Opinion
Civil Action No. 91-1630
July 21, 1999
FINDINGS OF FACT AND CONCLUSIONS OF LAW
This action arises from the financial collapse of several pension plans which were at all times covered by Title IV of the Employee Retirement Income Security Act of 1974 ("ERISA"), 29 U.S.C. § 1301 et seq. Plaintiff Pension Benefit Guaranty Corporation ("PBGC"), the statutory guarantor of these plans, filed a five count amended complaint against defendant White Consolidated Industries, Inc., ("WCI") seeking to recover unfunded benefit liabilities pursuant to various applications of 29 U.S.C. § 1362 and 1369. WCI had previously transferred the plans, along with a group of associated businesses, to Blaw Knox Corporation ("BKC"); thus, WCI was not the contributing sponsor of record at the time of the plans' termination.
Judge McCune of the United States District Court for the Western District of Pennsylvania dismissed the complaint in its entirety pursuant to a motion to dismiss filed by WCI. The United States Court of Appeals for the Third Circuit later affirmed in part and reversed in part Judge McCune's decision, concluding that PBGC had stated viable claims at Counts One and Four of the amended complaint. Pension Benefit Guaranty Corp. v. White Consolidated Industries, Inc., 998 F.2d 1192 (3d Cir. 1993) ("PBGC v. WCI"). Count One charges that WCI is liable for the unfunded pension liabilities pursuant to 29 U.S.C. § 1362 ("Section 1362") because the WCI-BKC sale transaction was a sham, having no legitimate business purpose or economic effect. Count Four charges that WCI is also liable for the unfunded pension liabilities pursuant to 29 U.S.C. § 1369 ("Section 1369") because a principal purpose of WCI's decision to consummate the WCI-BKC sale transaction was to evade pension liabilities. The court remanded the case to the district court for further proceedings on these counts.
Discovery in this case spanned several years and involved thousands of documents, hundreds of hours of depositions, and numerous experts. Beginning on March 3, 1997, the parties presented extensive testimony and other evidence during a ten day bench trial, after which the parties submitted proposed findings of fact and conclusions of law. The case has been extensively and expertly briefed and argued. Based on the evidence, arguments, and authorities presented, the court makes the following findings of fact and conclusions of law pursuant to Federal Rule of Civil Procedure 52.
I. Findings Of Fact
A. The Major Parties Involved In The WCI-BKC Transaction
1. The Pension Benefit Guaranty Corporation: The Pension Benefit Guaranty Corporation ("PBGC") is a wholly-owned United States Government corporation established pursuant to Title IV of ERISA. PBGC is the statutory guarantor of certain pension benefits payable to participants of private "defined benefit" pension plans. (3/3/97 Tr. 76:7-77:1 Deneen)
Trial testimony is cited within as follows: (Date of Witness Testimony; Page:Line of Trial Transcript; Name of Testifying Witness).
2. White Consolidated Industries, Inc.: White Consolidated Industries, Inc. ("WCI") is a manufacturer of appliances and home products and the former owner of five unprofitable steel-related companies (the "BK Businesses") and their underfunded pension plans (the "BK Plans").
3. Robert S. Tomsich and Blaw Knox Corporation: In 1985, WCI transferred the BK Businesses and the BK Plans to the Blaw Knox Corporation ("BKC"). (P30) BKC was created by Robert Tomsich ("Tomsich") specifically for the purpose of acquiring the BK Businesses and assuming the associated pension plans. Tomsich owned 78% of BKC. (P2) At that time, and currently, Tomsich was also the President and Chairman of NESCO, Inc., a large Cleveland-based holding company. (3/6/97 Tr. 142:14-143:24 Tomsich Depo.)
Plaintiff's and defendant's trial exhibits are cited within as (P x) and (D x) respectively.
4. The BK Businesses: The five companies transferred to Tomsich, collectively referred to as the "BK Businesses," consisted of: (1) Blaw-Knox Food Chemical Equipment; (2) Blaw-Knox Foundry Mill Machinery; (3) Aetna-Standard; (4) Blaw-Knox Equipment; and (5) Duraloy Blaw-Knox. (P30) Blaw-Knox Foundry Mill Machinery was comprised of two divisions — the Blaw-Knox Castings and Machinery Division in East Chicago, Indiana ("East Chicago") and the Rolls Division in Wheeling and Warwood, West Virginia. (P272 at 38230)
5. The BK Plans: The BK Plans transferred to Tomsich consisted of the Blaw-Knox Retirement Income Plan ("Plan 002"); Blaw-Knox Pension Plan ("Plan 003"); Aetna-Standard Engineering Company Retirement Income Plan ("Plan 004"); Blaw-Knox I.A.M. Pension Plan ("Plan 052"); Blaw-Knox Hourly Pension Plan ("Plan 053"); Blaw Knox Equipment Pension Plan ("Plan 054"); Duraloy Blaw-Knox Pension Plan for Salaried Employees ("Plan 055"); Duraloy Blaw-Knox Union Pension Plan ("Plan 056"); Blaw-Knox Equipment (Jackson, Mississippi Works) Hourly Pension Plan ("Plan 009"). (P30)
6. W. Derald Hunt: At the time of the transaction, W. Derald Hunt ("Hunt") was the Controller and Chief Accounting Officer for WCI. (3/13/97 Tr. 6:12-7:6 Hunt)
7. Daniel R. Elliott, Jr.: Daniel R. Elliott, Jr. ("Elliot") is, and was at the time of the transaction, the Senior Vice President-Law, General Counsel and Secretary of WCI. (3/14/97 Tr. 24:10-15, 26:25-27 Elliott) Hunt and Elliott were the co-architects and chief negotiators of the BKC/WCI transaction from the WCI side. (3/14/97 Tr. 48:9-49:10 Elliott)
8. Squire, Sanders Dempsey: Squire, Sanders Dempsey ("SSD"), lead by William H. Ransom ("Ransom"), acted as pension counsel to WCI during the transaction with BKC. SSD did not act as the lawyers who negotiated the terms of the purchase and sale. (3/11/97 Tr. 133:17-134:7 Ransom) The principal SSD attorneys who worked on this matter included Ransom, Frank Rasmussen ("Rasmussen"), and Carl Draucker ("Draucker"). (3/11/97 Tr. 69:24-72:5 Ransom; 3/12/97 Tr. 7:25-8:10 Rasmussen)
9. Wyatt Company: Wyatt Company ("Wyatt") had been WCI's actuary for many years prior to the transaction. (Parks 11:10-13, 22:7-24:7) As the enrolled actuaries for all of WCI's pension plans, Wyatt prepared the Annual Valuation Reports and Forms 5500 for these plans. The principal Wyatt actuaries on the WCI account were John Reynolds ("Reynolds") and Lee Parks ("Parks"). Neither testified live at trial. At WCI's request, Wyatt prepared studies and estimates of the unfunded pension liabilities of the BK Plans for planning and structuring the transaction.
