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Brundle v. Wilmington Trust, N.A.

United States District Court, E.D. Virginia, Alexandria Division

March 13, 2017

TIM P. BRUNDLE, on behalf of the Constellis Employee Stock Ownership Plan and a class of other individuals similarly situated, Plaintiff
v.
WILMINGTON TRUST N. A., as successor to Wilmington Trust Retirement and Institutional Services Company Defendant. Item Court's Findings of Impact on Price

          MEMORANDUM OPINION

         Plaintiff Tim P. Brundle ("plaintiff" or "Brundle") is a former employee of Constellis Group, Inc. ("Constellis"), and a former participant in an Employee Stock Ownership Plan ("ESOP") sponsored by Constellis. Defendant Wilmington Trust N.A. ("Wilmington") was the trustee for the ESOP in connection with Constellis' creation of the ESOP. Creating the ESOP involved purchasing 100% of Constellis' voting stock in December 2013 (the "2013 Purchase"). Less than a year after the ESOP was created, all its stock was sold (the "2014 Sale"). Plaintiff alleges that the 2013 Purchase involved transactions and payments prohibited by the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1106, resulting in the ESOP paying an inflated price for the Constellis stock. Specifically, plaintiff alleges that the $4, 235 per share paid in 2013 was not the fair market value of such stock, resulting in the ESOP overpaying for the stock by $103, 862, 000, see PTX[1] 512, which plaintiff seeks to recover for the ESOP.

         Following a bench trial, and for the reasons that follow, the Court holds that Wilmington is liable for violating § 1106(a)(1)(A), causing $29, 773, 250 in damage to the ESOP, but not liable for violating § 1106(a)(1)(B) or § 1106(b).[2]

         I. FINDINGS OF FACT

         An ESOP is a form of employee retirement benefit plan "designed to invest primarily in securities issued by its sponsoring company." Donovan v. Cunningham. 716 F.3d 1455, 1458 (5th Cir. 1983). Under the terms of the Plan Document ("Plan") governing Constellis' ESOP, the participant employees would not immediately own the stock purchased by the ESOP. Rather, the stock would be held by a trust and allocated to employees over time, as an incentive to remain with Constellis. The Plan defines a year of service as 1, 000 hours. DTX 120 at 28, 13. An employee begins to become vested in his shares at the completion of the second year of service, an amount that increases 20% per year until reaching 100% in the sixth year. Id. Alternatively, the employee would become fully vested upon reaching the designated retirement age while employed by Constellis. Id. A. Constellis Background Thomas Katis ("Katis") and Matthew Mann ("Mann") founded Constellis' predecessor, Triple Canopy, Inc. ("Triple Canopy"), as a private security firm in the fall of 2003. Tr. at 1091:5-8. Troubled by the unsavory reputation of the private security industry at that time, they hoped to build Triple Canopy into a company that would be a source of pride for its employees, who were primarily retired members of the U.S. Armed Forces. Id. at 1095:20-22. Although the founders had a significant operational role at the outset, they began to step back in the spring of 2004, naming Ignacio Balderas ("Balderas") as Chief Executive Officer ("CEO"). Id. at 1092:8-14. Triple Canopy's primary clients were the U.S. Department of State ("DoS") and U.S. Department of Defense ("DoD"). Id. at 1094:23-24. Over the next several years, the company experienced steady growth, Id. at 1095:13-14, landing a series of large contracts to provide security both for physical locations, known as "fixed site security, " and for key personnel, known as "personal security, " Tr. at 19:14-19. Triple Canopy also began to acquire other security firms. See Id. at 1093:17-1094:3. These acquisitions led the company to reorganize itself into Constellis, which became the parent company, with Triple Canopy being its largest subsidiary. See id.

         The first form of deferred compensation Constellis offered to its employees was an employee stock option program. See Tr. at 1099:5-13. Driven in part by a desire to monetize that program for the employees, in the fall of 2007 Constellis began considering an offer from Cerberus Capital Management to purchase the company. Id. Although the parties engaged in extensive negotiations, the deal fell through. In 2010, with no prospective sale on the horizon, Constellis cashed out its employee stock option plan as part of a restructuring and replaced it with a profit sharing plan that used Earnings Before Interest, Taxes, Depreciation, and Amortization ("EBITDA") as its benchmark. Tr. at 318:14-20.[3]

         The next serious offer to buy Constellis came in 2012, when the investment banking firm Teneo Holdings, Inc., attempted to broker a deal in which a private equity firm, Vestar Capital Partners ("Vestar"), would be the buyer. Although Vestar initially offered a price in the range of $340 to $350 million, it reduced its offer to $275 million as the closing date approached. Tr. at 1136:8-9. The deal fell through because of this last minute reduction, which Katis characterized as a "classic private equity move." Id. at 1100:6-12 By the end of 2013, Katis owned 31.1% of Constellis' outstanding stock, Mann owned 29.2%, Howard Acheson ("Acheson") owned 11.1%, John Peters ("Peters") owned 5.6%, and "other minority shareholders" held the remaining shares. PTX 2 at 14. Collectively, Katis, Mann, Acheson, and Peters are known as the "Sellers."[4]

         B. Considering an ESOP

         In June of 2013, Constellis board member Simon Crane ("Crane") approached its general counsel Juliet Protas ("Protas") about the possibility of forming an ESOP. Tr. at 1417:9-14. Several factors motivated Crane and the Sellers to consider this option. Katis believed that an ESOP provided him an "exit strategy" while being consistent with his vision of Constellis as a company focusing on taking care of its employees. Id. at 1418:16-22. Creating an ESOP is often driven by the shareholders' desire for liquidity, Id. at 945:10-11, although Katis testified that he had no urgent need for liquidity when the Constellis ESOP was formed, Id. at 1184:3.

