In a gnarled ESOP case, the 5th Circuit Court of Appeals recently issued an important decision on fiduciary liability and remedies in case of breach. The trial court had found the trustees violated their duties of loyalty and prudence and engaged in a prohibited transaction assisted by a disreputable appraiser. It expressly noted the remedy questions were harder to resolve than the liability questions, and it suggested its valuation-related findings might be “vulnerable” on appeal. It need not have worried.

Overpayment: When the owner of a closely held company wanted to divest himself of the company, he orchestrated a series of transactions to sell 100% of the company’s shares to its employees by way of an employee stock ownership plan. In each transaction, the plan bought stock through an employee stock ownership trust for which the owner-seller and two persons with whom he had a close working relationship served as trustees. The trustees based the share price on valuations an appraiser, who was beholden to the owner-cum-seller-cum-trustee, had performed.

Subsequently, the DOL and two plan participants filed separate lawsuits alleging the trustees overpaid for the stock because the appraiser’s valuations did not reflect the fair market value (FMV) of the stock. The district court, which consolidated the suits, found that neither the appraiser nor the trustees were truly independent and looking out for the interests of the ESOP and that it was not reasonable for the trustees to rely on the appraiser’s valuations.

The court rejected the DOL’s demand to rescind the transactions and instead awarded over $4.5 million in equitable restitution in the amount the ESOP overpaid. Overpayment was a function of the contract price and the stock’s fair market value on each transaction date. To calculate FMV, the court considered the testimony of three noted valuation experts retained by the plaintiffs, the DOL, and the defendants, respectively. The experts were equally credible, the court said. Different experts used different methods, different assumptions, different estimates, and they reached different conclusions. To arrive at a final value determination, they all averaged the results. “This method tempered the outliers that some methods produced,” the court observed with approval. For its part, the district court averaged the experts’ valuations but weighted the results the defendants’ expert achieved at 50% and the much lower valuations the DOL’s expert and the individual plaintiffs’ expert proposed at 25% each. It dismissed the appraiser’s valuations as “not credible.”

‘Thoughtful approach’: The defendants appealed the liability and remedy findings with the 5th Circuit, and the DOL cross-appealed on the remedy. The appeals court largely affirmed. It noted that the parties “fought bitterly” over valuation and remedies issues. On appeal, the defendants and the DOL particularly objected to the district court’s averaging process. (The plaintiffs defended it.) Their arguments had no traction.

Prior decisions “have frequently accepted an average of expert valuations or estimates falling within a range of evidence offered,” the 5th Circuit pointed out. Here, the district court “carefully” set forth its findings and explained their basis in the record. The district court acknowledged its approach would be wrong if one expert were more credible than another, and it reached a reasonable average supported by evidence, the appeals court said. The district court’s “thoughtful approach to a complex question was founded in established valuation methodology,” the appeals court concluded.

Takeaway: In a complex ESOP case in which valuation and remedies issues were paramount, the 5th Circuit upholds the district court’s decision to grant equitable restitution based on the lower court’s computation of how much the ESOP overpaid.

Find an expanded discussion of Perez v. Bruister, 2016 U.S. App. LEXIS 8046 (May 3, 2016) (Bruister II), in July’s Business Valuation Update; the court’s opinion will be available soon at BVLaw. A digest and the opinion of the district court, Perez v. Bruister, 2014 U.S. Dist. LEXIS 148314 (Oct. 16, 2014), are already available at BVLaw.