The opinion of the court was delivered by: Francis, United States Magistrate Judge.
MEMORANDUM OPINION AND ORDER
The popularity of leveraged buyouts reached its zenith in the 1980's, but the legal fallout from these transactions continues to descend on the courts. In the simplest terms, a leveraged buyout is the purchase of a company using its own assets as security for financing the acquisition. The consolidated cases here arose from the buyout of the Van Dusen Airport Services Company ("VDAS") in 1988. The plaintiffs are holders of senior subordinated notes issued by VDAS in 1987. In 1990, VDAS ceased making payments of interest and principal on the notes, and the plaintiffs commenced these actions, contending that the leveraged buyout constituted a fraudulent conveyance.
The plaintiffs contend that the transfer of VDAS's assets was an actual fraudulent conveyance in that it was accomplished with the intent to avoid the payment of creditors. They further claim that the buyout was a constructive fraudulent conveyance because the transfer was not made for fair consideration and rendered VDAS insolvent, unable to pay its debts as they came due, and without adequate working capital. The plaintiffs named as defendants the purchasers of VDAS, VDAS itself, and the prior owners who profited from the sale of their interests. As will be discussed in more detail below, a settlement was reached during the pendency of the action between the plaintiffs on one hand and VDAS and its new owners on the other.
The claims against the remaining defendants were tried before me on consent of the parties pursuant to 28 U.S.C. § 636(c). This opinion constitutes my findings of fact and conclusions of law under Rule 52 of the Federal Rules of Civil Procedure.
In January 1986, Miller Tabak Hirsch & Co., a group of investors including defendant Gary Hirsch, purchased a controlling interest in Van Dusen Air Incorporated ("VDAI"), a multifaceted aviation company. (Tr. 906-8, 914). *fn1 The following November, VDAI sold its divisions involved in the manufacture and sale of aircraft parts and engine overhaul to Aviall of Texas. (Tr. 910-12; PX 2 at 200086).*fn2 At the same time, VDAI transferred its fixed-base operations ("FBO") business to VDAS, a partnership whose principal owner was Mr. Hirsch. (Tr. 910-11). FBOs are airport-based businesses that provide fuel, maintenance, hangaring, and other services to aviation customers including companies that operate their own corporate aircraft. At the time VDAS was formed, it operated FBOs in (1) Minneapolis, Minnesota, (2) Lexington, Kentucky, (3) Columbus, Georgia, (4) Corpus Christi, Texas, (5) Anchorage, Alaska, (6) Boston, Massachusetts, (7) Detroit, Michigan, and (8) Atlanta, Georgia. (PX 2 at 200102). The operations in Atlanta and Detroit were not full-service FBOs, but rather locations where VDAS had a contract for fueling a major air carrier. (Tr. 1452; PX 2 at 200102; DX 147 at M0002076-77, M0002105-06).
From the outset, defendant Eugene DePalma was VDAS' Chief Executive Officer, and defendant Richard Meli was its Chief Operating Officer. (Tr. 914). They expanded the operation of VDAS by acquiring eight additional FBOs at five airports between June 1987 and May 1988 at a total cost of approximately $27.1 million:
FBODate of AcquisitionLocationPrice Paid ($mm)
Des Moines Flying ServiceJune 1987Des Moines, IA$4.3
Nashville Jet CenterJune 1987Nashville, TN4.3
Million AirOct. 1987Cleveland, OH2.3
Tennessee Jet Corp.Dec. 1987Nashville, TN4.0
Milwaukee Aero DyneDec. 1987Milwaukee, WI1.0
Nashville Aviation ServicesJan. 1988Nashville, TN3.2
Cedar RapidsJan. 1988Cedar Rapids, IA0.6
Milwaukee Aero ServicesMay 1988Milwaukee, WI7.4
(Joint Pre-Trial Order ("PTO"), Stip.Facts ¶ 21; DX 147 at M0002039).
For each FBO purchased, VDAS formulated an acquisition analysis that examined the FBO's historical financial performance, made adjustments based on consolidation into the VDAS chain, and projected earnings for the FBO. (DX 45, 46, 55, 61, 75). In general, VDAS anticipated doubling the earnings of the newly-acquired FBOs, since it had achieved similar results when it had previously purchased bases. (DX 61). VDAS also planned to upgrade and reorganize the operations at its new FBOs. For example, it intended to dispose of the charter and part sales businesses at Des Moines and focus on more profitable fueling and hangaring operations. (Tr. 917-20). At Nashville, VDAS planned to consolidate its three FBOs, renovate the premiere terminal facility known as the "Mansion," and reallocate hangar space to benefit its major customer, Northern Telecom. (Tr. 921-28). VDAS also anticipated capital improvement and consolidation of its two bases in Milwaukee as well as improvements at Cedar Rapids. (Tr. 932-37).