         Protas was receptive to the idea of an ESOP, in part because she had participated in a panel discussion with ESOP specialist Scott Meza of Greenburg Traurig LLP ("GT") a month earlier. Tr. at 1417:18-19. She took Crane's suggestion to Balderas, who authorized her to explore the idea. Id. at 1418:3-7. At GT's recommendation, Protas retained investment bankers CSG International ("CSG"), including managing partner George Thacker ("Thacker"), to advise Constellis on the prospect of an ESOP. Id. at 1421:9-11.

         CSG prepared a series of PowerPoint presentations for the Sellers and Constellis management about what an ESOP is and how to go about forming one. See PTX 626, 628. The first, titled "Preliminary ESOP Structural Analytics" and dated September 25, 2013, explained that the "Status Quo" left the shareholders with "no exit strategy" and that they were "limited to dividends for liquidity." PTX 626 at 6. Under those circumstances, CSG reported that an ESOP "optimizes results for all parties." Id. at 9 (emphasis in original). For the Sellers, this meant creating an "attractive liquidity structure, " optimizing "after-tax cash flow, " receiving "$307.8MM net of taxes over 6 years, " retaining "control until fully paid, " and participating "in future growth/[mergers and acquisitions] opportunities." Id. (emphasis in original). CSG also pointed out that by selling their shares to an ESOP, the Sellers would be able to roll over capital gains taxes, saving 23.8% on federal taxes. Id. at 18. Employees would benefit through a management incentive program and by obtaining equity in the ESOP. Id. at 9. Creating an ESOP in 2013 would result in Constellis becoming a "tax-free business" beginning in 2014 and receiving approximately $30 million through a tax refund for taxes paid in 2013; however, to fully realize these tax benefits, an ESOP had to own 100% of the company's stock. Id.

         CSG did not recommend a "traditional 100% ESOP." PTX 626 at 17. Instead, it proposed "a more advanced 100% structure that CSG developed." Id. In this "more advanced" ESOP structure, the Sellers would sell the ESOP 90% of their shares, and exchange the remaining 10% for warrants, id, which Katis described as "equity-like, " Tr. at 1173:15. The warrants would be financial instruments entitling the Sellers to buy back equity in Constellis at a designated price, known as the "strike price, " during a certain period of time. See Id. at 1173:19-21. Under CSG's proposed structure, the Sellers as warrant holders would retain significant elements of control over the company, most notably the ability to appoint a majority of the board of directors. Id. at 1603:21-22. Although the warrants would not create immediate value for the Sellers, eventually the sellers would be able to capture the warrants' value "by (1) selling the warrants back... in the future, or (2) selling the company." PTX 626 at 17. Under CSG's proposal, the Sellers would "control the company post transaction, " giving them the "flexibility" to follow through on these options. Id.

         In addition, because an ESOP rarely, if ever, begins its life with substantial assets, it is created by a heavily leveraged transaction in which the ESOP borrows the funds with which it buys the stock. Under the plan proposed by CSG, the Constellis ESOP was to borrow from the Sellers to buy their stock, meaning that the Sellers would also become the company's creditors. CSG pointed out that because the Sellers would "control the [b]oard, " they would also "control the timing of payment" on that debt. Id. at 19. CSG even suggested that Constellis might take on new debt in order to pay down the seller notes more quickly. Id.

         CSG's presentation stressed the after-tax benefits to the shareholders of selling Constellis to the ESOP, PTX 626 at 26, and the Court finds that these after-tax benefits for the Sellers were a major incentive for creating the ESOP. To highlight the advantages of an ESOP sale, CSG pointed out that to "match the $307.8MM in after-tax proceeds [to the Sellers], a traditional [mergers and acquisitions] transaction would have to" value Constellis at $421 million, which exceeded CSG's estimated valuation of Constellis by $100 million. Id. CSG continued to stress the benefit to the Sellers, reporting on September 26, 2013, one day after its preliminary presentation, that CSG had "looked at every possible scenario" and had not "seen any possible alternative that produces more after tax cash than the ESOP." PTX 625. Similarly, in a presentation to the Sellers and Constellis' management team on October 4, 2013, CSG focused on demonstrating the benefits to the shareholders of the proposed "advanced" ESOP. PTX 628.

         Immediately after the September 26, 2013, presentation, Constellis' management and the Sellers decided to move forward with the proposed ESOP. CSG had recommended that Constellis hire Wilmington to act as the trustee for the ESOP. Protas approved that choice after speaking with Greg Golden ("Golden"), a vice president of Wilmington, discussing the choice with Constellis' outside counsel, and conducting Internet research on Wilmington. Tr. at 1422:24-1423:4. Wilmington was chosen because Protas was impressed by her initial telephone conversation with Golden and considered Wilmington to be a "household name." Id. Within Wilmington, the Constellis transaction was overseen by the Fiduciary Services Sub-Committee ("FSSC"), which had four voting members for purposes of the Constellis transactions: Golden; Jennifer Matz ("Matz"), who was a Wilmington vice president and chair of the FSSC; John Lindak ("Lindak"); and Boyd Minnix ("Minnix"). The fifth FSSC member, Karen Bonn ("Bonn"), served as Wilmington's relationship liaison for Constellis and was therefore recused from voting on matters related to the Constellis ESOP.[5] See Id. at 84:5-9. Wilmington, in turn, retained Taylor English Duma, LLP ("Taylor English"), to act as its legal counsel because that firm was already on a list of approved law firms maintained by the legal team of Wilmington's parent corporation, M&T Bank. Id. at 326:7-15. The Taylor English attorneys working with Wilmington included corporate partners Denny Summers ("Summers") and Emily Horn ("Horn"), both of whom had worked on ESOP transactions for many years. DTX 251, 252.