Pension and welfare benefit plans generally are required to file an annual return/report, the Form 5500 Series, regarding their financial condition, investments, and operations. The annual reporting requirement is generally satisfied by filing either the Form 5500 or 5500-C/R and any required attachments. The Department of Labor, Internal Revenue Service, and PBGC jointly developed the Form 5500 and Form 5500-C/R so employee benefit plans could utilize the Form 5500 Series to satisfy annual reporting requirements under Title I and Title IV of ERISA and under the Internal Revenue Code.
B. WCI's Evaluation of the BK Businesses
10. In the early 1980's, WCI became concerned about the future of the BK Businesses. These businesses had negative net income in 1983, 1984 and 1985, and negligible positive income in 1982. (P40 at ¶ 13; 4/14/97 Tr. 112:14-113:11 Monheit). Operating losses between 1982 and 1985, not including outlays for interest, taxes and capital expenditures, totaled approximately $24 million. Between 1981 and 1985, capital expenditures totaled approximately $34 million and pension costs exceeded $10 million per year. (P40 at ¶ 13)
11. Moreover, the economic prospects for the market in which these businesses were operating was not promising. (3/5/97 Tr. 92:6-11, 93:2-97:14 Dalton; P35) The domestic steel industry was facing increasing international competition at this time and the BK Businesses would require significant additional capital expenditure to modernize their facilities to a competitive level. (P34 at ¶ 6)
12. WCI knew that the BK Businesses' net income would decrease dramatically upon the impending termination of a major contract with the Army for the production of M60 tanks (the "Tank Contract"). In the early 1980's, Blaw-Knox Foundry Mill Machinery, the division which produced the M-60s, accounted for all of the Businesses' aggregate net profit after offsetting all the other Businesses' losses. (3/12/97 Tr. 171:9-172:4 Stillman; 4/14/97 Tr. 113:14-114:7 Monheit) In its heyday in the mid-1970's, Blaw-Knox Foundry and Mill produced approximately 129 M60 tanks per month (P803) but production rates steadily declined through the late 70's and early 80's as the government began production of the new M-1 tank. (P141; P176; P759; P803)
13. By January of 1985, WCI knew that the tank contract would terminate no later than March 1986. General Dynamics, a substantial customer, had also informed WCI in January 1985 that there were no further orders beyond the work in progress. (P289) About this same time, WCI's outside counsel, Rasmussen, told the government that East Chicago (the plant still making M-60s) could not be kept open without significant commercial business which was "neither in hand nor on the horizon." (P293; 3/12/97 Tr. 26:23-29:15 Rasmussen) In June 1985, a study conducted by the consulting firm of Arthur D. Little, Inc., concluded that the tank contract was ending, and that the East Chicago facility was "unsellable" unless (1) WCI kept the pension liabilities, (2) the purchase price was minimal, and (3) public financing was made available to the buyer to develop the plant for commercial production. (P422 at I-3)
14. In 1982, the WCI Board of Directors decided to retain the outside consulting firm McKinsey Co. ("McKinsey"). WCI hired McKinsey to perform a strategic study to determine the most effective ways to improve WCI's overall value, and to evaluate the impact of the BK Businesses on the value of WCI. (3/13/97 Tr. 86:13-87:16 Cyert; 3/14/97 Tr. 27:14-23 Elliott; P34 at ¶ 7; Smith, 10:15-25, 11:13-25; Garda, 13:11-15; 15:12-21:18:12-19:11; 93:6-94:5)
15. Based on factors such as strategic potential, economic value and cash flow, McKinsey categorized WCI's businesses as "core businesses," "outliers," "potential outliers," and "Exit Businesses." (3/14/97 Tr. 27:23-28:18 Elliott; Garda, 164:25-165:12, 165:21-169:25; P224) The "Exit Businesses" were a group of unprofitable, heavy industrial businesses that McKinsey recommended should be sold or liquidated. (3/3/97 Tr. 222:16-24; 223:5-7 Blaydon; 3/13/97 Tr. 87:20-88:11 Cyert; 3/14/97 Tr. 28:11-18 Elliott; P34 at ¶ 8; P224) The Exit Businesses were generally engaged in steel or steel-related industries and all of them had dismal future prospects. (P224) The BK Businesses were designated as Exit Businesses (3/14/97 Tr. 28:11-18 Elliott)
16. McKinsey's recommendation that WCI sell or liquidate the Exit Businesses was accepted by WCI's Board of Directors. (3/13/97 Tr. 7:17-8:4 Hunt; 3/14/97 Tr. 28:11-16 Elliott; 3/3/97 Tr. 222:18-223:7 Blaydon; P34 at ¶ 8)
C. Establishment Of The Discontinued Operations Reserve
17. In the fourth quarter of 1984, WCI established a reserve for discontinued operations to provide for the losses it expected to incur in disposing of the Exit Companies (3/5/97 Tr. 166:12-167:19 McQuate Depo; P758) Consistent with Generally Accepted Accounting Principles ("GAAP") and in particular Accounting Principles Board Opinion ("APB Opinion") No. 30, the reserve included, inter alia, the estimated book value of the assets in excess of the proceeds expected to be realized on disposal; the estimated costs to be incurred in disposing of the assets; estimated unfunded pension liabilities; and the estimated cost of insurance benefits for retirees. (P192; 3/5/97 Tr. 166:12-167:19 McQuate Depo.) WCI estimated that it would incur a pre-tax loss of approximately $165 million in connection with the disposition of the BK Businesses. (P1; P284; P286; 3/4/97 Tr. 28:13-29:9 Zimmerman)
18. In calculating the reserve for the BK Businesses, WCI anticipated that one of the companies, Blaw-Knox Foundry and Mill Machinery, would be liquidated. Accordingly, WCI recorded shutdown costs and button-up costs for this business. WCI expected, however, that the other four BK Businesses would be sold, so costs of liquidation were not recorded for those businesses. (P1; P286; 4/14/97 Tr. 150:22-154:9 Monheit)
19. In order to reserve for the cost of funding the BK Plans after the assets of the BK Businesses had been liquidated or sold, WCI instructed its actuaries, Wyatt, to calculate the unfunded liabilities of all the BK Plans. Wyatt estimated that the unfunded liability of the BK Plans in the aggregate was approximately $71.5 million. This figure was based on vested benefits. It did not include liabilities for unvested benefits or for benefit increases that would result from salary increases if, in fact, the BK Plans continued and benefits continued to accrue. (P266; 4/14/97 Tr. 151:2-6, 169:9-16 Monheit) Wyatt's estimate of $71.5 million was the approximate cost of defeasing all vested liabilities assuming that WCI purchased annuities or investment instruments at or around the time the estimates were made. Accordingly, if WCI were to pay off the unfunded liabilities of the BK Plans over time (e.g., 30 years) it would cost more. (P1; 4/14/97 Tr. 157:16-159:23 Monheit) WCI estimated that amortized over 30 years the actual cost of funding the plans, including interest, was $152 million. (P1; 3/10/97 Tr. 158:24-161:1 Novak)
20. Provident Insurance Company estimated that WCI's liability for retirees health and welfare benefits was approximately $36 million. (P551) This figure was later revised to $23 million because it had not been reduced to present value. (3/4/97 Tr. 40:5-41:9 Zimmerman; 3/12/97 Tr. 91:2-11, 203:3-7 Stillman)
21. Several WCI witnesses, including Hunt (WCI's Chief Accounting Officer in the mid-80's) and an outside auditor, testified that WCI's discontinued operations reserve was based on the "worst case scenario." They characterized the reserve as "highly conservative" and "over-stated." This testimony, as it related to the portion of the reserve associated with the BK Businesses, was not fully credible for the reasons set forth in paragraphs 22 through 24, infra.
