Henry v. Champlain Enterprises, Inc.
| Decision Date | 26 April 2006 |
| Docket Number | Docket No. 05-0606-CV(L).,Docket No. 05-1013-CV(XAP).,Docket No. 05-0700-CV(CON). |
| Citation | 445 F.3d 610 |
| Parties | Joseph HENRY and Michael Malinky, Plaintiffs-Appellees, v. CHAMPLAIN ENTERPRISES, INC., d/b/a Commutair, Antony Von Elbe, John Arthur Sullivan, Jr., Ernest James Drollette and U.S. Trust Company of California, N.A., Defendants-Appellants, Andrew Price, William L. Owens and Champlain Air, Incorporated, Defendants. |
| Court | U.S. Court of Appeals — Second Circuit |
Terence J. Devine, DeGraff Foy Kunz & Devine, LLP, Albany, New York (Gary D. Greenwald, Anne Marie LaBue, Shayne & Greenwald Co., LPA, Columbus, Ohio, on the brief), for plaintiffs-appellees.
Robert N. Eccles, O'Melveny & Myers LLP (Jonathan D. Hacker, Arthur W.S. Duff, and Michael A. Maricco, O'Melveny & Myers; Edward A. Scallet, Lars C. Golumbic, Groom Law Group Chartered, on the brief), Washington, D.C., for defendants-appellants.
Edward R. Conan, Bond, Schoeneck & King, PLLC (Lillian Abbott Pfohl, on the brief), Syracuse, New York, for defendants-appellees.
Before: WINTER, POOLER, and SOTOMAYOR, Circuit Judges.
Defendants-appellants Champlain Enterprises, Inc., d/b/a Commutair, Antony von Elbe, John Arthur Sullivan, Jr., Ernest James Drollette and U.S. Trust Company of California, N.A. (collectively, "U.S.Trust") appeal from a judgment of the United States District Court for the Northern District of New York (Hurd, J.) finding that U.S. Trust failed to satisfy its fiduciary duty under Employee Retirement Income Security Act ("ERISA") §§ 404, 406, and 408, to ensure that plaintiffs-appellees' Employee Stock Ownership Plan ("ESOP") paid no more than fair market value for the convertible preferred stock it purchased from CommutAir on March 15, 1994, and awarding plaintiffs-appellees $15,713,745.11 in damages, prejudgment interest, and attorney's fees. For the reasons to be discussed, we vacate the judgment and damages award and remand the case to the district court for further proceedings consistent with this opinion.
The following facts are taken from the district court's opinion, which was issued after an eleven-day bench trial. See Henry v. Champlain Enters., Inc. ("Henry II"), 334 F.Supp.2d 252 (N.D.N.Y.2004). CommutAir is a corporation based in Plattsburgh, New York that provides regional commuter airline services to USAir passengers pursuant to a code-sharing agreement with the larger airline. It was founded in 1989 by John Arthur Sullivan, Jr., Antony von Elbe, and Ernest James Drollette (collectively, "the sellers"), each of whom owned a one-third share of the company. In 1993, the investment banks Prudential Securities and Alex Brown & Sons approached CommutAir, which was thriving financially, to discuss the possibility of a strategic alliance with another airline or an initial public offering ("IPO"). Reports generated at this time indicated that CommutAir had a total equity value ranging from $140 million to $225 million; these figures were not derived from a formal valuation of the company, but from an informal ranking of CommutAir in the industry. The sellers decided not to pursue an alliance or an IPO, but in late 1993 they began exploring the possibility of establishing an ESOP — an employee benefit plan designed to encourage employee ownership through investment in securities issued by a sponsoring company. To this end, Sullivan contacted Jack Curtis, an ESOP expert and attorney with the law firm Keck, Mahin & Cate ("KMC"). Curtis informed Sullivan about the general requirements of an ESOP transaction, including the need to hire legal counsel, a financial appraiser, and a trustee to represent the ESOP.
In December 1993, the sellers decided to assemble a team to develop an ESOP for CommutAir. Sullivan contacted U.S. Trust, a company with substantial experience as an ESOP trustee, and spoke with Norman Goldberg. At this time, it was the sellers' belief, based on the investment bankers' estimates, that CommutAir had a total equity value of $200 million. The owners of CommutAir wanted to sell the proposed ESOP approximately 30% of their company for $60 million. Goldberg informed Sullivan that U.S. Trust would require an independent appraisal of CommutAir if it were hired to represent the ESOP and that this process would entail significant investigation of the company. Goldberg gave Sullivan the name of several companies, including Houlihan, Lokey, Howard & Zukin ("HLHZ"), that provided financial appraisal services.