The Plaintiffs' Investment
In March 1987, in order to pay off existing debt and finance its expansion, VDAS issued twelve percent senior subordinated notes due in 1997 and valued at $50 million (the "twelve percent notes"). Interest on the notes would be payable each March 15 and September 15, beginning in September 1987. Each note was marketed in a "Unit" together with a Contingent Payment Obligation ("CPO"). A holder of a CPO would be entitled to a payment upon the occurrence of certain "triggering events" such as a merger of VDAS with another entity or a public offering of its partnership interests. (DX 7 at 02128-02132).
James T. Swanson, Senior Vice President and portfolio manager for Massachusetts Financial Services and investment advisor to the plaintiffs MFS/SUN Life Trust-High Yield Series, Massachusetts Lifetime Financial High Income Trust, and Lifetime High Income Trust (collectively, "MFS"), investigated the suitability of the investment. (Tr. 27-28, 38). MFS had previously invested in 14.5 percent private placement bonds issued by VDAI. (Tr. 36; DX 4). Mr. Swanson recommended that MFS now buy the VDAS units, noting in part that the company was an ideal candidate for a leveraged buyout. (DX 6).
Ultimately MFS purchased approximately $4 million of the twelve percent notes and the associated CPOs (PTO, Stip.Facts, ¶ 23). At the same time, plaintiffs Martin D. Rich and Norman I. Rich bought a total of $200,000 of the twelve percent notes and CPOs for NR Investment Associates and MR Investment Associates, partnerships made up of their respective family trusts. (Tr. 709-10). These entities subsequently transferred the investments to Tri-R By Products, a partnership between Martin and Norman Rich. (Tr. 709-10).
In March 1988, Mr. Hirsch first proposed the sale of VDAS. (Tr. 943-45; DX 107). As the initial step in a buyout, the limited partners of VDAS would exchange their interests for partnership interests in VII Partners, L.P. ("VII"). Air Partners, Inc. ("API"), which was the managing general partner of VDAS, would become the managing partner of VII. (DX 107).
Mr. Hirsch engaged Salomon Brothers, Inc. to prepare an offering memorandum for the sale of VDAS. (Tr. 948). This Memorandum reviewed VDAS' past performance and set forth cash flow projections developed by the company's management. (DX 108).
Initially, Mr. DePalma and Mr. Meli were asked about their interest in purchasing VDAS. Mr. DePalma declined because he preferred to remain as an operator rather than an owner, and Mr. Meli lacked the necessary capital. (Tr. 900-01; Deposition of Richard J. Meli dated Feb. 25, 1992 at 96). Other parties did express interest, including a partnership consisting of former United Airlines Chief Executive Officer Dick Ferris and golfer Arnold Palmer, Triton Energy Corporation, Bessemer Trust Company ("Bessemer"), the Wesray investment banking firm, and Mike Rosenthal, a former partner of Wesray. (Tr. 874, 950). The most serious inquiries were made by Bessemer and Mr. Rosenthal. Bessemer representatives discussed a potential transaction in the range of 100 to 110 million dollars. (Tr. 951-52). Mr. Hirsch and his partners rejected that bid because Bessemer was unwilling to give them a preferred interest in the new entity and because it sought indemnification with respect to any preexisting general partner liabilities. (Tr. 952-53). Mr. Rosenthal also discussed a price of approximately $105 million, together with a $5 million preferred interest for Mr. Hirsch's group. (Tr. 953). He indicated a desire to have Mr. DePalma continue to run the operation, and he had identified a likely source of financing. (Tr. 874-75, 953-55).
However, before any deal with Mr. Rosenthal could be consummated, Marc Bergschneider, with the financial backing of Wesray, began to pursue the opportunity. (Tr. 955-57). They formed an entity called MAST Resources, Inc. ("MAST") and prepared a memorandum for submission to banks in order to secure financing. (Tr. 95). MAST also developed its own projections of VDAS' future cash flow, which will be discussed below. (Tr. 127-28).
