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dismissing claim that interest rate was unreasonable only after a trial and a finding that “Plaintiffs offered no evidence that a more favorable rate of interest was available”
Summary of this case from Schmalz v. Sovereign Bancorp, Inc.Opinion
Case No. CIV-98-474-X.
October 4, 2001
FINDINGS OF FACT AND CONCLUSIONS OF LAW
This matter came on for trial before the Court sitting without a jury. Having heard the evidence presented at trial, having considered the proposed findings of fact and conclusions of law filed by the respective parties and having considered the applicable law, the Court hereby makes the following findings of fact and conclusions of law.
FINDINGS OF FACT Parties
1. Plaintiffs, James M. Bevel, III, David Stettler, Glen Boyd, Edward David Grigg, Jonell Hughey, and James D. Mullins, are former employees of J.P. EMCO, Inc. At all times relevant to this action, Plaintiffs were participants in the J.P. EMCO, Inc. Employee Stock Ownership Plan and Money Purchase Pension Plan ("the Plan").
2. Defendants, Bascom M. Higginbottom and W. F. Simpson, are former officers and directors of J. P. EMCO, Inc. At all times relevant to this action, Defendants were the members of the Plan's administrative committee and were the trustees of the J.P. EMCO, Inc. Employee Stock Ownership and Money Purchase Pension Trust ("the Trust"), which held the cash and employer stock of the Plan.
3. Plaintiffs bring this action against Defendants under the Employee Retirement Income Security Act of 1974, as amended, ("ERISA"), 29 U.S.C. § 1001, et seq. Plaintiffs allege that Defendants breached their fiduciary duties under section 404(a) of ERISA, 29 U.S.C. § 1104(a), and engaged in a prohibited transaction in violation of section 406(a)(1)(B) of ERISA, 29 U.S.C. § 1106(a)(1)(B).
Background
4. In 1973, General Tire Rubber Company ("General Tire") built a plant in Ada, Oklahoma and commenced an injection molding operation. The Ada facility produced painted injection molded rubber and plastic parts for automotive and commercial applications. Ford Motor Company ("Ford") was General Tire's primary customer.
5. For several years prior to 1983, General Tire attempted to sell the Ada facility without success. Early in 1983, General Tire tried unsuccessfully to sell its injection molding operation for $9,000,000.
6. On September 12, 1983, Paul Day and Joe Lear ("Day Lear"), who had been officers of General Tire, formed a joint venture company and acquired the assets and assumed some liabilities of General Tire's operation in a leveraged buyout for $4,500,000. At the time of purchase, General Tire's operation had an estimated liquidation value of $5,400,000.
7. Day Lear named their joint venture company J.P. EMCO Company, Inc. During its first complete year of operation in 1984, J.P. EMCO Company, Inc. had sales of $15,500,000 and a net income of $649,000.
8. Sometime in 1984, Day Lear, upon solicitation from Menke Associates, Inc. ("Menke Associates"), a third-party administrator of ERISA — regulated plans, established the Plan and the Trust. Menke Associates drafted the necessary documents for the Plan and the Trust.
9. In mid-1985, Day Lear agreed to sell J.P. EMCO Company, Inc. to Defendants for $10,332,000. Defendants were officers of J.P. EMCO Company, Inc. and previous members of management of General Tire. On August 1, 1985, Day Lear sold 461,250 shares of common stock to Defendants at $22.40 per share. In addition, Day Lear transferred 38,750 shares to treasury stock. The name of the company was changed to J.P. EMCO, Inc. ("EMCO"). Ford continued as EMCO's primary customer.
10. After purchasing EMCO, Defendants decided to continue the Plan and assumed the responsibilities as trustees of the Trust from Day Lear.
The Plan and Pre-1990 Contributions
11. A primary purpose of the Plan was to enable participants to acquire a proprietary interest in EMCO. The Plan provided that contributions to the Trust would be primarily invested in EMCO stock.
12. The Plan provided that contributions to the Trust could be paid in cash, shares of EMCO stock or other property as EMCO's Board of Directors determined.
13. In addition, the Plan provided that contributions in cash and other property received by the Trust would be applied to pay any outstanding obligations of the Trust incurred for the purchase of EMCO stock, or might be applied to purchase additional shares of EMCO stock from current shareholders, treasury shares or newly-issued shares from EMCO.
14. The Plan further provided that the administrative committee could direct the trustees to invest funds under the Plan in savings accounts, insurance policies on the life of any key employee, incidental life insurance policies, certificates of deposit, securities, or other equity stocks or bonds or in any other kind of realty or personal property, including interests in oil or other depletable natural resources, options, puts, calls, future contracts and commodities; or such funds might be held in non-interest-bearing bank accounts as necessary on a temporary basis.
15. The Plan had two components: a Stock Bonus Plan and a Money Purchase Pension Plan. The purpose of having the two components was to provide the maximum possible annual contribution for the Plan allowed under the Internal Revenue Code. By having two components, EMCO was able to annually contribute to the Trust a maximum of 25% of eligible payroll.
16. Between 1985 and 1989, the Trust purchased for the Plan approximately 144,208 shares of EMCO stock for $4,600,000. At the end of 1989, the Plan held approximately 29% of the outstanding shares of EMCO's common stock. Specifically, EMCO made contributions to the Trust for the years 1985 through 1989 in the amounts indicated below:
Year Stock Bonus Money Purchase Total Plan Pension Plan Contributions Contributions Contributions 1985 $636,044 $425,456 $1,061,500 1986 $793,995 $512,259 $1,306,254 1987 $879,446 $586,328 $1,465,774 1988 $957,718 $638,479 $1,596,197 1989 $909,293 $606,207 $1,515,500 TOTAL CONTRIBUTIONS $6,945,225 17. EMCO was the administrator of the Plan. Menke Associates provided a variety of Plan — related services to EMCO. Specifically, Menke Associates was involved in the calculating and accounting for the contributions to the Trust and the allocation of shares to Plan participants. It also prepared the participant benefit statements, which reported to employees their account balances on an annual basis, and the summary annual reports, which provided a summary report of the assets, liabilities, receipts, income, expenses, and disbursements of the Plan. In addition, Menke Associates prepared the Form 5500s, which constituted the annual returns for the Plan to the Internal Revenue Service.Purchase Offers for EMCO
18. Prior to 1990, Defendants received numerous third-party inquiries about purchasing EMCO. Defendants engaged Menke Titolo Capital Corporation ("Menke Titolo"), a sister company of Menke Associates, to solicit offers from third parties. On EMCO's behalf, Menke Titolo prepared and submitted an offering memorandum to a number of buyout firms and strategic buyers.
19. Subsequently, EMCO received letters of intent from two buyers — Wickes Companies, Inc. and Gold Dome Financial. Because Wickes Companies, Inc. provided the better offer, a stock purchase agreement was negotiated between the parties in March of 1988. Wickes Companies, Inc.'s offer of purchase was for $20,500,000. The transaction between the parties, however, was never consummated because Wickes Companies, Inc. was, itself, bought out.
Contract With Ford
20. On May 10, 1989, EMCO and Ford entered into a contract which provided that EMCO would become Ford's sole supplier of certain parts. As part of the agreement, EMCO agreed to reduce its part price by 5% per year, beginning on January 1, 1989 and continuing for the duration of the life of that part, up to a maximum of four years on a model year basis. Ford agreed to allow EMCO certain price adjustments on an annual basis. The contract provided that Ford could terminate its obligations under the contract by furnishing written notice of a termination date of no less than three months.
21. On June 19, 1989, Ford designated EMCO as a "Q1 Preferred Quality Supplier," signifying that EMCO would be retained as a "preferred long-term supplier" to Ford.