22. First, GAAP required WCI to use its best estimates of the costs for disposing of the BK Businesses. (P888; P287; P889; P748; P890) Russell McQuate, WCI's Director of Corporate Accounting, testified that, in fact, the reserve represented WCI's best estimate of the costs of exiting the BK Businesses. (3/5/97 Tr. 166:12-167:19 McQuate Depo.; 3/13/97 Tr. 81:7-82:6 Hunt)
23. Second, there is no evidence that any component of the reserve relating to the cost of exiting the BK Businesses is overstated. For example, Wyatt's estimate that the pension liabilities were $71.5 million was actually reduced by WCI to $59.6 million when recorded in the reserve. (4/14/97 Tr. 169:9-16 Monheit)
24. Third, while the total reserve is overstated, that overstatement results from a cushion of over $40 million added after the discrete costs associated with disposing of the BK Businesses were subtotaled. (P551; 4/14/97 Tr. 155:5-156:18 Monheit)
25. WCI's estimate that it would incur a pre-tax loss of $165 million on disposal of the BK Businesses was a reasonable estimate and provided a meaningful benchmark against which WCI measured the actual transaction.
26. Indeed, Hunt and Elliot used the $165 million estimated loss as a benchmark when presenting the proposed WCI-BKC sale to WCI's Board of Directors. (P1)
27. In a June 18, 1995 memorandum to WCI's Board members, Hunt and Elliot explained that "[b]ased on March 31, 1985 balance sheets of the divisions and the consideration of our letter of intent, the pre-tax loss on this disposal has been reduced to $97 million, for a savings of $68 million." (P1)
D. WCI's Attempts To Divest The BK Businesses
28. Beginning at least in the Spring of 1984, WCI attempted to sell the BK Businesses to several outside buyers as well as to the businesses' respective management teams. (Smith, 106:2-15; P252; P290; P229; P811) Although several individuals expressed an initial interest, WCI was unsuccessful in finalizing a sale. (P252; P216; P230; P305; Schuetz, 48:17-49:8, 60:20-61:7) For example, a proposed deal for the sale of Blaw-Knox Food Chemical to management fell through because the group was unable to obtain financing after several local banks concluded that the revenues of this business would be inadequate to support the debt service. (P290; P305; Ware, 133:7-13, 134:5-25)
29. Around this same time, WCI hired Lehman Brothers Kuhn Loeb ("Lehman Brothers") to evaluate and market the Exit Businesses. (3/3/97 Tr. 223:8-14 Blaydon; 3/13/97 Tr. 7:17-8:4 Hunt; 3/14/97 Tr. 29:22-30:1 Elliott; P238; Valdez, 8:10-19; Jacobs, 14:3-6; Smith, 102:4-8) Lehman Brothers prepared descriptive offering memoranda according to commonly applied and accepted methods, and proposed a marketing strategy for the BK Businesses. (3/14/97 Tr. 29:22-30:7; P34 at ¶ 10; Valdez, 18:2-5, 18:15-19:3; Ware, 65:18-24; P272, P273, P280, P281, P282)
30. Thereafter, over a period of nearly 12 months, Lehman Brothers attempted to market the BK Businesses. (P811; Valdez, 29:4-9; P34 at ¶ 11) Lehman Brothers shopped the BK Businesses with the understanding that WCI would retain the pension and health and welfare liabilities. (3/10/97 Tr. 47:16-48:21 Jarrell) Despite extensive efforts and contacts with hundreds of potential purchasers, Lehman Brothers was unable to find any potential purchaser who was willing to buy the BK Businesses for cash. (3/14/97 Tr. 93:15-94:17 Elliott; 3/10/97 Tr. 56:4-58:7 Jarrell) In fact, Lehman Brothers only discovered one individual who was seriously interested in acquiring the BK Businesses at all. (3/6/97 Tr. 74:25-76:1 Cvengros Depo.; 3/10/97 Tr. 61:2-10 Jarrell; P276)
31. The fact that Lehman Brothers was unsuccessful in selling these businesses even with WCI retaining the pension and health and welfare liabilities, indicates that the assets of these businesses were unmarketable in terms of a conventional sale. (4/14/97 Tr. 66:12-68:5 Monheit) It also shows that these businesses were worth substantially below the price that WCI was asking for them. (3/10/97 Tr. 56:4-58:7 Jarrell)
32. Additionally, during the time period that Lehman Brothers was shopping the BK Businesses, the steel industry was experiencing a great deal of merger and acquisition activity. The fact that the extensive efforts of Lehman Brothers produced only one potential buyer reinforces the conclusion that the BK Businesses were unattractive. (P34 at ¶ 12)
E. Joseph Cvengros
33. In or around December of 1984, Lehman Brothers identified Joseph M. Cvengros ("Cvengros") and his company, Anamag, as a potential purchaser of the BK Businesses. (3/6/97 Tr. 74:25-76:1 Cvengros Depo.; 3/10/97 Tr. 61:2-10 Jarrell; P276) By February 1985, Cvengros and WCI were discussing a possible deal in which Cvengros would assume some of the pension liabilities of the BK Businesses as partial consideration for the sale. (3/10/97 Tr. 62:21-63:6 Jarrell; P309; P306; P315; P340)
34. WCI asked its outside pension counsel, SSD, to evaluate whether WCI could be held liable for the unfunded pension liabilities of the BK Businesses if a potential purchaser assumed the pension plans. (3/14/97 Tr. 31:18-25 Elliott; 3/11/97 Tr. 70:10-72:20 Ransom; P303, P327, P315, P340, P10; Parks, 171:21-172:24) At this time WCI also talked to Wyatt about the amount of unfunded pension liability for the BK Businesses. (P303) Based upon the same Wyatt study used in establishing the discontinued operations reserve, WCI estimated that as of February 26, 1985, the unfunded pension liability was $71.5 million. (P303)
35. On April 25, 1985, Cvengros met with various representatives of WCI to discuss the potential purchase of the BK Businesses, and his ideas with respect to the BK Plans. (3/11/97 Tr. 95:11-96:9 Ransom; P6, P334, P7, P8, P9, P10)
36. By this time, WCI knew that it could be contingently liable for any unfunded pension obligations assumed by the buyer. (3/14/97 Tr. 31:18-35:1 Elliott) In particular, WCI was aware of the theories of predecessor liability advanced by PBGC in In re Consol. Litig. Concerning International Harvester's Disposition, 681 F. Supp. 512 (N.D.Ill. 1988) ("International Harvester"). (3/11/97 Tr. 70:10-75:16, 83:12-85:18 Ransom; 3/14/97 Tr. 31:18-35:1 Elliott; P6, P303, P329, P33, P327, P315, P340; Draucker, 27:25-30:8, 32:8-15, 73:18-75:14) SSD advised WCI that PBGC's position in 1985, as reflected in proposed legislation, was that predecessor liability could be imposed for five years after the sale of assets and transfer of pension liabilities. (P327; P340; 3/11/97 Tr. 139:12-18 Ransom) While WCI also considered whether it could be held liable under 29 U.S.C. § 4064, a provision of ERISA that applies only to multiple-employer plans, SSD attorney William Ransom advised that Section 4064 "did not provide a credible basis" for asserting predecessor liability. (3/11/97 Tr. 134:14-137:8 Ransom) Ransom's primary and principal concern was the theories of predecessor liability advanced by PBGC in the International Harvester case. (Id.
