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PEREIRA v. COGAN

May 7, 2003

JOHN S. PEREIRA, AS TRUSTEE OF TRACE INTERNATIONAL HOLDINGS, INC. AND TRACE FOAM SUB, INC., PLAINTIFF, AGAINST MARSHALL S. COGAN, SAUL S. SHERMAN, ANDREA FARACE, FREDERICK MARCUS, ROBERT H. NELSON, PHILIP SMITH, KARL WINTERS, TAMBRA KING, DEFENDANTS.


The opinion of the court was delivered by: Robert W. Sweet, United States District Judge

OPINION

Plaintiff John S. Pereira, as Chapter 7 Trustee (the "Trustee") of Trace International Holdings, Inc. ("Trace International") and Trace Foam Sub Inc. ("Trace Foam") (collectively "Trace") initiated this action against the controlling shareholder of Trace, Marshall S. Cogan ("Cogan") and seven other former Trace directors and/or officers: Saul S. Sherman ("Sherman"); Andrea Farace ("Farace"); Frederick Marcus ("Marcus"); Robert H. Nelson ("Nelson"); Philip Smith ("Smith"); Karl Winters ("Winters"); and Tambra King ("King").*fn1 The Trustee alleges that Cogan is in default of promissory notes to Trace in the amount of approximately $13.4 million, that Cogan engaged in self-dealing in breach of his fiduciary duty in receiving excess compensation in excess of $23 million, and that all of the defendants are in breach of their fiduciary duty of due care stemming from their failure to carry out their duties in the best interests of Trace and their subordination of those duties to the personal interests of Cogan. Finally, the Trustee also alleges that the Director-Defendants (i.e., Cogan, Farace, Marcus and Nelson) illegally approved the payment of dividends and the redemption of Trace shares when Trace's capital was impaired. After a trial before the Court and upon all the prior proceedings and the findings and conclusions set forth below, judgment will be granted in favor of the Trustee, in part, as set forth below.

The Issue

This action presents novel issues of corporate governance under Delaware law. Trace was a privately held corporation that was dominated by its controlling shareholder and founder, Cogan. Its board of directors and officers were content to let Cogan run the show; by and large they claim in their defense that they did not benefit from, and were not aware of, Cogan's self-dealing. Two primary issues are presented.

First, can a controlling shareholder and founder of a privately held corporation be held liable for, colloquially speaking, taking money out of one pocket and putting it into another? Cogan was a widely respected figure in the investment community. He was in large part the reason why Trace was able to attract lenders and investors. Without Cogan, Trace would not have performed as well as it did; it would not even, likely, be an entity. However, Cogan's acts of self-dealing were not without effect to others, as evidenced by the current bankruptcy and because Trace was the holding company of two public companies. Once Cogan created the cookie jar — and obtained outside support for it — he could not without impunity take from it.

The second and more difficult question posed by this lawsuit is what role the officers and directors should play when confronted by, or at least peripherally aware of, the possibility that a controlling shareholder (who also happens to be their boss) is acting in his own best interests instead of those of the corporation. Given the lack of public accountability present in a closely held private corporation, it is arguable that such officers and directors owe a greater duty to the corporation and its shareholders to keep a sharp eye on the controlling shareholder. At the very least, they must uphold the same standard of care as required of officers and directors of public companies or private companies that are not so dominated by a founder/controlling shareholder. They cannot turn a blind eye when the controlling shareholder goes awry, nor can they simply assume that all's right with the corporation without any exercise of diligence to ensure that that is the case.

As discussed later, it is found as a matter of fact that Trace was insolvent or in the vicinity of insolvency during most of the period from 1995 to 1999, when Trace finally filed for bankruptcy. Trace's insolvency means that Cogan and the other director and officer defendants were no longer just liable to Trace and its shareholders, but also to Trace's creditors. In addition, the insolvency rendered certain transactions illegal, such as a redemption and the declaring of dividends. It may therefore be further concluded that, in determining the breadth of duties in the situation as described above, officers and directors must at the very least be sure that the actions of the controlling shareholder (and their inattention thereto) do not run the privately held corporation into the ground.

Prior Proceedings

On July 21, 1999, Trace filed for protection under Chapter 11 of the Bankruptcy Code with the United States Bankruptcy Court for the Southern District of New York. On August 6, 1999, the Office of the United States Trustee appointed an official unsecured Creditors' Committee. See 11 U.S.C. § 1101(a) and (b). On October 18, 1999, the Creditors' Committee, with permission of the Bankruptcy Court, initiated an adversary proceeding by filing a complaint asserting certain causes of action belonging to Trace against Cogan, the Directors and other parties. On January 18, 2000, the Directors moved to dismiss the Complaint. On January 24, 2000, the Bankruptcy Court converted Trace's Chapter 11 case to a Chapter 7 case. On January 25, 2000, the Trustee was appointed. Shortly thereafter, the parties agreed to extend the time for the Trustee to respond to the pending motion to dismiss and, subsequently, that the Trustee would respond by filing an amended complaint.

On January 28, 2000, the Directors filed a motion to withdraw the bankruptcy reference of the adversary proceeding from the Bankruptcy Court, pursuant to 28 U.S.C. § 157(d). On May 15, 2000, the Trustee filed an amended complaint, and on July 31, 2000, the Trustee filed the Second Amended Complaint. The motion to withdraw the bankruptcy reference was granted, pursuant to a stipulation by the parties, on August 28, 2000.

In Pereira v. Cogan, 2001 U.S. Dist. LEXIS 2461 (S.D.N.Y. March 8, 2001) ("Pereira I"), the Defendants' motion to dismiss the Trustee's Second Amended Complaint on the grounds that, inter alia, Counts II, IV, V and VI failed to state a claim was denied. A few of these issues dealt with have resurfaced to be disposed of hereafter.

In Pereira v. Cogan, 267 B.R. 500 (S.D.N.Y. 2001) ("Pereira II"), the Trustee moved for partial summary judgment under Rule 56 of the Federal Rules of Civil Procedure, seeking to hold Cogan liable for the Cogan notes in the aggregate principal of $14 million. The Trustee also moved to dismiss Cogan's two affirmative defenses asserting unrelated offset claims against the notes. Cogan contended entitlement to a $4.7 million offset, based on compensation allegedly due to him under his 1987 Employment Agreement with Trace (the "1987 Agreement"), as renewed in 1997. In addition, he alleged a $12 million offset for severance, retirement and death benefits, under a 1985 Defined Benefit Deferred Compensation and Salary Continuation Agreement (the "1985 Agreement"). The Court granted the Trustee summary judgment with respect to the Cogan notes and voided the renewal of the 1987 Agreement as an unlawful self-dealing transaction and dismissed Cogan's two alleged offset claims.

In Pereira v. Cogan, 275 B.R. 472 (S.D.N.Y. 2002) ("Pereira III"), the Trustee filed a motion under Fed.R.Civ.P. 54(b) for entry of partial final judgment against Cogan on Count I. The Trustee also sought a stay of judgment under Fed.R.Civ.P. 62(h) on condition that Cogan pay the judgment amount into Court, pending the outcome of the action, or pay suitable bond. The Court granted the motion and, on May 14, 2002, entered partial final judgment of $19.5 million (representing the principal and interest on the Cogan notes) under Rule 54(b) and stayed the judgment pursuant to Rule 62(h). To date, Cogan has made no payment into court. Cogan admits to being insolvent. Id. at 474, 475.

In Pereira v. Cogan, 200 F. Supp.2d 367 (S.D.N.Y. 2002) ("Pereira IV"), the Trustee moved for partial summary judgment against Cogan seeking to dismiss $14.7 million of alleged offsets in the form of additional compensation or excess benefits claims. The Court dismissed the offsets except for Cogan's $3.6 million severance pay claim, which is addressed herein.

As a result of Pereira II through IV, the remaining issues under Count I are whether (1) the Trustee is entitled to recover for collection costs (including counsel fees) and late charges under the terms of the Cogan notes and (2) whether Cogan can sustain any of the three remaining alleged offsets: (a) a $3.6 million severance offset under Trace's alleged informal severance policy; (b) a $1.1 million offset for deferred compensation in 1999 on a quantum meruit basis; and (c) an offset of $41,265.28 for unreimbursed advances made to Trace.

As a result of Pereira II, the invalidity of the 1997 renewal of the 1987 Agreement has already been decided, but the issue in Count II remains whether Cogan received excessive compensation in the total amount of $23,763,206 for the period from July 21, 1993 to December 31, 1999.