         Wilmington also needed a financial advisor, for which it turned to the firm of Stout Risius and Ross ("SRR"), which had extensive ESOP experience and had been on Wilmington's list of approved financial advisors since 2009. DTX 5 at 1. As of 2013, it had provided "valuation and advisory services to every major institutional ESOP trustee in the United States" and its ESOP practice included 15 full time professionals, including Scott Levine ("Levine") and Aziz El-Tahch ("El-Tahch"), who were the primary analysts tasked with the Constellis valuations. See Id. at 1-2. Levine was a Certified Public Accountant ("CPA"), Accredited in Business Valuation ("ABV"), a Chartered Financial Analyst ("CFA"), and an Accredited Senior Appraiser ("ASA") with 18 years of experience who had performed roughly 1, 500 ESOP valuations. Id. at 2. El-Tahch was a CFA with 12 years of experience who had conducted roughly 750 ESOP valuations. Id.

         Although Constellis had no previous relationship with CSG or Wilmington, SRR, TED, CSG, GT, and Wilmington had worked with one another regularly. Records show that between 2010 and 2015, CSG was listed as the referral for more than 50% of Wilmington's ESOP projects. See PTX 159. SRR acted as Wilmington's financial advisor for 14 of those ESOPs. Id. As of the date Constellis engaged Wilmington, CSG had already referred 23 ESOPs to Wilmington. Id. GT had referred business to Wilmington on at least four occasions, and actually served as Wilmington's counsel in one instance. Id. SRR and Wilmington have worked together at least 25 times, id, and Matz could not recall Wilmington ever asking SRR to revise any of its valuation reports, Tr. at 1405:4-13.

         For its services in connection with the 2013 Purchase, Wilmington charged Constellis a flat fee of $150, 000, to be paid regardless of whether or not the ESOP transaction closed. Tr. at 335:19-23. If the transaction closed, Wilmington would also receive a minimum payment of approximately $80, 000 per year in fees for serving as the ESOP's ongoing trustee.[6] Id. at 336:16. Protas approved the fee arrangement, after consulting those familiar with the industry, finding it to be reasonable in light of the overall amount at stake in the deal. Id. at 1423:18-21. There is no evidence in the record suggesting that these fees were unreasonable and the Court finds that they were reasonable.[7]

         C. Constellis' Value in 2013

         A crucial step in forming an ESOP is to arrive at the fair market value of the stock that the ESOP is going to purchase. The "fair market value" is "the price at which the property would change hands between a willing buyer and a willing seller, neither being under any compulsion to buy or sell and both having reasonable knowledge of relevant facts." Estate of Godley v. Comm'r of Internal Revenue. 286 F.3d 210, 214 (4th Cir. 2002) (internal citations and quotation marks omitted). It is a widely shared view, and the Court finds, that valuing closely held stock is an "inexact science, " see, e.g., Donovan. 716 F.2d at 1473, in which valuation professionals commonly employ two basic methodologies, each of which incorporates a substantial degree of latitude for "judgment calls" by the analyst, see, e.g., Tr. at 672:19-20; 823:6-9.

         The first method, which all of the experts considered more useful in trying to value a closely held corporation like Constellis, is the Discounted Cash Flow ("DCF") method. See PTX 1 at 53. This method begins by estimating the company's projected cash flow far enough into the future to arrive at the company's "terminal growth rate, " or the rate at which it can plausibly be expected to grow indefinitely into the future. Id. at 54. That projection is then discounted by a number of factors designed to take into account current cash reserves and liabilities. Id. at 55. Because the DCF is calculated by default on a marketable, controlling-interest basis, additional discounts may be necessary to reflect the nature of the shareholder's stake. Id.

         The second method, the Guideline Company Method ("GCM")[8] begins by identifying various publicly traded companies (the "guideline companies") that experience similar market forces as the company that is the subject of the valuation (the "subject company"). PTX 1 at 45. When conducting a GCM analysis, the goal is to identify a factor by which the subject company's EBITDA or revenue must be multiplied to estimate the company's total enterprise value (a "multiple"). Id. The first step in determining the subject company's multiples is to identify the guideline companies' multiples. Id. To calculate the guideline companies' multiples, each guideline company's stock price is used to derive an enterprise value for that company. See Id. at 46. That enterprise value is then divided by the guideline company's EBITDA (or revenue) to arrive at the multiple. Id. at 47. By default, these calculations are made on a single share basis, and may be adjusted based on market forces. PTX 2 at 46. Once the multiples for the guideline companies have been identified, the risk that the guideline companies face is compared to any risks the subject company may have. Id. at 50. If the subject company is riskier than the guideline companies, lower multiples should be applied to the subject company's EBITDA and revenue to estimate an enterprise value for the subject company. Tr. at 1216:13-20. If the subject company is less risky, higher multiples are used. See id.

