     07-0355-cv
     Henry v. Champlain Enterprises

 1                          UNITED STATES COURT OF APPEALS
 2
 3                              FOR THE SECOND CIRCUIT
 4
 5                                August Term, 2008
 6
 7   (Argued:    October 21, 2008                 Decided: June 19, 2009)
 8
 9                              Docket No. 07-0355-cv
10
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12
13   JOSEPH HENRY and MICHAEL MALINKY,
14
15               Plaintiffs-Appellants,
16
17                     v.
18
19   U.S. TRUST COMPANY OF CALIFORNIA, N.A.,
20
21               Defendant-Appellee,
22
23   CHAMPLAIN ENTERPRISES, INC., doing business as COMMUTAIR, ANTHONY
24   VON ELBE, JOHN ARTHUR SULLIVAN JR., ERNEST JAMES DROLLETTE,
25   ANDREW PRICE, WILLIAM L. OWENS, CHAMPLAIN AIR, INC.,
26             Defendants.
27
28   - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
29
30   B e f o r e:    FEINBERG, WINTER, and POOLER, Circuit Judges.
31
32         Appeal from a judgment of the United States District Court
33   for the Northern District of New York (David N. Hurd, Judge),

34   dismissing appellants’ complaint of alleged violations of the

35   Employee Retirement Income Security Act.         The court held that

36   appellants suffered no damages even if violations did occur.           We

37   hold that when an Employee Stock Ownership Plan incurs debt to

38   finance a purchase of shares of stock and then later sells the

39   shares in exchange for cancellation of some of that debt, the

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1    debt cancellation in the second transaction should not be

2    construed as having reduced the purchase price paid in the first

3    transaction.   We therefore vacate and remand to the district

4    court.

 5                                  TERENCE J. DEVINE (Stanley H.
 6                                  Shayne, Shayne Nichols, LLC,
 7                                  Columbus, Ohio; Gary D. Greenwald,
 8                                  Keller Rohrback, PLC, Phoenix,
 9                                  Arizona, on the brief), DeGraff,
10                                  Foy, Kunz & Devine, LLP, Albany,
11                                  New York, for Plaintiffs-
12                                  Appellants.
13
14                                  EDWARD A. SCALLET (Lars C. Golumbic
15                                  and Dipal A. Shah, Groom Law Group
16                                  Chartered, Washington, D.C.; Robert
17                                  N. Eccles, Jonathan D. Hacker, and
18                                  Schan S. Duff, O’Melveny & Myers,
19                                  LLP, Washington, D.C., on the
20                                  brief), Groom Law Group Chartered,
21                                  Washington, D.C., for Defendant-
22                                  Appellee.
23
24   WINTER, Circuit Judge:

25        Joseph Henry and Michael Malinky appeal from Judge Hurd’s

26   dismissal of their complaint after a remand from this court,

27   Henry v. Champlain Enterprises, Inc., 445 F.3d 610 (2d Cir. 2006)

28   (“Henry III”). The complaint alleged violations of the Employee

29   Retirement Income Security Act (“ERISA”).   After the remand, the

30   district court held that appellants suffered no damages even if

31   ERISA violations occurred.   Henry v. Champlain Enters., Inc., 468

32   F. Supp. 2d 368, 373 (N.D.N.Y. 2007) (mem.) (“Henry IV”).   The

33   principal issue is whether the district court properly concluded

34   that an award of damages to appellants would constitute a


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1    windfall.   For the reasons set forth below, we disagree and

2    vacate the judgment.

3                                 BACKGROUND

4         We assume familiarity with the facts and procedural

5    history as set forth in our prior decision, see Henry III, 445

6    F.3d at 613-17, and recite only those relevant to the present

7    issues.

8         CommutAir is a corporation that provides regional commuter
9    airline services.   Appellants are participants in CommutAir’s

10   Employee Stock Ownership Plan (“ESOP”).   In 1994, the ESOP

11   purchased 540,000 shares of CommutAir convertible preferred

12   stock from CommutAir’s three owners –- Anthony von Elbe, John

13   Arthur Sullivan, Jr., and Ernest James Drollette (“the

14   sellers”) –- at a total price of $60 million.   The ESOP

15   financed this purchase by paying $9 million in cash, for which

16   the ESOP issued a promissory note to CommutAir, and by issuing

17   a total of $51 million in promissory notes to the three

18   sellers.

