Donovan v. Cunningham

Decision Date17 October 1983
Docket NumberNo. 82-2296,82-2296
Citation716 F.2d 1455
Parties4 Employee Benefits Ca 2329 Raymond J. DONOVAN, Secretary of the United States Department of Labor, Plaintiff-Appellant Cross-Appellee, v. Kenneth R. CUNNINGHAM, Defendant-Third Party Plaintiff-Appellee-Cross-Appellant, L.J. Carter and Mark W. Perrin, Defendants-Third Party Plaintiffs-Appellees-Cross-Appellants-Cross-Appellees, Salvador Esparza and Edward F. Fritcher, Defendants-Third Party Plaintiffs-Appellees-Cross-Appellants, v. Wilford H. HAIRELL and A. Mitchell Robertson, Defendants-Third Party Plaintiffs-Appellees-Cross-Appellants- Cross-Appellees, v. ALLIED BANK OF TEXAS, Third Party Defendant-Cross-Appellee-Cross-Appellant, v. METROPOLITAN CONTRACT SERVICES, INC., Third Party Defendant-Cross-Appellee.
CourtU.S. Court of Appeals — Fifth Circuit

Paula J. Page, Edward A. Scallet, Attys., Dept. of Labor, Plan Benefits Sec. Div., Washington, D.C., for plaintiff-appellant cross-appellee.

Susman & Kessler, Morton L. Susman, Houston, Tex., for Cunningham, Hairell, Robertson & Metropolitan Contract.

Lorance & Thompson, Larry D. Thompson, Houston, Tex., for Carter & Perrin.

Dickerson, Hamel, Early & Pennock, C. Leland Hamel, Houston, Tex., for Esparza & Fritcher.

Butler, Binion, Rice, Cook & Knapp, Tom M. Davis, Jr., Daniel F. Shank, Houston, Tex., for Allied Bank of Texas.

Appeals from the United States District Court for the Southern District of Texas.

Before THORNBERRY, GEE and WILLIAMS, Circuit Judges.

GEE, Circuit Judge:

The Secretary of Labor brought this lawsuit against various fiduciaries of a certain employee stock ownership plan ("ESOP") established under the Employee Retirement Income Security Act of 1974 ("ERISA"). 1 The Secretary's principal claim is that these defendants breached their duties as fiduciaries under ERISA by purchasing certain stock on behalf of the ESOP for more than adequate consideration. The suit was tried without a jury and the district court entered judgment for the defendants. The Secretary has appealed.

An ESOP is a form of employee benefit plan designed to invest primarily in securities issued by its sponsoring company. 29 U.S.C. Sec. 1107(d)(6) (1976). The ESOP concept is the brainchild of Louis O. Kelso, who has advanced it as a device for expanding the national capital base among employees--an effective merger of the roles of capitalist and worker. 2 Congress has enacted a number of laws designed to encourage employers to set up such plans. See note 23, infra.

As is true of all employee benefit plans covered by ERISA, ESOPs are subject to an impressive and somewhat bewildering array of rules and regulations governing their substance and administration, as well as their eligibility for favorable tax treatment. See generally L. Brown, ERISA Source Manual (1982-1983). For present purposes an understanding of these details is unnecessary; a thumbnail sketch of basic ESOP mechanics will suffice. An employer desiring to set up an ESOP will execute a written document to define the terms of the plan and the rights of beneficiaries under it. 29 U.S.C. Sec. 1102(a) (1976). The plan document must provide for one or more named fiduciaries "to control and manage the operation and administration of the plan." Id., Sec. 1102(a)(1). A trust will be established to hold the assets of the ESOP. Id., Sec. 1103(a). The employer may then make tax-deductible contributions to the plan in the form of its own stock or cash. If cash is contributed, the ESOP then purchases stock in the sponsoring company, either from the company itself or from existing shareholders. Unlike other ERISA-covered plans, an ESOP may also borrow in order to invest in the employer's stock. In that event, the employer's cash contributions to the ESOP would be used to retire the debt. With this overview in mind, we can now turn to the facts relevant to the Secretary's appeal.


Metropolitan Contract Services, Inc. ("MCS") is a contract trucking firm engaged in the business of making bulk deliveries for retail stores in several states. On December 15, 1975, the MCS board of directors voted to establish an ESOP (the "Metropolitan ESOP"), effective July 1, 1975, for the employees of MCS. The plan document provided that decisions regarding plan administration and investments were to be made by named fiduciaries composing a five-member administrative committee to be appointed by the MCS board of directors. In August 1976, the members of the MCS board of directors appointed themselves as the administrative committee of the ESOP, and at all times relevant to this case the current MCS directors served simultaneously as administrative committee members. As required by ERISA, a trust was established to maintain custody of ESOP assets. At all relevant times, Allied Bank of Texas ("Allied Bank") served as trustee.