         The analyst must next determine how to reconcile the results of the DCF and GCM methods. All analysts agreed, and the Court finds, that it is preferable for these numbers to be close to each other. Tr. at 1534:19-22. If they are not, some process must be used to merge the two results into a single enterprise value for the company. Once the enterprise value is determined, the company's liabilities must be subtracted and any cash on hand added to arrive at an equity value. PTX 2 at 59. The equity value may be discounted further to account for certain business realities, such as a lack of control or a lack of marketability. See Id. at 60. When the final equity value has been reached, that number is divided by the number of outstanding shares to arrive at a per share value for the stock in question. Id. at 61.

         SRR was the second valuator to calculate a fair market value for Constellis' stock in 2013. The first was Andy Smith ("Smith") of the McLean Group ("McLean"), who had been performing an annual valuation of a single share of Constellis stock for at least the three preceding years. See PTX 1, 4, 5. Constellis used the McLean reports to price employee stock options and for financial reporting purposes. Tr. at 536:17-19. The 2013 McClean report provided a valuation of Constellis as of January 31, 2013, incorporating only information that was "known and knowable" as of January 31, even though the report was not completed until June 19, 2013. Tr. at 652:16-19. Smith performed both a DCF and GCM evaluation, although he found the guideline companies to be so different from Constellis that he did not ultimately give the GCM result any weight in his final valuation. See Tr. at 655:1-23. This approach was consistent with his habit of performing both evaluations and then choosing the more reliable, except where the two results were relatively close. Id. at 655:14-19.

         In performing his DCF analysis, Smith relied on "management's prepared forecasts" which only covered "the remaining 11 months of 2013 to 2014." PTX 1 at 54. In using those projections to arrive at an enterprise value, Smith had to calculate a "weighted average cost of capital" ("WACC"), which is used to discount projected cash flows. Id. at 55. Smith calculated a WACC of 15%, in part by factoring in a "Specific Company and Industry Risk Factor" of 7%. Id. Smith acknowledged that a 7% risk is relatively high, but he felt it was necessary because "Constellis represents more of a risk to potential investors than that of the sector as a whole, " in large part because of its "heavily concentrated contract backlog." Id. at 57. Given that a high percentage of Constellis' revenue was tied up in a small number of contracts primarily involving two government agencies, the Court finds that it was reasonable and prudent for Smith to adjust his valuation downward due to the company's performance being so highly dependent on the continued performance on those few contracts. Factoring in the 15% WACC, Smith estimated Constellis' enterprise value to be $213, 397, 018. Id. at 10. After adding in cash and subtracting debt, he calculated Constellis' equity value at $165, 015, 140. Id. This resulted in an estimated fair market value of $1, 838.11 per share for the voting stock and $1, 746.20 for the non-voting stock after further discounting for lack of control[9] and lack of marketability. Id.

         Less than one year later, SRR produced a draft evaluation, dated November 14, 2013. PTX 170. Using the same basic approach used by McLean but differing in the details, that evaluation concluded that the fair market value range for a single share of stock on a controlling interest basis was between $3, 865 and $4, 600. Id. at 35. One of the most significant differences between the two valuations was that SRR factored both the GCM and DCF methods into its final conclusion, and added a 10% control premium to the comparable company multiples in its GCM analysis. According to SRR, adding a control premium was appropriate because the ESOP would hold 100% of the stock and have some rights typically associated with being a majority shareholder.[10] See PTX 2 at 116. SRR chose multiples for Constellis that were at or below the low end of the range produced by the guideline companies' multiples for EBITDA, but mostly above the median for revenue. PTX 170 at 24. This produced a range of enterprise value from $290 million to $345 million. Id. Like McLean, SRR's DCF analysis began by adopting management projections. See PTX 170 at 26. According to SRR and Wilmington, Constellis had a relatively "robust" process for developing projections. Tr. at 1378:19-25. Both lauded the "bottoms up" approach that Constellis used, Id. at 1257:17, meaning that the projections were developed by looking at each contract or prospective contract, and giving the contract one of three designations: "backlog, " for an awarded contract upon which more revenue was due; "option, " for contracts that Constellis had the option to obtain; or "pipeline, " for contracts for which Constellis was planning to submit a proposal and anticipated a non-trivial chance of winning. Id. at 1354:22-1355:5. The process was overseen by Raymond Randall ("Randall"), who was then Constellis' Senior Vice President for Strategic Initiatives, and who reported to Magnani. Id. at 1353:16-17; 1355:11.

         Constellis gave SRR projections that extended to the year 2018, as opposed to the one year of projections that McLean received. In these projections, Constellis advised SRR that it expected EBITDA of $67.5 million for 2014, compared to the $52.2 million figure it had given McLean. Compare PTX 170 at 26, with PTX 1 at 59. SRR considered those projections to be "conservative, " both because of the method Constellis used and because historical data showed that Constellis had beaten its projections almost every year. Tr. at 1204:9-22; 1517:2-6.

         SRR also differed somewhat from McLean in how it calculated the WACC discount rate. Of particular significance, SRR used a metric called "beta" to assess the risk of Constellis relative to that of the industry overall. PTX 170 at 27. A beta of 1.0 would mean that Constellis faced the same risk as the industry as a whole. See Tr. at 388:9-16. A lower number meant Constellis was less risky, and a greater number meant Constellis was more risky. See id SRR chose a beta of 0.7, reflecting its belief that Constellis was a less risky investment than other companies in the industry. PTX 170 at 27. SRR's overall WACC was 11.5%. Id. Using these numbers, SRR's enterprise value range under the DCF method was $290 million to $322 million. Id. at 35.

