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Hugler v. First Bankers Trust Services, Inc.

United States District Court, S.D. New York

March 29, 2017

EDWARD HUGLER, Acting Secretary of Labor, United States Department of Labor, Plaintiff,


          Vincent L. Briccetti, United States District Judge.

         Plaintiff Edward Hugler, [1] Acting Secretary of the United States Department of Labor (the “Secretary”), brings this action against defendants First Bankers Trust Services, Inc. (“First Bankers”), and the Employee Stock Ownership Plan of the Rembar Company, Inc. (the “ESOP”), [2] asserting First Bankers breached fiduciary duties owed under the Employee Retirement Income Security Act of 1974 (“ERISA”), 29 U.S.C. § 1001 et seq., and also improperly caused the ESOP to engage in a prohibited transaction under ERISA.

         Before the Court are First Bankers's motion for summary judgment (Doc. #118) and the Secretary's cross-motion for partial summary judgment (Doc. #134).

         For the reasons set forth below, both motions are DENIED.

         The Court has subject matter jurisdiction pursuant to 28 U.S.C. § 1331.


         I. Factual Background

         The parties have submitted briefs, statements of material facts, and declarations with supporting exhibits, which reflect the following factual background.

         A. The Parties

         In 2005, The Rembar Company Inc. (“Rembar”) was a closely-held corporation located in Dobbs Ferry, New York. Rembar manufactured and distributed precision parts and components made from refractory metals, and distributed refractory metals in raw form to lower-volume producers.

         First Bankers is a trust company based in Quincy, Illinois, that acts as trustee and custodian for employee benefit and personal trust accounts. In April 2005, Rembar retained First Bankers to serve as trustee for the Rembar ESOP in connection with a transaction in which the ESOP would purchase 100% of Rembar's stock from selling shareholders Frank Firor, Virginia Keilty, and Rosemary Brockett.

         B. Rembar Evaluates the Feasibility of Establishing an ESOP

         Prior to the 2005 ESOP transaction, Firor was Rembar's chief executive officer, chairman of the board of directors, president, and majority stockholder. Firor owned 81.88% of Rembar's then outstanding shares, Keilty owned 11.77%, and Brockett owned 6.35%.

         In January 2005 after Firor became interested in selling his Rembar shares, Rembar engaged Corporate Solutions Group (“CSG”), an investment bank, to evaluate the feasibility of establishing an ESOP[3] to purchase Rembar stock from its owners. CSG informally estimated that the value of 100% of Rembar's common stock was approximately $15, 719, 000. This figure included a 10% control premium, which “represent[ed] a premium a strategic buyer would pay to acquire a controlling stake in [Rembar].” (Sullivan Decl. Ex. G, DOL0008724, DOL0008726).

         At CSG's suggestion, Rembar established an ESOP formation committee to retain a valuation company to prepare a preliminary valuation. Firor participated in the formation committee's activities.

         On February 8, 2005, the formation committee retained Empire Valuation Consultants, LLC (“Empire”) to prepare a preliminary valuation of the fair market value of Rembar's stock. In connection with the preliminary valuation work Empire performed, it reviewed a confidential information memorandum prepared by CSG that contained historical and financial data concerning Rembar.

         Empire and CSG engaged in discussions regarding the value of Rembar's stock before Empire issued its preliminary valuation. Terence Griswold, a managing director at Empire, testified that his firm initially proposed a valuation “in the high 13 millions, and [CSG] said 20 million.” (Sullivan Decl. Ex. I, at 93:2-16). CSG urged Empire to increase its preliminary valuation conclusion, and specifically sought to persuade Empire to adjust valuation factors such as the discount rate. Empire and CSG ultimately agreed to a valuation of $15.5 million after Empire communicated to CSG, “We're not going any higher.” (Id. Ex. I, at 96:18-19).

         Empire subsequently issued a preliminary valuation on March 4, 2005, to the Rembar formation committee c/o Walter Pastor (Pastor was a Rembar officer named to head the formation committee). The preliminary valuation was also shared with Firor. Empire's preliminary valuation concluded that as of February 15, 2005, for potential ESOP purposes, the fair market value of 100% of Rembar's common stock was $15.5 million, on a controlling interest basis. This valuation conclusion included the application of a 25% control premium and used a weighted average cost of capital discount rate that was calculated based on a capital structure of 50% debt and 50% equity.