The Plan's Purchase of EMCO
22. In the latter part of 1989, John Menke, president of Menke Associates, suggested to Defendants that they sell their EMCO stock to the Plan. Mr. Menke believed that the Plan was the logical buyer of the stock because the Plan was already established and it then owned in the range of 25% to 28% of EMCO's stock. Mr. Menke believed it was a win/win situation for all parties because of the tax savings for EMCO for any money borrowed for a buyout, the tax incentives to Defendants as sellers of the stock and the eventual ownership of EMCO by the employees. Furthermore, Mr. Menke recognized that if EMCO's common stock were sold to a third party rather than to the employees, the Plan would be terminated.
23. Thereafter, Defendants engaged Menke Associates to facilitate the Plan's purchase of the stock.
24. At Defendants' request, Menke Associates performed a valuation study of EMCO as of August 31, 1989 to determine the fair market value of EMCO's common stock. On October 13, 1989, Robert Ireland, who conducted the valuation on behalf of Menke Associates, opined that the fair market value of the common stock equity of EMCO on an enterprise basis was $24,000,000, or $48.00 per share, based upon 500,000 shares of common stock outstanding. Defendants' 355,792 shares of common stock were thus valued at $17,078,016.
25. In the appraisal report, Mr. Ireland stated that EMCO "expects to do well in the future, but is cognizant of economic predictions of a slow down or decline in new car sales." However, Mr. Ireland also stated that Ford's market share of new car sales had been increasing and that the rate at which Ford and other car manufacturers had employed plastic parts in new models had been increasing.
26. The Plan did not have sufficient assets to purchase all of Defendants' shares of common stock. To acquire Defendants' shares of common stock, the Plan had to obtain financing in the amount of $15,500,000. EMCO agreed to provide the necessary funds to the Plan. However, in order to obtain the funds, EMCO had to obtain financing from outside sources.
27. With the assistance of Menke Titolo, Defendants explored financing arrangements for EMCO. All of the proposed financing arrangements involved a primary or senior loan to EMCO in the amount of $7,100,000 being made by a commercial lender and a secondary, or subordinated loan to EMCO in the amount of $8,400,000 being funded by a mezzanine lender.
28. The senior loan of $7,100,000 would be secured with EMCO's assets and would to be offered at an interest rate a few points above the prime rate of interest at the time. The subordinated loan of $8,400,000, secured only with a secondary lien on the remaining assets of EMCO, would have to be provided at a significantly higher rate of interest.
29. Menke Titolo narrowed the field of potential lenders for the senior loan to EMCO from over a hundred down to six, and then to two finalists, Security Pacific Business Credit, Inc. ("SPBC") and Sovereign Bank. Defendants selected the financing proposal offered by SPBC for the senior loan to EMCO ("SPBC loan"). SPBC offered a slightly lower interest rate and had less restrictive covenants. The proposed financing arrangement was set forth in a letter dated December 11, 1989.
30. Defendants elected to finance the subordinated loan of $8,400,000 ("subordinated loan") to EMCO. Defendants were willing to be more flexible with the subordinated loan than other mezzanine lenders would be. Rates of interest offered by most mezzanine lenders ranged between 22% to 24%. One mezzanine lender, Churchill Capital, charged between 17% and 22%. The stated interest rate for the subordinated loan would be 17%. Defendants were to obtain the $8,400,000 to fund EMCO's loan via a bridge loan from SPBC.
31. On December 11, 1989, Defendants adopted the Amended and Restated Certificate of Incorporation of J.P. EMCO, Inc., increasing EMCO's authorized shares from 500,000 to 700,000.
32. On January 24, 1990, Defendants adopted an amended and restated Plan to be effective as of January 1, 1989. The Plan provided that the shares of EMCO common stock acquired by the Trust with proceeds of a loan would be credited to a suspense account. It also provided that for each Plan year during the duration of that loan, the number of shares of common stock to be released from the suspense account and allocated to the stock accounts of participants would be determined pursuant to either the general rule or the special rule. It further provided that once the Plan's administrative committee selected either the general rule or special rule, that rule would be used exclusively for allocation of the shares of common stock.
33. In addition, the amended and restated Plan provided that a participant would be entitled to direct the voting of any voting shares of EMCO common stock allocated to the participant's stock account with respect to any vote required for the approval or disapproval of any corporate merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all the assets of a trade or business, or other similar transactions prescribed by regulation.
34. On March 19, 1990, Defendants, as members of EMCO's Board of Directors, unanimously consented to EMCO issuing 29,167 shares of common stock to the Trust in exchange for the Trust paying EMCO the sum of $1,400,016. The money obtained by EMCO from the sale of additional stock was to be used to refinance an industrial revenue bond and to pay all the required fees for the loan transaction.
35. At Defendants' request, Independent Appraisals, Inc., performed an appraisal study of EMCO to help determine the fair market value of EMCO as of February 28, 1990 and March 26, 1990. Robert Wilkes, on behalf of Independent Appraisals, Inc., opined that the fair market value of EMCO was $24,000,000 and with 500,000 shares outstanding, the value per share of common stock was $48.00.
36. Independent Appraisals, Inc. was also retained by Defendants to express an opinion as to the fairness of the transaction to the Plan. Mr. Wilkes, on behalf of Independent Appraisals, Inc., specifically opined that the transaction was fair from a financial point of view.
37. Keck, Mahin Cate, acting as special counsel to the Trust and the Plan, issued an opinion to SPBC on March 26, 1990, which opined, in part, that the subject loans would constitute exempt loans under Treasury Regulation Section 54.4975-7(b) and that the delivery of the loan and stock acquisition agreements on behalf of the Plan and the performance of the Plan under those agreements would not constitute prohibited transactions under section 406.
38. Defendants would not have proceeded with the Plan's purchase of their stock if they had not received favorable results from the fairness opinion of Independent Appraisals, Inc. and the legal opinion of Keck, Mahin Cate.
39. On March 26, 1990, Defendants sold their 355,792 shares of EMCO common stock to the Plan for $17,078,016. On the same date, the Trust, on behalf of the Plan, purchased an additional 29,167 shares of newly issued common stock from EMCO for $1,400,016. The purchase of common stock by the Plan came from existing cash in the Trust, EMCO's 1989 cash contribution to the Trust for the Plan, and loans from EMCO to Plan in the amount of $15,500,000. The effect of the March 26, 1990 transaction was to vest total ownership and control of EMCO with the Plan.
40. On March 26, 1990, Defendants, as members of the Board of Directors, consented to Amendment Number 1 to the Plan, effective January 1, 1990, which provided, in part, that a participant was entitled to direct the voting of EMCO stock allocated to his stock account to the extent such stock was newly acquired by or transferred to the Trust in connection with the Plan loan.
41. In the Court's Order of July 27, 2000 ruling on the parties' cross-motions for summary judgment, the Court found that no genuine issue of fact existed as to the adequacy of consideration paid by the Plan for EMCO's common stock. Plaintiffs had admitted in their summary judgment motion that the shares of common stock were worth $48.00 per share as of March 26, 1990.
42. Prior to the March 26, 1990 transaction, the value of EMCO's stock had been steadily increasing every year.
43. Prior to the March 26, 1990 transaction, Defendants did not believe that losing the Ford contract was a possibility. They had no basis for concern about EMCO's future viability or the impact of the debt obligation resulting from that transaction.
44. As of March 26, 1990, EMCO had enough cash flow to service the senior loan, and once the senior loan was repaid, to successfully amortize its subordinated loan.
