HOLLISTER, INC., et al., Defendants.

Nos. CIV. 2:04–1358 WBS GGH, 2:05–0559 WBS GGH, 2:05–1726 WBS GGH.

United States District Court, E.D. California.

April 6, 2012.

Scottlynn J. Hubbard IV, Kari Hubbard (on the briefs), 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.

MEMORANDUM OF DECISION

WILLIAM B. SHUBB, District Judge.

After conducting a fifteen-day bench trial and providing the parties with extended time to submit post-trial briefing, the court finds in favor of all defendants on all of plaintiffs' claims under the Employee Retirement Income Security Act (“ERISA”), 29 U.S.C. §§ 1001–1461. This memorandum constitutes the court's findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52(a).

I. Factual and Procedural Background

Defendant Hollister, Inc. (“Hollister”) is a privately-held Illinois corporation that develops, manufactures, and markets medical devices in the fields of ostomy, continence care, and wound care. Hollister is the wholly-owned and operating subsidiary of defendant The Firm of John Dickinson Schneider (“JDS”). JDS is an Illinois close corporation that holds all of Hollister's capital stock.

John D. Schneider, who only had a high school education and initially began a printing business, founded JDS and developedHollister into a prosperous company. Schneider desired for JDS and Hollister to remain independent and employee-owned companies and wanted his employees to share in their success. Schneider accomplished these goals through a direct shareholder program and the Hollister Employee Share Ownership Trust (“HolliShare” or “Plan”).

HolliShare is a non-contributory, tax qualified defined contribution profit sharing plan designed to provide retirement benefits to Hollister's non-union employees in the United States. It is governed by a written instrument, the HolliShare Employee Share Ownership Trust (“Plan Instrument”). HolliShare's predominant asset, which totals approximately 95% of its total value, is its JDS common shares. The Plan Instrument mandates that HolliShare's assets be invested in JDS shares to the maximum extent practicable. When initially funded in 1974, HolliShare received 11,950 common shares of JDS that were purchased from shareholders. In exchange, HolliShare assumed the obligation to pay the long-term promissory notes issued to the shareholders to purchase the shares. In late 1974, the Plan transferred 4,007 shares back to JDS along with the related promissory note obligations, leaving the Plan with 7,943 shares. HolliShare has not purchased JDS shares since 1975, but the number of its total shares has increased due to two 100–for–1 stock splits and a 9–for–1 stock dividend.

HolliShare's ownership of JDS shares has proved to be an extraordinary investment, and the annual increases in value of JDS shares according to JDS's valuations exceeded most publicly-traded investments. For example, from 1977 through 2010, the mean average increase in JDS's share price was 26.79% each year, whereas the mean average increase for the Standard & Poors 500 index was 8.8% per year, the mean average increase for the Mid–Cap Index was 14.09% per year, and the mean average increase for the Small–Cap Index was 15.24% per year.

HolliShare participants are neither required nor permitted to contribute to HolliShare. HolliShare primarily raised the liquidity to pay benefits to participants through annual cash contributions from Hollister and cash paid by JDS for the repurchase of the Plan's stock. Hollister is required to contribute 5% of the aggregate compensation of participants to HolliShare each year, but, in recent years, Hollister has contributed between 7.5% to 8.5% of the aggregate compensation, totaling approximately $33 million in contributions since 1990. Because HolliShare invests primarily in JDS common shares, the principal factor that determines the change in value of each HolliShare participant's account is the annual decline or appreciation in the value of the Plan's JDS common shares, and the balance in each participant's account is generally based on the participant's pro-rata percentage of the value of HolliShare. Participants in HolliShare learned about the Plan and its financial condition in annual reports, which were referred to by the parties as and often bore the title of “HolliShare Highlights.”