Ultimately, VDAS accepted MAST's proposal for a buyout. In its financing memorandum in May 1988, MAST identified the purchase price as $122 million. (DX 124 at 3). Houlihan Lokey Howard & Zukin ("Houlihan Lokey"), an investment banking firm that furnished a solvency opinion to MAST on August 5, 1988, calculated the purchase price as approximately $124 million. (DX 173 at 1). At trial, Mr. Bergschneider estimated the amount paid for VDAS as between $110 and $120 million. (Tr. 122). This consisted of $105 million of long-term debt assumed by VDAS together with the preferred stock retained by the sellers, which was valued at between $5 and $15 million.
On May 9, 1988, API, VII, and FBO Acquisition Corp. ("FBOAC") entered into a Purchase Agreement for the sale of VDAS. (PX 41 at 100008 & Tab 4; PX 34). FBOAC was an entity formed by MAST. (PTO Stip.Facts ¶ 31). On August 2, API authorized the transfer to VII of its partnership interest in Riverside Acquisition Corp. ("RAC"), a limited partnership that held stock in Penn Traffic Co. (PX 41, at 100009 & Tab 13 at 100237). In return for the partnership interest, VII gave VDAS a promissory note for $2.7 million that would be cancelled upon consummation of the LBO. (PX 40; PX 36 § 6.6 at 46).
On August 5, all limited and general partners of VDAS except API exchanged their partnership interests in VII, and VII became a general partner in VDAS. At the same time, VII and API, as sellers, and FBOAC and Jet Services, L.P. ("Jet"), another MAST entity, entered into an Amended and Restated Purchase Agreement. (PX 36).
The LBO closed on August 8, 1988.*fn3 It was financed primarily by loans from Security Pacific National Bank ("Security Pacific"), consisting of (i) a $45 million term loan (plus an additional $10 million revolver) (the "Senior Credit Facility"); and (ii) Senior Subordinated Notes in the principal amount of $10 million. The Senior Credit Facility was secured by all of VDAS' assets. (DX 204; PX 41 at Tabs 65-83). Of the proceeds of the loan, Security Pacific retained $1,757,917 in fees, $22,790,999 went to VII, and $30,451,084 went initially to VDAS. From the funds that it received, VDAS paid off $27,058,663 in existing debt, paid $550,000 in legal fees, and transferred $1,630,000 to MAST. VDAS thus retained $1,212,421 in cash from the loan. (PX 44, 78).
The proceeds of the LBO were distributed to the partners in VII. Among the individual defendants, Mr. Hirsch received $2,030,793 individually, and millions of dollars were transferred to entities in which he had an equity interest (PX 44; Tr. 999-1006). Mr. DePalma received $1,064,153, and Mr. Meli, $212,830. (PX 44).
At the same time, the defendants retained some investment in VDAS. VII continued to hold a ten percent limited partnership interest (PTO, Stip.Facts ¶ 31), as well as a preferred partnership interest with a face value of $15 million. (Tr. 958-59). Mr. DePalma and Mr. Meli also invested $150,000 each in VDAS at the time of the LBO. (Tr. 750-51, 875).
Prior to closing, the sellers offered to make certain payments to bondholders in connection with the LBO. First, the sellers agreed to redeem the CPO portion of the Units while at the same time maintaining that the LBO was not a "triggering event" requiring redemption. (Tr. 31, 957-58; DX 148). MFS tendered all of its CPOs and, at $75 per unit, received $304,500. The Rich plaintiffs likewise accepted the offer and received a total of $15,000. In addition, in order to compensate holders of the twelve percent notes for any decline in value resulting from the LBO, VDAS made a payment of $20 per note. (Tr. 33-34, 726, 967-68; DX 166. PTO Stip.Facts ¶ 33). These payments amounted to $81,200 for MFS and $4,000 for the Rich plaintiffs. (DX 517; PTO Stip.Facts ¶ 34).
At the first VDAS board meeting following the LBO, it was reported that earnings had fallen short of the projections for the month of July. This was attributed to fluctuating maintenance and equipment sales. (PX 19 at M0003929). By the end of August, Mr. Meli advised Mr. Bergschneider that operations were performing significantly below target relative to pre-LBO projections by MAST. He attributed this shortfall to the failure to take certain operating improvement measures in August, the failure to realize certain "upside potential" items, and an overall volume of business that was below expectations. (PX 17 at 1).