SPBC Loan
45. The initial term of the SPBC loan to EMCO was three years, but the loan could be automatically renewed thereafter for successive one-year terms. The annual interest rate for the loan was 85% of SPBC's prime lending rate plus an additional 2.25%. On March 26, 1990, the prime rate was 10%. The interest rate effective on March 26, 1990 was approximately 10.4%. SPBC offered a discounted rate on the primary portion of the senior debt because 50% of the bank's interest income earned on the acquisition loan was tax exempt.
46. The SPBC loan to EMCO was evidenced by two promissory notes, the Term Note and the Supplemental Term Note. The Term Note in the principal amount of $3.7 million was secured by the receivables and inventory of EMCO. The Supplemental Term Note in the principal amount of $3.4 million was secured by the equipment and all other current and fixed assets of EMCO. The terms and conditions of the loan were set forth in the Loan and Security Agreement between SPBC and EMCO. As additional security for the SPBC loan, Defendants executed limited non-recourse guaranties and note pledge agreements, pledging a total of $2,000,000 in General Electric corporate bonds, to guarantee EMCO's payment of the SPBC loan.
47. The maturity date of the SPBC loan was March 26, 1993. However, EMCO negotiated renewals of the SPBC loan in 1993 and 1994, extending the remaining debt obligation until January 31, 1995. The new interest rate for the senior debt was 85% of the prime rate plus 4%.
48. By January 4, 1995, EMCO paid in full the outstanding balance of the SPBC loan and accrued interest.
Subordinated Loan
49. The subordinated loan was evidenced by a promissory note between Defendants and EMCO. The terms and conditions of EMCO's repayment of the subordinated loan were set forth under the Subordinated Loan Agreement.
50. The stated interest rate on the subordinated loan was 17%. However, under the terms of the Subordinated Loan Agreement, Defendants were to receive interest payments only at a rate of 13% per annum until such time as the SPBC loan was repaid. The remaining 4% interest was deferred and accrued. In addition, principal payments by EMCO to Defendants on the subordinated loan were restricted while the SPBC debt existed. The subordinated loan had an initial term of three years but was renewable for successive one-year terms as long as the SPBC debt existed.
51. From 1990 until 1995, EMCO paid interest to Defendants in the amount of $5,465,136 on the subordinated loan. No payments of principal, however, were made to Defendants.
Plan Loan
52. EMCO's loan of $15,500,000 to the Plan ("Plan loan") was evidenced by three term promissory notes — A Term Note B Term Note constituting the senior portion of the debt and C Term Note, the subordinated debt. The terms and conditions of the Plan loan were set forth by the ESOP Credit Agreement. The Plan loan was a non-recourse loan and was secured by the EMCO common stock purchased with the loan proceeds.
53. The A Term Note and B Term Note of the Plan loan were payable within three years, with principal payments based on an amortization schedule of approximately $84,000 per month. The terms of Notes A and B were extended to five years or 58 months by the terms of the second and third loan modification agreements. The C Term Note or the Subordinated debt had an initial term of five years. The C Term Note's principal balance was due at the expiration of its initial term except as extended by subsequent renewals of the note.
54. For the years 1990 through 1995, the Plan did not receive contributions from EMCO in the form of cash. To satisfy its contribution obligations, EMCO decreased the principal amount due on Notes A and B of the Plan loan by the same amount that it paid in principal on the SPBC loan.
55. Plan contributions were made in excess of the minimum amount required for the years 1990 through 1995 in the following amounts: Year Stock Bonus Money Purchase Total Plan Pension Plan Contributions Contributions Contributions Total Contributions $7,221,819
1990 $894,857 $596,571 $1,491,428 1991 $239,286 $198,714 $438,000 1992 $334,927 $679,373 $1,014,300 1993 $194,903 $819,397 $1,014,300 1994 $746,531 $967,769 $1,714,300 1995 $895,396 $654,095 $1,549,491 56. The Plan never paid any interest to EMCO on the promissory notes of the Plan loan. EMCO forgave all interest payments due EMCO under the Plan loan.Allocation Method for Release of Shares Pledged as Collateral
57. In 1990, the Plan's administrative committee, in accordance with the amended and restated Plan, effective January 1, 1989, selected the general rule for the allocation method for release of shares pledged as collateral for the Plan loan. Under the general rule, the plan committee was to withdraw from the suspense account, a number of shares of EMCO stock equal to the total number of shares of EMCO stock held in the suspense account prior to the withdrawal multiplied by a fraction of the principal and interest paid for the Plan year over the sum of principal and interest paid for the Plan year plus the principal and interest to be paid for all future years (principal and interest allocation method).
58. Effective for the Plan year 1991, the method of releasing stock from the suspense account was changed from the general rule (principal and interest allocation method) to the special rule (principal — only allocation method). The allocation method was changed because Menke Associates discovered a conflict between what the Plan said and what section 415 of the Internal Revenue Code allowed. The Plan was amended on June 15, 1992 by way of Amendment Number 2 to allow for the change in the allocation method.
59. Under the special rule, the Plan's administrative committee was to withdraw from the suspense account, a number of EMCO shares equal to the total number of shares held in the suspense account prior to the withdrawal multiplied by a fraction of the amount of principal paid for the Plan year over the sum of principal paid for the Plan year plus the principal to be paid for all future Plan years. This method of allocation was made retroactive to the inception of the Plan loan, and the shares of stock allocated under the general rule were reallocated accordingly.
60. For the years 1990 through 1993, the cumulative rate that shares were released under the special rule allocation method was greater than the amount of shares that would have been released had the general rule allocation method remained in place.
61. Because there were two components of the Plan — the Stock Bonus and Money Purchase, each having separate financial statements — and only one loan between the Plan and EMCO, the Plan loan was recorded only on the financial statements of the Stock Bonus component of the Plan. The 1990 Form 5500s and financial statements disclosed that the Plan loan was booked to the Stock Bonus Plan. A corresponding disclosure was made in the notes of the financial statements of the Money Purchase component for the Plan year 1990 and each year thereafter, stating that the Plan loan had been recorded only on the statements of the Stock Bonus component but that the loan was being treated jointly as an obligation of each.
Post-Stock Acquisition Offer of Purchase of EMCO
62. In late 1990, the automotive division of Textron, Inc., approached Defendants concerning the purchase of EMCO. Textron made a purchase offer of $25,000,000. However, the purchase was not consummated because of a freeze placed on acquisitions by the corporate office of Textron.
Loss of Ford Business
63. In 1994, Ford started to change the design theme on its cars. The change in styling eliminated a lot of the type of product that EMCO supplied to Ford. At the same time, Ford decided to narrow its suppliers to companies larger than EMCO. Consequently, EMCO had to look for other business opportunities.
General Motors
64. Defendants became aware that General Motors ("GM") had a piece of business similar to what they had done for Ford. Defendants obtained the work from GM and were successful with it. Indeed, GM awarded EMCO its "Supplier of the Year" award. As the GM work increased, it became clear to EMCO that a new paint facility would be required in order to handle the business.
65. After receiving assurances from GM that EMCO was going to get a GM contract, Defendants proceeded with plans to build the paint facility in 1995. The paint facility would cost around $15,000,000.
66. The facility required financing from various sources, including Defendants, who personally loaned $2,700,000 for the completion of the project. This loan was separate and in addition to the $8,400,000 subordinated loan they made to EMCO on March 26, 1990.
67. In addition to Defendants' loan for the paint facility, ENCO procured loans from a couple of banks. Agreements with NBD Bank and other secured creditors were entered into regarding the subordinated loan made to EMCO in 1990. Under these agreements, payments of accrued interest and principal to Defendants were restricted until the obligations of the other lenders were paid. Liquidity Problems
68. In 1996, EMCO experienced problems with its GM business. A design change appeared in a GM molded part that EMCO had not anticipated. In addition, parts which had been accepted off EMCO's paint line by GM personnel, were thereafter rejected by GM's assembly plant at rates of almost 100% due to a surface imperfection problem. Such problems began affecting EMCO's liquidity.