The Trustee has withdrawn his fraudulent conveyance claim under Count III seeking avoidance of the 1997 renewal of Cogan's 1987 Agreement and recovery of excess compensation. He also withdrew his claim under Count VI seeking to pierce the corporate veil of Trace and hold Cogan personally liable for Trace's legitimate obligations.

Cogan withdrew with prejudice his demand for a jury trial.

A non-jury trial was held from November 12, 2002, to November 26, 2002. Both sides called a number of witnesses and presented numerous exhibits. Post-trial briefing and argument was completed on April 7, 2003.

Findings of Fact

The following constitute the findings of fact of this Court and are based upon the trial, approximately 2,000 exhibits, and the proposed findings of facts from the Trustee, from the Officer- and Director-Defendants other than Cogan (collectively "the non-Cogan Defendants") and from Cogan.

Parties

1. Trace International

Trace International is a Delaware corporation and at all times relevant to this proceeding maintained its headquarters at 375 Park Avenue, New York, New York. Trace International, a privately held corporation, was formerly known by the names General Felt Industries from 1971 to 1987; Knoll International Holdings from 1987 to 1990; and `21' International Inc. from 1990 to 1995. As discussed above, Trace International and Trace Foam filed a petition under Chapter 11 of the Bankruptcy Code on July 21, 1999. The case was converted to proceedings under Chapter 7 on January 24, 2000.

Trace International's financial books and records, including its general ledger, were prepared and maintained in Trace International's Saddlebrook, New Jersey office (the "Saddlebrook Office"). Trace's Saddlebrook Office staff were responsible for Trace's account and bills payable, payroll, cash management, check issuance, bank accounts, bank reconciliations, bank wire transfers, disbursements and receipts. The Saddlebrook staff created financial statements and analyses and effectuated the movements and disbursements of Trace funds. The Saddlebrook Office staff is described in greater detail below.

2. The Trustee

The Trustee was appointed Chapter 7 trustee on January 25, 2000. The Trustee brings this lawsuit by and on behalf of Trace's bankruptcy estate and for the benefit of its creditors. It appears unlikely that Trace's creditors will be paid in full even if the Trustee recovers all of the damages sought in this action.

3. Cogan

Cogan was the majority common stockholder of Trace*fn2; Chief Executive Officer ("CEO") of Trace; and Chairman of Trace's Board of Directors (the "Board") from 1984 to 1999. Through these positions, Cogan controlled the management and operations of Trace. Cogan, a graduate of Harvard Business School, was a senior partner at Cogan, Berlind, Weill & Levitt ("CBWL"), prior to joining Trace.

In 1974, Cogan and Steven Swid formed Trace. From 1974 until 1999, Cogan's duties were to buy companies, to fund and invest in those companies, to manage Trace in a responsible way, to govern the company in a way that could attract qualified personnel, and to put controls and policies in play that would allow Cogan to build a company. During that period of time, Cogan assisted Trace and its subsidiaries in raising more than $11 billion of capital. Cogan also was required to fulfill certain operational activities for Trace's subsidiaries, including pricing decisions, customer and supplier relations and personnel decisions.

Cogan received salary and bonuses from Trace as well as from certain Trace affiliates, i.e., Foamex International, Inc. ("Foamex"), United Auto Group, Inc. ("UAG") and Crown Home Furnishings, Industries, Inc. ("CHF"). As discussed in greater detail below, Cogan received total compensation from Trace and its affiliates of almost $42.1 million from 1993 to 1999. Cogan set the compensation for himself, as well as for the other Defendants.

4. Farace

Farace was a director and officer of Trace. He was the managing director of investment banking at Lehman Brothers before joining Trace and holds a masters of business administration. Farace was a member of the Board from December 15, 1993 to December 29, 1997. During that period, Farace was Trace's Executive Vice President and then President,*fn3 from December 15, 1994 to December 29, 1997. Around April 1997, Farace was named CEO of Foamex. His employment functions at Trace ended around June 1997 when he assumed the Foamex position, and he resigned from Trace in December 1997. Farace ceased employment at Foamex in 1999.

Farace served as a transaction specialist at Trace and was sometimes referred to as Trace's in-house investment banker. In that capacity, he participated in the negotiation of numerous transactions on behalf of Trace and its portfolio investment companies, including acquisitions and dispositions, initial public offerings and financings and refinancings. A number of these transactions are described, infra. Farace also worked on special projects such as the recruitment of Frank Foley ("Foley") to lead CHF in mid-1997, and the negotiation of Foley's employment agreement.

As a Trace officer, Farace did not sign or approve checks while employed by Trace. He never authorized the transfer of money from Trace to the account of any Trace employee or director, nor did he ever prepare or oversee the preparation of financial statement. Farace did not regularly interact with the Saddlebrook Office or with Trace's outside auditor.

As a Trace director, Farace regularly kept himself apprised of the financial condition of the company by reviewing the Trace audited financial statements, daily cash reports, non-GAAP balance sheets, and through daily discussions with the principal senior executives at Trace. The final annual audited financial statements read by Farace were the 1996 annual statements, which were issued on May 14, 1997. The 1997 annual statements were published after Farace resigned from Trace.

Farace also reviewed all unanimous written consents*fn4 distributed to him for signature and attended and made presentations at Board meetings in 1995.

Farace's compensation was about $435,000 in 1995, and approximately $1 million in 1996 and 1997. Of Farace's salary in 1997, Trace only paid approximately $240,000, the remainder coming from Foamex.

5. Marcus

Marcus was a director and officer of Trace. Marcus was director of institutional sales and a member of the investment policy committee at Carter, Berlind & Weill (a predecessor of CBWL) and then an institutional salesman and a member of the equity investment policy committee at Drexel, Burnham, Lambert before joining Trace. Marcus was a member of the Board from 1975 until March 15, 1999, and he served on the Trace Compensation Committee in 1997 and 1998. Marcus was also an officer of Trace from 1984 through March 1997. He was Vice Chairman of the Board and Trace's Senior Managing Director. Marcus ran the `21' Club as part of his operating responsibilities at Trace.

Marcus was the key Trace executive dedicated to investor relations on behalf of Trace and, in particular, its portfolio companies that were taken public. He was responsible for securing approximately 25% of the orders for the initial public offering ("IPO") shares of Foamex in 1993. Afterward, he continued to serve as Trace's representative to institutional investors with respect to Foamex. Concerning the IPO of UAG in 1996, Marcus likewise assisted in the marketing of the offering to investors and in maintaining relationships and communications with institutional investors before and after the IPO.

In 1996, Marcus worked with Cogan in the establishment of the Trace Global Hedge Fund and brought a major investor into the fund. He was also responsible for launching a Trace restaurant venture in 1994 called Stick to Your Ribs, which operated from approximately 1995 through 1996, when it was destroyed by fire at year-end.

In his duties as an officer, Marcus never supervised the treasury, accounting or bookkeeping operations of Trace, and no one performing such functions reported to Marcus. Nor did he prepare or oversee the preparation of financial statements while at Trace. He did not interact regularly with the Saddlebrook Office or Trace's outside auditor, and he did not sign or approve checks while at Trace.

In his role as a director, Marcus kept himself apprised of the financial condition of the company by reviewing the Trace audited financial statements, daily cash reports, non-GAAP balance sheets and through discussions with the principal senior executives at Trace. He also reviewed the unanimous written consents distributed to him for signature and attended and made presentations at Board meetings in 1995.

Marcus personally invested in Trace by purchasing shares of common stock in 1984 and subsequently in 1991. The cost of these two investments was approximately $850,000.

Marcus' annual compensation was approximately $758,000 in 1994 through 1996. In 1997, his salary was $650,000. Marcus did not receive any compensation from the portfolio companies during this period. Marcus has been in retirement since 1998.

6. Nelson

Nelson was a director and officer of Trace. A certified public accountant, Nelson was a former auditor at Coopers & Lybrand ("C&L"), Trace's outside auditor, and holds a bachelors degree in business administration. Nelson was the Chief Financial Officer ("CFO") at Trace from February 1987 to 1999, and in 1995 he became Chief Operating Officer ("COO") and Senior Vice President. As CFO, Nelson was ultimately responsible for Trace's financial books and records, including those audited by C&L, and overseeing Trace's annual tax returns and cash management functions. Nelson was also very involved in Trace's acquisitions and financings. Nelson's office was located in Trace's New York headquarters, and he rarely visited the Saddlebrook Office, where the individuals responsible for creating and maintaining Trace's financial records worked.

