Lack of Notes not Proof of Fiduciary Violation

May 1, 2006 ( - The 2nd Circuit US Court of Appeals vacated a district court's judgment that a trustee failed to satisfy its fiduciary obligation to make sure an employee stock ownership plan (ESOP) did not pay more than the fair market value for company stock.

In its decision the appellate court said the district court focused too much on notes that were taken in a meeting discussing the terms of the stock purchase.   The appellate court said the lack of more written documentation was not sufficient evidence that the trustees failed in their fiduciary duties under the Employee Retirement Income Security Act (ERISA).

In addition, the appellate court vacated the district court’s award for damages, saying the lower court did not provide adequate reasoning for the amount of the award.

In 1993 CommutAir decided to develop an ESOP for its employees.   At the time, CommutAir was believed to have an equity value of $200 million, and the company wanted to sell to the new ESOP approximately 30% of the company for $60 million.

During the course of due diligence, the value of CommutAir was restated to be $174 million.   However, the company also received a report from a firm it hired to do a financial appraisal that said the terms of the purchase agreement were fair.   The ESOP purchased 540,000 shares for $111.11 per share for a total of $60 million.

In 1998, the IRS issued a notice to CommutAir, saying the ESOP paid too much for the shares in 1994.  

Several participants sued the company, the ESOP trustee, and others alleging that the trustee’s, U.S. Trust’s, investigation into the terms of the CommutAir ESOP transaction failed to qualify for ERISA’s good-faith exception to the prohibition against transactions by ESOPs with interested parties, thereby rendering the transaction prohibited.

The district court agreed and awarded more than $15.7 million in damages, prejudgment interest, and attorney’s fees to the plaintiffs.   The lower court’s decision was based on the fact that there was only one set of written notes showing the company and its trustee investigated the terms of the purchase.   Though the defendants told of other meeting and phone calls, no written documentation of these inquiries existed.

The appellate court vacated the judgment and award and remanded the case back to the lower court for further consideration.

The opinion in Henry v. Champlain Enterprises, Inc. can be accessed here .