Court Declines to Limit Damages in Neil v. Zell By: Sarah Kimberly, skimberly@kellerrohrback.com, and Erin Riley, eriley@kellerrohrback.com, Keller Rohrback LLP, Seattle, WA, 206-623-1900 The U.S. District Court for the Northern District of Illinois recently denied GreatBanc Trust Co.’s motion for partial summary judgment seeking to limit damages in Neil v. Zell, No. 08-6833 (N.D. Ill.). The court (Judge Pallmeyer) held that “[t]he amount to which [plaintiffs] would have been entitled [had the ESOP been properly managed] has not been established in this case, but neither has it been limited to $2.8 or $15.3 million.” Neil v. Zell, No. 08-6833, ___ F. Supp. 2d ___, 2011 WL 722747, at * 11 (N.D. Ill. Feb. 28, 2011). BackgroundThe Tribune Co.—whose holdings include the Chicago Tribune and the Los Angeles Times—filed for Chapter 11 bankruptcy protection in December 2008, less than a year after the company went private in an $8.3 billion leveraged buyout. The buyout was the result of a complicated transaction led by real estate investor Samuel Zell that used the Tribune Co.’s ESOP to buy back $250 million in shares of Tribune stock. The company was also converted from a C-corporation to an S-corporation, which allowed for certain tax advantages. Just three months before the bankruptcy filing, in September 2008, six plaintiffs filed a class action against Zell, the Tribune Co., GreatBanc (the ESOP trustee), and others alleging that the buyback by the ESOP violated both ERISA’s general fiduciary duty and its prohibited transaction provisions. The Tribune Co. and most of its officials have since been dropped as defendants. Additionally, Judge Pallmeyer earlier ruled that Zell would not be liable for damages because he did not control the company in 2007 when the transactions occurred. SeeNeil v. Zell, 677 F. Supp. 2d 1010, 1021-22 (N.D. Ill. 2009) (limiting potential recovery from Zell and Defendant EGI-TRB to equitable relief). Accordingly, GreatBanc is the only remaining defendant with significant liability. The Tribune Co. initially hired GreatBanc to serve as the trustee of the ESOP to represent employee interests in the leveraged buyout. The transaction at issue in this case is the ESOP’s April 1, 2007 purchase of newly issued unregistered shares of Tribune stock for $28 per share with a promissory note in the principal amount of $250 million to be paid over 30 years using contributions from the Tribune Co. itself. “In addition to being unregistered, the shares were subject to a trading limitation. In approving this purchase, GreatBanc agreed that the shares would be transferable only pursuant to a public offering registered under the Securities Act of 1933, under Rule 144 or 144A of the Securities and Exchange Commission, or some other, unspecified, legally available means of transfer.” Neil v. Zell, No. 08-6833, ___ F. Supp. 2d ___, 2010 WL 4670895, at *1 (N.D. Ill. Nov. 9, 2010) (internal citations omitted). At the time of the April 1, 2007 purchase, “[m]ore than 240 million shares of Tribune stock were available for public trade on the New York Stock Exchange . . . but starting April 25, 2007, Tribune began a tender offer to repurchase up to 126 million publicly traded shares. Following the stock repurchase, Tribune merged with the ESOP and all Tribune shares not held by the ESOP were retired or cancelled, making the ESOP Tribune’s sole shareholder.” Id. (internal citations omitted). The Tribune Co. and GreatBanc also entered into a pledge agreement, which set forth the details of a suspense account that held the ESOP’s shares of Tribune stock until payment on the promissory note was received. “Each year, at the end of the ‘Plan year,’ shares [were to be] released from the pledge equal to the number of outstanding shares still pledged multiplied by the fraction of the outstanding principal and interest that was paid in that year.” Neil, 2011 WL 722747, at *2 (citation omitted). On April 1, 2008, the Tribune Co. made a $15.3 million cash contribution to the ESOP, consisting of $2.8 million in principal and $12.5 million in interest, which the ESOP immediately paid back to the company to release shares. In November 2010, the court granted plaintiffs’ motion for partial summary judgment and ruled that GreatBanc had violated its fiduciary duty by allowing the ESOP to purchase shares that could not readily be traded. SeeNeil v. Zell, No. 08-6833, ___ F. Supp. 2d ___, 2010 WL 4670895 (N.D. Ill. Nov. 9, 2010). The court found that GreatBanc’s purchase of $250 million in unregistered shares from the Tribune Co. rather than buying Tribune stock on the open market in the first stage of the leveraged buyout