In 1996, Nelson dedicated the majority of his efforts to Trace's affiliate, UAG, which went public that year. Although he worked mainly on UAG matters, he retained his CFO title at Trace. Nelson was a member of the Board from June 23, 1994 until January 24, 2000. Nelson became a member of the Compensation Committee on February 16, 1995. Nelson also worked for other Trace affiliates, including CHF and Foamex, each of which he served as a vice president.

Nelson's initial annual compensation was $160,000, but it ultimately peaked at $1.2 million. After working for Trace for one year, Nelson received a $350,000 bonus. During the relevant years, Nelson earned from as much as $872,108 in 1996 as a result of a $600,000 bonus related to the UAG public offering to as little as $58,497 in 1998.

7. Winters

Winters was an officer of Trace. A certified public accountant and former auditor at C&L, Winters holds a masters in business administration. Winters was an employee of Trace from September 1993 to December 1999, and on June 23, 1994 he was elected as Vice President of Trace. In 1995, Winters, who reported to Nelson, assumed most of the CFO duties from Nelson, but was not named CFO. Winters' job at Trace was to provide Trace and its operating companies with technical support for accounting issues.

Winters did not calculate Trace's surplus. He did not have a bookkeeping role at Trace, but rather served as a technical consultant with regard to accounting issues. He also provided support to Trace's investment issues regarding Foamex, including an IPO undertaking and began to liaison with Trace lenders and investors. He assisted lenders with due diligence issues including reviewing documents, forecasts, balance sheets, income statements and legal situations to guide them in determining whether to invest in Trace.

Winters had limited involvement in Trace's personnel issues. He had no knowledge of who set Cogan's compensation and no authority to set any Trace employee's compensation. Winters' role in the compensation process was to input into a computer spread-sheet salary and bonus information about personnel other than Cogan and his daughter, who did not appear on that sheet. Winters did not deal with balance sheet issues, GAAP profit and loss statements and GAAP statement of cash flows. Nor did he have the authority to, and in fact never did, approve Trace loans.

Winters' starting compensation was $120,000 from Trace alone. His compensation from Trace and its subsidiaries peaked at $450,000. Trace paid Winters' salary only through the end of 1994. After that time, Winters' salary was paid by Trace subsidiaries, and from Trace he solely received occasional bonuses and the use of a company car.

8. Smith

Smith was an officer of Trace. A former partner in the law firm of Akin Gump Strauss Hauer & Feld ("Akin Gump"), Smith was General Counsel of Trace from January 1988 to December 21, 1999. Smith was also Vice President and Secretary.

In the role of corporate secretary, Smith maintained the corporate minute books and, when requested by the chairman, sent out notices of board meetings. He took the minutes of Board meetings and drafted unanimous consents. He was assisted in these matters by King, who eventually replaced Smith as Trace's corporate secretary.

Smith often hired and supervised outside counsel for Trace, including Akin Gump; Willkie Farr & Gallagher ("Willkie Farr"); and the Delaware corporate law firm Richards, Layton & Finger ("Richards Layton"). The three law firms provided advice and drafted memoranda, resolutions and unanimous consents for Trace.

From 1995 to 1998, Trace subsidiaries paid Smith's salary, and his sole compensation from Trace was the use of a company car and an occasional bonus. In 1999, his total compensation from Trace was $60,000.

9. Saddlebrook Office Staff

The individuals in the Saddlebrook Office responsible for creating and maintaining Trace's financial records were all long-time Trace employees: Don Betson ("Betson"), Ronald Mamary ("Mamary") and Lever Thompson ("Thompson"). These individuals are not parties to this action.

Betson was Trace's vice president and controller. He supervised the Saddlebrook Office prior to his 1996 departure.

Mamary was Trace's assistant controller under Betson and, after Betson left, Mamary assumed supervisory control of the Saddlebrook Office and was promoted to controller.

Thompson was a twenty-year employee in the Trace accounting department in the Saddlebrook Office. His duties extended to cash management, payroll, reconciling bank accounts and effectuating wire transfers. He also created summaries of Trace's cash and investments.

Mamary, and Betson before him, created financial statements and analysis of Trace's books and records from his computer, on which he maintained Trace's general ledger, in the Saddlebrook Office. Only Mamary and Betson had access to this computer. Trace's New York office employees did not have access to the Saddlebrook computer system.

Mamary regularly generated statements of cash flows backup. Trace's lenders, such as Bank of Nova Scotia ("BNS"), were familiar with these financial documents. Mamary also had the ability to access Trace's bank accounts to effect wire transfers from those accounts.

Betson, Mamary and Thompson all had the ability to contact Trace's outside payroll manager, ADP, and add people to Trace's payroll.

Betson, Mamary and Thompson distributed financial reports out of the Saddlebrook Office.*fn5

The Saddlebrook Office staff cut Trace's checks using a mechanical engraved imprint known as a check-stamping machine. The engraved imprint bore Winters' and Mamary's signatures. Either Mamary or Betson operated the check-stamping machine. Nelson, Smith and Winters did not use this machine, and there is no evidence that they ever manually wrote a Trace check. Their approval was not required for such issuance, either.

The Saddlebrook Office staff ordered Trace's wire transfers. In that office, Mamary, Betson and Thompson had the ability to direct the wiring of Trace funds from Trace's bank accounts.

Trace and Its Investments

Trace was primarily a holding company that had three principal investments. It held approximately 44 to 46% of Foamex, which was a public company through the relevant time period. It also held an interest in UAG, first as a private company where Trace owned about 39% and then as a public company after UAG's IPO in October 1996, from which point on Trace owned approximately 22 to 24%. Trace also owned CHF, a private company, from February of 1995 to the end of the period analyzed. Trace's holdings in these entities constitute between 90 and 95% of its assets.

It is also not disputed that Trace had no operations and therefore had no operating expenses. Trace's only expenses were salaries, fringes, office rent, professional fees, administrative salaries and interest. These general and administrative expenses were approximately $13 million per year, or $1.1 million per month. Trace did not have sufficient income to cover these general and administrative expenses.

According to Trace's own financial records, it had negative operating cash deficits ranging from $15.1 million in the year 1995 up to $44.5 million for the year 1998, for a total operating deficit of approximately $103 million for the period.

As a result of the fact that Trace had minimal or no cash flow from its operations, its only means of funding its cash flow deficits was by borrowing against its primary assets, Foamex and UAG. The value of Trace's holdings in Foamex and UAG fluctuated significantly.*fn6

Trace Transactions and Financings

During the relevant period, Trace engaged in a number of transactions and financings, none of which are particularly germane to the determination of liability in the instant case. These transactions are, however, described in greater detail in Appendix A.

Foamex Going Private Transaction

In the summer of 1997, Cogan, Farace, Nelson, Smith and Winters discussed Trace's status and future opportunities concerning its ownership interest in Foamex. Winters advised that Trace sell its interest in Foamex because (1) market conditions were ripe for such a transaction and (2) it had the opportunity to purchase Crain, a competitor, to increase its appeal to potential Foamex suitors. Trace thereafter purchased Crain and retained JP Morgan to find a strategic partner to acquire Foamex.

In January 1998, Cogan decided that Trace should purchase the publicly held shares of Foamex instead of selling the company. In January and February of 1998, Winters met with several investment banks and commercial lenders to determine the feasibility of taking Foamex private.

Foamex's independent directors hired Beacon Group Capital Services ("Beacon"), an advisory firm that counseled companies on going-private transactions, to advise as to the fairness of Trace's offer to purchase Foamex's outstanding public shares.*fn7

Trace made an offer of $17 per share, and Beacon advised that it would not be fair to the Foamex shareholders. As a result, Trace raised its offer to $18.75 per share, a price that Beacon deemed fair. Beacon informed Trace's board of its opinion and soon thereafter delivered the opinion in writing, which the Foamex Board of Directors accepted. At the time Beacon rendered its fairness opinion, Foamex stock was trading below $18.75 per share.

On August 18, 1998, following Trace's public offer to purchase the Foamex shares and the execution as of June 25, 1998, of an Agreement and Plan of Merger in connection with the Trace offer, Donaldson Lufkin & Jenrette ("DLJ") and BNS together issued a commitment letter to provide $510 million and $340 million, respectively, or a total of $850 million, of revolving credit and term loan facilities upon consummation of the contemplated merger. The commitment letter also provided that DLJ and BNS would undertake to use reasonable commercial efforts to form a syndicate of lenders to participate in the credit facilities.

Trace was unable to consummate the $18.75 per share buyout proposal and, on October 16, 1998, withdrew its offer.*fn8 Although Trace later submitted another offer to purchase all of the outstanding shares of common stock of Foamex not then owned by Trace or its subsidiaries (this time at $12.00 per share), Trace was unable to consummate this buyout proposal either.