JDS has two classes of shares, preferred ¹ and common, neither of which has a generally recognized public market. The JDS Articles of Incorporation ² (“JDS Articles”) provide several restrictions on JDS shares relevant to this case. First, under Article Five, only certain persons and entities are entitled to own JDS shares, including holders of shares as of May 5, 1978, select directors and officers of JDS or Hollister, select JDS or Hollister employees, and any deferred benefit plan maintained by JDS and/or Hollister.³ (Ex. 533, Art. V, ¶ II.C.)

Second, Article Five restricts the manner in which holders of JDS stock may transfer ownership. Specifically, subparagraph II.D.2.a gives JDS a right of first refusal by requiring that any holder of JDS stock who intends to transfer one or more shares must first offer to sell those shares to JDS. Subparagraph II.D.3.b further provides that the price paid for any common share purchased by JDS under its right of first refusal “shall be its book value as of the end of the calendar month in which the Repurchase Date occurs ... computed in accordance with generally accepted accounting principles.” ⁴ (Ex. 531, Art. V, ¶ II.D.3.b.)

The JDS Articles also provide that when JDS repurchases shares pursuant to its right of first refusal, it is obligated to pay only a 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. Not only did HolliShare's cash needs always exceeded the $5,000 and $250,000 minimums, it could not receive a promissory note for its sale of JDS stock because ERISA prohibited it from accepting a promissory note as payment from an employer. See29 U.S.C. § 1106(a)(1)(B).

In addition to the right of first refusal, subparagraph II.D.7.a provides for the sale of JDS shares under “exceptional circumstances”:

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.

(Ex. 531, Art. V, ¶ II.D.7.a.)

The Plan Instrument permits the sale of the Plan's JDS stock and does not set the price for such sales but requires that the sales be conducted in accordance with the JDS Articles. (Ex. 9–9.14, § 11.01(2).) Defendants testified at trial that, since the mid–1980s, HolliShare has sold its holdings of JDS common shares to JDS pursuant to the “exceptional circumstances” provision of subparagraph II.D.7.a, not the right of first refusal embodied in subparagraph II.D.2.a. Defendants testified that HolliShare and JDS entered into an agreement in the mid–1980s (“mid–80s agreement”) ⁵ that has since governed JDS's repurchases of common shares from HolliShare. Neither the mid–80s agreement nor its terms were memorialized in writing. Defendants testified that the terms of the agreement were that HolliShare would provide advance projections of the Plan's cash needs, HolliShare would sell shares back to JDS once a year, the purchase price would be the audited book value from December 31 of the prior year, JDS would purchase all of the shares HolliShare sought to sell, and JDS would pay all cash for the shares.

Although the theories underlying plaintiffs' claims have evolved as this case has progressed, the heart of plaintiffs' case at trial was that the price JDS paid for HolliShare's sales of its JDS stock should have been 1) the current month-end book value from the month in which the sale took place (“month-end book value”); or 2) a price determined to be the fair market value of the shares. Plaintiffs contend that, by selling at the December 31 book value from the year prior to the sale (“December 31 book value”) instead of the month-end book value or the fair market value, the HolliShare fiduciaries breached their duties under ERISA and caused the Plan to suffer extraordinary losses.

The parties have stipulated as to a variety of details concerning the challenged transactions, including the sale date, the December 31 book value that was used for the sale price, the number of shares sold, and, for almost all of the sales, the month-end book value for the month in which the challenged transactions occurred. ( See Docket No. 630 (“Stipulation of Facts”).) Between 1981 and 2007, HolliShare sold its shares to JDS on nineteen occasions. The years in which sales took place, the number of shares sold, and the cash proceeds generated were as follows: 1981 (69,300 shares for $997,227.00); 1982 (38,000 shares for $723,140.00); 1985 (20,000 shares for $1,368,400.00); 1986 (180,000 shares for $12,619,800.00); 1987 (100,000 shares for $9,756,000.00); 1993 (75,000 shares for $25,830,000.00); 1995 (30,000 shares for $14,697,300.00); 1996 (166,973 shares for $10,000,012.97); 1...