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Chesemore v. Fenkell

United States Court of Appeals, Seventh Circuit

July 21, 2016

Carol Chesemore, et al., on behalf of themselves, individually, and on behalf of all others similarly situated, Plaintiffs-Appellees/ Cross-Appellants,
David B. Fenkell, Defendant-Appellant/ Cross-Appellee,
Alliance Holdings, Inc., et al., Defendants-Appellees.

          Argued May 18, 2015

         Appeals from the United States District Court for the Western District of Wisconsin. No. 09-cv-413-wmc William M. Conley, Chief Judge.

          Before Kanne and Sykes, Circuit Judges, and Ellis, District Judge. [*]

          Sykes, Circuit Judge.

         Trachte Building Systems, Inc., a Wisconsin manufacturer, established an employee stock ownership plan ("ESOP") in the mid-1980s when ESOPs were a popular employee-benefits instrument. In the late 1990s, David Fenkell and Alliance Holdings, Inc., a company he founded and controlled, developed a niche specialty in buying and selling ESOP-owned, closely held companies with limited marketability. In the typical transaction, Fenkell would merge the ESOP of an acquired company into Alliance's own ESOP, hold the company for a few years with its management in place, and then spin it off at a profit (assuming everything went as planned).

         In accordance with this business model, Alliance acquired Trachte in 2002 for $24 million and folded its ESOP into Alliance's ESOP. Fenkell projected that the company would fetch around $50 million in five years. When the time came to sell, however, Trachte's profits were flat, its growth had stalled, and no independent buyer would pay anywhere near that price. So Fenkell offloaded the company to its employees in a complicated leveraged buyout. Greatly simplified, the deal involved three steps. First, Fenkell directed the creation of a new Trachte ESOP managed by trustees beholden to him. Next, the accounts in the Alliance ESOP were spun off to the new Trachte ESOP. Finally, the new Trachte ESOP used the employees' accounts as collateral to incur debt to purchase Trachte's equity back from Alliance. Multiple interlocking transactions to that effect closed on the same day in August 2007. When all was said and done, Trachte and the new Trachte ESOP had paid $45 million for 100% of Trachte's stock and incurred $36 million in debt.

         The purchase price was inflated and the debt load was unsustainable. By the end of 2008, Trachte's stock was worthless. The losers in this deal-the employee participants in the new Trachte ESOP-sued Alliance, Fenkell, his handpicked trustees, and several other entities alleging breach of fiduciary duty in violation of ERISA. The district court held a bench trial and issued a comprehensive opinion finding the defendants liable. Chesemore v. Alliance Holdings, Inc. (Chesemore I), 886 F.Supp.2d 1007 (W.D. Wis. 2012). After an additional hearing, the judge crafted a careful remedial order making the class and a subclass whole. Chesemore v. Alliance Holdings, Inc. (Chesemore II), 948 F.Supp.2d 928 (W.D. Wis. 2013). The judge later awarded attorney's fees and approved settlements among some of the parties.

         Fenkell appealed. He concedes liability but raises many objections to the remedial order, the award of attorney's fees, and the settlements by his codefendants. The only substantial issue is a challenge to the judge's order requiring him to indemnify his cofiduciaries. We held more than 30 years ago that ERISA allows this. Free v. Briody, 732 F.2d 1331, 1337–38 (7th Cir. 1984). Since then a circuit split has arisen on this subject, but we're not persuaded that Free should be overruled. None of Fenkell's other arguments has merit.

         The plaintiffs filed a cross-appeal seeking a larger award of attorney's fees and contesting the judge's refusal to award costs against Fenkell. We reject these challenges. Finally, while we've had this case under advisement, the district court found Fenkell in contempt for failing to comply with the remedial order. Fenkell appealed that order as well, but his arguments are frivolous. Accordingly, we affirm in all respects.