37. Prior to the April 25, 1985 meeting with Cvengros, SSD obtained copies of the pleadings filed in International Harvester from the federal district court in Chicago, and forwarded them to WCI's General Counsel, Elliott. (P329; P333) Elliott prepared a list of matters for possible discussion at the meeting, including 1) "significance of Wisconsin Steel — Harvester litigation on SSD conclusions on residual pension liability"; and 2) "What assurances does WCI receive against residual pension liability exposure to PBGC; does Anamag meet the PBGC 30% of asset value and pension asset test?" (3/3/97 Tr. 100:11-101:9 Deneen; P6) Hunt raised the question during the meeting as to "how WCI could be held harmless" in the type of transaction that was under consideration. (P9; 3/13/97 Tr. 113:10-114:1 Hunt)
38. By the conclusion of the April 25, 1985 meeting, Cvengros was proposing a deal in which the buyer would assume the non-retiree assets and liabilities of the BK Plans, WCI would pay $25 million to the buyer and the buyer would terminate the BK Plans before or immediately after closing. (P8; P9; P10) Cvengros also contemplated having PBGC review the deal before closing. (P10) In addition, Cvengros refused to have the buyer assume any of WCI's collective bargaining agreements. (P390)
39. WCI and its counsel recognized serious problems with Cvengros' proposal. WCI's biggest concern was that if the buyer failed or defaulted on the pension liabilities, WCI would be liable. (3/11/97 Tr. 97:13-100:13 Ransom; P8; P9; P10) Ransom advised WCI that if the buyer terminated the plans immediately after the closing, PBGC could seek to hold WCI liable for all of the termination liabilities under the theories advanced by PBGC in International Harvester. (P10; Ransom, 304:4-305:2; 320:1-321:17; 323:5-326:12) In a memorandum dated April 29, 1985, Ransom stated that a proposal whereby termination of the pension plans was contemplated as part of the deal was a "double edged sword" and would leave "very little room for WCI to avoid an International Harvester/Wisconsin Steel situation." (P10) In another reference to International Harvester which appears in his notes from the April 25, 1985 meeting, Ransom identified PBGC as a "problem" because WCI "must still get over dumping initially — not necessarily 5 years." (3/11/97 Tr. 148:17-149:14 Ransom; P8)
40. Ransom was also concerned that if the BK Plans were terminated as part of the transaction, WCI would be viewed as the plan sponsor on the date of termination. (3/11/97 Tr. 154:6-14 Ransom) Then, PBGC would not even need to use theories of "predecessor" liability. Because he perceived termination of the plans to create a significant risk to WCI, Ransom advised WCI that it should not enter into a transaction in which the buyer terminated the BK Plans as part of the transaction. (3/11/97 Tr. 154:19-24 Ransom; P10)
41. Ransom also advised WCI that it was a bad idea to disclose a deal to PBGC before closing. (3/11/97 Tr. 102:18-103:13 Ransom; P10; Ransom, 167:1-168:5) Ransom was particularly concerned that if the parties went to PBGC prior to the close of the transaction, WCI would be left with "relatively little bargaining room with the PBGC." (P10; Ransom, 303:3-304:3) Ransom concluded, however, that if problems relating to the transfer of pension liabilities were worked out in the context of plan termination, as opposed to before the deal, the situation might be "sufficiently cloudy as far as the PBGC was concerned (i.e. they might have to use International Harvester/Wisconsin Steel theories to recover from WCI)." (P10)
42. Based on Ransom's advice, WCI considered Cvengros' proposal risky and economically unattractive. (3/13/97 Tr. 121:4-123:23 Hunt) After the April 25, 1985 meeting, although Cvengros sent several draft proposals to WCI, neither Hunt nor anyone else at WCI had any further substantive communications with Cvengros or his representatives. (3/13/97 Tr. 122:21-123:23 Hunt)
43. Sometime around or after April 25, 1985, WCI identified Tomsich as a potential buyer who might be convinced to accept an offer involving the assumption of pension liabilities that was more favorable to WCI than Cvengros' proposal. (P351; P354; P355; P356)
44. On June 11, 1985, Cvengros' attorneys met with PBGC officials to discuss the proposed transaction. PBGC told Cvengros' attorney Bertrand Harding ("Harding") that it wanted "full value," for the plans. (Harding, 29:14-41:5; 3/12/97 Tr. 39:22-41:12 Mackiewicz; 3/3/97 Tr. 137:14-139:1 Mackiewicz Depo.; P382) The day after this meeting, Harding had one or more telephone conferences with WCI. (Harding, 28:19-29:8; P410)
45. One week later, on June 18, 1985 WCI signed a letter of intent with Tomsich. (P1) On June 25, 1985, Hunt sent Cvengros a letter confirming that WCI had signed a letter of intent with another party because WCI had "concluded that another offer was of more value" to it. (P411; Cvengros, 118:24-119:22)
F. Robert Tomsich
46. Around the end of April 1985, Karl Ware ("Ware"), a WCI Executive Vice-President, called Tomsich, a Cleveland business man who owned a diversified group of businesses through a holding company called NESCO, Inc. (3/5/97 Tr. 159:16-160:6 Ware Depo; 3/14/97 Tr. 41:21-24 Elliott) Ware knew Tomsich socially through the Cleveland Yacht Club where they both were members. (3/5/97 Tr. 159:16-160:21 Ware Depo; Tomsich, 10:24-11:13) Roy Holdt, WCI's Chief Executive Officer at the time, also had a casual social relationship with Tomsich and had known him for several years prior to 1985. (3/5/97 Tr. 161:24-162:6 Ware Depo.) Tomsich was not one of the potential buyers contacted by Lehman Brothers.