69. EMCO also faced another liquidity problem. A disagreement arose between one of EMCO's prime contractors and a subcontractor, resulting in the filing of a mechanic's lien by the subcontractor. EMCO had to report the lien to the bank, which immediately impacted EMCO's line of credit.
70. Defendants made several trips to GM's headquarters to inquire whether GM would extend funds to EMCO or provide substitute business to allow EMCO to generate some cash. GM agreed to subsidize the operation if EMCO would declare bankruptcy and allow GM to bring in an outside management team. Defendants understood that if EMCO refused these conditions, GM would move its business elsewhere.
Bankruptcy
71. On October 17, 1996, EMCO filed a Chapter 11 petition in bankruptcy.
72. EMCO's stock was the Plan's primary asset holding. At the time of EMCO's bankruptcy, the Plan had cash assets of approximately $140,000.
73. The cost of preparing and mailing participant account statements ranged between $10,000 to $20,000. No participant account statements were sent during bankruptcy proceedings because the value of stock was either impossible to determine or was worthless. In addition, the Plan would have had to pay the cost for sending the statements because the bankruptcy judge would not allow use of EMCO's funds or assets to finance the costs.
74. During the course of this litigation, the parties reached an agreement that the remaining cash assets of the Plan would be not be distributed until the litigation's conclusion.
75. Defendants never received principal payments on the subordinated loan or the paint facility loan. Defendants filed claims against EMCO in bankruptcy totaling $11,100,000-$8,400,000 for the subordinated loan and $2,700,000 for the paint facility loan. Defendants received approximately $700,000 for the secured claims.
Investigation and Filing of Lawsuit
76. In the fall of 1993, Plaintiff, David Stettler, became suspicious of the March 26, 1990 transaction, after observing from his 1992 participant statement that the price of the EMCO stock was decreasing. Between March 26, 1990 and December 31, 1993, the value of the stock held by the Plan declined from $48.00 per share to $24.35 per share. Stettler began an investigation into the fluctuation of stock price and formed an Employee Stock Ownership Plan Committee through the local union. Plaintiff, Glen Boyd, was a member of the committee.
77. On March 1, 1994, the committee sent a letter to Defendants, asking 24 questions regarding the stock, the loan and the Plan. Defendants responded to the letter on March 21, 1994. In that letter, Defendants offered to meet with the committee on March 29, 1994 to discuss the questions. The committee declined Defendants' offer by letter dated March 24, 1994. Defendants provided the committee with the valuation section of the appraisal by Mr. Wilkes on March 29, 1994. They also provided to the committee the Valuation Summary Determination and Conclusions sections of the J.P. EMCO, Inc. stock valuation reports for 1986 through 1992 on May 10, 1994.
78. All information obtained by the committee from Defendants was forwarded to Kenneth Klingenberg, an attorney retained by the local union. At the first meeting with Mr. Klingenberg, Plaintiffs discussed concerns about whether Defendants breached their fiduciary duties. They were suspicious of how the loan was being repaid. Mr. Klingenberg advised Plaintiffs that he needed to review the Plan documents and all loan documents.
79. On September 28, 1994, the committee requested a complete copy of the Plan program and a complete copy of all loan documents. Defendants consulted with Mr. Menke in responding to the request. Mr. Menke informed Defendants that Plan documents was a defined term under ERISA and that it did not include loan documents. Although Menke Associates encourages their clients to provide such information, Mr. Menke advised Defendants that disclosure of loan documents was not a legal requirement under ERISA. On October 3, 1994, Defendants provided a copy of the Trust and the Plan to the committee. Defendants, however, declined to provide a copy of all loan documents on the basis that the loan documents contained confidential information, such as salary, bonuses, and expenses, and Defendants did not want such information to get into the hands of competitors.
80. On October 26, 1994, Mr. Klingenberg sent a letter to the committee giving his preliminary analysis of the matter. The committee was advised that its concerns were real and justified.
81. On October 31, 1994, the committee requested information from Defendants on the total number of shares outstanding of the company stock along with the number of shares allocated to the employees' company stock accounts with respect to employer securities acquired on or after January 1, 1990. Defendants provided the requested information on November 8, 1994.
82. Thereafter, the committee requested a copy of the 1993 annual report and the 1993 appraisal. Defendants provided the Valuation Summary Determination and Conclusions sections of the J.P. EMCO, Inc. Stock Valuation report as of December 31, 1993. They also provided the Annual Form 5500 reports for the year ending December 31, 1993.
83. As of December 31, 1995, EMCO's stock was worth $14.90 per share.
84. After EMCO filed bankruptcy on October 16, 1996, Plaintiffs actively sought financial assistance to file their lawsuit. The vice-president of the local union at the time, Juanita Haskins, sent a letter to the international union, stating that Plaintiffs were ready to file lawsuits in federal court but that the lawsuits were going to require more money than the local union could afford. The letter further advised that the statute of limitations was running out.
85. The instant lawsuit was filed on October 2, 1998.
86. In the amended complaint and in the amended pretrial order, Plaintiffs alleged claims under section 404(a) of ERISA, 29 U.S.C. § 1104(a), against Defendant, Consulting Fiduciaries, Inc. ("CFI"). On February 10, 1997, the Plan and Trust retained CFI to represent their interests in EMCO's bankruptcy proceedings. CFI provided independent fiduciary decision making, consultation, and alternative dispute resolution services to ERISA — regulated plans, plan sponsors, trustees, and investment advisors. CFI alleged a cross — claim against Defendants, Bascom M. Higginbottom and W.F. Simpson, and Defendants alleged a cross-claim against CFI. CFI also alleged a third-party claim against the Plan and the Trust. During the trial, Plaintiffs and CFI resolved Plaintiffs' claims against CFI. Plaintiffs thereafter dismissed all claims against CFI and dismissed all bankruptcy — related claims against Defendants with prejudice. CFI dismissed its cross-claim against Defendants with prejudice and Defendants dismissed their cross-claim against CFI without prejudice. CFI also dismissed the third-party claim against the Plan and the Trust with prejudice.
CONCLUSIONS OF LAW
87. Any finding of fact stated above which could be properly characterized as a conclusion of law is incorporated herein. Any conclusion of law hereinafter stated which could be properly characterized as a finding of fact is incorporated in the above findings of fact section.
Jurisdiction and Venue
88. This Court has jurisdiction over the subject matter of this action under section 502(e)(1) of ERISA, 29 U.S.C. § 1132(e)(1), and 28 U.S.C. § 1331. Venue is proper in this district under section 502(e)(2) of ERISA, 29 U.S.C. § 1132(e)(2) and 28 U.S.C. § 1391(b).
89. The Plan is an employee stock ownership plan as defined in section 407(d)(6)(a) of ERISA, 29 U.S.C. § 1107(d)(6)(A).
90. Defendants were, at all times relevant to this action, fiduciaries with respect to the Plan within the meaning of section 3(21)(A) of ERISA, 29 U.S.C. § 1002(21)(A).