         Like all the experts in this case, SRR felt that the DCF method was better suited to valuing a closely held corporation like Constellis. Accordingly, it gave the DCF value twice the weight of the GCM result. See PTX 170 at 35.[11] As a result, SRR concluded that Constellis' enterprise value ranged from $275 million to $330 million. Id. After adding cash and removing debt, Constellis' equity value was found to range between from $283 million and $338 million. Id. SRR then applied a 5% discount for lack of marketability.[12] Id. Although there was no readily accessible market for Constellis' stock, ESOP participants would be able to exercise a "put" option to sell the stock back to the company, which SRR felt justified a small discount.

         SRR concluded that the range of fair market value of equity was $256 million to $305 million, with the median being $281 million. PTX 170 at 35. Divided equally among the number of shares outstanding, SRR found the fair market value per share to range from $3, 865 to $4, 600, with the median fair market value of equity per share being $4, 232.50, which SRR rounded up to $4.235. See id.

         Each party called a financial expert to testify concerning SRR's work. Dana Messina ("Messina"), plaintiffs expert, is the Chief Executive Officer of Kirkland Messina, a financial services firm. Tr. at 693:13-21. He holds a Master's in Business Administration from the Harvard Business School, PTX 152 at 33, has 25 years of experience providing business valuations in ESOP transactions, Tr. at 694:2-13, and has consulted for the Department of Labor in over 100 investigations, Id. at 696:7-12. Jeffrey Tarbell ("Tarbeir), defendant's expert, is a director of the financial services firm Houlihan Lokey and a Co-Head of their ESOP Valuation practice. DTX 232 at 5. He holds a Master's in Business Administration from the University of Chicago and the ASA and CFA accreditations. Id. He is currently vice chair of the Business Valuation Committee of the American Society of Appraisers and is the immediate past chair of the Valuation Advisory Committee of the ESOP Association. Id.

         D. Wilmington's Evaluation of the Constellis ESOP

         The Court finds that Wilmington rushed its evaluation of the Constellis ESOP, failed to follow its own policies, and failed to adequately vet SRR's conclusions.

         Wilmington had scheduled a meeting to discuss the November 2013 SRR valuation report for Thursday, November 14, 2013 at 1:00 p.m. Although Wilmington's policy called for receiving any valuation report at least 48 hours in advance of any meeting scheduled to discuss the report, Tr. at 72:10-18, SRR's November 2013 Report was not forwarded to the FSSC until 4:58 p.m. on Tuesday, November 12, and not all members of the FSSC had reviewed the entire draft before the meeting with SRR. Golden testified that he did not need to review every part of the report because he had already seen Constellis' audited financial statements as well as a Confidential Information Memorandum ("CIM"), which included much of the raw data underlying SRR's analysis. Tr. at 98:16-99:3. Mate's testimony about whether she reviewed the entire report before the meeting was inconsistent, and the Court finds her original answer at her deposition when she testified that she could not specifically recall reading the report more credible than her contradictory trial testimony.[13] Id. at 1400:15-1401:17.

         Both Golden and Matz took handwritten notes at the November 14 meeting, which was conducted by conference call. See PTX 173; 174. Each relied heavily on those notes when asked to discuss what occurred at the meeting, and neither had any specific recollection beyond what was preserved in the notes. Those notes showed that SRR discussed several features of its report, including Constellis' growth and diversification efforts; SRR's conclusion that the projections provided by Constellis' management were "conservative, " PTX 174 at 2; the management role of the founders; Constellis' proposed acquisition of CGI Group and Strategic Social, LLC; the 2012 Vestar offer to buy Constellis, which SRR reported as having involved a $338 million enterprise value;[14] an audit by the Defense Contracting Auditing Agency ("DCAA") for overtoiling by $62 million; and the valuation conclusions that SRR reached in its draft report. Id. at 2-4.

         Once El-Tahch finished presenting SRR's report, members of the FSSC asked a number of questions about SRR's analysis. A non-voting FSSC member asked about the financing terms for the ESOP transaction. PTX 174 at 5. Lindak inquired about how Constellis' projections incorporated risk. Id. Tr. at 1487:10-15. He also asked whether the different types of outstanding stock were treated differently for purposes of the control premium (they were not). PTX 174 at 5. Summers asked about the DCAA audit, and was assured that Constellis was confident that it would not be liable for having to repay $62 million, in part because Constellis believed that the statute of limitations had run on some claims. Id. at 6. Matz asked whether there was a chance that Constellis' planned acquisitions of CGI and Strategic Social could fall through, and El-Tahch advised that they were "advanced but could always fall through." Id. He assured her that if that happened, the transaction price would not "fall out of [SRR's] range." Id. A question was asked about who formulated the projections, and El-Tahch responded that it was independent management rather than the Sellers. Id.

         By the November 14 meeting, Golden admits that he knew that another firm had prepared a valuation of Constellis in 2013. SeeTr. at 120:23-121:6. Even so, no one from Wilmington asked to see the McLean report. See Id. at 121:14. In fact, Golden could not even say that anyone from Wilmington had asked basic questions about the McLean report, including who performed it, when, and what methodology it employed. See Id. at 121:7-14.