47. On May 31, 1985, WCI sent both Cvengros and Tomsich an identical letter which suggested that there were several purchasers interested in acquiring the BK Businesses. (P364; P265) Two proposed letters of intent were also enclosed with each letter. (P364; P265) One of the proposed letters provided for the purchase of the BK Businesses through the assumption of the pension obligations ("version #1"), and the other, through cash ("version #2"). (3/14/97 Tr. 35:24-36:3 Elliott; P364; P365) Although version #1 provided for the purchase of the BK Businesses through the assumption of liabilities, many of its terms were substantially different than those proposed by Cvengros. (P365; P12)
48. Tomsich never submitted any counter proposals to WCI's draft letters of intent. (3/6/97 Tr. 235:9-16, 238:4-7 Tomsich Depo.) After comparing the economics of the deal involving the assumption of pension liabilities to the cash deal, Tomsich and his advisors concluded that the buyer was being asked to "assume" approximately $67 million in pension and benefit liabilities in version #1. Version #2 did not specify the amount of cash consideration but there is evidence that Tomsich thought that the assets were worth approximately $20 million. (P16; P18; 3/14/97 Tr. 94:18-96:18 Elliott) Lehman Brothers had estimated the value of the assets to be $32 million. Tomsich recalled that the expected purchase price under the second option was "very high" and substantially above the book value and net worth of the BK Businesses. (3/6/97 Tr. 263:14-25 Tomsich Depo.)
49. Tomsich chose the deal involving assumption of the BK Plans knowing that neither he nor NESCO would ever have to pay the unfunded liabilities. Tomsich learned that under ERISA, corporations and individuals related by more than 80% common ownership (who are then members of a "controlled group") have joint and several liability for the unfunded pension liabilities of all the controlled group members. If Tomsich owned less than 80% of the stock of the buyer corporation, neither he personally nor NESCO would be part of the buyer corporation's controlled group and neither would be liable for the pension liabilities if the BK Plans terminated. (3/14/97 Tr. 49:11-19, 94:18-98:1 Elliott; P2; 3/5/97 Tr. 164:14-166:11 Tomsich Depo.; 3/6/97 Tr. 150:5-151:2 Tomsich Depo.; 3/14/97 Tr. 20:21-21:2 Hunt)
50. The provision of the letter of intent, whereby Tomsich would own only 78% of the buyer corporation, became the linchpin of the deal. (3/5/97 Tr. 164:14-166:11 Tomsich Depo.) Baker Hostetler, Tomsich's lawyers, gave him a written opinion that neither he personally nor his other corporations would have any liability for the BK Plans' unfunded liabilities. (P2) Without the assurance by his attorneys that NESCO and he personally would not be liable to PBGC for the BK Plans' underfunding, Tomsich would not have consummated the transaction. (3/5/97 Tr. 164:14-166:11 Tomsich Depo.)
51. This structure enabled WCI to evade massive unfunded pension liabilities without requiring Tomsich to actually assume them. (3/5/97 Tr. 164:14-166:11 Tomsich Depo.) For this reason, it would be inaccurate to characterize the liabilities transferred to Tomsich as "consideration" for the BK Businesses' assets, within the traditional meaning of that term, because neither Tomsich nor his company was obligated to pay the liabilities. Only the assets of the buyer corporation were at risk of being used to satisfy the pension obligations, and Tomsich was not paying anything for these assets. As discussed, infra, the assets were woefully inadequate to satisfy the BK Plans' unfunded liabilities either through the operating income they could reasonably be expected to produce over time, or through their liquidation value upon plan termination. (P40)
52. In addition to limiting Tomsich's ownership interest to 78%, the other major features of the letter of intent signed on June 18, 1985 were as follows: (1) the buyer was to assume the unfunded pension liabilities for current employees and post-1982 retirees; (2) WCI was to keep the pension liability associated with pre-1982 retirees which were purportedly fully funded because they were supposedly covered by a dedicated bond fund; (3) WCI was to pay $20 million into the BK Plans over 5 years; (4) the buyer also assumed the liability for retiree health and life insurance benefits, without any contribution from WCI. (P1)
53. On June 19, 1985, the day after Tomsich signed the letter of intent, representatives of WCI met and decided, unilaterally, that the first draft of the purchase and sale agreement would assume that the buyer would take over the entire pension and retiree medical and life insurance liability, including the "dedicated bond fund." This included retiree pension liability from all of the BK Businesses as well as some additional plants that had been closed for many years and were not transferred to BKC in the sale.
54. This major decision was reached despite the fact that the Letter of Intent did not provide for the assumption of these additional liabilities and despite the fact that Tomsich was not even present at the meeting. (P1, P402, P19; Ransom, 411:19-416:13; P788) The reason for WCI's change of mind on this issue is clear: WCI had been informed that it would end up with significant unfunded liabilities if it retained the dedicated assets and liabilities in the BK Plans. (P17; P384)
55. Tomsich could afford to be indifferent even to such a significant modification of the deal because he did not intend to pay the liabilities. (3/14/97 Tr. 49:11-19, 94:18-98:1 Elliott) Indeed, he was confident that PBGC would be the entity which was ultimately responsible for the payment of these liabilities. (3/5/97 Tr. 162:19-164:6 Tomsich Depo.)
56. Consequently, Tomsich never conducted any independent actuarial studies of the BK Plans. Tomsich hired Towers Perrin Forster Crosby ("TPFC") merely to "look over the shoulders" of Wyatt. William Kuendig ("Kuendig") was the TPFC actuary assigned to the engagement. Kuendig neither reviewed Wyatt's "calculations" nor did any independent calculations of his own. In fact, Kuendig was instructed by Tomsich not to check on Wyatt's "calculations" or to determine how they valued the pension liabilities, but to presume that Wyatt's actuarial work was correct and done properly. (3/6/97 Tr. 3:14-4:7, 8:3-9:3, 15:24-17:4, 17:24-20:16 Kuendig Depo.; P444; P731; Kuendig, 10:24-11:15, 12:4-13, 14:19-20, 21:21-22:22, 24:23-25:4, 37:16-17, 68:21-69:5)
G. The Estimates Of Pension Liability Used In The Transaction Did Not Reflect Economic Reality
57. When WCI began negotiating with Cvengros and Tomsich for the assumption of pension liabilities, it had its actuaries at Wyatt recalculate the estimates of the BK Plans' unfunded liabilities. The recalculated liability was substantially less than any liability number it had previously calculated.