91. Plaintiffs have authority to bring this action by virtue of sections 502(a)(2) and 502(a)(3) of ERISA, 29 U.S.C. § 1132(a)(2) and § 1132(a)(3)
Section 406(a)(1)(B) Claim
92. Section 406(a) of ERISA bars a fiduciary of an employee benefit plan from causing a plan to engage in certain transactions with a "party in interest." 29 U.S.C. § 1106(a); Harris Trust Sav. Bank v. Salomon Smith Barney. Inc., 530 U.S. 238, 120 S.Ct. 2180, 2184, 147 L.Ed.2d 187 (2000). Section 406(a)(1)(B) provides in pertinent part that "[a] fiduciary with respect to a plan shall not cause the plan to engage in a transaction, if he knows or should know that such transaction constitutes a direct or indirect . . . lending of money or other extension of credit between the plan and a party in interest." 29 U.S.C. § 1106(a)(1)(B). Under section 3(14), a "party in interest" includes an "employer whose employees are covered by [the] plan." 29 U.S.C. § 1002(14). In this case, Plaintiffs specifically allege that Defendants violated section 406(a)(1)(B) because they caused the Plan to enter into the subordinated portion of the Plan loan, namely, the C Term Note, with EMCO.
93. Section 406's prohibitions are subject to both statutory and regulatory exemptions. See, Sections 408(a) and 408(b) of ERISA, 29 U.S.C. § 1108(a),(b); Harris Trust Sav. Bank, 120 S.Ct. at 2185. Section 408(b)(3) specifically exempts from the prohibition of section 406(a)(1)(B) "[a] loan to an employee stock ownership plan . . . if — (A) such loan is primarily for the benefit of participants and beneficiaries of the plan, and (B) such loan is at an interest rate which is not in excess of a reasonable rate." 29 U.S.C. § 1108(b)(3). Defendants specifically contend that the statutory exemption of section 408(b)(3) applies to the C Term Note.
94. Defendants carry the burden of proving the statutory exemption.Lowen v. Tower Asset Management. Inc., 829 F.2d 1209, 1215 (2d Cir. 1987); Donovan v. Cunningham, 716 F.2d 1455, 1467-68 (5th Cir. 1983),cert. denied, 467 U.S. 1251 (1984); Marshall v. Snyder, 572 F.2d 894 (2d Cir. 1978); New York State Teamsters Council Health and Hosp. Fund. v. Estate of Deperno, 816 F. Supp. 138 (N.D.N.Y. 1993), aff'd in part, 18 F.3d 179 (2d Cir. 1994).
95. In addition to claiming that the statutory exemption applies, Defendants also claim that Plaintiffs' section 406(a)(1)(B) claim is barred by the applicable statute of limitations. See, Section 413 of ERISA; 29 U.S.C. § 1113. The Court, however, need not address this affirmative defense. The Court finds that Defendants have presented sufficient evidence to prove that the statutory exemption applies.
96. The Secretary of Labor has promulgated regulations covering loans to an employee stock ownership plan. 29 C.F.R. § 2550.408b-3. In regard to the requirement of a loan being primarily for the benefit of participants and beneficiaries, the regulations provide that all surrounding facts and circumstances are to be considered. Such facts and circumstances include (1) at the time the loan is made, the interest rate for the loan and the price of securities to be acquired with the loan proceeds should not be such that plan assets might be drained off; (2) the terms of the loan, at the time the loan is made, must be at least as favorable to the employee stock ownership plan as the terms of a comparable loan resulting from arm's-length negotiations between independent parties; (3) the proceeds of the loan must be used, within a reasonable time after their receipt, only for acquiring qualifying employer securities, to repay such loan or to repay a prior exempt loan; (4) the loan must be without recourse against the employee stock ownership plan and the assets of the employee stock ownership plan that may be given as collateral are qualifying employer securities; and (5) in the event of default, the value of plan assets transferred in satisfaction of the loan must not exceed the amount of default. 29 C.F.R. § 2550.408b-3(c)(2) (3)(d), (e) (f).
97. The third, fourth, and fifth elements of this regulatory standard are not at issue in this case. The evidence was uncontroverted that the proceeds of the loan were used immediately to consummate the stock — acquisition transaction and the Plan loan was without recourse against the Plan. The Plan loan was collateralized by the qualified employer securities — the unallocated common stock of EMCO. It was likewise uncontroverted that EMCO took no action to collect any portion of the C Term Note of the Plan loan upon the Plan's default.
98. As to the first and second elements, the Court concludes that Defendants have satisfied their burden of proof. First, the purchase price of the stock and interest rate were not such that they would drain off the Plan's assets. In the summary judgment ruling, the Court found no genuine issue of fact existed as to the adequacy of consideration paid for the stock. Plaintiffs admitted in the summary judgment motion that the stock was worth $48.00 per share. In addition, the stated interest rate for the C Term Note was 17%. The evidence showed that such interest rate was the lowest rate charged by mezzanine lenders at the time. Moreover, no interest payments were ever paid by the Plan because EMCO forgave such payments. The Court finds that the acquisition of fairly-valued employer securities with borrowed, interest-free funds could not constitute a drain of the Plan's assets.
99. The evidence presented revealed that the terms of the C Term Note of the Plan loan were comparable or more favorable than rates that were available for comparable loans negotiated at arm's — length between independent parties. No evidence was adduced concerning the availability of any comparable loan which included an interest rate more favorable than the interest rate extended by EMCO.
100. Considering the facts and circumstances, the Court finds that the subordinated portion of the Plan loan or the C Term Note was primarily for the benefit of the Plan participants and beneficiaries.
101. At trial, Plaintiffs claimed that the C Term Note was not primarily for the benefit of Plan participants and beneficiaries because the allocation method was changed from the general rule to the special rule. The evidence presented, however, showed that the change in the allocation method had no material effect on the rate at which shares were allocated to Plan participants and beneficiaries. Indeed, for the years 1990 through 1993, the cumulative rate that shares were released under the special rule allocation method was greater than the amount of shares that would have been released had the general rule allocation method remained in place. Moreover, it was shown that the change in allocation methods occurred to comply with the provisions of section 415 of the Internal Revenue Code. Furthermore, it was shown that the Plan was amended to allow for the change in allocation methods. The Court therefore concludes that the change in allocation method does not effect the Court's prior finding that the C Term Note was primarily for the benefit of the Plan participants and beneficiaries.
102. The Secretary of Labor has also identified certain factors to consider in analyzing the second part of the statutory exemption, namely, whether the interest rate of a loan is in excess of a reasonable rate of interest. These factors are (1) the amount and duration of the loan; (2) the security and guarantee (if any) involved; (3) the credit standing of the employee stock ownership plan and the guarantor (if any); and, (4) the interest rate prevailing for comparable loans. 29 C.F.R. § 2550.408b-3(g).
103. The first, second and third factors are not in dispute. The amount of the Plan loan was equal to the fairly valued stock the Plan was acquiring. The C Term Note was for $8,400,000 and had an initial term of five years. Only unallocated, qualifying employer securities collateralized the loan and no issues have been raised concerning the credit standing of the Plan. The factor in dispute between the parties is the fourth factor, namely, whether the prevailing interest rate was reasonable as measured against a comparable loan between independent parties.
104. The evidence presented demonstrated that the stated rate of interest on the C Term Note was comparable or more favorable than comparable rates from mezzanine or other third party lenders. As stated above, the stated rate of interest of 17% on the C Term Note was the lowest rate offered by mezzanine lenders at the time. Moreover, the evidence was undisputed that no interest rate was actually charged to the plan. Furthermore, Plaintiffs offered no evidence that a more favorable rate of interest was available. Plaintiffs elicited testimony that Defendants gave no consideration to offering a discounted interest rate on the subordinated loan to EMCO because of the beneficial tax treatment they received in the stock-acquisition transaction and then having such discounted interest rate passed through to the Plan in the C Term Note from EMCO. However, Plaintiffs presented no evidence as to what the discounted interest rate should have been and whether it would have been more favorable than the stated interest rate of 17% or the interest rate of 0%, which was actually charged to the Plan.