Accordingly, on August 30, Mr. Meli requested permission to draw down $1.25 million of the revolver to allow VDAS to pay its trade debt more quickly and to provide an operating "cushion" of $250,000. At this time, Mr. Meli estimated that VDAS had cash available of $500,000 beyond allowance for normal working capital needs. He also anticipated that an additional $3 million would be drawn down to make interest payments on the twelve percent notes due on September 15. (PX 18).
VDAS did utilize the revolver to make the September 15, 1988 payments on the twelve percent notes. It also succeeded in reducing its accounts payable. (PX 20 at 202927). At the same time, management began to implement some of the strategies that Mr. Meli had previously identified as necessary to achieve projected earnings. (PX 20 at 202926-27). Nevertheless, on September 22, 1988, VDAS sought relief from certain of the covenants contained in its loan agreement with Security Pacific. (PX 20 at 202928). While acknowledging that cash flow had fallen short of projections, VDAS emphasized that its problems were temporary and that relief would not be necessary after the March quarter. (PX 20 at 20298).
VDAS did make the required payments on the twelve percent notes in March and September 1989. (PTO Stip.Facts ¶ 38). However, in January 1989 the company adopted an annual budget $3.4 million less than the final LBO projections. (PX 23). On January 23, the Chief Financial Officer of VDAS warned Security Pacific that it was "quite clear that the budgeted cash flow from operations [would] be insufficient to meet existing financial covenants." (PX 23 at S100957).
At the end of February 1989, VDAS again reported its financial condition to Security Pacific. It now estimated that annual cash flow for the period ending June 30, 1989 would fall short of the post-LBO projections by $2.7 million. (PX 24 at S101599, S101601). VDAS noted that the large majority of the bases were performing satisfactorily, but that Nashville and Milwaukee were not. (DX 266 at MV048052). VDAS also indicated that a new competitor had begun operations at the Lexington airport and would cost VDAS about $500,000 per year. (DX 266 at MV048057).
On September 22, 1989, VDAS announced that it expected that by the end of the month it would no longer be in compliance with certain covenants of its senior credit agreement. As a consequence, it anticipated that Security Pacific would prohibit further payments on the subordinated debt, including the twelve percent notes. (PX 28). Indeed, on March 15, 1990, VDAS was required to suspend payments on the twelve percent notes and in November 1990, the company was liquidated. (PTO Stip.Facts ¶¶ 38, 39).
The plaintiffs contend that VDAS was doomed from the moment the LBO was consummated. According to the defendants, VDAS remained a viable entity after the LBO but was subject to a series of unforeseen events that contributed to its demise.
The first such event was customer response to the imposition of a ramp fee by VDAS. This was a surcharge imposed on all customers using VDAS facilities, which would be offset by reduced fuel prices. (Tr. 816-18; DX 235). In theory, this change in pricing policy was designed as an incentive for customers to buy fuel from VDAS. In practice, it had adverse consequences. First, customers reacted negatively, especially in Nashville where the base lost eight of its primary customers to the competing FBO. (Tr. 819-22, 883, 888-89; DX 502 at Tab V, Exh. 18, 19). At the same time that VDAS was losing sales in Nashville, its competitor's sales were increasing. (DX 502 at Tab V, Exh. 19). Thus, Nashville's performance did not merely fail to meet projections; it actually declined. (Tr. 805-06; DX 323 at MV000470). To exacerbate the situation, Mr. Bergschneider was quoted in Aviation International News as stating that pilots who did not like the ramp fee could take their business elsewhere. (Tr. 1415-16). Moreover, the new pricing policy limited VDAS' ability to raise its fuel prices since it was committed to maintaining a discount for customers who paid the ramp fee. Accordingly, when fuel prices rose in early 1989, VDAS' profit margin on fuel sales was squeezed. (DX 294 at 12, 15).
A second major factor in VDAS's decline was the deterioration of maintenance revenues at Nashville. At first, Mr. Meli believed he had mistakenly overestimated earnings based on temporary revenue increases resulting from a policy change by an engine manufacturer. VDAS' Nashville base was a licensed maintenance shop for Garrett 331 engines. In 1987, Garrett extended the number of flight hours permitted between full engine overhauls, thus increasing the number of minor overhauls, or "hot sections," that would be performed. Mr. Meli initially felt that the increased revenue from hot sections was a one-time phenomenon that he should not have included in projections. (Tr. 842). However, he now contends that the policy change permanently increased the number of hot sections to be performed and was properly factored into his projections. (Tr. 828-29).