I. COUNT I: THE COGAN NOTES TOTALING $14.3 MILLION

A. The Notes

Paragraph 6(A) of each of the eight promissory notes at issue requires that if Cogan is late in making payment of any installment of principal or interest, he is liable for a one-time charge of 2% of the overdue amount. The Court has already determined that Cogan failed to pay all past due principal sums, as well as interest installments due December 31, 1998 and December 31, 1999. Pereira II, 267 B.R. at 504. Cogan does not dispute the amount of the Trustee's previous calculation of $356,493.96 in late charges.

Paragraph 6(E) of the all the notes requires that, if Cogan is in default and has been required to pay immediately in full, the Note Holder (now, the Trustee) has the right to recover all costs and expenses for enforcing such note, including "reasonable attorney's fees." It was earlier held that Cogan had defaulted on the outstanding Cogan notes and payment in full was required. Pereira II, 267 B.R. at 504; Pereira III, 275 B.R. at 476.

B. Cogan's Alleged Offsets

Cogan asserts that he is entitled to offsets for (1) an informal severance policy providing $3.6 million; (2) deferred compensation of $1.1 million; and (3) expenses of $41,265.28. Each is addressed in turn.

1. Informal Severance Policy

Trace did not have a written severance policy for senior executives. Cogan, however, claims a $3.6 million offset under an alleged informal severance policy. The Court has ruled that, in order for Cogan to succeed on an informal severance policy claim, he must show both that Trace had a regular practice of making severance payments and that he relied on this practice in accepting or continuing his employment. Pereira IV, 200 F. Supp.2d at 378-79.

a. Regular Practice

Cogan testified that Trace had a regular unwritten practice concerning senior executive severance. After having observed the demeanor of Cogan while he testified at length about this and other issues, it should be noted that, while a commanding and impressive witness, his assurance did not establish credibility in this instance nor in others which follow.

Here, for instance, Cogan's testimony was merely conclusory and unsupported by the evidence, including testimony by other defendants. Cogan's sole example of the alleged regular practice concerned Farace. Farace, however, testified that it "is absolutely not accurate" that he ever received Trace severance and that he instead received from Foamex "two years of severance, pursuant to an employment agreement." Farace and Winters make no claims for severance. Nelson, Smith and Marcus all have claimed severance under written deferred compensation agreements rather than under an informal practice.

Cogan earlier claimed that through Nelson's testimony he would show that Trace had a severance policy for its senior executives that was not reduced to writing. At trial, Nelson testified that, "Trace didn't have any specific severance policy with respect to executives other than if somebody had an employment contract."

Further, Cogan testified that Trace's informal policy mirrored the written policy of Foamex. At his deposition, however, Cogan stipulated that the Foamex written policy did not apply to executives.

No regular practice of making severance payments other than by agreement was established by the evidence.

b. Reasonable Reliance

The 1987 Agreement, which was voided in 1997, provided for at least five years' severance. Further, it specifies the "intention" of the parties that "this Agreement shall supersede and be in place of any and all prior agreements or understandings between them." 1987 Agreement, § 27. Section 22 states "[n]o agreements or representations, oral or otherwise, express or implied" regarding the same subject matter were made if they were not expressed in the Agreement.

At the summary judgment stage, the Court drew the following inference in Cogan's favor given the above provisions: "Presumably, Cogan relied on the unwritten policy in that he was assured that even if his written contract was voided for some reason, he might still receive the usual severance package of one year's salary." Pereira IV, 200 F. Supp.2d at 379. At trial, when Cogan was asked whether the alleged informal policy was "sort of a backstop in case your contract was declared void," Cogan answered, "No."

Cogan's position at Trace gave him no reason to fear being fired. He was the CEO, Board Chairman and the majority shareholder. Cogan also had a ten-year contract with Trace. Further, there is no evidence that Cogan was subjected to any meaningful oversight by the Board.

The evidence failed to establish reliance by Cogan, and indeed the policy did not in fact exist.

2. Deferred Compensation

Cogan claims that in 1999 he voluntarily deferred a portion of his $3.6 million annual salary, and that he is now entitled to a $1.1 million offset under the equitable doctrine of quantum meruit.

Cogan deferred payment in order to conserve cash in light of Trace's financial difficulties. In 1999, Trace was still experiencing the adverse effects of the failure of the Foamex going private transaction, and Cogan was working to enhance the value of Trace's assets. In particular, Cogan negotiated the infusion of approximately $83 million in UAG by companies controlled by Roger Penske. Cogan was also working on a restructuring of the debt of BNS and a number of transactions to enhance the value of Foamex, including negotiations to combine operations with a Canadian company called Woodbridge Foam. Neither came to fruition.

Cogan did not serve as a full-time Trace employee in 1999. In January 1999, Cogan signed a two-year Foamex Employment Agreement with Foamex requiring him to be based at the Foamex headquarters in Linwood, Pennsylvania. Thus, he could not have worked full-time in 1999 at Trace's headquarters located in New York. In 1999, Cogan's annual salary under the Foamex agreement was $850,000.

In addition, Cogan covenanted away his 1999 Trace compensation. Cogan signed a Unanimous Written Consent of the Board, dated as of August 14, 1998, which approved the issuance of Series U Preferred Stock and an associated Certificate of Designation. In the certificate, Trace agreed that if the Series U Preferred Stock were not redeemed by December 31, 1998, Cogan would not receive any compensation unless and until the price of UAG reached $50 per share.*fn9 Trace later failed to redeem the shares, and UAG traded at only the $5 to $13 range in 1999. Since the two prerequisites did not occur, Cogan was not entitled to any compensation from Trace in 1999.

Finally, 1999 was the year in which Cogan led Trace into bankruptcy from which it never emerged. Cogan also that year defaulted on his substantial borrowings from Trace, further injuring the company. No factual basis for a quantum meruit claim has been established.

3. Expenses

Cogan offered no support other than brief and conclusory testimony for his offset claim of $41,265.28 in un-reimbursed advances made to Trace.*fn10

II. COUNT II: COGAN'S EXCESSIVE COMPENSATION

In Count II of the Complaint, the Trustee alleges that Cogan received excess compensation from Trace as a result of Cogan's self-dealing, and seeks to recover such excess amount of compensation from Cogan for the benefit of Trace's estate.

A. Self-Dealing Versus Ratification of Cogan's Compensation from 1988 to 1994*fn11
The Trustee contends that Cogan set his own compensation levels, without the approval of an independent board of directors, and therefore Cogan bears the burden of proving that his compensation was "entirely fair" to Trace. Cogan, but not the other Defendants, contends that the other Defendants played a role in determining the amount of his compensation. All Defendants contend that in 1996 the Compensation Committee of the Board ratified Cogan's compensation retroactively for the period 1988 through 1994.

Based on the findings set forth below, Cogan's compensation was neither approved nor effectively ratified by an independent board or compensation committee, and accordingly Cogan bears the burden of proving, under the doctrine of self-dealing, that the level of the compensation was entirely fair to Trace for the entire period covered by the Trustee's damage claim. In any case, as the following facts demonstrate the compensation was excessive regardless of where the burden lies.

1. The 1987 Agreement

On August 5, 1987, Cogan and an alleged Trace predecessor entered into an agreement providing for Cogan's employment as Chairman and CEO for a 10-year "Initial Term" through August 4, 1997 (the "1987 Agreement"). The 1987 Agreement provided that Cogan was to receive compensation of $2.4 million per year,*fn12 and that Cogan's compensation could be increased only if the Board authorized the increase. It also provided for four additional 10-year "Renewal Terms" spanning the period from August 4, 1997 to August 4, 2037. Under the 1987 Agreement, each of these Renewal Terms would occur automatically unless the Trace Board, by a three-quarters vote of its entire membership, affirmatively declined to review the Agreement or Cogan himself elected not to renew the Agreement.

The terms and conditions of the 1987 Agreement were drafted by Akin Gump and overseen by independent Merrill Lynch investment bankers and other independent investors. At the time, Trace was planning to raise approximately $125 million through the issuance of common stock to the public and to raise another $350 million through the issuance of public debt. Merrill Lynch was the lead underwriter with respect to the offering of common stock and Drexel Burnham Lambert was the leader underwriter with respect to the public debt offering. To better assure the success of these two public offerings, the underwriters insisted that Cogan be committed to a long-term employment agreement.

Trace's independent directors,*fn13 who constituted a majority of Trace's Board of Directors at the time, ratified the 1987 Agreement, guided by advice of counsel and after Feld made a presentation concerning it.