On January 14, 1994, the sellers convened a meeting with the team slated to represent the proposed ESOP; this meeting was attended by representatives of CommutAir, U.S. Trust, KMC, and HLHZ, as well as investment bankers. At this meeting, a banker from Alex Brown & Sons gave a presentation regarding CommutAir and outlined the general terms of the proposed transaction. On January 17, 1994, the sellers circulated a draft offer stating that they would sell 30% of the company to the ESOP in the form of convertible preferred stock for $60 million. The offer anticipated that the purchase would be financed by a cash loan from CommutAir to the ESOP that would be paid to the sellers and by promissory notes issued to the sellers for the balance of the purchase price. On January 19th, the sellers submitted their draft offer to Goldberg and, on January 20th, a special fiduciary committee officially engaged U.S. Trust as trustee for the proposed ESOP.
U.S. Trust then retained KMC as legal counsel for the transaction. KMC's primary responsibilities were to conduct a due diligence review of CommutAir and to assist in negotiating revisions in the terms of the securities to be purchased by the ESOP. U.S. Trust also retained HLHZ as an independent financial advisor. HLHZ's primary responsibility was to evaluate the financial terms of the transaction, including the value of the CommutAir securities sold to the ESOP, and to render a "Fairness Opinion" that provided a detailed analysis of whether the transaction was fair to the ESOP.
The ESOP team began its due diligence review of CommutAir in early January 1994. In anticipation of the meeting on January 14th, CommutAir Vice President Andrew Price submitted management projections of the company's financial performance to HLHZ. Price's projections, which were prepared in November 1993, used CommutAir's financial data from 1992 through October 1993 and forecast the company's performance through 1995. HLHZ asked Price to submit a revised forecast that projected performance through 1998. For the revised projections, Price relied primarily on data from the final two months of 1993.
On February 2, 1994, members of the ESOP team, including Andrew Stull (a representative of HLHZ) and Michael Shea (a financial analyst from U.S. Trust), visited CommutAir headquarters to evaluate Price's projections and assess the airline's financial status. In preparation for this meeting, both HLHZ and KMC forwarded due diligence requests to CommutAir, and Stull and Shea began gathering company documents and receiving background information on CommutAir.1 At the meeting, representatives from U.S. Trust and HLHZ toured CommutAir's facilities and met with the company's senior management. Sullivan described the meetings as "rigorous" and claimed that he and other members of CommutAir's senior management were "grilled" for hours.
Some time prior to February 28th, HLHZ provided Goldberg with a preliminary valuation report concluding that CommutAir had a total equity value of $180 million. Goldberg made handwritten notes on this document identifying areas of concern in preparation for a meeting with HLHZ to discuss the basis of its valuation. In reference to the management projections submitted by Andrew Price, Goldberg wrote, "1994 — projections look robust." He also noted: "Equity risk high — judgment about forecasts uncertain." Next to the schedule containing HLHZ's comparative publicly-traded company analysis, Goldberg noted that HLHZ's selection of above-the-median multiples would have to be justified, as would HLHZ's use of a 9.5% long-term growth rate. Goldberg asserts that these notes represented only some of his concerns; others he communicated to HLHZ orally. U.S. Trust in-house financial analyst Michael Shea testified that he too expressed concerns during multiple phone calls with HLHZ but, like Goldberg, kept no written records indicating the content of these calls.
On February 28th, Goldberg and Shea met with Stull to discuss HLHZ's preliminary valuation. Although Goldberg and Shea took no notes, Stull did. Stull's notes concern, inter alia, the justification for the projected growth rate, the use of above-the-median multiples for comparable companies, the fact that the dividends were set to terminate upon payment of the debt, the threat of competition from other airlines, and the use of a weighted average cost of capital that exceeded the industry average. Stull's notes also contain questions, descriptions of topics that would require additional research, and directives to himself to "take out" certain numbers, "explain" various calculations, and "call [somebody] about regional airlines growth."
Following the February 28th meeting, Goldberg asked KMC to draft a security purchase agreement that specified the terms of the convertible preferred stock so that the parties could begin negotiations. In early March, Goldberg received a draft of HLHZ's opinion on the fairness of the proposed transaction. This draft opinion addressed the concerns expressed in Goldberg's notes on the preliminary valuation statement and in Stull's notes from the February 28th meeting: it further reduced the total equity value of CommutAir from $180 to $174 million; removed the highest selected comparable company multiples; and changed the...
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