The defendants attribute the loss of maintenance revenues at Nashville to the termination of Dean Dhom, who was the head of the maintenance facility at Nashville and former owner of Tennessee Jet Corp. (Tr. 826-27). Mr. Dhom was fired in September 1988, and his departure triggered the resignation of several key mechanics at Nashville. (Tr. 827, 879-81). The maintenance business at that FBO steadily deteriorated, resulting in the firing of Mr. Dhom's successor. (Tr. 826, 881).
The third significant event was the emergence of a competing FBO at Lexington. Sprite Flite was VDAS' largest fuel customer at that base. (DX 49 at MV009929). In 1987, Mr. Meli learned that Sprite Flite had acquired a lease to property adjacent to VDAS and had petitioned the airport for permission to open an FBO there. (Tr. 753). In November of that year, Mr. Meli and other VDAS employees met with Jack Baugh, the owner of Sprite Flite, in an effort to dissuade him from competing with VDAS. (Tr. 754-55; DX 277 at MV050664). VDAS argued that a second FBO would not be economically viable and that Sprite Flite's interests would be better served by buying fuel at a discount from VDAS. (Tr. 755). When Sprite Flite rejected these overtures, VDAS sought to remove Sprite Flite from its premises and Sprite Flite retaliated by threatening to challenge VDAS' operating lease and to bring an antitrust action. (Tr. 755-56; DX 277 at MV050664). This legal battle was avoided when the parties entered into a moratorium agreement dated January 6, 1988. By that agreement the parties suspended their legal disputes pending Sprite Flite's efforts to open an FBO at Lexington. (PX 10).
VDAS continued to believe that Sprite Flite would not proceed with this project. Management did not consider the traffic at Lexington sufficient to support two FBOs. (Tr. 754-55, 890). Furthermore, the Sprite Flite location was undesirable because it had no facility for a fuel farm. (Tr. 890). On July 1, 1988, Mr. Meli noted that Sprite Flite appeared to be "stalled" in its efforts to finance an FBO and expressed hope that the plans would soon be abandoned. (Tr. 765, 1505; DX 150 at CPM0005372).
They were not. Sprite Flite obtained the necessary financing and opened the competing FBO in March 1989. Ultimately, Spite Flite captured eighty-five percent of the transient business and fifty percent of the total business at Lexington. (Tr. 1408-10). At present, there is once again a single FBO at Lexington operated by a company known as Sun Jet. (Tr. 1410-11).
The final factor cited by the defendants as contributing to the failure of VDAS is management's deviation from previous business strategies. VDAS had planned substantial renovations to its facilities in Nashville and Milwaukee. (Tr. 927-29; DX 90, 91, 92, 97, 104). Prior to the LBO, VDAS had engaged engineers to draft plans for the "Mansion," the key structure at Nashville, but no construction had begun. (Tr. 1480-81; DX 104). VDAS had also planned to shuffle the location of various operations at Nashville. (Tr. 928). After the LBO, however, Mr. Bergschneider determined not to make the expenditures necessary to follow through on these improvements. (Tr. 836-37).
The defendants also argue that VDAS abandoned its proven policy of acquiring single-site FBOs. Mr. Bergschneider had discussed with Mr. Hirsch continuing to make such acquisitions, and the additional $10 million in senior subordinated financing from Security Pacific was available for such purposes. (Tr. 962-65). However, after the LBO, Mr. Bergschneider focused instead on the possibility of merging with another large FBO chain, but no such deal was ever consummated. (Tr. 877-78; DX 318, 322).
Throughout the period relevant to this litigation, business decisions concerning VDAS-made by its management, by potential purchasers of the company, and by creditors-were based on budget projections. These projections were formulated first by Mr. Meli and subsequently by MAST. Their reliability is a linchpin of this case.
In December 1987, Mr. Meli drafted the projections for VDAS's 1988 operating plan. In order to do so, he accumulated and analyzed budgets for each individual base prepared by the base and regional managers. (Tr. 898-99, 947; DX 49). On this basis, Mr. Meli estimated total 1988 earnings at $11 million, *fn4 a $2 million increase over 1987. (DX 50 at MV010476).
Mr. Hirsch and his partner James A. Lash suggested to Mr. Meli that the 1988 plan was overly optimistic with respect to Nashville. (Tr. 781-83). In his memorandum accompanying the plan, Mr. Meli acknowledged the validity of this point, but concluded that because of the lack of operating experience at Nashville, no refinement of the projection was warranted. (DX 50 at MV010468).