19        Appellee U.S. Trust was the ESOP’s trustee during this

20   transaction.

21        In 1999, CommutAir settled a dispute with the Internal

22   Revenue Service over CommutAir’s deductions for its

23   contributions to the ESOP.   The settlement was based on an

24   assumption that the fair market value of the purchased stock,

25   at the time of purchase, was only $51 million rather than $60

                                     3
1    million.      This settlement triggered Section 5.7 of the 1994

2    stock purchase agreement, which provided, inter alia, that in

3    the event of a “final determination” that the shares’ purchase

4    price exceeded the purchased shares’ fair market value as of

5    the date of the sale, the sellers would make up the difference

6    (plus interest) either in cash or in additional shares “valued

7    in accordance with their actual fair market value” at the time

8    of the 1994 purchase and sale.1               Accordingly, in 2004 the

9    sellers gave the ESOP an additional 191,000 shares.

10        Meanwhile, in November 2001, appellants had brought the

11   present action against U.S. Trust and others, alleging in

12   pertinent part that the 1994 stock purchase had violated

13   Section 406 of ERISA, which generally prohibits an employee

14   plan’s fiduciaries from causing the plan to engage in

15   transactions with a “party in interest,” including purchases of

16   the employer’s securities.            29 U.S.C. § 1106(a).         Section 408

17   of ERISA provides an exception to this general prohibition,



          1
              Section 5.7 of the agreement reads as follows:

                          In the event of a final determination by the Internal
                   Revenue Service, the Department of Labor, a court of
                   competent jurisdiction or otherwise that the fair market
                   value of the shares of ESOP [c]onvertible [p]referred
                   [s]tock as of the [c]losing is less than the [p]urchase
                   [p]rice, then the [s]ellers, jointly and severally, shall
                   pay to the [t]rust an amount equal to the difference between
                   the [p]urchase [p]rice and said fair market value for the
                   such shares of ESOP [c]onvertible [p]referred [s]tock, plus
                   interest at a reasonable rate [from] the date of [c]losing
                   to the date of such payment. Such payment may be made
                   either in cash, or in the form of shares, valued in
                   accordance with their actual fair market value as of the
                   [c]losing.


                                               4
1    allowing a plan in certain circumstances to purchase the

2    employer’s stock if the plan receives “adequate consideration,”

3    which in this case would have been the “fair market value of

4    the asset as determined in good faith by the trustee.”    29

5    U.S.C. §§ 1002(18), 1108(e)(1).

6         After a bench trial, the district court held that Section

7    406 applied to the 1994 agreement but the Section 408 exception

8    did not, because U.S. Trust had failed to demonstrate that it
9    had undertaken an “adequate, good-faith” investigation of the

10   stock’s value.   Henry v. Champlain Enters., Inc., 334 F. Supp.

11   2d 252, 268-70, 274 (N.D.N.Y. 2004) (“Henry II”). Finding that

12   the fair market value of the stock that the ESOP received had

13   not been $60 million, but only $52.25 million, the district

14   court awarded appellants $7.75 million in damages against U.S.

15   Trust.   Id. at 274-75.   A subsequent amendment to the judgment

16   added awards of prejudgment interest and of attorneys fees and

17   expenses.   Henry IV, 468 F. Supp. 2d at 370-71.

18        U.S. Trust appealed.    In April 2006, we vacated the

19   district court’s judgment and award of damages and remanded for

20   the district court to:    (i) identify the specific errors, if

21   any, that occurred in the $60 million valuation of the

22   CommutAir stock; (ii) determine whether a prudent fiduciary

23   would have detected those errors under the circumstances

24   prevailing at the time of the 1994 transaction; (iii)

25   articulate reasons for its specific award of prejudgment

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1    interest; and (iv) if the district court did award damages on

2    remand, explain why those damages would not result in a

3    windfall to the ESOP.    Henry III, 445 F.3d at 621, 623-24.   In

4    discussing the windfall issue, we specifically called attention

5    to the 2004 grant of 191,000 extra shares to the ESOP.    Id. at

6    624.

7           In February 2006, while the first appeal was pending, the

8    ESOP sold all of its CommutAir stock to CommutAir in exchange
9    for CommutAir’s cancellation of the outstanding $9 million

10   promissory note and for CommutAir’s owners’ cancellation of the

11   balance on the $51 million in promissory notes.    Although this

12   transaction occurred after the first appeal was argued and

13   before our decision was issued, the parties never informed us

14   of this transaction.