58. Between late 1984 and the time of the transaction in September 1985, the "amount" of the BK Plans' unfunded liabilities as calculated by Wyatt decreased from nearly $80 million to $40 million. (P266, P303, P318, P321, P322, P358, P348, P458) This decrease of approximately $40 million resulted from the way Wyatt calculated the liabilities, including the assumptions it used; it did not result from any decrease in the number of participants entitled to benefits or to any decrease in the level of their benefits. (3/5/97 Tr. 22:22-35:15, 39:1-41:14 Logue; P37)
59. PBGC expert Dennis E. Logue, Ph.D., ("Professor Logue") concluded that the economically relevant value of the unfunded pension liabilities and health and welfare benefits to BKC on September 27, 1985, with the BK Plans ongoing, as was required under the WCI-BKC Agreement, was approximately $98.3 million, $74.6 million for unfunded pension liabilities and $23.7 million for health and welfare benefits. (3/5/97 Tr. 22:22-35:15 Logue; P37)
60. Professor Logue's $74.6 million figure was consistent with Wyatt's earlier $71.5 million figure which was calculated outside the negotiation process. Professor Logue's calculation was also consistent with the advice Mary Riebold, WCI's testifying actuarial expert, gave to buyers who were assuming pension liabilities as part of a sale; namely, that it should take into account its "Post Acquisition Intentions and Projections" in calculating the true amount of pension liabilities it is assuming, including the effect of anticipated shutdowns and other business changes and anticipated salary increases. (3/11/97 Tr. 37:4-38:11 Riebold; P887)
61. We find that Professor Logue's calculation is the most accurate calculation of the amount of unfunded pension liabilities and health and welfare benefits BKC assumed in September, 1985.
62. In April 1984, Wyatt estimated the total unfunded liabilities of the BK Plans including "shutdown benefits" as of December 31, 1983, to be approximately $88 million. (P4) In October 1984, Wyatt calculated the unfunded liabilities at $71.5 million as of December 31, 1984. (P266) WCI used this $71.5 million figure (after offsetting the overfunding in some of the individual BK Plans) as the amount it disclosed to the public and to the capital markets in WCI's discontinued operations reserve. (3/13/97 Tr. 74:25-77:3 Hunt)
The term "shutdown benefits" is a misnomer. These are benefits payable to eligible participants who lose their jobs through any number of ways, including lay off and disability. (3/4/97 Tr. 99:24-100:5, 115:23-116:14 Langhans; 3/11/97 Tr. 38:22-39:21 Riebold; P36; P825)
63. Notwithstanding that Wyatt had already calculated the BK Plans' unfunded liabilities as of December 31, 1984, WCI asked its actuaries to recalculate them again as of January 1, 1985, specifically for the negotiations. (P318; P322) In a draft letter dated April 11, 1985 Wyatt calculated that the additional "shutdown" liabilities that would be incurred if the BK Businesses closed was $11,090,000. (P318) Hunt told Wyatt to prepare a new version of the April 11, 1985 letter for "the eyes of the buyer" without the information on shutdown liabilities. (P322) Accordingly, Wyatt deleted the calculation of "shutdown benefits" from an April 16, 1985 version of the letter on the stated ground that "there would be no plant shutdowns or massive layoffs involving the divisions." (P322) This assumption ignored the fact that the tank contract would end soon and that it was highly unlikely that East Chicago would remain open afterwards. (P293) Wyatt failed to mention, or otherwise provide information on, the fact that WCI had already laid off massive numbers of employees who would soon be eligible for "shutdown benefits" even if the facilities continued to operate. (P293; P321; 3/11/97 Tr. 15:12-16:11 Riebold)
64. In an April 16, 1985 letter, Wyatt "calculated" the total unfunded vested (accrued) liabilities of the underfunded BK Plans to be $55.4 million as of January 1, 1985. (P321) Wyatt then offset the overfunding in Plans 002 and 005 against the amount of underfunding and concluded that the aggregate unfunded vested liability was $46.8 million. (P321) That letter understated the pension liabilities as follows:
a) At WCI's specific request, Wyatt actuary Reynolds excluded over $11 million in shutdown or 70/80 benefits from its calculations on the stated ground that "there would be no plant shutdowns or massive layoffs involving the divisions." (P322) Reynolds failed to mention, or otherwise provide information on, the fact that WCI had already laid off many employees who were already or soon would be eligible for such benefits, even if the facilities remained open. (P293; 3/11/97 Tr. 38:22-42:13 Riebold)
b) The supposed underfunding in the April 16, 1985 letter did not take into account the BK Plans' dedicated assets and liabilities. On the relevant date of the study, January 1, 1985, several of the individual BK Plans had almost $4 million less in total assets than their dedicated liabilities alone and were deficient by more than $11 million when the Plans' "dedicated" assets were considered. (3/4/97 Tr. 154:9-162:14 LaBombarde) WCI later convinced Tomsich to assume the BK Plans' dedicated assets and liabilities on the ground that those liabilities were fully funded and it would not increase the amount of liabilities BKC was assuming. (P606)
c) Wyatt used a 14% interest assumption to calculate the present value of the BK Plans' "dedicated" liabilities even though there was no dedicated bond fund to justify the use of the 14% rate. (P38; 3/4/97 Tr. 145:4-12 LaBombarde) The BK Plans' unfunded liabilities would have increased by $11 million using an appropriate assumption. (P36; 3/4/97 Tr. 100:11-101:3 Langhans)
d) The April, 16, 1985 letter did not include all the accrued liabilities under the BK Plans for which BKC would be responsible; they only included vested liabilities for the underfunded Plans and nonvested benefits in the sufficiently-funded Plans only to the extent funded. The exclusion of these benefits was misleading in light of the fact that BKC had to keep the BK Plans ongoing.