By unanimous written consent dated April 1, 1989, the Executive Committee of the Board approved and adopted 1989 salary increases and 1988 bonuses for certain Trace employees, including an award of a 1988 bonus to Cogan in the amount of $5.25 million. The members of the Executive Committee at that time were Sherman, Marcus and Cogan.

2. Cogan Increases His Salary

In 1991, Cogan unilaterally increased his base salary under the 1987 Agreement to $3.6 million annually.*fn14 There is no evidence that the Trace Board took any contemporaneous action to approve this increase. Cogan claims that the Board ratified it the next year, at an annual meeting held on July 21, 1992. There, the Board ratified "all past acts and decisions, including, without limitation, all purchases, sales, borrowings, leases, contracts, contributions, compensations, proceedings, elections and appointments, by the officers of [Trace], in the name of and on behalf of Trace since the last election of officers at the regular meeting of [Trace's] Board of Directors." The Board members in attendance at that meeting were Cogan, Feld, Hershon, Lawrence C. Horowitz, Marcus and Shapiro. There is no evidence regarding any discussions of Cogan's compensation, nor any evidence that the Board members were aware of Cogan's compensation.

The minutes of the June 24, 1994 annual meeting of the Board recorded that:

Various members of the Board commented on Mr. Cogan's strong leadership and the outstanding contributions made by him since his founding the Company. His performance was thought to compare favorably with the performance of the heads of many investment banking firms, merchant banks and leveraged buy-out companies as well as other entrepreneurs. Mr. Nelson then reviewed Mr. Cogan's compensation from 1991 through 1994.
The directors in attendance at that meeting were Cogan, Feld, Marcus and Sherman, of whom only Cogan and Marcus were then officers of Trace.

3. The Board's Ratification of Cogan's Past Compensation

The Board explicitly attempted to retroactively ratify compensation for years 1988 through 1994.

Sometime after January 10, 1996 and prior to June 18, 1996, a unanimous written consent dated as of January 3, 1996, was signed by the two members of the Compensation Committee, Nelson and Sherman.*fn15 It recommended that the Board ratify Cogan's compensation for the period from 1988 through 1994, inclusive, and contained the following findings*fn16:

Mr. Cogan's performance as Chairman and Chief Executive Officer was reviewed favorably and was considered to have been vital to the success of the Company, and . . . the various subsidiaries . . . for which Mr. Cogan rendered services from 1988 through 1994;
a review of Mr. Cogan's compensation relative to the Company's performance over time demonstrated that his compensation increased and decreased commensurate with the Company's revenue and earnings growth . . . and in proportion to that of the other officers and executives; and
Cogan's compensation [as Chairman and CEO in the forms of salary and bonus from 1988 through 1994 were deemed] was comparable to or below that of similarly situated executives at investments banks, commercial banks, closely held investment companies, leveraged buyout firms, and medium sized diversified holding companies.
That consent was circulated to the Board sometime after June 18, 1996, along with a unanimous written consent dated as of January 4, 1996 (the day after the Compensation Committee's recommendation was effectively dated). The unanimous written consent adopted the recommendation of the Compensation Committee and restated the findings above. It was signed by Sherman, Cogan, Farace, Nelson and Marcus.

The decision to ratify Cogan's compensation was the result of advice from an outside counsel to Trace, Melvyn R. Leventhal ("Leventhal"), who recommended to the Board in writing that it review and approve the Compensation Committee's resolution in which the Committee considered the reasonableness of Cogan's compensation between 1988 and 1994 inclusive.*fn17 That advice was received sometime between January 10, 1996 and June 18, 1996. There is no indication why Leventhal advised that the previously received compensation be ratified.

The evidence does not establish that the ratification by the Board was a well-informed decision of a truly independent board.*fn18 First, there is no agreement on what level of compensation the Compensation Committee or the Board believed they were ratifying. The resolution adopting the ratification contains no recitation of the amounts of compensation being ratified for any of the years at issue. While Farace testified that, at the time of the ratification of Cogan's compensation for 1988 through 1994, the Board was presented with a schedule reflecting the figures year by year, no such table has been presented into evidence. In addition, the directors have provided contradictory testimony as to their belief of what level of compensation they were ratifying. Marcus testified that he thought the Board was ratifying the base amount of $2.4 million under the 1987 Agreement. Farace thought he was ratifying the amount stated in the minutes, which contain no amount. Cogan, who appeared to assume the validity of the unilateral increase in his base salary to $3.6 million in 1991, testified that he thought the only things being "ratified" were his bonus payments for the years in question.

The fact that none of the participants in the ratification process can agree on exactly what they were ratifying, and the lack of any illuminating information in the board resolutions, are reasons to find the ratification ineffectual.

Further, the evidence at trial demonstrated that neither the Compensation Committee nor the Board followed procedures that would lead to an informed decision as to whether Cogan's compensation for the seven-year period was reasonable. The evidence demonstrates that the Committee did not in fact conduct any real investigation into the reasonableness of Cogan's compensation. It is undisputed that the Committee retained no compensation consultant or other professional to assist it. Nor does it appear that the Committee consulted any salary surveys or other analyses. While the Committee's findings purport to find that Cogan's compensation was comparable to that of "similarly situated executives," none of the witnesses at trial knew who the similarly situated executives were, where they worked, or how much they made. It thus appears that the only support for this assertion was, at best, the anecdotal information that the Committee and other Board members had from business acquaintances and, in the case of Nelson, information he recalled from reading articles in business periodicals such as Business Week. Nelson reported this information to Sherman, who relied on him for information when he ratified Cogan's compensation.

Cogan also failed in his burden to demonstrate that the Committee or the Board was "independent" in connection with the purported ratification of his compensation. Sherman, the only member of the Board not on Trace's payroll, was a long-time business associate and personal friend of Cogan, with whom he had other overlapping business interests. Nelson, the only other member of the Committee, was Trace's CFO and was dependent on Cogan both for his employment and the amount of his compensation, as were Farace and Marcus, the other Board members who approved the Committee's ratification of Cogan's compensation. There is no evidence that any member of the Committee or the Board negotiated with Cogan over the amount of his compensation, much less did so at arm's length.

4. Cogan's Compensation After January 1, 1995

There is no evidence that the Committee or the Board took any action to set, review or approve Cogan's compensation for any period subsequent to January 1, 1995.*fn19 The Board held its last meeting in September 1995, and the Committee never held a meeting.

Because Cogan did not elect not to renew the 1987 Agreement and because the Board did not address the propriety thereof, it was automatically renewed on August 4, 1997, for another 10-year term through August 4, 2007. That renewal was declared void, and thus Cogan was not entitled to the $2.4 million salary under the 1987 Agreement after it expired in 1997. Pereira II, 267 B.R. at 509-11.*fn20

5. Board Inaction Regarding the Renewal

All of the defendants were aware or should have been aware that the 1987 Agreement was up for renewal in August 1997.*fn21

The evidence at trial confirmed the finding in Pereira II that there was no Board approval of the 1997 renewal. There is not any Board resolution or other Board minutes on this subject in the Trace minute book or elsewhere. The custodians of the minute book, King and Smith, attested to its completeness. Furthermore, Farace testified credibly that the Board did not consider whether or not to renew the Agreement. In addition, Cogan and Nelson acknowledged, in affidavits admitted against those parties, that the Agreement was "automatically" renewed in 1997.

Nor is there any evidence even of any discussions regarding whether the Board should consider the renewal. Farace and Marcus claim that they took no action with regard to the renewal because they relied on their assessment of Cogan's performance and qualifications, their knowledge of what other similarly situated executives were earning, Trace's audited financial statements, Trace's financial records, information supplied by other officers in Trace's Saddlebrook office and daily stock quotes for Foamex. There is no record of any such consideration in the corporate minutes.

The Defendants presented no evidence that a hypothetical wholly independent Board would have approved the 1997 renewal of the 1987 Agreement. The fact that the 1987 Agreement was originally approved by the Trace Board in 1987*fn22 does not cure the failure of any (independent or other) Board approval in 1997 or the absence of hypothetical independent board approval evidence.

As a result, Cogan's compensation for all relevant times subsequent to January 1, 1995 is found to have been determined by Cogan alone, without supervision or control by the Committee or the Board. Accordingly, it is concluded that Cogan bears the burden of proving that his compensation for the relevant time period was "entirely fair" to Trace. The parties offered evidence of the reasonableness of Cogan's compensation through their expert witnesses.