         I. Background

         Trachte Building Systems designs and manufactures steel self-storage systems in Sun Prairie, Wisconsin. In the 1980s Stephen Pagelow, the son-in-law of Trachte's founder, acquired a controlling interest in the company and took over as president and chairman of the board. In 1987 Pagelow directed the establishment of an employee stock ownership plan, or ESOP, as a benefit to employees, selling some of his shares to the plan.[1] Throughout the 1990s Trachte experienced significant growth in both sales and operations.

         David Fenkell established Alliance in 1994 and at all relevant times was its president, CEO, and sole director. Fenkell also was president, CEO, and sole director of two Alliance subsidiaries, A.H.I., Inc., and AH Transition Corporation. (We'll refer to these companies collectively as "Alliance" unless the context requires otherwise.) Alliance was in the business of buying and selling ESOP-owned, closely held companies that might other wise be difficult to sell. Alliance's business model was to fold the acquired company's ESOP into its own ESOP, leave the existing management in place, and spin off the company to another buyer a few years later, hopefully at a substantial profit. In short, Fenkell and Alliance made money by flipping ESOP-owned, closely held companies with limited marketability.

         By 2002 Pagelow was looking for a way to gradually exit Trachte in anticipation of fully retiring in a few years. Enter Alliance, which that year acquired 80% of Trachte's common stock for $24 million and all of its preferred stock for $2 million. The 2002 transaction-more accurately, a series of interlocking transactions-involved folding the Trachte ESOP into Alliance's own ESOP by transferring the employees' accounts to the Alliance ESOP and exchanging the Trachte stock for Alliance stock. Trachte employees thus became participants in the Alliance ESOP, and the old Trachte ESOP was dissolved. Pagelow retained 20% of Trachte's common stock and a 40% ownership interest in a subsidiary. He also agreed to stay on as chairman for five years. In exchange he received a put option giving him the right to tender his Trachte shares to the company in 2007 at a price keyed to the prior year's appraised value.

         After the 2002 transaction, Pagelow resigned as Trachte's president and was replaced by Jeffrey Seefeldt, a longtime Trachte manager. Pagelow immediately reduced his workweek and gradually began to cut back on his day-to-day management of the company. In the fall of 2005, Pagelow exercised part of his put option early. In mid-2006 he broke his hip, which radically reduced his involvement with the company.

         During this time, Trachte's sales increased steadily but profits remained flat. Despite its stagnant profitability, the on-paper value of Trachte's stock rose dramatically, from $25.4 million in 2003 to $44.9 million in 2006. Pagelow's put option-coming due in 2007-was pegged to the 2006 appraised value, but Alliance lacked the liquidity to satisfy it. Faced with the prospect of having to borrow to satisfy Pagelow's option and with serious doubts about Trachte's future performance, Fenkell decided it was past time to sell.

         At the time of the 2002 transaction, Fenkell had projected that Trachte would sell for as much as $50 million in 2007. Throughout 2006 he looked for a buyer at or near that price, but he came up empty-handed. Failing to find an independent buyer at his desired price, Fenkell devised and implemented a complicated leveraged buyout to off-load the company onto Trachte's employees. The district court's opinion meticulously describes the history and details of this transaction, as well as the lack of any truly independent due diligence on behalf of Trachte's employees. Chesemore I, 886 F.Supp.2d at 1021–40. Because liability is uncontested here, a radically simplified summary will suffice.

         First, on August 22, 2007, Fenkell orchestrated the removal of Trachte's entire board of directors and installed Seefeldt and James Mastrangelo, the chief operating officer, as the sole board members. Id. at 1036. Then, following a plan of Fenkell's devising, Seefeldt and Mastrangelo directed the creation of a new Trachte ESOP, installing themselves and Pamela Klute, the company's vice-president of human resources, as trustees. Id.