65. In August 1985, Wyatt later "updated" its April 16, 1985 letter. (P458) In a letter dated August 13, 1985, Wyatt reported that as of July 31, 1985 the BK Plans' underfunding had decreased $6.6 million, to $40.2 million. (P458) The $6.6 million reduction corresponded to a calculated increase of $6.8 million in the overfunding in Plan 002 (from an $8.1 million excess reported for Plan 002 in the April 16, 1985 letter to a $14.9 million excess reported for Plan 002 in the August 13, 1985 letter). (P321, P458) This overfunding disappeared by closing a month later on September 27, 1985 — the excess assets in Plan 002 that BKC received on that date totaled only $8.5 million. (P816)
66. Wyatt's pre-sale letters inaccurately portrayed the amount of underfunding BKC was assuming. WCI was fully aware of that fact. In the first draft of the WCI-BKC Purchase and Sale Agreement, next to the language which requires WCI to warrant the representations made to the Buyer, one of SSD's lawyers wrote in the margin, "Except Wyatt; problem with Wyatt; Wyatt out!!!" (P414 at 27) In all subsequent drafts as well as the final Purchase and Sale Agreement, WCI expressly declined to warrant the accuracy of any representations made by Wyatt. (P414, P466, P469, P472, P408, P30) In an early draft letter of intent Hunt wrote "catastrophic if disclosed" next to the paragraph setting forth that the Buyer would assume the pension liabilities as quantified by Wyatt. (P14) In addition, according to a memorandum Ransom wrote in June 1985, Hunt announced that he would not entertain any questions about Wyatt's $46.8 million underfunding figure in the April 16, 1985 letter. (P23)
67. Wyatt's underfunding calculations performed specifically for the negotiations were inconsistent and unreasonable.
68. WCI contends that the difference between the $46.8 million and the $40.6 million figures reported by Wyatt and the $74.6 figure reported by Professor Logue is due in large part to the fact that Professor Logue based his calculations on a projected benefit obligation ("PBO") number, which takes into account pensioners' future salary increase, whereas Wyatt used an accumulated benefit obligation ("ABO") number, which does not take such increases into account. WCI contends that Wyatt's use of an ABO figure was proper.
69. As Professor Logue pointed out, however, a PBO figure should be utilized when valuing pension liabilities for an entity that is presumed to be a going concern, as was the assumption for the BK Businesses. (3/5/97 Tr. 26:20-27:5 Logue)
70. In any event, there was no substantial difference between a PBO and an ABO figure for the BK Plans because a large number of people were already retired and collecting benefits. (3/5/97 Tr. 27:6-25 Logue)
H. The Transaction
71. WCI controlled the drafting of all versions of the Purchase and Sale Agreement. (Tomsich, 242:3-10) Tomsich did not understand the pensions (3/13/97 Tr. 64:17-65:21 Hunt) and his principal negotiator, the Reverend Benjamin Lantz ("Lantz"), had never been involved in any prior corporate transactions. (3/6/97 Tr. 145:23-146:4, 186:24-187:6 Tomsich Depo; Lantz, 6:17-7:9). In fact prior to coming to NESCO, Lantz had spent his entire career in academia. (3/6/97 Tr. 144:11-25 Tomsich Depo; 3/13/97 Tr. 60:8-15 Hunt) Lantz's education and training were in Critical Biblical Research. (Lantz, 105:19-106:8)
72. On September 27, 1985, BKC and WCI executed a Purchase and Sale Agreement ("WCI-BKC Agreement") and related agreements whereby WCI transferred the BK Businesses to BKC. (P30) The major provisions of the WCI-BKC Agreement were as follows:
(a) WCI transferred and BKC acquired essentially all the assets of the BK Businesses plus a cash payment by WCI in the amount of $20 million. (P30 at ¶ 2.1.1-1.14) The assets of the BK Businesses retained by WCI included all cash and cash balances and all accounts receivable as of the closing date. (P30 at ¶ 2.2.1 — 2.2.13; 3/4/97 Tr. 29:17-30:1 Zimmerman)
(b) The "consideration" BKC was to give for the sale was the assumption of all liabilities of the BK Businesses including all current balance sheet liabilities, all liabilities with respect to the pension plans assumed, and all retiree and medical and life benefits. (P30 at ¶ 3.1, 8.1; 3/4/97 Tr. 31:14-16 Zimmerman)
(c) WCI warranted that there had been no material adverse change in the BK Businesses since August 31, 1985 EXCEPT
(i) the M60 contract was expected to expire in approximately seven months (P30 at ¶ 4.1.6); and
(ii) the BK Businesses continued to incur operating losses, to face substantial competition from foreign competitors, and to suffer from conditions affecting the industries in which they competed. (P30 at ¶ 4.1.6)
(d) WCI also warranted that no representation made by WCI in the WCI-BKC Agreement or in any writing furnished to BKC contained any untrue statement of material fact. (P30 at ¶ 4.1.24) However, excluded from the scope of the warranties were any analysis, valuation, or conclusion contained in any report or letter of Wyatt. (P30 at ¶ 4.1.25)
(e) In addition to the $20 million cash paid at closing, WCI was to pay BKC $20 million in five equal annual installments due on September 15, 1986 through 1990. (P30 at ¶ 5.1.8; 3/14/97 Tr. 64:23-65:2 Elliott) BKC executed an Irrevocable Assignment whereby these annual payments were assigned to the pension trusts. (P500) WCI also agreed to pay BKC $6 million for retiree medical and life insurance benefits and severance obligations, payable $2 million at closing and $2 million on the next two anniversary dates. (P30 at ¶ 5.1.9)
(f) BKC assumed the outstanding amounts owed under a $7.2 million Industrial Revenue Bond that had been issued by Duraloy Blaw-Knox to acquire new equipment. (P30 at ¶ 2.1.14) BKC executed a mortgage and security agreement securing this obligation. (P30 at ¶ 5.2.7, 2.1.14)
(g) BKC obtained a letter of credit in favor of WCI. WCI could draw down the funds if PBGC threatened to terminate the BK Plans or if BKC went into bankruptcy. (P30 at ¶ 7.2.7) BKC obtained the letter of credit with $15 million of the $20 million paid by WCI to BKC at closing. (3/4/97 Tr. 29:24-30:10 Zimmerman) WCI agreed to reduce the letter of credit by $5 million after 42 months plus $5 million on each anniversary thereafter, but only if there had not been a claim or demand asserted or threatened with respect to any of the assumed plans, BKC had made the required payments to the BK Plans, plan termination proceedings had not been initiated by BKC or PBGC, and BKC was not in bankruptcy. (P30 at ¶ 7.2.7(b); 3/4/97 Tr. 34:9-35:6 Zimmerman)
(h) While the letter of credit was outstanding, BKC was not permitted to return any capital contributed in cash, sell assets except in arms-length transactions for fair consideration, make loans to majority shareholders, enter into transactions with shareholders except on an arm's-length basis, or guarantee obligations of majority shareholders. (P30 at ¶ 5.2.13; 3/14/97 Tr. 65:5-9 Elliott; 3/4/97 Tr. 32:1-22 Zimmerman)
(i) During the first year after closing BKC had to provide WCI with monthly income statements and balance sheets. (P30 at ¶ 5.2.14) During the second through fifth years, BKC provided WCI with quarterly income statements and balance sheets as well as certified annual financial statements. (P30 at ¶ 5.2.15, 5.2.16; 3/14/97 Tr. 65:10-19 Elliott)