B. The Experts' Analyses on Fair Compensation

The Trustee contends that Cogan received in excess of $23 million in excess compensation. The Defendants argue that, even including the unauthorized loans received by Cogan that are discussed in Counts I and IV, Cogan was not overpaid. The resolution of the parties' conflicting positions regarding whether Cogan received excess compensation rests primarily on the assessment of the expert reports and testimony offered by the two sides. The Trustee relied on the expert reports and testimony of Kenneth Petersen ("Petersen"), who was a consultant with KPMG at the time his expert report was prepared and has more than twenty years' experience as a compensation consultant. The Defendants offered the expert reports and testimony of Herbert T. Mines ("Mines"), who is currently chairman of his own business, Herbert Mines Associates ("Associates"), an executive search firm that is hired by the board of a company or its CEO to find an executive they wish to recruit from the outside.

1. The Experts' Backgrounds

KPMG hired Petersen in early 2000 to re-establish its compensation consulting business, which KPMG had previous sold to Mercer. Over the course of his career, Petersen has advised hundreds of corporate boards of directors, compensation committees and corporate officers on issues of executive compensation and benefits. He has also testified as an expert witness in numerous bankruptcy cases on behalf of both debtors and creditors.

Mines has a bachelor's degree in economics and a master's degree in industrial and labor relations. In his career, Mines has recruited approximately one thousand executives, of which approximately 300 have been the senior most executives of a company. Associates recruits an average of 100 executives per year. Mines is a member of the Association of Executive Search Consultants.

Mines was originally contacted by counsel for Cogan in early 2001 and asked whether he could support Cogan's Employment Agreement. Mines advised the Defendants that he could not support the agreement because of the length of its term and the automatic renewal provision. About six months later, Mines was again contacted by counsel for Cogan and asked to consider evaluating the reasonableness of Cogan's compensation for the period 1993 through 1998, and he agreed to do so.

2.Neither Expert Chose Appropriate Comparators

During his testimony, Petersen described a process of analysis called "benchmarking," which is a generally accepted method used by compensation consultants and experts to determine reasonable compensation levels for corporate executives. In a "benchmarking" study, the consultant gathers information about the salaries of other executives in a "comparator" group selected by the consultant. The information is generally obtained from publicly available sources such as proxy statements filed with the Securities and Exchange Commission. It is important for the benchmarking study that the members of the comparator group be comparable to the executive position being evaluated. That means that the comparator group should be composed of executives performing similar tasks at companies in similar industries and of similar size and revenue as the company whose executive position is being benchmarked.

Both experts utilized this methodology. Neither chose an appropriate comparator group, perhaps in part because Trace utilized a hybrid form, combining qualities of the two groups that each chose.

a. Petersen's Group

Petersen assembled a group of fifteen comparator companies for which relevant compensation data was available for the years 1993 through 1999. All of these companies were in businesses which Petersen considered, based on the Bureau of Census Standard Industrial Codes ("SIC"), to be in industries comparable to one or more of Trace's operating affiliates. These comparables included, for example, companies in various chemical industries that Petersen considered comparable to Foamex; companies in the auto parts and auto dealership industries that were comparable to UAG; and companies in the home furnishing industry that were comparable to CHF. In selecting these companies, Petersen also attempted to find companies that were all roughly comparable in size, based on revenue in 1999, to Trace and its consolidated affiliates. The fifteen companies' 1999 revenues ranged, in rounded numbers, from $767.9 million to $3.779 billion, with the average revenue of the group at $1.902 billion and the median revenue at $1.63 billion. These figures compare to Trace's 1999 revenue of $1.357 billion.

Using the proxy statements filed with the SEC by the comparator group companies, Petersen determined the total annual cash compensation (salary plus bonus) for the chief executive officers of the comparator companies for the years 1995 through 1999.*fn23 Petersen calculated that the relevant amount for determining Cogan's reasonable "target" compensation was the compensation paid to an executive at the 75th percentile of this group. Petersen chose this amount based on an authoritative study, ECS 2001/2002 Industry Report in Top Management Compensation, showing that only 28.6% of companies "target" top management total cash compensation at or above their market's 60th percentile. Petersen's choice of the 75th percentile is reasonable based on this reasoning. Moreover, Mines used the same 75th percentile figure when comparing executives' salaries to Cogan's.

Petersen's study concludes that Cogan's reasonable compensation for each of the years is as follows:

1999 1,322,000

1998 1,388,000

1997 1,188,000

1996 1,163,000

1995 1,074,000

1994 1,074,000

1993 1,074,000

TOTAL $8,283,000

The defendants object to these findings on several grounds. First, they argue that Mines' comparator groups are more appropriate and therefore these figures are flawed. While correct, the argument is unavailing due to the conclusion below that Mines' comparator group is also inappropriate. Second, Mines criticizes Petersen's analysis on the grounds that Petersen considered only the cash compensation (salary and bonuses) and did not take into account the non-cash compensation (i.e., stock options and restricted stock) that the comparator group received. In light of the finding that Petersen's figures are not appropriate, and the means by which the Court determines the reasonable compensation due Cogan, there is no need to address this second point.

b. Mines' Comparator Group

Mines determined that it was inappropriate to compare Cogan to the heads of operating companies (as Petersen did) and instead compared Cogan with the heads of venture capital firms or with individuals who would receive a finder's fee*fn24 as a result of significant transactions.

Mines looked to how heads of venture capital firms were paid, calculating for each year the salary based on the base salary, plus bonus and long-term incentive in the 75th percentile. Aggregate compensation paid during the five-year period from 1996 through 2000 was $45,375,000. The average annual compensation was $9,075,000, and Mines used this level of compensation for a six-year period, resulting in a total compensation for the six-year period of $54,450,000. Mines was not able to get information as to compensation of managing partners at equity firms prior to 1996, but determined that there would not have been significant variation in the terms of his analysis.

Between 1987 and 1999, Cogan received approximately $54 million from Trace, including loans the Board did not authorize,*fn25 and therefore Mines concluded that Cogan's compensation was reasonable under either test.

Based on the above analysis, Mines concluded that Cogan's compensation in the years 1993 through 1998 was reasonable because Cogan was in essence running a venture capital firm, and the compensation he could have derived had he been paid as an entrepreneur running a venture capital firm was within the range of what he actually earned.

The Trustee argued that Petersen's comparator group was more appropriate, and also took issue with a number of other choices Mines made in reaching his figures. For instance, Mines relied on a compensation study prepared by another firm, Mercer, that did not contain sufficient information to allow him to identify and separately evaluate compensation at the subset of the companies in the Mercer study that could be regarded, by any measure, as comparable in size to Trace. Indeed, Mines did not even know the identity of the companies included in the survey, companies that included private investment powerhouses. Further, Mines only purchased a few "relevant" pages of the Mercer report rather than the entire document, and he did not update his report when he received earlier portions of Mercer reports. It is true that this methodology, in addition to the fact that Mines was only able to obtain compensation figures from 1996 to 2001, rather than 1993 to 1999, likely resulted in inflated numbers. Such inflation is dealt with in the findings below that neither expert is correct, but that an average of the two is the most appropriate means of determining a reasonable compensation.

Mines' suggestion that Cogan's role at Trace was similar to that of a manager at a private equity fund is rejected, however. Trace was not structured or operated like private equity fund, which typically manages investments made by the public or a number of passive investors.

c. Trace Had Attributes of Both an Equity Fund and an Operating Company

Neither expert was able to credibly argue that his findings were correct because Trace was not so easily compartmentalized into either Petersen's operating company comparator group nor Mines' equity fund paradigm. Instead, Trace had attributes of both. For instance, Cogan in many ways acted like a venture capitalist: he participated in efforts to increase the value of Trace and its affiliates and was involved in financings, mergers and acquisitions. While heads of operating companies do get involved in some of these issues, they have large staffs (and frequently separate departments), which do all the work with respect to these kinds of activities. Frequently these staffs report to the Chief Financial Officer, rather than the CEO. It is only when the preliminary work has been done that the CEO of an operating company is brought in.

On the other hand, however, Cogan and his colleagues were active in managing the day-to-day business affairs of Trace and its affiliates,*fn26 just as with an operating company. In addition, the structure of Cogan's compensation at Trace in the form of salary and bonus more closely resembles that of a corporate CEO rather than managers at private equity firms who, as Mines recognized, receive the largest portion of their compensation in the form of "carried" equity interests.