         C. Engagement of First Bankers as ESOP Trustee

         On April 13, 2005, following the issuance of the preliminary valuation and at CSG's suggestion, Firor signed an engagement letter on behalf of Rembar appointing First Bankers to act as the ESOP's independent trustee in connection with the transaction.

         Paragraph 9(a) of the FBTS engagement letter states:

As Trustee, First Bankers shall be entitled . . . to: (a) retain the Trustee's own independent financial advisor of its choosing to assist in the evaluation of the proposed transactions, and to perform the annual valuation and any other required valuations, which advisor is acceptable to the Company; provided however, that the Company shall not unreasonably withhold such acceptance.

(Sullivan Decl. Ex. B, at DOL0019924). Paragraph 11 then provides:

         First Bankers's continued engagement as Trustee is contingent upon the following:

(a) First Bankers's engagement of Empire Valuation Consultants to serve as its independent financial advisor;
(b) First Bankers's approval of valuation report(s) and/or fairness opinion(s) furnished by such independent financial advisor; and
(c) First Bankers's approval of the Trust Agreement and associated documents.

(Id. at DOL009925).

         After the ESOP engaged First Bankers, CSG instructed Empire to send First Bankers an engagement letter. Empire complied and sent First Bankers an engagement letter dated April 5, 2005, which was countersigned by First Bankers and Rembar as of May 25, 2005. The letter specified that Empire was engaged to act as financial advisor to First Bankers in its capacity as trustee to the ESOP. It also stated that Empire would “express its updated opinion as to the fair market value of Rembar's common stock on, or before a date where [sic] Empire will present its conclusions to the Trustee” and “render a fairness opinion as of the Transaction Date with respect to the acquisition of the common stock by the ESOP.” (Schnapp Decl. Ex. 3, at 1). The engagement letter further stated that Empire “will represent only the interests of the ESOP participants and beneficiaries.” (Id.). Empire's initial engagement letter with the Rembar ESOP formation committee had stated it “will represent only the interests of the ESOP participants and beneficiaries, acting through committee and the ESOP trustee when selected.” (Id. Ex. 4, at 1-2).

         First Bankers also retained Brian Snarr, an attorney of the law firm Morrison Cohen LLP, as its legal counsel in connection with the 2005 ESOP transaction.

         As part of its role as trustee, First Bankers formed an employee benefits committee (the “EB committee”) to represent the ESOP's interests and vote on whether to approve the 2005 transaction. Such approval required the unanimous vote of the EB committee members. Among the eight First Bankers employees who served on the EB committee were certified public accountants, holders of masters of business administration degrees, and licensed attorneys. Specifically, the EB committee members included: First Bankers's president, Brian Ippensen; First Bankers's administrative trust officer, Kimberly Serbin; and First Bankers's business development officer, Merri Ash.

         Prior to its appointment as trustee of the Rembar ESOP, the EB committee conducted a pre-acceptance review process to determine the feasibility of the proposed transaction. This review process involved an examination of Rembar and its business (including its performance and financial history), and a review of the proposed transaction structure.

         D. The Limitation Agreement

         One of the agreements entered into as part of the Rembar ESOP transaction was a limitation agreement dated as of June 17, 2005, among Rembar, First Bankers as the ESOP's trustee, and the selling shareholders. The recitals of the limitation agreement provide, inter alia:

[T]he price the Trust proposes to pay for the Common Stock is based in part on a valuation of the Common Stock that contemplates certain limitations on the base and incentive compensation paid to certain employees of the Company in the future, as well as other operational limitations, covenants and obligations of the parties hereto as set forth in this Agreement; and . . . the Trust will not, however, purchase the Common Stock unless the Company covenants to take certain steps provided herein to assure that the value of the Common Stock will not be diminished following such purchase.

(Schnapp Decl. Ex. 15, at DOL0016293).