constituted a prohibited transaction under ERISA. Recently, GreatBanc sought to limit its liability to either the $2.8 million principal payment made in 2008, or, alternatively, the $15.3 million in principal and interest. The Court Rejects GreatBanc’s Damages TheoriesIn denying GreatBanc’s motion for partial summary judgment on the issue of damages, Judge Pallmeyer declined to adopt GreatBanc’s maximum damages argument. Essentially, GreatBanc had argued “that because the ESOP has paid only $15.3 million on the $250 million note, [GreatBanc’s] maximum possible liability is that amount, or, alternatively, the $2.8 million of that amount that was paid as principal.” Neil, 2011 WL 722747, at *3. Judge Pallmeyer found that “Defendant asks the court to view the purchase as a single transaction, one in which the trustee never spent $250 million because much of the assets purchased remained pledged and practically unavailable to the ESOP. In the alternative, Defendant asks the court to view the purchase as an apparition—though it appeared that the ESOP purchased $250 million in Tribune Company stock, it did not.” Id. at *5. The court was not persuaded by GreatBanc’s arguments or its attempt to characterize the $250 million purchase as illusory because it was funded with a promissory note. Instead, the court recognized that “regardless of what benefits may accrue to the sponsor of an ERISA plan as the result of its creation, the ESOP itself must be administered for the benefit of the employees. As such, the stock purchased for the plan and later distributed to employee accounts constitutes a genuine asset that necessarily represents other benefits to the employees foregone as the result of the ESOP arrangement.” Id. at *6. Thus, the court found that employee benefits have an actual rather than illusory value, because “‘[e]mployee benefits are not a mere gratuity, but a form of deferred wages. Clearly, if the ESOP’s holdings in the employer securities are worthless, the employees have lost certain of these deferred wages.’” Id. (quoting Reich v. Valley Nat. Bank of Arizona, 837 F. Supp. 1259, 1286-87 (S.D.N.Y. 1993)). Accordingly, the court found that “[t]he loss of deferred compensation is a genuine loss.” Id. at *7. And “the fact that the money to purchase the stock was borrowed does not mean that money was not lost.” Id. While Plaintiffs did not endorse a specific measure of damages, they did provide three possibilities: “(1) the difference between the amount paid for the stock and its actual value at the time of purchase; (2) the difference between the performance of the ESOP investment and a hypothetical prudent investment; and (3) the total amount lost due to an improper investment.” Id. Although Judge Pallmeyer did not expressly approve any of these damages proposals, she found they were all legitimate measures of damages. The court noted: “The maximum recovery would simply put employees in the place they would have been in had the $250 million been prudently, properly, and legally invested. . . . They seek only what they would have received from the plan had Defendant not been in breach.” Id. at *12. The court concluded that Plaintiffs were seeking “‘make-whole’ recovery,” and, accordingly, “they are [] entitled to what should have been in the account at the time of retirement absent the breach of trust.” Id. at *13 (emphasis in original). ConclusionIn her opinion, Judge Pallmeyer declines to throw ERISA out the window and instead relies not only on the express language of the statute but also its intent. The court rejects the “plan design” argument, recognizing that because the ESOP had assets, GreatBanc’s “‘decision to invest them [in Tribune Co. stock] was subject to ERISA’s fiduciary standards, regardless of the fact that the ESOP was committed to this investment under the Plan documents before its receipt of any contribution.’” Id. at *6 (quoting Reich, 837 F. Supp. at 1286-87). Similarly, the court recognizes that an ERISA plan “‘must be created for the exclusive benefit of participating employees and also be structured to distribute benefits to participating employees at retirement. It is not proper to establish and administer an ESOP for the exclusive purpose of wringing tax benefits from the Government.’” Id. (quoting Reich, 837 F. Supp. at 1286) (emphasis in original). With over $280 billion worth of retirement savings invested in employer securities in defined contribution plans,1 it is important for courts to recognize—as Judge Pallmeyer does here—that ERISA’s strict fiduciary duties are “the highest known to the law.” Donovan v. Bierwirth, 680 F.2d 263, 272 n.8 (2nd Cir. 1982). |