         At the meeting, Wilmington also held a discussion about how to proceed with the deal. The FSSC decided that it would seek a special indemnity from the Sellers for the full amount of the potential DCAA audit liability, notwithstanding Constellis' assurances that it was unlikely to have to pay anything. Tr. at 1013:8-14. With that proviso, the FSSC authorized Golden, Bonn, SRR, and Taylor English to carry out negotiations on a price per share within a range of $3, 900 to $4, 235. PTX 174 at 7. There is nothing in any of the Wilmington officials' notes reflecting any questioning about the range of share prices SRR presented or about how to negotiate an appropriate price. In terms of timing, SRR noted that minority shareholders had to be given a tender offer at least 20 days before closing. Between that requirement and the December 31 deadline for being eligible to obtain the tax advantages for 2013, there was a relatively short window in which to agree on a price with Constellis and extend the tender offer. PTX 174 at 1; DTX51 at 1.

         Constellis and CSG sent their opening position of $4, 525 per share, a figure just $75 below the maximum of the range calculated by SRR, on Wednesday, November 13, 2013, a day before Wilmington's meeting. Negotiations over the price and term sheet began in earnest on Friday, November 15, 2013, the day after Wilmington's meeting with SRR. Throughout those negotiations, Constellis was represented by CSG's Thacker, and Wilmington communicated with Thacker only through representatives from Taylor English, although the lawyers spoke with Golden and Bonn to develop a negotiation strategy. Wilmington's opening bid was $3, 900, the bottom of the range it was willing to pay. DTX 56 at TED016013. Thacker replied at 3:02 p.m., proposing that the parties "come to an agreement on the per share value" while Constellis and CSG worked on their response to the term sheet "because the tender offer documents are scheduled to go out next Monday." PTX 50 at 8. In the same email, he lowered Constellis' asking price to $4, 350 per share. Id. Sometime shortly after this email, someone from Wilmington's team proposed a price of $4, 100 per share, to which Thacker responded with $4, 250 as the per share price, remarking that "in the interest of time, " Wilmington should respond to the share price "while the term sheet is being finalized." Id. at 7. At 4:50 p.m., Wilmington rejected $4, 250, informing Thacker that its "best and final offer" was $4, 235 per share and requiring that "the period during which the Warrant Holders can control the Board of Directors... be limited to 12 years." Id. at 6. Thacker accepted the share price on behalf of Constellis at 4:59 p.m. Id. at 5-6.

         The parties did not reach a final agreement on the complete term sheet until Friday, November 22, 2013. In the final version, the warrants were divided into two series, with "Series A" expiring at the end often years and "Series B" expiring at the end of 15 years. PTX 50 at ¶ 709. Only the holders of the Series A warrants were entitled to designate members of the Constellis board of directors. Id. at ¶ 710. According to the term sheet, the strike price of the warrants was to be set at "no less than 90 percent of the post-transaction fair market value per share." Id. at ¶ 709. By email, Thacker assured Wilmington's team that Constellis would be using 100% of the fair market value as the strike price, and that "a higher strike price is more beneficial for the Trustee." Id. at 2.

         Under the terms of the transaction, Constellis agreed to adopt a "management retention plan." PTX 50 at ¶ 710. Essentially, this meant that it would pay a cash bonus to certain key members of the management team if they agreed to stay on for a set period of time following the transaction to ensure continuity of management, which would be a benefit to the ESOP as the new owner of Constellis. The final term sheet did not specify how long management would need to stay to earn the bonus, a change from an earlier version that would have required staying on for 36 months. Compare PTX 50 at ¶ 710, with DTX 56 at TED016019. It was "anticipated" in the term sheet that the management incentive plan would be paid in cash and would be worth 5% of the transaction price in total, meaning that the amount paid to management was linked to the overall sale price. See PTX 50 at ¶ 710.

         On top of the cash bonus, the term sheet authorized Constellis to issue stock appreciation rights ("SARs") to management. PTX50atWT710. Although the exact group of people eligible for SARs was to be determined later, the Sellers were prohibited from participating in the SARs program. PTX 50 at ¶ 710. When the transaction closed, there was no guarantee that the SARs would be issued or exercised. Nevertheless, the SARs were to be an incentive to "help management get to" Constellis' projected growth levels, Tr. at 156:25, and the Court finds that all parties expected the SARs eventually to be issued.

         Finally, the Sellers and Constellis agreed to include "reasonable commercially acceptable and customary representations and warranties[.]" PTX 50 at ¶ 711-12. For most potential breaches, the aggregate amount of the indemnification would be capped at "30% of the Transaction Price for actual loss due to breach of representation and warranties through setoff of the Seller notes." Id. at ¶ 712.[15] In other words, the ESOP would only be reimbursed for a breached warranty for an amount up to 30% of the total purchase price. Id. Moreover, the ESOP would only receive cash as compensation for a breached warranty if the value of any resulting injury exceeded the balance of the debt owed to the Sellers; otherwise, it was to be compensated by reducing the amount owed to the Sellers. Id. Notwithstanding the general 30% cap, the Sellers agreed to indemnify the ESOP trust for the full amount of any liability arising from any "adverse outcome in the DCAA matter." Id.