Because neither party presented evidence regarding an appropriate comparator group, the findings of both Petersen and Mines with regard to what constitutes reasonable compensation are rejected. Instead, the following figures, based on the average of Petersen's year-by-year figures with Mines' average compensation of $9,075,000, are adopted:

1999: $5,198,500

1998: 5,231,500

1997: 5,131,500

1996: 5,119,000

1995: 5,074,500

1994: 5,074,500

1993: 5,074,500

3. Cogan's Compensation from Trace and Its Affiliates Will Be Considered for Cogan's Liability
The Trustee contends that in considering the reasonableness of Cogan's compensation, it is appropriate to consider the total amount Cogan received from both Trace and its affiliates, while Cogan contends that the relevant amount is only the amount paid to Cogan directly from Trace itself.

The compensation of the CEO of a corporate holding company should include compensation for the services the CEO provides to the corporation's subsidiaries. Cogan's Employment Agreement with Trace provided that the compensation for his services "may be allocated among and paid by any combination of [Trace] and its subsidiaries and/or divisions . . .," and that his duties as Trace CEO could be delegated to executives of Trace's "divisions or subsidiaries." In addition, when Cogan and the other Board members purported to approve retroactively Cogan's Trace compensation from 1988-94, they cited, inter alia, Cogan's services to "the various subsidiaries of the Company."

Cogan's testimony at trial attempted to differentiate between the "strategic" investment-management services he provided at the Trace level and the "operational" management services he provided at the affiliate level. This testimony is rejected on credibility grounds. The evidence presented at trial indicates that Cogan and his colleagues in fact viewed running the day-to-day operations of the affiliates as part of their job at Trace, and placed little significance on which of the entities were covering their paychecks in what amount. The officers of Trace typically held the same or comparable offices at the affiliate level, so there was no clear delineation between their functions at the various entities.*fn27 Employees were routinely reassigned from the Trace payroll to the affiliates' payrolls, and vice versa, without any apparent change in job functions or responsibilities. There was no correlation between the time an individual spent working on the affairs of Trace or its affiliates and the percentage of the individual's total compensation that was paid by Trace or the affiliate in question.

It is also appropriate to look to the total amount of Cogan's compensation when considering its reasonableness because both experts relied on comparability studies of other full-time executives. If, as Cogan suggests, he was working part-time for the other affiliates, and being compensated by the affiliates for that portion of time, it follows that the amount of compensation he received directly from Trace should have been adjusted to reflect the less-than-full time commitment of his efforts to Trace itself. For all of these reasons, in determining Cogan's liability, the appropriate figure is the total compensation received from Trace and its affiliates.

It is therefore concluded that Cogan's liability for excess compensation will be determined based upon the following figures:

Year Reasonable Compensation Compensation From Trace and Affiliates
1999 5,198,500 2,805,469

1998 5,231,500 6,500,965

1997 5,131,500 5,652,546

1996 5,119,000 4,755,680

1995 5,074,500 4,746,855

1994 5,074,500 8,356,366

1993 5,074,500 9,279,000

TOTAL 25,755,000 42,096,881

It should be noted, however, that the same does not hold true for the non-Cogan Defendants. These defendants have been sued in their capacities as Trace directors and officers. As such, the duties they owed (and which the Trustee claims they breached) were to Trace. No evidence has been presented to support a finding that, by permitting subsidiaries to excessively compensate Cogan, the directors and officers were in breach of their fiduciary duties to Trace. As a result, the appropriate figure for the Director- and Officer-Defendants is the amount of compensation Cogan received from Trace alone.

The potential liability for the non-Cogan Defendants under Count IV will be based upon the following figures:

Year Reasonable Compensation Compensation From Trace
1999 5,198,500 897,413

1998 5,231,500 3,785,017

1997 5,131,500 3,783,228

1996 5,119,000 3,753,872

1995 5,074,500 3,788,520

1994 5,074,500 7,606,366

1993 5,074,500 8,826,249

TOTAL 25,755,000 32,440,665

C. Cogan's Efforts at Trace

Cogan testified at length about various deals that he spearheaded and that purportedly resulted in millions of dollars in profits for Trace. For instance, Cogan testified that (1) a $2 million investment in GFI in 1974 resulted in a $89 million sale in 1989; (2) an initial investment of $250,000 in Knoll in 1977 led to an eventual sale in 1991 for $104 million; (3) a $5 million investment in Color Tile in the 1980's led to a sale for approximately $75 million; (4) a $10 million profit on a $10 million investment in Sotheby's; (5) Trace sold Sheller Globe for $187 million in 1987 after a $14 million investment from Trace and $65 million from Lehman Brothers in 1985; and (6)Trace sold the `21' Club in 1995 for $22.8 million after an initial investment of $5 million in 1984. He now would have the Court make findings of fact that his efforts resulted in these huge profits.

In the absence of any further evidence to support the claimed returns-on-investments listed above, the Court cannot find that the exact figures as claimed by Cogan were those actually realized by Trace. It is unclear from Cogan's testimony what other costs were incurred by Trace in preparing the various investments for sale, whether by heavily investing in them or even the pro rata expense of Trace's operational costs that may be attributed to the investments. For instance, as discussed in Appendix A, the sale of the `21' Club netted Trace a profit of approximately $6.4 million. Yet from Cogan's testimony, it would appear as though the sale resulted in a profit of more than double that amount. As a result, the most that can be found is that Cogan was instrumental in pursuing and shaping investments that apparently resulted in large returns-on-investment for Trace. However, these deals, while commendable, do not alter the factual finding above that Cogan's compensation was excessive. Such efforts were taken into consideration in the determination that Petersen's comparator group was inappropriate, however.

Similarly, the Defendants tout the fact that from 1995 to 1998, the key lenders to Trace such as BNS*fn28 and Republic Bank, knew the approximate level of Cogan's annual compensation and did not object to it. Further, they note that Cogan's compensation, even when combined with that of other Trace employees, did not violate the $12 million ceiling BNS had established on total Trace compensation. The fact that lenders did not object to Cogan's compensation does not establish that it was not excessive.

D. Summary

The damage calculation, as set forth below, establishes that the Trustee is entitled to recover almost $7 million in excess compensation from Cogan:

Date Actual Reasonable Excess Compensation Compensation Compensation
7/21/93- 12/30/93*fn29 $4,142,762 $2,266,145 $1,876,617
1994 8,356,366 5,074,500 3,281,866

1995 4,746,855 5,074,500 N/A

1996 4,755,680 5,119,000 N/A

1997 5,652,546 5,131,500 521,046

1998 6,500,965 5,231,500 1,269,465

1999 2,805,469 5,198,500 N/A

Total $6,948,994

III. Count IV: Breach of Fiduciary Duty

A. The Alleged Breaches

The alleged breaches revolve around (1) the repurchase from Dow Chemical Company ("Dow") of Trace stocks (the "Dow re-purchase"); (2) declared and undeclared dividends; (3) Cogan's compensation; (4) loans to Cogan; (5) loans to insiders of Trace and its subsidiaries; (6) Cogan's birthday party at MOMA; and (7) Cogan's daughter's job at Trace. Each will be detailed separately. It is undisputed that the Board only took action with regard to the 1996 ratification of Cogan's past compensation and certain of the dividends.

1. The Repurchase of Trace Stocks from Dow

a. Dow's Investment in 1992 and the Re-negotiation in 1995

In 1992, Dow, a critical supplier to Foamex since 1982, agreed to fund the purchase of Trace preferred stock. Dow lent $20 million to a DLJ subsidiary, BSI, and the loan was made, bearing interest at an annual rate of 7%, or $1.4 million, payable quarterly. As part of the same transaction, Trace sold 1,000 shares of Trace Series A Preferred Stock ("Series A Preferred") to BSI for $20 million, which BSI pledged to Dow as security for its $20 million debt. The Series A Preferred accrued dividends, which were payable quarterly "out of any funds legally available" at the annual rate of $1,400 per share.

The annual dividend rate remained in effect for five years, until the Dow/BSI loan matured. Thereafter, the annual per share dividend rate increased to $20,000, multiplied by the three-month United States Treasury Bill rate plus 6%. Because Trace had the option of continuing to pay interest, the Series A Preferred was a perpetual instrument. If Trace exercised its right to redeem the Series A Preferred, the per-share price would be $20,000 (aggregate $20 million) plus accrued but unpaid dividends.

As part of the same transaction, Trace loaned $10 million to Dow in the form of a purchase of a $10 million Dow note. The Dow note accrued interest at a rate keyed to the rate of 3-month commercial paper. In turn, Trace guaranteed up to $10 million of BSI's debt to Dow and pledged the Dow note as collateral for said guarantee.