15          The 2006 sale/debt-forgiveness transaction did not purport

16   to be a settlement of any issue relevant to this appeal.    There

17   is an indication in the record that the CommutAir securities

18   may have been worthless in 2006, but nothing in the record

19   explains the reason for the 2006 transaction.    On the record
20   before us, the 2006 transaction was independent of earlier

21   transactions and was desired by the parties to it, which did

22   not include U.S. Trust, in light of their economic

23   circumstances.

24          On remand, the district court dismissed all claims against

25   U.S. Trust on the ground that any award of damages would be a

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1    prohibited windfall to the ESOP.              Henry IV, 468 F. Supp. 2d at

2    372-73.     It concluded that addressing the other issues

3    mentioned in our remand was therefore unnecessary.                    Id. at 373.

4          The present appeal ensued.

5                                        DISCUSSION

6          When this case was first before us, we noted that “[t]he

7    aim of ERISA is ‘to make the plaintiffs whole, but not to give

8    them a windfall.’”         Henry III, 445 F.3d at 624 (quoting Jones
9    v. UNUM Life Ins. Co. of Am., 223 F.3d 130, 139 (2d Cir.

10   2000)). We also noted that in light of the provision of extra

11   shares to the ESOP in 2004, inter alia, the district court

12   should decide on remand whether an award of damages against

13   U.S. Trust would constitute a windfall.                Id. at 623-24.

14         On remand, the district court addressed the windfall

15   issue, but not with reference to the 2004 provision of extra

16   shares.     Instead, it reasoned that because the February 2006

17   sale of the ESOP’s CommutAir shares to CommutAir involved

18   cancellation of approximately $14.5 million of the ESOP’s

19   debt,2 the ESOP ultimately paid only $45.5 million for its

20   CommutAir shares.        Henry IV, 468 F. Supp. 2d at 372.               The

21   district court reached that figure by subtracting the $14.5

22   million in loans forgiven in the 2006 transaction from the $60



            2
              The amount was based on $9 million owed to CommutAir and the approximately $5.5
     million still owed to the owners of CommutAir -- von Elbe, Sullivan, and Drollette.


                                               7
1    million purchase price in the 1994 transaction.3                   Id.    The

2    district court then concluded that because $45.5 million was

3    less than $51 million, which was the lowest estimate of the

4    value that the purchased CommutAir shares had at the time of

5    the 1994 purchase, “any award of damages would constitute a

6    windfall.”      Id.

7          The district court assumed that when a purchaser of stock

8    incurs debt to finance the purchase and then later sells the
9    stock in exchange for cancellation of some of that debt, the

10   debt cancellation in the second transaction should, for

11   purposes of ERISA, be construed as having reduced, post facto,

12   the purchase price in the first transaction, and thus to have

13   reduced any loss for which damages should be awarded.                     We

14   disagree.

15         Neither the district court nor appellee has offered any

16   justification for such an assumption, which we regard as


            3
              The parties disagree over which figures the district court should have used in
     calculating the supposed effect of the 2006 transaction on the 1994 purchase price.
     Appellants argue that the district court should have arrived at a purchase price of
     $54.5 million, rather than $45.5 million. Appellee argues that the district court’s
     calculation was correct. Although the details of these dueling calculations are
     immaterial to the disposition of this appeal, in order to avoid any inference that
     might arise on remand from our silence, we note that we disagree with appellants.
     Appellants tally up the ESOP’s costs as follows: $51 million in promissory notes to
     von Elbe, Sullivan, and Drollette; $9 million in cash to von Elbe, Sullivan, and
     Drollette; and a $9 million promissory note to CommutAir, for a total of $69 million.
     What appellants overlook is that if the $9 million promissory note to CommutAir is
     treated as part of the 1994 transaction, then what the ESOP received was not merely
     540,000 shares of CommutAir convertible preferred stock, but rather those 540,000
     shares plus $9 million in cash from CommutAir. The ESOP did not give CommutAir a $9
     million promissory note in exchange for nothing. It gave that note in exchange for
     cash. Thus, in the corrected version of appellants’ calculation, the ESOP paid $69
     million for $9 million in cash plus 540,000 shares. Netting out the $9 million in
     cash, the price that the ESOP paid for the shares alone was $60 million.