105. Based on the evidence presented, the Court finds that the stated rate of interest of 17% on the C Term Note was a reasonable rate of interest.
106. Because the C Term Note was primarily for the benefit of Plan participants and beneficiaries and had a reasonable rate of interest, the Court finds that the Term C Note is exempt from the prohibited transaction rule of section 406(a)(1)(B). Accordingly, the Court finds that Defendants are entitled to judgment on Plaintiffs' section 406(a)(1)(B) claim.
107. In their proposed findings of fact and conclusions of law, Plaintiffs claim that the "average price of $52.06 per share paid to the ESOP to purchase the shares annually purchased by the MPP was not for adequate consideration. No valuation of the ENCO stock supports this price. Hence, each sale constituted an additional prohibited transaction pursuant to the provisions of 29 U.S.C. § 1106 and 1108." The Court concludes that this claim is not properly before the Court as such claim was never set forth in the amended complaint or the amended pretrial order.
Section 404(a) Claims
108. Section 404(a)(1) of ERISA provides that "a fiduciary shall discharge his duties with respect to a plan solely in the interest of the participants and beneficiaries." 29 U.S.C. § 1104(a)(1)(A). A fiduciary's duty to act "solely in the interest" of participants and beneficiaries is based upon the common law duty of loyalty imposed upon trustees. Berlin v. Michigan Bell Tel. Co., 858 F.2d 1154, 1162 (6th Cir. 1988). A fiduciary breaches his duty of loyalty whenever he acts to benefit his own personal interest. See, e.g., Marshall v. Kelly, 465 F. Supp. 341, 350 (W.D. Okla. 1978) (loans and payment to plan fiduciary and his wholly — owned company). A fiduciary also breaches his duty of loyalty when he acts in favor of the interests of a third party, even if his own personal interest is not directly implicated. See, e.g., Marshall, 465 F. Supp. at 350-51 (fiduciary extended loans to personal friend on terms more favorable than those available to plan participants).
109. Section 404(a)(1)(B) of ERISA requires a plan fiduciary to discharge his duties "with the care, skill, prudence, and diligence under the circumstances then prevailing that a prudent man acting in a like capacity and familiar with such matters would use in the conduct of an enterprise of a like character and with like aims." 29 U.S.C. § 1104(a)(1)(B). A fiduciary's prudence is measured in accordance with the "prudent person" standard developed in the common law of trusts. Donovan v. Mazzola, 716 F.2d 1226, 1231 (9th Cir. 1983),cert. denied, 464 U.S. 1040, 104 S.Ct. 704, 79 L.Ed.2d 169 (1984). The prudence standard is objective, and is based on how a person with experience or familiarity with the matter or transaction at hand would act. Katsaros v. Cody, 744 F.2d 270, 279 (2d Cir.), cert. denied, 469 U.S. 1072 (1984). The prudence standard does not look to the success or failure of a fiduciary's conduct but, rather, only to the prudence of his conduct and the procedures he utilizes. See e.g., Roth v. Sawyer — Cleator Lumber Co., 16 F.3d 915, 918 (8th Cir. 1994) ("prudent person standard not concerned with results"); Schaefer v. Arkansas Medical Soc'y, 853 F.2d 1487 (8th Cir. 1988) (fiduciary imprudent by failing to investigate properly before recommending decision to council); Brock v. Walton, 794 F.2d 586, 588 (11th Cir. 1986) (fiduciary acted prudently when he followed prudent procedures, even though investment return fell below prevailing market rate). It is the court's task to inquire whether the fiduciary employed the appropriate methods of investigation. Donovan v. Cunningham, 716 F.2d 1455, 1467 (5th Cir. 1983), cert. denied, 467 U.S. 1251, 104 S.Ct. 3533, 82 L.Ed.2d 839 (1984).
110. The plaintiff has the burden of establishing a prima facie case of breach of fiduciary duty under section 404(a), including proof of breach and loss or ill-gotten profit. Martin v. Feilen, 965 F.2d 660, 671 (8th Cir. 1992), cert. denied, 506 U.S. 1054 (1993).
111. Defendants contend that all of Plaintiffs' section 404(a) claims are barred by the applicable statute of limitations. See, Section 413 of ERISA; 29 U.S.C. § 1113. The Court, however, need not address this affirmative defense. The Court finds that Plaintiffs have failed to establish their section 404(a) claims.
112. Plaintiffs claim that Defendants violated their fiduciary duties under section 404(a) because they failed to follow the terms of the Plan and provide benefit statements to the Plan's participants and beneficiaries after EMCO filed for bankruptcy on October 17, 1996. The evidence revealed that no participant statements were sent because the value of EMCO's stock was either impossible to determine or was worthless. In addition, the evidence showed that the Plan would have had to bear the costs of preparing and mailing the statements because the bankruptcy judge would not allow the use of EMCO's funds or assets to finance the costs. The evidence showed that the preparation and mailing costs were between $10,000 and $20,000 and the Plan only had approximately $140,000 left in cash assets. Because the value of EMCO's stock could not be determined or was worthless and the Plan only had approximately $140,000 left in cash assets, the Court finds that Defendants did not violate their fiduciary duties under section 404(a) in failing to prepare and mail benefit statements to Plan participants and beneficiaries. The Court therefore finds that Defendants are entitled to judgment on this section 404(a) claim.
113. Plaintiffs claim that Defendants violated their fiduciary duties under section 404(a) because they failed to renegotiate the terms of the Plan loan between EMCO and the Plan at any time between 1990 and 1996. Based upon the evidence presented, the Court finds that the terms of the Plan loan did not warrant renegotiation between 1990 and 1996. Plaintiffs failed to adduce any evidence there were more favorable terms available from other lenders that could have been offered to the Plan. The repayment terms of the Plan loan were reasonable and, by January 1995, the principal obligations of the Plan loan under the A Term Note and the B Term Note had been retired. The principal repayment terms of the C Term Note remained flexible and were tied to EMCO's available cash flow. More importantly, EMCO extended credit to the Plan interest free. There was no evidence offered to show that the Plan could have received $15,500,000 from any third party without the payment of interest. The Court thus finds that Defendants did not breach their fiduciary duties under section 404(a) in failing to renegotiate the Plan loan. Accordingly, the Court finds that Defendants are entitled to judgment on this section 404(a) claim.
114. Plaintiffs claim that Defendants breached their fiduciary duties under section 404(a) in making the decision to sell the remaining shares of EMCO stock to the Plan and to deplete the Plan's cash assets and burden it with $15,000,000 of debt. Plaintiffs contend that Defendants failed to engage in a thorough investigation of the merits of the transaction. Plaintiffs also contend that Defendants did not act exclusively for the benefit of the participants and beneficiaries in engaging in the transaction. The Court, however, finds that Plaintiffs have failed to sufficiently establish their section 404(a) claims.
115. Section 404(a)(1)(B) "imposes an unwavering duty on an ERISA trustee to make decisions with single-minded devotion to a plan's participants and beneficiaries and, in so doing, to act as a prudent person would act in a similar situation." Morse v. Stanley, 732 F.2d 1139, 1145 (2d Cir. 1984). Prudence focuses on the process that the fiduciary undertakes in reaching his decision. As previously stated, prudence is a test of conduct, not results. Roth, 16 F.3d at 919-20. The fiduciary's conduct is judged from the perspective at the "time of the . . . decision" and not from "the vantage point of hindsight." Katsaros, 744 F.2d at 279. A fiduciary's lack of familiarity or knowledge of a matter provides no excuse for a breach of fiduciary duty to use due care. Id. When a fiduciary lacks sufficient experience with and knowledge of a matter, prudence requires that he undertake a careful and impartial investigation, including the retention of independent, outside experts.Schaefer, 853 F.2d at 1492 (fiduciary imprudent by failing to properly investigate before recommending decision to council); Donovan v. Bierwirth, 680 F.2d 263, 271-73 (2d Cir.) (use of independent outside experts constitutes part of prudence required by fiduciaries), cert. denied, 459 U.S. 1069 (1982).
