In appealing the dismissal of her lawsuit with the 4th Circuit Court of Appeals, an ESOP plaintiff frequently invokes the Brundle case in which the same appeals court affirmed a $30 million judgment for the ESOP. The dismissal was a rare victory for ESOP defendants after several major court rulings in favor of ESOP plaintiffs.
No harm done: At issue was the 2016 sale of shares in a construction company to an ESOP. An independent trustee oversaw the transaction and an experienced ESOP appraisal firm prepared the valuation underlying the transaction and subsequent annual valuations. The ESOP paid $198 million for an 80% ownership stake in the company (8 million shares). The transaction was financed with a loan from the company and the selling shareholders received warrants that would enable them to acquire additional voting stock. A 2016 year-end annual appraisal, which came about a month after the ESOP’s formation, valued the shares at $64.8 million.
The plaintiff, a former company employee, sued. The gist of the allegations was that the $64.8 million valuation showed the trustee (and other defendants) caused the plan to overpay for company stock. Last fall, the district court dismissed the case, finding the plaintiff had not shown an “injury in fact.” The plaintiff had no standing “to pursue her claims in this Court.”
The court said the plaintiff “fundamentally misunderstands” the transaction and the subsequent valuation. According to the court, the ESOP had taken on debt to obtain the stock. The expected value of the ESOP’s shares, in the short term, would be zero. However, the $64.8 million year-end valuation meant the shares had already appreciated in value by about 33% in less than a month. Rather than suffering an injury, the ESOP “realized an immediate equitable benefit.” The court analogized the situation to obtaining a mortgage when buying a home and ultimately finding the home is worth more than the mortgage. The buyer would be able to buy the house at a discount and “be left with a tidy profit” if she sold the house after paying off the mortgage, the court postulated.
Premature dismissal: The appeal argues the district court prematurely decided the merits of the plaintiff’s claim when it dismissed the case on jurisdictional grounds. The court’s decision was based on “irrelevant and unsupported factual findings.” The appeal maintains the complaint showed the plaintiff had a “personal stake in the outcome of the controversy” by alleging that the contested transaction negatively affected the plaintiff’s retirement account. At this early stage in the litigation (prediscovery), the issue was whether the plaintiff’s complaint stated facts sufficient to show an injury, not whether the plaintiff’s claims had merit. U.S. Supreme Court and 4th Circuit precedent required the district court to take the plaintiff’s allegations as true, the appeal says. The district court violated precedent.
The appeal frequently refers to the heavily litigated Brundle v. Wilmington Trust case. Brundle presented facts similar to those the plaintiff alleged here, the appeal says. It points to the “same unique warrant structure” and says the ESOP valuation here, performed by the appraisal firm that had done the Brundle appraisal, “contained similar errors as those in Brundle.” For example, the ESOP valuation failed to consider that the warrants could “dilute the ESOP’s share of ownership to just 60% of the Company” and the warrants allowed the sellers to “retain elements of control over the Company.” The district court failed to address, “much less assume the truth of,” the plaintiff’s allegation that the ESOP valuation was inflated for these reasons.
The plaintiff calls the district court’s mortgage analogy flawed. For one, it focused on equity values after the contested transaction when the proper inquiry would have been whether the ESOP paid more than fair market value at the time of the transaction. Further, the mortgage analysis assumes the price the ESOP paid was correct and “entirely sidesteps the proper analysis of whether the ESOP paid too much for [company] stock,” the appeal argues. The plaintiff asks the 4th Circuit to reverse the district court and let the case proceed to discovery so she can prove her claims.
Stay tuned for further developments in this case.
A digest of the district court’s ruling in favor of the defendants in Lee v. Argent Trust Co., 2019 U.S. Dist. LEXIS 132066 (Aug. 7, 2019), and the court’s opinion are available to subscribers of BVLaw. Digests for Brundle v. Wilmington Trust N.A., 241 F.Supp. 3d 610 (E.D. Va. 2017); Brundle v. Wilmington Trust N.A., 258 F. Supp. 3d 647 (E.D. Va. 2017); and Brundle v. Wilmington Trust N.A., 919 F.3d 763 (4th Cir. 2019), and the courts’ opinions also are available at BVLaw.