                                               8
1    incorrect.4     If an investor pays $100 for 20 shares of stock

2    and later sells those shares back to the original seller for

3    $25, the result is not that the investor paid only $75 for the

4    shares.     Rather, the result is that the investor lost $75 on

5    that investment.

6          Although the transactions in the present case involved

7    payment chiefly in the form of debt obligations and debt

8    forgiveness, rather than cash, the fundamental logic remains
9    the same.     If the hypothetical investor above paid for the 20

10   shares with $100 of IOU’s and later resold the shares to the

11   original seller for a cancellation of $25 of IOU’s, no one

12   would deem the resale to have altered the original price so

13   that no loss was incurred.           So too, when the ESOP purchased

14   CommutAir shares in 1994 for $60 million, financed by incurring

15   debt, and then in 2006 sold those shares (plus additional

16   shares received in 2004) in exchange for forgiveness of $14.5

17   million in debt, the result was not a decrease in the price

18   paid in 1994, but rather the realization of a substantial loss


            4
              Appellee also suggests that the $9 million promissory note to CommutAir should
     not be included in any calculation of the ESOP’s losses because, as a result of the
     2006 sale that involved canceling that debt, the ESOP never expended any earnings to
     repay that loan. Apart from one district court case that merely notes that an
     employer’s ESOP contributions are compensation, not a gratuity, Reich v. Valley Nat’l
     Bank of Arizona, 837 F. Supp. 1259, 1287 (S.D.N.Y. 1993), appellee offers no legal
     authority for its contention that only repayments of debt, and not the assumption of
     indebtedness itself, constitute a loss. Appellee nevertheless contends that the
     proper “economic analysis” of these transactions requires such an approach. This
     contention overlooks the obvious fact that the assumption of indebtedness has
     immediate legal and economic consequences even before the borrower begins to repay the
     debt. For example, the borrower’s plans for the future are now constrained by the
     obligation to commit future income streams to repaying the loan, and the borrower’s
     ability to obtain future loans at a low rate decreases, because the borrower is now a
     greater credit risk.

                                              9
1    on that investment.

2         We, therefore, overturn the conclusion that, on the basis

3    of the 2006 transaction, the ESOP paid only $45.5 million for

4    the CommutAir shares that it acquired.   The 2006 transaction

5    had no effect on the 1994 transaction’s purchase price, which,

6    on the record before us, was $60 million.    See supra Note 2.

7         The issue posed, inter alia, in our Henry III remand,

8    whether an award of damages against U.S. Trust would result in
9    an impermissible windfall, still remains impossible for us to

10   determine.   Whether the ESOP ultimately was overcharged depends

11   not only on the purchased shares’ price, but also on their

12   value.   How much the total number of shares that the ESOP

13   acquired in 1994 and 2004 was worth at the time of the 1994

14   transaction is a question of fact that the record before us

15   does not answer.   We therefore remand again for the district

16   court to consider this issue, if the district court determines

17   that appellants are entitled to recover damages from U.S.

18   Trust.

19        As noted, supra, the district court concluded that the

20   2006 transaction mooted the issue of the appropriateness of

21   awarding costs against appellants and the other issues that we

22   earlier directed it to consider on remand.    Henry IV, 468 F.

23   Supp. 2d at 373.   Our decision of course restores the need to

24   resolve these issues.

25        Appellants raise an additional argument that the ESOP’s

                                    10
1    interest payments were excessive because its loan amortization

2    schedule was based on a total share purchase price of $60

3    million rather than on a lesser amount.   As we have just noted,

4    what is at issue in this case is not whether the ESOP paid less

5    than $60 million for the CommutAir shares that it received in

6    1994 and 2004, but rather how much those acquired shares were

7    worth at the time of the 1994 transaction. If those shares were

8    worth less than $60 million, and if damages are awarded against
9    U.S. Trust, then the interest overpayment argument may perhaps

10   be relevant to the district court’s damages calculation.    It is

11   not, however, an issue for us to address in this appeal.

12                             CONCLUSION

13        For the foregoing reasons the judgment of the district

14   court is vacated, and we remand to the district court for

15   further proceedings consistent with this opinion and our

16   opinion in Henry III.

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