116. Notwithstanding the fiduciary's duty to seek independent advice when he lacks the requisite experience and knowledge, the fiduciary is ultimately responsible for making a prudent decision. Katsaros, 744 F.2d at 279, Mazzola, 716 F.2d at 1234. Consequently, the use of an outside adviser is not a complete defense to an imprudence charge. Roth, 16 F.3d at 918, Mazzola, 716 F.2d at 1234. However, it is evidence that the fiduciary acted reasonably and prudently. Donovan v. Walton, 609 F. Supp. 1221, 1227 n. 10 (S.D. Fla. 1985). The defense may fail if the fiduciary failed to investigate the qualifications of the advisers, provided them with misinformation or was not reasonably justified in relying on their advice under the circumstances. Howard v. Shay, 100 F.3d 1484, 1489 (9th Cir. 1996) (to rely on expert's advice, "fiduciary must (1) investigate the expert's qualifications, (2) provide the expert with complete and accurate information, and (3) make certain that reliance on the expert's advice is reasonably justified under the circumstances"), cert. denied, 520 U.S. 1237, 117 S.Ct. 1838, 137 L.Ed.2d 1042 (1997).
117. In the instant case, the evidence showed that Defendants engaged independent legal counsel for the Plan. The Plan's legal counsel issued an opinion indicating the Plan loan was exempt under ERISA. Two independent appraisals of the stock's value were obtained by Defendants. In addition, Defendants requested and received a fairness opinion from Independent Appraisal, Inc. indicating the transaction was fair to Plan participants.
118. There was no evidence adduced that the outside advisers were not experienced and qualified to provide the opinions and appraisals. There was also no evidence adduced that Defendants provided the advisers with information that was not complete and up-to-date. Furthermore, there is nothing in the record to indicate that Defendants were not reasonably justified in relying upon the opinions and appraisals.
119. During trial, Plaintiffs challenged the validity and independence of the appraisal issued by Mr. Wilkes, on behalf of Independent Appraisals, Inc. Plaintiffs specifically questioned why five pages of the text of the appraisal were verbatim from text in the appraisal issued by Mr. Ireland, on behalf of Menke Associates. The evidence adduced from Plaintiffs' counsel's questioning revealed that the challenged text was background information about EMCO and could have been found in various sources, including Menke Associates' offering memorandum. No other evidence was adduced as to the origin of the text. The Court concludes that the evidence in the record failed to show that Mr. Wilkes' appraisal lacked independence or validity.
120. The evidence presented showed that Defendants considered the effects of the leveraged buyout as well as the long-term benefits to the Plan and reasonably determined that it was for the primary benefit of the participants and beneficiaries to proceed with the transaction. The Plan was clearly an eligible purchaser of the stock, it already owned 29% of the stock, EMCO's stock value had been increasing, and there had been numerous inquiries from third-parties concerning acquisition of EMCO, as well as a recent offer from Wickes Companies, Inc. to purchase EMCO for $20,500,000. The acquisition of Defendants' stock was consistent with the objectives of the Plan, and the Plan documents clearly allowed for loans to acquire the employer securities. The Court concludes that the Plan fulfilled its purpose of obtaining ownership of EMCO's stock through the loan transaction.
121. The Court notes that there was no evidence developed which linked EMCO's undertaking of the SPBC loan or its subordinated debt obligations to Defendants to EMCO's liquidity problems. EMCO's cash flow problems which developed in the summer of 1996 were not in any way attributable to the stock acquisition loans. The evidence showed that EMCO's debt to SPBC had been retired by January 1995, almost a year-and-half before EMCO's liquidity problems. Additionally, Defendants made no effort to collect any principal payments due from EMCO on the subordinated loan after the SPBC loan was retired. In fact, Defendants extended additional credit to EMCO in the amount of $2,700,000 to assist in the capitalization of EMCO's new paint facility during this time period. The evidence showed that EMCO's bankruptcy was entirely attributable to factors related to the difficulties associated with the loss of the Ford contract and problems with the GM work, both of which were completely unrelated to the stock acquisition indebtedness.
122. Plaintiffs claim that Defendants' conduct was not prudent because EMCO lacked a diversified customer base. While it was uncontroverted that Ford was EMCO's primary customer at the time of the March 26, 1990 transaction, it is likewise uncontroverted that Ford was J.P. EMCO Company, Inc.'s primary customer when the Plan was established. ERISA has no requirement that a company have a certain number of customers to qualify for the establishment and continuation of an employee stock ownership plan. ERISA also does not have a requirement that a company only have customers who cannot terminate sales contracts. The evidence showed that Defendants considered the possibility that EMCO might lose the Ford contract but concluded that it was an impossibility. The evidence showed that in June of 1989, prior to the subject transaction, EMCO received Ford's "Q1 Preferred Quality Supplier" award, signifying that EMCO would retain its status as a preferred supplier of Ford parts. Ford had been a primary customer of the Ada facility since 1973. There was no evidence adduced that Defendants knew or should have known at the time of the March 26, 1990 transaction that EMCO was going to lose Ford's business approximately four years later.
123. At trial, Plaintiffs claimed that Defendants breached their fiduciary duties under section 404(a)(1)(B) by failing to consider alternative investments for the Plan's assets. The Plan specifically allowed the administrative committee to direct the trustees to invest the Plan's funds in investments other than EMCO common stock and Plaintiffs contend that Defendants should have invested in the Plan's funds in alternative investments rather than in EMCO common stock.
124. A fiduciary of an employee stock ownership plan is "exempted from ERISA's duty to `diversify the investments of the plan.'" Martin, 965 F.2d at 665 (quoting 29 U.S.C. § 1104(a)(1)(C) and (2)). As a general rule, these fiduciaries cannot be held liable for failing to diversify investments, regardless of whether diversification would be prudent under the terms of an ordinary non-ESOP pension plan. Employee stock ownership plans are also exempted from ERISA's "strict prohibitions against self-dealing, that is `deal[ing] with the assets of the plan in his own interest or for his own account.'" Martin, 965 F.2d at 665 (quoting 29 U.S.C. § 1106(b)(1)). However, the statutory exemptions for employee stock ownership plans in ERISA "do not relieve a fiduciary . . . from the general fiduciary responsibility provisions of [§ 1104] which, among other things, require a fiduciary to discharge his duties respecting the plan solely in the interests of plan participants and beneficiaries and in a prudent fashion . . . nor does it affect the requirement . . . that a plan must be operated for the exclusive benefit of employees and their beneficiaries." Martin, 965 F.2d at 665 (quoting 44 Fed. Reg. No. 168 at p. 50369 (August 28, 1979)). Thus, "ESOP fiduciaries must, then, wear two hats, and are `expected to administer ESOP investments consistent with the provisions of both a specific employee benefits plan and ERISA.'" Moench v. Robertson, 62 F.3d 553, 569 (3rd Cir. 1995) (quoting Kuper v. Quantum Chem. Corp., 852 F. Supp. 1389, 1395 (S.D.Ohio 1994)), cert. denied, 516 U.S. 1195, 116 S.Ct. 917, 133 L.Ed.2d 847 (1996).