In 1995, Dow, Trace and BSI entered into a Master Recapitalization Agreement, under which (1) Dow paid Trace the $10 million balance on the Dow note; (2) Trace paid BSI $10 million in consideration for BSI's consent, inter alia, to halve the annual dividend rate from $1,400 to $700 per share multiplied by the three-month Treasury bill rate plus 6%; (3) BSI paid Dow the $10 million received from Trace to repay part of the outstanding balance on the Dow/BSI loan; and (4) the Trace guarantee terminated. These terms had the effect of reducing Trace's Series A Preferred annual dividend obligation and redemption price by 50%, with a corresponding reduction in interest obligation and outstanding balance owed to Dow, and a repayment of $10 million of Dow's investment.

b. Cogan's Purchase of the Dow Stocks

Reacting to a demand of Dow in 1997,*fn30 Cogan and Smith drafted, and Cogan executed, a letter to Dow dated October 9, 1997, in which they committed Trace to redeem or to cause the purchase of Dow's investment in Trace over a three-year period commencing with a $3 million installment by May 1998. The letter was written and delivered without the knowledge of Farace or Marcus. A letter dated April 9, 1998, in which Dow discussed the obligation, was copied to Smith and Winters after its receipt, according to a handwritten note on the letter.

Pursuant to its 1997 agreement to purchase the Dow stock or cause it to be purchased, Trace had only two options. Richards Layton had advised Smith that Trace could not redeem the Dow stock without also paying dividend arrearages on Trace's pari passu convertible preferred stock,*fn31 which were in excess of $2 million.*fn32 Therefore, that option would require Trace to use $5 million in cash. The second option was the one taken by Trace. To circumvent the legal impediments to Trace's redeeming the Dow Shares directly, Smith devised a plan to disguise the redemption as a purchase by Cogan. Thus, Smith, Cogan, Nelson and Winters agreed that Trace would lend $3 million to Cogan, who then used these Trace funds to purchase the Dow Shares. Cogan then pledged the Dow Shares to Trace.

The Board was not notified of, or requested to consider, the loan or the Dow transaction.

Prior to May 1, 1998, the $3 million loan was made to Cogan, and Cogan issued to Trace a promissory note in the amount of $3.722 million, the terms of which were set by Cogan's personal attorney and accountant, Michael Schwartzbard ("Schwartzbard"). Ultimately, Maurice Lefkort, a partner at Wilkie Farr, prepared the Note and the attached stock pledge agreement and stock certificate.

On May 4, 1998, Cogan informed Dow that Trace "today redeemed $3 million of Trace's Series A preferred stock. Trace has honored its commitment to redeem this portion of the Preferred. . . ." At his deposition, Cogan admitted that Trace, through M.S. Cogan, redeemed $3 million of Trace's Series A Preferred stock.

Farace believed that Trace had redeemed the Dow Shares. Cogan, Nelson or Winters told Farace, as President of Foamex,*fn33 that Trace had redeemed the Dow Shares. Farace was not a member of the Board at the time of the redemption. The Trustee does not assert the Farace was liable for the loan, but does claim that Farace was responsible for the October 1997 commitment to Dow, despite Farace's recusal from the issue.

Marcus knew the Dow Shares had been redeemed, and he believed that Trace had redeemed them.*fn34 Marcus believed that Dow's request for a stock repurchase should be accommodated due to the important relationship Dow had with Foamex. As of May 1998, he also believed based upon his own approximation of Trace's assets and obligations that Trace had a surplus.

There is no record in Trace's Corporate Minutes concerning the redemption of the Dow Shares. According to Nelson, "Trace didn't have adequate surplus" to redeem the Dow Shares.

2. Dividends

On July 29, 1993, Richards Layton prepared a twenty-page memorandum advising the Trace Board of the legal standards under Delaware law for determining when a corporation may declare dividends (the "Dividend Memorandum"). According to its Executive Summary:

As a general matter, directors of a Delaware corporation may make a dividend only out of the corporation's "surplus." A corporation (by resolution of its board of directors) may in certain circumstances transfer amounts previously designated as "capital" to "surplus" to the extent such "capital" including amounts in excess of the aggregate par value of issued shares of capital stock of the corporation and so long as the fair market value of the assets of the corporation remaining after the reduction in capital is sufficient to pay the corporation's debts. A court will defer to the board's decision to transfer such capital and declare and pay a dividend from surplus so long as the board determines that the dividend or the transfer of such capital would not cause the value of the corporation's debts to exceed the value of its assets as determined via techniques or methods that are generally accepted within the financial community. In making this determination, a board of directors is entitled to rely on the books of the corporation and the statements and reports of its officers as well as on opinions by experts whom the board has selected with reasonable care. Furthermore, the board must consider contingent and other liabilities in its analysis as to the ability to declare and pay a dividend or to transfer capital to surplus.
Dividend Memorandum, at 1-2. The memorandum was distributed to all of the members of the Trace Board. Cogan, Nelson, Farace and Marcus were all familiar with the Dividend Memorandum.

Smith, in his role as general counsel, explained the Delaware dividend declaration standards to Nelson.

While Nelson claims to have followed a standard procedure each time Trace considered paying dividends, there is no corroborating evidence of any such process.*fn35 There is no evidence of any calculations, nor that Nelson showed this calculations to other Directors or discussed his methodology with them. There were no practices or procedures in place to ensure that Nelson understood how to calculate whether Trace had sufficient surplus to pay a dividend.

When the directors decided that Trace should pay a dividend, Nelson so informed King, so that she could prepare and circulate a unanimous written consent. Richards Layton had prepared the initial form of the unanimous written consent and each time a dividend was declared, King modified and updated the form with information relevant to each subsequent dividend and sent it to the Board members for their signatures. Once she received back all the signed written consents, she informed Betson or Mamary, and they had Thompson prepare and send the dividend checks.

During the relevant time period, Trace paid dividends aggregating $5,122,989, as follows:

Date Paid Amount Stock

02/95 $350,000 Series A Preferred ("Series A")

05/95 $350,000 Series A

08/95 $175,000 Series A

02/96 $175,000 Series A

05/96 $175,000 Series A

08/96 $175,000 Series A

11/96 $175,000 Series A

12/96 $638,166 Convertible Preferred ("Convertible")

02/97 $175,000 Series A

05/97 $175,000 Series A

07/97 $638,166 Convertible

08/97 $191,100*fn36 Series A

11/97 $176,225*fn37 Series A

12/97 $638,166 Convertible

02/98 $278,000 Series A

06/98 $638,166 Convertible

The Board ratified by unanimous written consent just eight of the above dividends, those being distributed in February 1995, May 1995, August 1995, November 1996, December 1996, May 1997, July 1997 and December 1997.*fn38 There is no evidence that the Board approved or ratified any of the other distributions.

The unanimous written consents approving the payment of dividends recite that Trace has sufficient surplus to pay dividends.

Further, while the Defendants contend that there is no evidence of any distribution in February and May 1996, Nelson testified that the distributions to Dow were regularly given. His testimony was also supported by cancelled checks and correspondence with preferred stockholders. The Defendants' contention that Trace somehow forgot to give contractually required distributions to one of the major suppliers to one of its subsidiaries — and that Dow had no reaction to this failure — is insupportable. Given Nelson's testimony, the Defendants would have to present some evidence that the distributions were not in fact given in those two periods; they have failed to present any such evidence.

In late 1998, Nelson determined, applying the test in the Dividend Memorandum, that Trace did not have sufficient capital surplus to declare a dividend. After this determination, Smith requested that Willkie Farr review the surplus computation to ensure its accuracy.

The Trustee does not contend that Farace is liable for any dividends paid in 1998.

In May 1999, the Delaware Court of Chancery in a case entitled Barbuto v. Trace Int'l Holdings, Inc., ordered Trace to pay dividend arrangements on its Convertible stock that accrued on June 30, 1995; December 31, 1995; and June 30, 1996. Anthony G. Barbuto, as trustee for Lambert Brussels Financial Corporation, had moved for partial summary judgment against Trace International and its directors seeking the payment of dividends accrued, but not yet paid, on June 30, 1995, December 31, 1995, and June 30, 1996, at the rate of $839.94 per share. Those dividends were never paid. Moreover, a final judgment was never entered in the case.

3. Cogan's Compensation

As discussed in Part II, supra, from 1993 to 1999, Cogan received excess compensation of $6,948,994 from both Trace and its subsidiaries. Also as discussed above, the non-Cogan defendants will not be liable for that entire amount, but only the amount of excess compensation Cogan received from Trace. Based on the findings above, the non-Cogan Defendants may be liable for $4,207,303 in excess compensation:

Date Actual Reasonable Excess Compensation Compensation Compensation
7/21/93- 12/30/93*fn39 $3,941,582 $2,266,145 ...

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