         E. The 2013 Purchase

         The tender offer issued on Monday, November 18, 2013, four days after Wilmington's meeting with SRR, with December 20 set for closing. SRR issued a complete opinion on the fairness of the transaction, including a revised valuation of the stock, in the days leading up to the closing.[16] That December 2013 report contained several revisions from the November draft. By December, Constellis' proposed acquisition of CGI had fallen through. As a result, projected revenues had declined. Tr. at 472:11-13. The second major change related to outstanding stock options. In November, SRR had assumed that nearly all people holding stock options would exercise them before the transaction closed, see Tr. at 415:7-12, diluting the value of the company by $4.5 to $5.9 million, PTX 170 at 35. By December, it was clear that far fewer people had actually done so, Tr. at 1262:8-9, reducing the range of dilution to $300, 000 to $400, 000, PTX 2 at 61. These changes largely balanced one another out in the final valuation reconciliation. In the end, the GCM enterprise value range was unchanged, and the DCF range shifted downward by $2 million at the low end and $8 million at the high end. Compare PTX 2 at 61, with PTX 170 at 35. This brought the concluded enterprise value range down to $275 million to $325 million. Compare PTX 2 at 61, with PTX 170 at 35. Instead of providing a revised median market value on a per share basis, the December report simply repeated the agreed upon purchase price of $4, 235. PTX 2 at 61.

         Key numbers from the 2013 McLean and SRR reports discussed above are summarized in the following table:

Valuation Metric
McLean January 2013
SRR November 2013
SRR December 2013
GCM Enterprise Value
n/a
$290 to $345 million
$290 to $345 million
DCF Enterprise Value
$213, 397, 018
$267 to $322 million
$265 to $314 million
Concluded Enterprise Value
$213, 397, 018
$275 to $330 million
$275 to $325 million
Marketable, Controlling Interest Value of Equity
$165, 015, 140
$283 to $338 million
$279 to $329 million
Fair Market Value on a Per Share Basis[17]
$1, 838.11[18]
$3, 865 to $4, 600
$3, 865 to $4, 555

         Incorporating those changes, SRR opined that

the consideration to be paid by the ESOP for shares of Class A Common stock pursuant to the terms of the ESOP Purchase is not greater than Fair Market Value of such shares; the interest rate[s][on the debt the ESOP was to take on]... are not in excess of a reasonable rate; the financial terms ... are at least as favorable as would be the financial terms of a comparable loan resulting from arm's-length negotiations between independent parties; and the exercise price of the Warrants, on a per share basis, is at least equal to 90% of the Fair Market Value of the underlying common stock on a per share basis; and the terms and conditions of the Transaction, taken as a whole, are fair to the ESOP from a financial point of view.

DTX 111 at 4.

         El-Tahch sent the draft of the report to the FSSC at 4:06 p.m. on December 18. DTX 97. Again, less than 48 hours after receiving that 125-page report, on December 19, 2013, the trustee team held a final meeting with SRR to discuss the fairness opinion. The meeting lasted only half an hour, and FSSC members asked very few questions.[19] DTX 106; 107; see also Tr. at 185:4-5. Indeed, Lindak did not even attend the meeting. Tr. at 1491:23. At the conclusion of this meeting, the FSSC approved the 2013 Purchase. Tr. at 1381:20-21.

         On December 20, 2013, the 2013 Purchase closed. The parties have stipulated that the ESOP purchased purchased 47, 586.55 shares of Class A Common Stock at $4, 235 per share, DTX 112 at 1, 8, making the total purchase price $201, 529, 032.77. [Dkt. 139] at 3. The Stock Purchase Agreement ("SPA") provided that the Sellers would exchange the remainder of their stock for warrants, making the ESOP the owner of 100% of Constellis' outstanding stock. DTX 112 at 1, 28-29. The funding for the 2013 Purchase came from three sources: approximately 24% from a cash contribution from Constellis, approximately 7% from a loan from Constellis, and approximately 69% from a loan from the Sellers. PTX 2 at 7. On December 27, the parties refinanced the transaction, DTX 118, with Constellis assuming the ESOP's debt to the Sellers, and the ESOP executing a note in favor of Constellis for that amount. PTX 2 at 8.

         Consistent with the term sheet, the SPA contained a series of representations and warranties, which were divided between those made by the Sellers and those made by Constellis. See DTX 112 at 8-25. Significantly, it was Constellis, not the Sellers, that represented to the ESOP that "there has not been any event or condition of any character that has or would be reasonably expected to have a Material Adverse Effect"[20] on the company. Id. at 11. By contrast, the Sellers made no warranty about the accuracy of Constellis' financial projections.

         The Investor Rights Agreement ("IRA"), executed at the same time as the SPA, essentially enabled the Sellers to maintain control of Constellis by providing that, out of a five-member board of directors:

[F]or so long as all of the Series A warrants have not been exercised or terminated, the holders of at least 51% of the outstanding Series A Warrants shall have the right to designate three of the members of the Board, and to select the replacement Board member in the event of the resignation, death or incapacity of any member of the Board designated by such holders[.]"

DTX 115 at 6. A fourth director would "be independent from management of the Company, who shall be selected by the remaining members of the Board[.]" Id. In short, under the IRA, the ESOP had the power to appoint only one member of the board. The IRA provided that the warrant holders could not exercise their power in a way that caused "the Trustee to violate its fiduciary obligations under ERISA, " but did not identify any specific mechanism by which the trustee could stop the designation of a board member if it felt that its obligations under ERISA were in danger of being violated. See id.[21]

         It was extremely unusual for the warrant holders to be able to appoint a majority of the board members when the ESOP held 100% of the company's shares. Smith testified that he knew of only one other ESOP that owned 100% of the shares but did not have a majority of the board of directors, and that the Department of Labor had opened an investigation into that case.