125. In Moench, the Third Circuit attempted to find "a way for the competing concerns [of ERISA fiduciaries and ESOPs] to coexist." Moench, 62 F.3d at 570. In determining that subjecting an ESOP fiduciary's investment decisions to a strict standard of review was inappropriate, the Third Circuit noted that such scrutiny "would render meaningless the ERISA provision excepting ESOPs from the duty to diversify." Id. This, in turn, would risk transforming ESOPs into ordinary pension plans, thus frustrating Congress's desire to encourage employee ownership and contravening the intent of the parties. The Third Circuit found that the better balance between these concerns was achieved by measuring a fiduciary's decision to continue investing in employer securities for an abuse of discretion. Moench, 62 F.3d at 571. Thus, it held that "keeping in mind the purpose behind ERISA and the nature of ESOPs themselves, . . . an ESOP fiduciary who invests the assets in employer stock is entitled to a presumption that it acted consistently with ERISA by virtue of that decision. However, the plaintiff may overcome that presumption by establishing that the fiduciary abused its discretion. . . ." Moench, 62 F.3d at 571.
126. Under Moench, Defendants' decision in regard to purchasing the remaining employer securities was reasonable. Plaintiffs may rebut this presumption of reasonableness by showing that a prudent fiduciary acting under similar circumstances would have made a different investment decision. In support of their contention that Defendants breached their fiduciary obligation to diversify, Plaintiffs point to the fact that Defendants admitted that they did not consider investing the Plan's funds in other investments allowed by the Plan. Plaintiffs argue that Defendants should have considered the alternative investments before proceeding forward with the transaction. However, Plaintiffs presented no evidence that at the time of the decision to proceed with the transaction, Defendants had any reason to be concern with the transaction. The only evidence presented was that EMCO lost Ford's business approximately four years after the transaction and filed for bankruptcy in 1996. There was no evidence that EMCO was financially deteriorating when Defendants made the decision to invest in EMCO's common stock. There was also no evidence of any impending problems with EMCO. To the contrary, the evidence in the record established that EMCO was stable and doing well at the time of the March 26, 1990 transaction. There was nothing in the record demonstrating that it was imprudent for the Plan to have bought EMCO's stock in 1990, just as it had been doing since 1984. There was no evidence that a prudent fiduciary under similar circumstances would not have invested in EMCO's stock. The Court had previously found that there was no genuine issue of material fact as to the adequacy of the consideration and the C Term Note was primarily for the benefit of participants and beneficiaries and did not have an interest rate in excess of a reasonable rate of interest. The evidence established that EMCO had the cash flow to service the SPBC loan and after that was repaid, to successfully amortize the subordinated loan. The evidence further demonstrated that the value of the stock had been steadily increasing prior to the transaction. Furthermore, the evidence further established that Defendants conducted a careful and impartial investigation prior to entering the transaction. Therefore, the Court concludes that Plaintiffs did not rebut the presumption by establishing that Defendants abused their discretion in investing in the EMCO's common stock.
127. From the evidence in the record, the Court concludes that Defendants' course of conduct and decision to engage in the March 26, 1990 transaction satisfied ERISA's duty of prudence. Accordingly, Defendants are entitled to judgment on this section 404(a)(1)(B) claim.
128. Plaintiffs also claim Defendants breached their duty to act "solely in the interest" of the Plan under section 404(a)(1)(A) in making the decision to sell their stock to the Plan and burdening the Plan with $15,500,000 of debt. Plaintiffs contend that Defendants were acting with dual loyalties rather than acting exclusively in the interest of participants and beneficiaries. A fiduciary is not prohibited from being on both sides of a transaction involving an employee stock ownership plan's assets, but he must serve both masters (or at least the plan) with the utmost care and fairness. Martin, 965 F.2d at 670. Conflicts or potential conflicts of interest require that a fiduciary to consult with independent advisers. Martin, 965 F.2d at 670. In the instant case, Defendants consulted with independent advisers in regard to the March 26, 1990 transaction. Defendants engaged in a careful and impartial investigation into the transaction. The Court concludes that Defendants did not breach their duty of loyalty to the Plan. Accordingly, Defendants are entitled to judgment on this section 404(a)(1) claim.
129. In their proposed findings of fact and conclusions of law, Plaintiffs claim that Defendants breached their duty of loyalty codified in section 404(a)(1) because they did not disclose to the participants and beneficiaries of the Plan the specifics of the $8,400,000 loan which they made to EMCO and which EMCO in turn made to the Plan. Plaintiffs also claim that Defendants breached their duty of loyalty because they made intentional misrepresentations regarding the terms of the loan. This claim, however, is not properly before the Court as it was never alleged in the amended complaint or the amended pretrial order.
130. Plaintiffs contend that Defendants violated their fiduciary duties under section 404(a) in failing to resign from their position as trustees. Plaintiffs claim that Defendants should have resigned because of their alleged conflict of interest in being the sellers of stock, the lenders to EMCO, the only directors and officers of EMCO and the sole members of the Plan's administrative committee. "`When a fiduciary has dual loyalties, the prudent person standard requires that he make a careful and impartial investigation of all investment decisions.'"Schaefer, 853 F.2d at 1492, citing Bierwirth, 680 F.2d at 271. In the instant case, Defendants conducted a careful and impartial investigation of the stock and loan transactions. Defendants sought guidance from disinterested third parties. Those third parties confirmed Defendants' belief that the transactions were legally proper and fair to the Plan. The Court concludes that Defendants took adequate and reasonable steps before engaging in the March 26, 1990 transaction. The Court thus concludes that Defendants did not breach their fiduciary duties under section 404(a) in failing to resign their position as trustees. Accordingly, the Court finds that Defendants are entitled to judgment on this section 404(a) claim.
131. Plaintiffs claim that Defendants violated their fiduciary duties under section 404(a) to Plan participants by failing to have the 1990 loan transaction evaluated for "fairness" through the eyes of an independent trustee. As previously stated, Defendants sought impartial guidance from disinterested parties in deciding whether the loan transaction was fair to the Plan. Robert Wilkes, on behalf of Independent Appraisals, Inc., opined that the transaction was fair. Keck, Mahin Cate opined that the loan transaction was proper under ERISA. Moreover, the evidence in this case demonstrated that the terms of the Plan loan were reasonable. Therefore, the Court finds that Defendants did not breach their fiduciary duties in failing to have the loan transaction evaluated for "fairness" through the eyes of an independent trustee. Defendants are thus entitled to judgment on this section 404(a) claim.
132. At trial, Plaintiffs challenged Defendants' decision to authorize additional stock in December of 1989. Plaintiffs have never made any claim or allegation of a derivative shareholder action either in their amended complaint or the amended pretrial order. The voting rights issue is wholly unrelated to any ERISA allegation or claim made in this lawsuit. However, even if such claim had been pleaded, the Court finds that the claim would fail. At the time of the alleged voting issue, Plaintiffs only owned 29% of the stock while Defendants owned over 71% of the stock. Plaintiffs' minority interest could not have affected Defendants' election to authorize additional stock.
Conclusion
133. In conclusion, the Court finds that Defendants are entitled to judgment on Plaintiffs' section 406(a)(1)(B) claim and section 404(a) claims. Judgment shall issue forthwith.
JUDGMENT
This action came on for trial before the Court sitting without a jury, and the issues having been duly tried and findings of fact and conclusions of law having being duly entered,
IT IS HEREBY ORDERED AND ADJUDGED that Plaintiffs take nothing on their claims against Defendants, Bascom M. Higginbottom and W.F. Simpson, and that Plaintiffs' action against Defendants, Bascom M. Higginbottom and W.F. Simpson, be dismissed on the merits.