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Henry v. U.S. Trust Company of California

June 19, 2009



Appeal from a judgment of the United States District Court for the Northern District of New York (David N. Hurd, Judge), dismissing appellants' complaint of alleged violations of the Employee Retirement Income Security Act. The court held that appellants suffered no damages even if violations did occur. We hold that when an Employee Stock Ownership Plan incurs debt to finance a purchase of shares of stock and then later sells the shares in exchange for cancellation of some of that debt, the debt cancellation in the second transaction should not be construed as having reduced the purchase price paid in the first transaction. We therefore vacate and remand to the district court.

The opinion of the court was delivered by: Winter, Circuit Judge

Argued: October 21, 2008

Before: FEINBERG, WINTER, and POOLER, Circuit Judges.

Joseph Henry and Michael Malinky appeal from Judge Hurd's dismissal of their complaint after a remand from this court, Henry v. Champlain Enterprises, Inc., 445 F.3d 610 (2d Cir. 2006) ("Henry III"). The complaint alleged violations of the Employee Retirement Income Security Act ("ERISA"). After the remand, the district court held that appellants suffered no damages even if ERISA violations occurred. Henry v. Champlain Enters., Inc., 468 F. Supp. 2d 368, 373 (N.D.N.Y. 2007) (mem.) ("Henry IV"). The principal issue is whether the district court properly concluded that an award of damages to appellants would constitute a windfall. For the reasons set forth below, we disagree and vacate the judgment.


We assume familiarity with the facts and procedural history as set forth in our prior decision, see Henry III, 445 F.3d at 613-17, and recite only those relevant to the present issues.

CommutAir is a corporation that provides regional commuter airline services. Appellants are participants in CommutAir's Employee Stock Ownership Plan ("ESOP"). In 1994, the ESOP purchased 540,000 shares of CommutAir convertible preferred stock from CommutAir's three owners --- Anthony von Elbe, John Arthur Sullivan, Jr., and Ernest James Drollette ("the sellers") --- at a total price of $60 million. The ESOP financed this purchase by paying $9 million in cash, for which the ESOP issued a promissory note to CommutAir, and by issuing a total of $51 million in promissory notes to the three sellers.

Appellee U.S. Trust was the ESOP's trustee during this transaction.

In 1999, CommutAir settled a dispute with the Internal Revenue Service over CommutAir's deductions for its contributions to the ESOP. The settlement was based on an assumption that the fair market value of the purchased stock, at the time of purchase, was only $51 million rather than $60 million. This settlement triggered Section 5.7 of the 1994 stock purchase agreement, which provided, inter alia, that in the event of a "final determination" that the shares' purchase price exceeded the purchased shares' fair market value as of the date of the sale, the sellers would make up the difference (plus interest) either in cash or in additional shares "valued in accordance with their actual fair market value" at the time of the 1994 purchase and sale.*fn1 Accordingly, in 2004 the sellers gave the ESOP an additional 191,000 shares.

Meanwhile, in November 2001, appellants had brought the present action against U.S. Trust and others, alleging in pertinent part that the 1994 stock purchase had violated Section 406 of ERISA, which generally prohibits an employee plan's fiduciaries from causing the plan to engage in transactions with a "party in interest," including purchases of the employer's securities. 29 U.S.C. § 1106(a). Section 408 of ERISA provides an exception to this general prohibition, allowing a plan in certain circumstances to purchase the employer's stock if the plan receives "adequate consideration," which in this case would have been the "fair market value of the asset as determined in good faith by the trustee." 29 U.S.C. §§ 1002(18), 1108(e)(1).

After a bench trial, the district court held that Section 406 applied to the 1994 agreement but the Section 408 exception did not, because U.S. Trust had failed to demonstrate that it had undertaken an "adequate, good-faith" investigation of the stock's value. Henry v. Champlain Enters., Inc., 334 F. Supp. 2d 252, 268-70, 274 (N.D.N.Y. 2004) ("Henry II"). Finding that the fair market value of the stock that the ESOP received had not been $60 million, but only $52.25 million, the district court awarded appellants $7.75 million in damages against U.S. Trust. Id. at 274-75. A subsequent amendment to the judgment added awards of prejudgment interest and of attorneys fees and expenses. Henry IV, 468 F. Supp. 2d at 370-71.

U.S. Trust appealed. In April 2006, we vacated the district court's judgment and award of damages and remanded for the district court to: (i) identify the specific errors, if any, that occurred in the $60 million valuation of the CommutAir stock; (ii) determine whether a prudent fiduciary would have detected those errors under the circumstances prevailing at the time of the 1994 transaction; (iii) articulate reasons for its specific award of prejudgment interest; and (iv) if the district court did award damages on remand, explain why those damages would not result in a windfall to the ESOP. Henry III, 445 F.3d at 621, 623-24. In discussing the windfall issue, we specifically called attention to the 2004 grant of 191,000 extra shares to the ESOP. Id. at 624.

In February 2006, while the first appeal was pending, the ESOP sold all of its CommutAir stock to CommutAir in exchange for CommutAir's cancellation of the outstanding $9 million promissory note and for CommutAir's owners' cancellation of the balance on the $51 million in promissory notes. Although this transaction occurred after the first appeal was ...

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