Last year, a complex ESOP case involving a labyrinth of novel transactions resulted in a district court finding that the defendants flouted certain ERISA fiduciary requirements (see BVWire, Oct. 17, 2012). Recently, the court issued a finding on damages and remedies dominated by business valuation issues.
The story begins in 2002, when Alliance Holdings, one of the defendants, bought Trachte Building Systems Inc. for $24 million. The idea was to merge the Trachte ESOP into the Alliance ESOP and then flip the company for a profit.
Flipped out: By 2007, Alliance could not find a suitable buyer, so it devised a complex leveraged buyout. The Alliance ESOP spun off the Trachte employees' accounts into a new Trachte ESOP, and the Alliance shares in those accounts were exchanged for Trachte shares held by an Alliance entity. Using the shares as loan collateral, Trachte and the Trachte ESOP redeemed or purchased all of Trachte's outstanding equity from the defendants. In the end, the Trachte ESOP paid more than $38 million for Trachte's common equity and Trachte took on $36 million in debt. Trachte’s stock collapsed, and the company folded under the debt load—bringing the account balances of plan participants down with it.
Trachte employees sued, alleging that Alliance, its management, the two ESOPs, and trustees breached their fiduciary duties. As the court put it in its liability decision, the transaction was rife with conflicts of interest and acts of negligence—and the Trachte valuation was the outcome of “questionable judgments” and “lack of independent scrutiny.” The court noted that no independent person was looking out for the employees' interests in the ESOPs.
Mix and match: To assess damages and remedies, the court had to compute how much the Trachte ESOP overpaid, which, in turn, meant determining the company’s fair market value (FMV) at the time of the 2007 transaction. The parties’ experts, it said, offered “wildly, at times absurdly, different approaches. Ultimately, it arrived at a “reasonable estimate” by correcting and combining two flawed, but contemporaneous, valuations. One was a fairness opinion that a national valuation firm had done in connection with the transaction. Among its problems was that the firm, on orders of the defendants, relied on a company “take-down” letter stating the FMV of Trachte’s common equity was worth $44.1 million in late August 2007. Also, it applied a $1.9 million tax shield relating to the Trachte plan’s ability to take principal and interest deductions for the 2002 purchase of Trachte. Ultimately, it concluded the FMV of the common equity was between $26.2 million to $40.1 million.
The court first subtracted $1.9 million for the tax shield, which it said was a benefit to the Trachte ESOP but was a feature “unique to an individual buyer” and as such not part of the FMV calculation. Moreover, it applied a 10% discount for lack of marketability (DLOM)—the fairness opinion included none—saying that expert testimony suggested a range from 1% to 10%. It decided the highest figure was appropriate because a private auction did not generate a price that was acceptable to the seller.
In the final analysis, the company’s common equity value was $30 million, which meant the Trachte ESOP had overpaid by over $8.32 million, the court concluded.
Find an extended discussion of Chesemore v. Alliance Holdings, Inc., 2013 U.S. Dist. LEXIS 80969 (June 4, 2013), in the September issue of Business Valuation Update; the opinion is available at BVLaw.