In March 1988, Mr. Meli increased the projected annual earnings for VDAS from $11 million to $14.4 million. (DX 108 at 200051). This change reflected the acquisition of new FBOs in late 1987 and early 1988 and anticipated that VDAS would be able to double the earnings of the newly acquired bases as it had done with prior acquisitions. (Tr. 949; DX 45, 46, 55, 61, 75). Mr. Meli projected VDAS's earnings into the future as follows:
March 1988 Projections (Dollars in Millions)
(DX 108 at 200051). These projections were incorporated in an offering memorandum prepared by Salomon Brothers Inc. in order to attract buyers for VDAS. (DX 108).
The next projections were formulated not by Mr. Meli but by MAST. Taking Mr. Meli's $14.4 million figure as a starting point, MAST then made adjustments based on its own base-by-base review of the company. (Tr. 127-28). MAST also reformulated the projections from calendar year 1988 to fiscal year 1989. (Tr. 131). Finally, it took into account the acquisition of Milwaukee Aero Services, which took place in May 1988. (Tr. 961-62, 991). MAST was aware that VDAS was falling short of the projections made in the 1988 operating plan. (Tr. 100-01). Nevertheless, MAST arrived at projected earnings of $17.3 million. (DX 124 at M0000487).
In June 1988, Mr. Meli and Mr. DePalma engaged in a base-by-base review of VDAS in connection with the financing of the impending sale. (Tr. 762; DX 134). Based on their evaluation, Mr. Meli prepared a new set of projections dated July 1, 1988. (DX 150). In this instance, Mr. Meli outlined three sets of figures, each based on somewhat different operating assumptions: The MAST Model, a model based on conservative expectations, and a model that he considered the most likely outcome. (DX 150 at CPM0005365).
With respect to each FBO, Mr. Meli indicated what expectations had to be met in order to meet the conservative projection as well as what additional potential had to be realized in order to achieve the most likely outcome. For example, for the Cleveland base, the most likely outcome projection was based on attracting two new corporate customers, a prospect that Mr. Meli considered "50/50." (DX 150 at CPM0005367-68). At Nashville, the conservative estimate required VDAS to raise certain prices and relocate its piston maintenance program. (DX 150 at CPM0005368-69). The most likely outcome was dependent upon increasing retail fuel volume, providing ground handling services for airlines, building rental parking, and providing new hanger space for Northern Telecom, the major customer. (DX 150 at CPM0005369). Mr. Meli acknowledged disappointing results at Des Moines and the difficulty of taking actions that would alter the situation significantly. (DX 150 at CPM0005370). For Milwaukee, the conservative projection depended upon raising fuel prices and hangar rental rates. Beyond that, Mr. Meli identified "upside potential" of $250,000, consisting of $150,000 if Northwest Airlines doubled recently added flights to that airport and $100,000 from rental of office space made available by the integration of operations. However, the most likely forecast assumed realization of $150,000 of this potential, not of the full amount. (DX 150 at CPM0005368).
In sum, Mr. Meli's most likely outcome projection was less than the MAST model projection for Minneapolis, Des Moines, Corpus Christi, Anchorage, Boston, and Cleveland. It exceeded the MAST estimates for Milwaukee, Nashville, Columbus, and Detroit, and was approximately equal to MAST's forecasts for Cedar Rapids, Lexington, and Atlanta. Where MAST had projected annual earnings of $17.3 million for VDAS for fiscal year 1989, Mr. Meli's conservative projection was $16.1 million and his most likely outcome forecast was $16.8 million. (DX 150 at 0005365).
Based on the most likely outcome figures calculated by Mr. Meli, VDAS created Final LBO Projections used to obtain financing for the transaction. They forecast cash flow through 1992 as follows:
Final LBO Projections (Dollars in Millions)
The figure for 1989 was obtained by adjusting Mr. Meli's $16.8 million number for fiscal year 1989 to calendar year 1989, using a projected annual growth rate of close to 8.5%. The same growth rate was then applied in order to project each year into the future. (Tr. 814-16; DX 164, 167). The 8.5% rate was based on the fact that VDAS operated at 20% earnings/revenue margin. Accordingly, a 1% real price increase would result in a 5% increase in earnings. In addition, a 1% increase in revenues would generate a 2% increase in earnings, while any increase for inflation would be reflected proportionately in earnings. (Tr. 813-16; DX 167). Mr. Meli then assumed an annual inflation rate of 3-4%, annual growth in revenues of 1-2%, and annual price increases of 0.5%. This resulted in projected annual growth in earnings of between 7.5% and 10.5%. (Tr. 816; DX 164).