During the time period when the Metropolitan ESOP was established and the transactions challenged by the Secretary took place, the board and administrative committee consisted of appellees Cunningham, Fritcher, Hairell, Robertson and Esparza. Mr. Cunningham was chairman of the board, chief executive officer and sole shareholder of MCS. Mr. Fritcher was secretary-treasurer and comptroller of MCS; defendants Hairell and Robertson were vice-presidents. Mr. Esparza was president of Metro Contract Services, Inc., another company wholly owned by Mr. Cunningham.

In 1977, after the challenged transactions had taken place, appellees Fritcher and Esparza were replaced on the board and administrative committee by appellees Perrin and Carter. Mr. Perrin, who had been outside counsel to MCS since before the ESOP was established, had become president of the company in mid-1977. Mr. Carter replaced Mr. Fritcher as comptroller.

The Secretary alleges that the appellees breached their fiduciary duties to the ESOP in connection with two transactions whereby the ESOP acquired MCS stock from Mr. Cunningham (the "ESOP transactions"). The first transaction occurred in August 1976. The defendants who were then members of the MCS board of directors 3 voted in that capacity to contribute $288,000 in cash to the ESOP for the purpose of acquiring stock from Cunningham. Then, in their capacity as members of the administrative committee, the same appellees voted to purchase 1440 shares of MCS stock from Cunningham at $200 per share for a total of $288,000. As a result of this transaction, the ESOP owned approximately 14% of the 10,100 outstanding MCS shares; Cunningham retained the remaining 86%.

The second challenged transaction occurred in February 1977. The same appellees, in their dual capacities as directors and administrative committee members, purchased on behalf of the ESOP an additional 5000 shares of MCS stock from Cunningham at $200 per share, for a total price of $1 million. To fund this second purchase, the administrative committee caused the ESOP to borrow $1 million from Allied Bank of Texas. Pursuant to the plan document and the loan agreement, MCS was obligated to make sufficient yearly ESOP contributions to amortize this loan. After this second transaction, the ESOP owned 34% of the outstanding MCS stock, and Cunningham held the balance of 66%. 4

In his complaint, the Secretary alleged that the defendants who were members of the administrative committee at the time of the two ESOP transactions breached various duties imposed upon them by ERISA by "failing to follow the procedures necessary to determine the fair market value of the shares" and by "causing the Plan to pay defendant Cunningham more than adequate consideration" for his stock. Cunningham was alleged to have violated certain rules against self-dealing. The Secretary also alleged that the successor fiduciaries Perrin and Carter are liable as co-fiduciaries under ERISA for concealing or failing to remedy the misconduct of the other committee members. He sought to enjoin the defendants from violating ERISA and from serving as fiduciaries under ERISA for five years. He also asked the court to order defendants to "restore the Plan to its rightful economic place," and for other appropriate equitable relief.

We will first address the appellees' claims that for various reasons the district court's judgment in their favor is no longer reviewable. Because we conclude that such is not the case, we will review the merits by first examining the relevant provisions of ERISA and will then seek to measure the defendants' conduct by the yardstick set up by the statute.


The appellees argue that the Secretary's appeal must be dismissed because of the preclusive effect of a settlement entered in a related lawsuit. They argue that the settlement renders this appeal moot, or alternatively that it bars our consideration of the issues presented by way of res judicata or collateral estoppel. We are not persuaded.

The Secretary filed the present action in January of 1980. In October of 1980, a number of private plaintiffs, some of whom were beneficiaries of the Metropolitan ESOP, 5 filed a class action in Alabama federal district court (the "Alabama lawsuit") against the same persons who are defendants in the present case. The plaintiffs in the Alabama lawsuit complained of the same transactions at issue in the present case, contending, as does the Secretary, that the defendants breached their duties under ERISA. 6

The present case proceeded to judgment and this appeal was filed. The defendants then offered to settle the Alabama lawsuit. Relying in part upon the district court's decision in this case, the Alabama district court approved and entered a comprehensive settlement agreement that purports to bind all participants in the Metropolitan ESOP and all defendants in that case. Adcock v. Pioneer Contract Services, Inc., No. CV80-L-5274-NE (N.D.Ala. July 30, 1982) (unpublished final order). The agreement provides that all issues of the defendants' performance of their fiduciary duties are settled,...

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