         Section 3.2(d) of the limitation agreement contains a covenant of First Bankers as trustee, which provides:

Board of Directors. For so long as the Seller Subordinated Note[4] in favor of Frank Firor is outstanding, the Trustee, acting on behalf of the Trust, shall vote all of the shares of Common Stock held by the Trust to cause the Board of Directors to be at all times comprised of a majority of directors designated by Frank Firor.

(Schnapp Decl. Ex. D, at 6).

         Other key provisions of the limitation agreement include Section 3.1(a), which limits Firor's annual compensation from Rembar for the following five fiscal years to $75, 000 per year, and Section 3.1(c), which requires Rembar to distribute the company's annual net earnings as a shareholder dividend, unless the board of directors exercises its discretion to retain up to $100, 000 of its net earnings each year.

         E. First Bankers's Diligence, Negotiations, and Approval of the Transaction

         On April 12, 2005, First Bankers's counsel, Snarr, sent a request for due diligence materials to Rembar's counsel, Stanley Bulua, asking for numerous documents related to Rembar's corporate formation, business matters, risk factors, financials, and tax information, among other things. (Schnapp Decl. Ex. 6). Snarr also prepared a due diligence memorandum, a draft of which was circulated to Bulua on May 17, 2005, identifying various issues relating to the proposed ESOP transaction, including issues with Rembar's financial statements, and documentation that Rembar had not yet provided. Before it approved the transaction, First Bankers also received an “ESOP Transaction Memorandum” prepared by Bulua, along with a due diligence report prepared by Snarr. First Bankers performed its own due diligence by, inter alia, making an on-site visit to Rembar on April 28, 2005, accompanied by representatives from Empire and its legal counsel; reviewing financial information provided by Rembar; and reviewing the memoranda and analyses prepared by its counsel and Empire. Empire also conducted a diligence interview with Rembar representatives by telephone.

         First Bankers claims it reviewed Empire's final valuation in draft form to ensure the completeness of its information, scrutinize and understand the methodologies used, and formulate any questions it may have based on the information it contained. The Secretary disputes whether First Bankers actually engaged in such a review of Empire's report, pointing out that much of Ippensen's testimony that First Bankers relies on discusses how First Bankers generally reviews final valuation reports in draft form and conducts due diligence, as opposed to what kind of review First Bankers actually engaged in here. (See, e.g., Schnapp Decl. Ex. 24, at 98:17-106:5).

         The parties also dispute whether and the extent to which First Bankers and Empire engaged in discussions regarding Empire's valuation ahead of the June 13, 2005, EB committee meeting.

         According to the Secretary, the only steps First Bankers took to determine the fair market value of Rembar were: (i) participate in a meeting with Rembar management prior to the engagement of First Bankers; (ii) conduct an on-site visit at Rembar on April 28, 2005; (iii) receive Empire's final valuation report; and (iv) hold an EB committee meeting on June 13, 2005, in which Empire participated by telephone. The Secretary disputes that First Bankers actually analyzed Rembar's financial information, Empire's valuation reports, or the legal due diligence memoranda.

         First Bankers claims it used the information it obtained from its initial due diligence process to test the reasonableness of Empire's final valuation. But, again, the Secretary points out that the Ippensen testimony upon which First Bankers relies in making this statement discusses what First Bankers generally does, not what it actually did with respect to the Rembar transaction. (See Schnapp Decl. Ex. 24, at 103:20-104:20). Serbin, on the other hand, affirmatively testified that First Bankers went through Empire's valuation report page-by-page to discuss each section it contained. (Schnapp Decl., Ex. 25, at 116:21-117:16).

         On June 13, 2005, the EB committee held a meeting to consider whether to approve the Rembar ESOP transaction.[5] Snarr explained the structure of the proposed transaction and Joe Eckl of Empire discussed Empire's final valuation. Notes from the meeting indicate the EB committee members asked questions during Snarr and Eckl's presentations, and the issues discussed include: Rembar's capital structure and tax status, the structure of the ESOP, the structure of the transaction, and the financing for the transaction. Eckl's presentation concluded by valuing Rembar at $16 million. Following this discussion, the EB committee voted unanimously to approve the Rembar ESOP transaction.