These projections were made in an environment where the Federal Aviation Administration was forecasting 4% annual real growth in the turbojet and turboprop industries in connection with which VDAS did the vast majority of its business. (Tr. 816, 938-39; DX 108 at 6-7, 20, DX 507, DX 513). At the same time, FBO chains including Combs Gates and Butler Aviation were projecting higher rates of growth for their own earnings. (Tr. 1400-01, 1544-45; DX 502 at 202707, PX 82 at 38). On the other hand, the projections did not account for any potential economic downturn when decreases in volume or real prices would have similarly magnified negative effects on earnings. (Tr. 842, 849).
Apart from VDAS and MAST, a number of independent entities analyzed the company to ascertain its value or solvency. One, of course, was Security Pacific, which conducted a due diligence review in connection with its financing of the transaction. David Risdon, a Vice President, participated in this review along with other employees of Security Pacific. They visited a number of the FBOs and met with VDAS management. (Deposition of David L. Risdon dated April 27, 1992 at 92-97). They also analyzed VDAS's financial projections in relation to the available historical data. (Risdon Dep. at 93, 97-98, 197).
Security Pacific did not place unquestioning reliance on the VDAS projections. (Risdon Dep. at 257). Rather, it conducted a sensitivity analysis, altering the assumptions utilized by VDAS to determine the effect on the forecast. (Risdon Dep. at 108-09, 115, 118). As a result of this procedure, Security Pacific concluded that VDAS' projection of $17 million in earnings for 1989 was overly aggressive, and it adopted a figure of $15.7 million as more realistic. (DX 137 at S102984).
Nevertheless, Security Pacific agreed to finance the LBO with a term loan of $45 million and a revolving credit line of $10 million. It also provided VDAS with an additional $10 million loan at the same subordinated level as the twelve percent notes. (PTO Stip.Facts ¶ 32). Security Pacific proceeded with the transaction despite the fact that it had historically rejected fifty to seventy percent of all requests for LBO financing. (Risdon Dep. at 90).
Bankers Trust Company also committed to finance the LBO. (DX 141). There is no evidence in the record of specific steps taken by Bankers Trust in conducting any due diligence review, but it may be presumed that such a commitment would not be made cavalierly. Ultimately, MAST chose to accept Security Pacific's offer because the financing costs were lower. (Tr. 135).
The financial condition of VDAS at the time of the LBO was also analyzed by Arthur Young & Company ("Arthur Young"), the company's outside accountants. First, Arthur Young examined VDAS' consolidated balance sheet as of August 1, 1988. It concluded that the balance sheet fairly reflected the financial condition of VDAS in conformity with generally accepted accounting principles. (DX 171 at MV026167). That balance sheet reflected assets of $131,385,000, total debt of $115,097,000, and partnership equity in the amount of $16,288,000. (DX 171 at MV026168). Since the balance sheet incorporated the LBO transaction, it suggested that VDAS would be somewhat more than $16 million "in the black" immediately after the LBO.
In conducting its analysis, Arthur Young determined that the projections made by VDAS management were reasonable. (Tr. 1071-72). However, Arthur Young did not formally audit, examine, or review those projections. (Tr. 1085). Because it did not consider VDAS to be facing imminent insolvency, Arthur Young conducted its analysis on a going concern rather than a liquidation basis. (Tr. 1069-71).
Arthur Young also provided two other valuations of VDAS. The first, submitted on May 25, 1988, was for the purpose of obtaining financing for the LBO. (DX 147, Tab I at M0002135). Arthur Young utilized the discounted cash flow method of valuation. (Tr. 1011-12). Pursuant to this method, the analyst projects the cash flow of the company for some period into the future and then determines the terminal value of the business at the conclusion of the projected period. Finally, the analyst discounts both the projected cash flow and the terminal value back to the present.
Arthur Young used VDAS' projections as the basis for its analysis. It tested the reasonableness of these forecasts by comparing them to industry growth figures and by conducting field due diligence. (Tr. 1013-14). Nonetheless, in its opinion letter Arthur Young stated that it had "not examined the forecasted data or the underlying assumptions...." It also ...