         The leveraged buyout itself involved 11 separate steps, each of which occurred sequentially and was conditioned on the completion of all previous and subsequent steps. The district judge grouped these steps into three baskets. First, in steps 1–3, the accounts of the Trachte employees in the Alliance ESOP were spun off to the new Trachte ESOP, and their Alliance shares were exchanged for Trachte shares held by A.H.I. Id. at 1037–38. Next, in Steps 4–7, Trachte used the new Trachte ESOP accounts as collateral for loans to pay off the "phantom" stock plan of Alliance employees and redeem Trachte stock held by Alliance and Pagelow. Id. at 1038. Finally, in Steps 8–11, Trachte and the new Trachte ESOP acquired all Trachte equity held by Alliance, Alliance employees, and Pagelow. Id. at 1038–39.

         This series of interdependent transactions closed on August 29, 2007. By the end of that day, Trachte and the new Trachte ESOP had paid $45 million in consideration for Trachte's total equity and incurred about $36 million in debt. Id. at 1039.

         Trachte did not flourish after the 2007 leveraged buyout. It held its own until May 2008, but at that point projected that it would not meet its loan covenants. By the end of 2008, Trachte's stock was worthless.

         Their equity wiped out, a group of current and former Trachte employees filed this class action alleging breach of fiduciary duty in violation of ERISA. The class includes current and former employees who participated in the old Trachte ESOP, the Alliance ESOP, and the new Trachte ESOP. A subclass comprises those participants in the new Trachte ESOP who would have remained employees of Alliance- and thus participants in the Alliance ESOP-but for the August 2007 transaction. Fenkell and Alliance were the primary targets of the suit. The complaint also named the trustees of the new Trachte ESOP as defendants. Pagelow, the new Trachte ESOP, and the Alliance ESOP were named as nominal defendants.[2]

         After extensive litigation and a bench trial, the judge found the defendants liable. Fenkell and Alliance had insisted that they were not fiduciaries because all they did was spin off the Alliance ESOP to the new Trachte ESOP. The judge was not persuaded. He found:

Fenkell and Alliance (1) arranged the 2007 [t]ransaction so that it would only occur on terms favorable to them and disfavorable to a minority interest [(i.e., the Trachte legacy accounts)] in the Alliance ESOP; (2) ensured no one on the other side of the transaction would look out for those interests after the spinoff; and (3) ensured that those charged with decision-making authority on the other side of the transaction would remain answerable to Alliance and Fenkell should they not go through with it. In short, it was a classic example of "heads I win, tails you lose."

Chesemore I, 886 F.Supp.2d at 1052. The judge continued: "Fenkell and Alliance designed the transaction so that either the accounts of the Trachte participants in the Alliance ESOP would be used as leverage to buy Trachte from Alliance or the accounts would revert to their prior situation with no change." Id. at 1053.

         In other words, if there had been an actual independent fiduciary on the other side, Fenkell and Alliance wouldn't have gotten away with it. They installed trustees who "(1) had a conflict of interest that placed them under substantial duress during the negotiation and assessment of the deal; and (2) lacked the experience and the incentive to assess a deal of this type and complexity." Id. at 1054. Although the trustees formally made the decision to use the new Trachte ESOP accounts as collateral for the buyout, Fenkell and Alliance controlled that decision and orchestrated the entire complex transaction. In exercising that control, the judge concluded, they violated fiduciary duties owed to the plaintiffs.

         The judge also held, however, that the defendants' fiduciary breach was not wholly responsible for Trachte's total collapse; the 2008 financial crisis also played a role, although the inflated purchase price and excess debt placed tremendous pressure on the company and sealed its fate. In the end, and after an extensive additional hearing, the judge crafted an intricate remedial order making the class and the subclass whole. As relevant here, he ordered the trustees to restore $6, 473, 856.82 to the new Trachte ESOP, allocated to the class members' accounts according to their shares as of the date of judgment. Chesemore II, 948 F.Supp.2d at 950. He ordered Fenkell and Alliance to restore $7, 803, 543 to the Alliance ESOP, allocated to the subclass members' ...

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