         Tr. at 619:25-620:2.[22] Indeed, Constellis' own counsel, Marc Baluda ("Baluda") of GT, sent an email to Protas and Thacker, among others, in November asking how many board members they envisioned after the transaction. PTX 242 at CSG027460. He observed that "warrant holders nor[m]ally have the right to appoint a minority, so two of five, three of seven, etc." Id. Thacker replied that in CSG's deals, warrant holders have "been given the right to appoint a majority." Id., He explained that this was "how they retain operational control over the company until they've been paid." Id. The ESOP's lack of control was further reflected in the plan document ("Plan"), which directed Wilmington to "vote all Employer Securities held by it at such time and in such manner as the Administrator [i.e., Constellis] decides[.]" DTX 120 at 46. The Plan identified several exceptions to that requirement, with the most relevant being for a "merger or consolidation, recapitalization, reclassification, liquidation, dissolution, sale of substantially all assets of a trade or business, or such similar transaction as may be prescribed in Treasury regulations." Id. Golden and Summers agreed that a sale of the company, as opposed to a sale of its assets, was not covered by this exception. Tr. at 249:24-250:1; 1041:14-16. Therefore, under the Plan Wilmington had no authority to break from Constellis' instructions when voting on a sale of the company.

         A companion document, executed to establish the trust to hold the ESOP's assets (the "Trust Agreement"), further outlined the trustee's duties. According to § 3.03 of the Trust Agreement, the trustee had to vote, tender, and exchange the stock it held on behalf of the ESOP "in the manner set forth in the Plan... and consistent with its duties described in Section 2.03 herein." DTX 121 at 9. Section 2.03, in turn, provided that the Trustee must perform its duties "in accordance with the terms of the Trust Agreement to the extent, in the good faith judgment of the Trustee, that the Trust Agreement is consistent with the provision of the [Internal Revenue] Code and ERISA." Id. at 3.

         Read together, the Plan, the Trust Agreement, Triple Canopy's by-laws, and the IRA[23]did not provide a clear avenue for relief if the trustee felt that directions from Constellis with respect to a sale of the company were in tension with its ERISA obligations. When asked how the ESOP might go about stopping an action by the board of directors given its minority position, if Wilmington felt the action was inconsistent with ERISA, Protas admitted that the only recourse would be to "file a lawsuit to fight about it." Tr. at 1448:6-8. As a practical matter, she continued, "I guess [the board] could do anything." Id.

         F. Developments in Early 2014

         Constellis experienced a number of setbacks at the beginning of 2014, the most significant of which related to a contract with DoS to provide fixed-site security in Iraq. The umbrella contract, known as the Worldwide Protective Services ("WPS") contract, was divided into task orders. Constellis had been awarded a $300 million task order to provide security in Basra, Iraq. DTX 2 at 17. The incumbent protested that award, and in January 2014 the DOS rescinded the award and requested new, best and final offers from Triple Canopy and its competitor. Id. This change both reduced Constellis' projected revenue from the contract by over $100 million and pushed that revenue further into the future. Id. Another major development in 2014 involved Constellis' sub-contract on the Kuwait Base Operations Security Support Services ("KBOSSS") contract, which involved providing fixed-site security at two military bases in Kuwait. DTX 2 at 17. In February 2014, the prime contractor, Exelis Inc., informed Constellis that it planned to hold a competition to fill the subcontractor role that Constellis had been expecting to fill. Id. This development also reduced Constellis' projected revenues by tens of millions of dollars. Id.

         Constellis suffered a number of smaller problems, including the DoS making a formal demand for payment of $62.2 million in connection with the DCAA audit. DTX 2 at 18. Although Constellis planned to defend against that demand, eventual liability seemed more likely. See id Even though the ESOP had successfully negotiated an indemnification for the full amount of any ensuing liability, that amount would have to be set off against the Seller notes rather than being paid to the company in cash. See Id. Consequently, as SRR observed in the summer of 2014, "repayment of the claim would negatively affect [Constellis'] operating liquidity." Id.

         Two other developments contributed to the inauspicious beginning of 2014 for Constellis. First, Constellis lost its bid for a $338 million contract to provide protective services in Germany. DTX 2 at 18. The company persuaded the DoD to rescind its award to a competitor and reopen discussions with Constellis, but management put the odds of winning this contract no higher than 33%, and probably lower than that. Id. Second, the DoD informed Constellis that it would be terminating a contract to provide security to a U.S. Marine Corps base in Afghanistan, Camp Leatherneck, four months earlier than anticipated. Id. This decision reduced Constellis' backlog for 2014 by several million dollars. Id.

         G. The ACADEMI Sale

         As this bad news was breaking, in February 2014, Katis was contacted by Jason DeYonker ("DeYonker"), the founder and managing partner of Forte Capital Advisors ("Forte"), who was interested in buying Constellis. Tr. at 1118:18-24. Forte owned ACADEMI, which was formerly known as Blackwater, a major competitor of Constellis in the private security market. Id. at 1221:10-14; 1119:16-21. DeYonker's interest in Constellis had been piqued by the press release announcing Constellis' sale to the ESOP. Id. at 1118:18-24.

         Katis initially balked at the idea of selling Constellis to ACADEMI, in part because there was bad blood between the two companies. Not only had Katis and Mann founded Constellis in an effort to combat the bad reputation that Blackwater had given the industry, the two companies openly feuded for years. Tr. at 1119:16-21. Katis believed that Blackwater had used unfair tactics in competing against Triple Canopy and Constellis. Id. at 1119:22-25. DeYonker managed to convince Katis that ACADEMI had changed under new leadership. Id. at 1120:1-15. In Katis' words, DeYonker and his partners had come in "and bought the ...


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