         F. Empire's Final Valuation

         Consistent with Eckl's presentation at the EB committee meeting, Empire's final valuation report dated June 16, 2005, concludes:

[I]t is our opinion that the fair market value of 100% of the common stock of the Rembar Company, Inc. is reasonably stated at $16, 000, 000 as of June 16, 2005 for ESOP transaction purposes. It is our further opinion that a purchase by the ESOP is not more than adequate consideration as defined in Section 3(18)(B) of ERISA and the proposed regulations thereunder.

(Sullivan Decl. Ex. L, at 53).

         In reaching its valuation conclusion, Empire analyzed and relied on Rembar's reviewed financial statements for the five years ended May 31, 2000 through 2004, internally prepared results for the eleven months ended April 30, 2005, and financial projections provided by Rembar's management.

         G. The Transaction

         On June 17, 2005, the ESOP purchased 100% of the 100, 000 issued and outstanding shares of Rembar from the selling shareholders for $15.5 million (representing $155 per share). In order to finance the stock purchase, the ESOP borrowed $15.5 million from Rembar, to be paid back over a 26-year term at an annual interest rate of 4.83%. The ESOP loan was secured by the shares purchased from the selling shareholders. Rembar, in turn, financed the ESOP loan with $4 million cash on hand, $5 million bank term loans, and a $6 million one-day loan. Rembar also borrowed $6.5 million from the selling shareholders in exchange for subordinated notes, which Rembar then used to pay back the $6 million one-day loan.

         H. Subsequent Events

         Following the consummation of the 2005 ESOP transaction, Rembar made payment on its debt obligations until 2009, when it became unable to service its debts as they became due. On July 30, 2009, as part of a restructuring, the ESOP surrendered the unallocated Rembar shares to Rembar, and Rembar purchased the allocated shares held by the ESOP for $15, 500 (representing $1.0075 per share), cancelled the ESOP loan, and terminated the ESOP. (Schnapp Decl. Ex. 16; Sullivan Opp'n Decl. Ex. EE). The selling shareholders also cancelled the outstanding debt Rembar owed them pursuant to the subordinated notes. (Schnapp Decl. Ex. 18, at 5).

         II. Procedural History

         On November 28, 2012, the Secretary filed its initial complaint against Firor, First Bankers, and the ESOP. (Doc. #1). Firor moved to dismiss pursuant to Rule 12(b)(6), and the Secretary filed an amended complaint on May 3, 2013. (Doc. #15). The amended complaint alleges that in connection with the 2005 ESOP transaction, (i) First Bankers and Firor breached their fiduciary duties to the ESOP in violation of ERISA § 404(a)(1)(A), (B) & (D), 29 U.S.C. § 1104(a)(1)(A) & (B); (ii) First Bankers caused the ESOP to engage in a prohibited transaction in violation of ERISA § 406(a)(1)(A) & (D), 29 U.S.C. § 1106(a)(1)(A) & (D); and (iii) Firor was subject to equitable relief, including disgorgement.

         On June 17, 2013, Firor again moved to dismiss (Doc. #21); the Court denied that motion on January 13, 2014 (Doc. #28).

         Following a lengthy and contentious discovery period, the parties participated in the Court-annexed Mediation Program, which resulted in a settlement agreement between the Secretary and Firor. On May 3, 2016, the Court entered a Consent Partial Judgment and Order pursuant to which, inter alia, (i) Firor neither admitted nor denied the allegations in the amended complaint; (ii) Firor is permanently enjoined and restrained from engaging in any further action in violation of Title I of ERISA and from acting as a fiduciary or service provider to any employee benefit plan subject to Title I of ERISA; (iii) Firor agreed to pay $1, 090, 090 to the Rembar ESOP for distribution to the individual ESOP participants and beneficiaries; and (iv) the Secretary agreed that such payment shall operate as a dollar-for-dollar offset of any amount owed by First Bankers to the ESOP resulting from a settlement or judgment in the present litigation. (Doc. #108).

         On August 12, 2016, First Bankers moved for summary judgment (Doc. #118), and on November 21, 2016, the Secretary cross-moved for partial summary judgment (Doc. #134).


         I. Summary Judgment Standard

         The Court must grant a motion for summary judgment if the pleadings, discovery materials before the Court, and any affidavits show there is no genuine issue as to any material fact and it is clear the moving party is entitled to judgment as a matter of ...

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