Date: 08-13-2001

Case Style: William P. McDannold v. Star Bank, N.A., et al.

Case Number: 00-3461

Judge: Merritt

Court: United States Court of Appeals for the Sixth Circuit

Plaintiff's Attorney: Stephen M. Perry of Casner & Edwards, Boston, Massachusetts

Defendant's Attorney: Thomas R. Schuck of Taft, Stettinius & Hollister, Cincinnati, Ohio

Description: In 1987, John Endres decided to sell his interest in Electro-Jet Tool & Manufacturing, an aerospace machine shop that he founded and long managed. After fruitless negotiations with a Canadian firm, he agreed to sell his 82.5% stake in Electro-Jet to the company's own employees. As part of the transaction, the then-existing profit sharing plan was converted into an employee stock ownership plan ("the ESOP" or "the plan"), as defined in the Employment Retirement Income Security Act of 1974. See 29 U.S.C. § 1107(d)(6). To finance the $12.5 million purchase, the plan contributed $2.3 million of its own pension assets and obtained a non-recourse loan of $10.2 million from Star Bank, then known as The First National Bank of Cincinnati. The bank was secured, among other collateral, by a pledge of 268,000 shares in Electro-Jet, that portion of stock purchased with the loan amount. Star Bank perfected its interest by taking possession of the shares, which apparently it still retains.

Litigation ensued when plaintiffs discovered that the shares they bought were worthless--and, according to plaintiffs, were essentially worthless at the time of the transaction. Plaintiffs, the trustee and beneficiaries of the plan, claim that the $12.5 million purchase price for the Electro-Jet stock was grossly overvalued. Plaintiffs note that quality control problems led Electro-Jet's largest customer, General Electric, to significantly reduce its orders. As a result, plaintiffs allege, Electro-Jet sales for the last three calendar months of 1987 were one half that of the previous year's. According to plaintiffs, no independent audit was conducted of financial statements for the fiscal year ending September 30, 1987, though by then the company was operating at a loss from which it never recovered.

Plaintiffs assert that they knew none of this. They claim that Endres and the officers of Electro-Jet kept these operating losses secret while negotiating the buyout. They further claim that Star Bank, as former trustee of the plan, failed to investigate or bring any action on behalf of the plaintiffs once the losses were discovered. Plaintiffs sued Endres, Star Bank, and several former Electro-Jet executives for breach of fiduciary duty under ERISA. Endres, in turn, named as third-party defendants his lawyer, Thomas A. Simons, and Simons' former law firm.

Plaintiffs also sued the professional advisors whom the plan retained to structure the transaction. This second set of defendants--collectively, the "settling defendants"--consists of William Kirkham, who represented the plan during the buyout; Kirkham's firm, Lindhorst & Dreidame; and Gradison & Company, a consulting firm that furnished an appraisal of the Electro-Jet stock. Claiming malpractice and misrepresentation under state law, plaintiffs alleged that these legal and financial advisors failed to represent the plan properly by using incomplete appraisals and financial reports that did not reveal the extent of Electro-Jet's losses.

Here, we need not consider the merits of either the ERISA or the malpractice claims. While the former await further proceedings in District Court, the latter eventually settled for $1.75 million. Instead, we narrow our focus to the malpractice settlement fund, whose distribution has been stayed until resolution of this appeal. Our task is twofold: We must decide whether a secured creditor is entitled to the settlement as "proceeds"of a stock pledge and what effect, if any, the settlement should have upon the on-going litigation between plaintiffs and the remaining defendants.

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Click the case caption above for the full text of the Court's opinion.

Outcome: We AFFIRM the decision on the issue of proceeds but VACATE the court's approval of the settlement and REMAND for further consideration of a possible right to contribution and the overall fairness of the settlement and set-off in light of new Supreme Court authority.

Plaintiff's Experts: Unknown

Defendant's Experts: Unknown

Comments: None