(j) BKC assumed all of the following pension plans associated with the employees and retirees of the BK Businesses: Plans 002, 003, 004, 052, 053, 054, 055, 056, and 009 (the BK Plans). (P30 at ¶ 6.1) Plans 003 and 002 also included employees and retirees of four Blaw Knox plants which WCI closed prior to the sale because of underutilization and obsolescence of those plants. One of these plants had been closed since 1968. The total amount of unfunded pension liability associated with closed plants that were never owned or operated by BKC was $16 million. (3/14/97 Tr. 79:17-81:25 Elliott; P217; P92 at 006219)
(k) BKC succeeded to all rights and obligations of WCI under the assumed plans, including full responsibility for all liabilities and obligations of the plans whether contingent, known, or unknown. (P30 at ¶ 6.4.1.-6.4.3; 3/14/97 Tr. 82:1-84:7 Elliott) BKC agreed to indemnify and hold WCI harmless for all benefits under the assumed plans, the minimum funding obligations of the plans, and the termination of any assumed plans. (P30 at ¶ 6.4.3; 3/14/97 Tr. 82:1-84:7 Elliott)
(l) BKC agreed that for each plan year after closing, until and including 1990, it would contribute to the plans an amount no less than the greater of (i) the amount necessary to satisfy the minimum funding required by § 412 of the IRS Code and § 302 of ERISA; and (ii) the amount necessary to satisfy the minimum funding required by the terms of the Plans; but under no circumstances could the aggregate contribution total less than $400,000 for 1985 or less than $1.2 million for 1986-90. The obligation under both clauses (i) and (ii) were determined without regard to any credit balance in the funding standard account carried over from any prior year, or transferred from another assumed plan. (P30 at ¶ 6.4.4)
(m) Until 1990, BKC was required to give WCI 30 days notice of the spin-off, division, merger, or transfer of assets or liabilities of any assumed plan. (P30 at ¶ 6.4.6)
(n) If an overfunded plan terminated prior to January 1, 1992, BKC had to use the excess to reduce unfunded liabilities in other plans. (P30 at ¶ 6.4.5)
(o) BKC agreed to recognize the unions and to offer employment to all BK employees covered by collective bargaining agreements (including employees on lay-off and call back) at the same wages, benefits, and conditions of employment provided by the union contracts in effect at closing. (P30 at ¶ 6.9)
(p) BKC was capitalized at $1 million of unencumbered capital. (P30 at ¶ 7.2.6; 3/4/97 Tr. 34:4-8 Zimmerman)
(q) At closing WCI delivered to BKC (1) a draft in the amount of $2 million; (2) a draft in the amount of $15 million endorsed over to the cash collateral account at Ameritrust; and (3) a draft in the amount of $5 million. (P30 at ¶ 9.2.7 — 9.2.8)
(r) Ameritrust granted BKC an approval of loans facility, capped at $15 million, with the amount of credit limited to 80% of BKC's qualified accounts receivable plus 25% of inventory. This loan was secured by Ameritrust's first lien on all the assets of BKC. BKC would be in default of the loan if, inter alia, a pension plan terminates or a claim or demand arising from the Plans is made against WCI. (3/14/97 Tr. 98:15-108:14 Elliott)
(s) BKC also entered into a security agreement with WCI which secured BKC's obligation under the WCI-BKC Agreement to assume the pension liabilities. WCI's security interest in all of the assets of BKC was subordinate to Ameritrust's first lien. BKC would be in default of the security agreement with WCI if a claim or demand arising from the assumed plans is made against WCI; or if PBGC or BKC initiated a plan termination. (3/14/97 Tr. 98:15-108:14 Elliott)
I. WCI's Expressed Purpose For The Sale To BKC
1) June 18 Memorandum
73. In a memorandum to WCI senior management, dated June 18, 1985, Hunt and Elliott compared the cost to WCI of doing the proposed Tomsich deal with the reserves established at year end 1984 for discontinuing these operations. (P1) The analysis showed that WCI saved $68 million by doing the Tomsich deal as compared with the planned disposition. (P1; 4/14/97 Tr. 157:13-159:23 Monheit) A small portion of the savings resulted from the fact that BK Foundry and Mill Machinery was being sold, not liquidated, and WCI therefore avoided shutdown and button-up costs for that division. By far, however, the largest component of the savings emanated from transferring the unfunded pension liabilities. (P1; 4/14/97 Tr. 157:13-159:23 Monheit) In the discontinued operations reserve, WCI estimated that it would pay $59.6 million to fund the BK Plans. (P1 at 49550) If it did the Tomsich deal, WCI estimated that it would pay only $17 million, the present value of $20 million in five annual installments. The $43 million difference that would flow to WCI from the Tomsich deal was the direct result of WCI not paying the unfunded pension liability. (P1 at 49550; 4/14/97 Tr. 157:13-159:23 Monheit)
74. The June 18 memorandum expressly stated that the "principal economic benefit to WCI" was the assumption by the buyer of the pension liabilities and the health and welfare obligations. (P1)
75. The June 18 memorandum also contained WCI's comparison of cash flows under two scenarios. Assuming that the net unfunded pension liabilities of the BK Plans were approximately $46 million as set forth in Wyatt's April 16, 1985 study, discussed infra, WCI estimated that it would have had to pay $184 million over 30 years if it kept all the obligations for retiree benefits in connection with its divestiture of the BK Businesses, after considering an up-front receipt of $32.5 million in proceeds. A full $152 million of that $184 million was directly related to defeasing the unfunded pension liabilities associated with the BK Businesses: $46 million to pay off the "principal" amount of the underfunding; $8 million for WCI's current contribution to the Plans; and $98 million for the "pension interest" that would allow WCI to pay off the liabilities on an ongoing basis over 30 years rather than all at once in a termination. (P1 at 49549) Under the proposed Tomsich deal, WCI anticipated having to pay out only a total of $25 million relating to the BK Plans. (P1 at 49550)
76. Hunt and Elliott did inform their superiors, however, that this "overall economic benefit" was "not without some risk to WCI." (P1) They mentioned the International Harvester case, and the fact that "[i]f Buyer fails in the early years of its operation, there might be an attempt by the Pension Benefit Guaranty Corporation (PBGC) . . . to cause WCI to pay the then unfunded pension liabilities." (P1) But since WCI would "be counseled throughout by Squire, Sanders Dempsey on this matter to minimize [its] exposure," Elliott and Hunt concluded that the economic benefit of the deal "far outweighs" the risk. (P1) Indeed, Hunt and Elliot included calculations which showed that WCI would be in substantially the same position on a cash-flow basis if the buyer failed within the first seven years after the deal and WCI ended up paying the transferred retiree liabilities. (P1)
2) WCI's Comparison Of The Tomsich Deal To A Cash Sale
77. Around the time of the June 18 memo, WCI also prepared an analysis that compared both the Tomsich deal and a cash sale "as is, where is" to estimates recorded in the discontinued operations reserve. (P910) The analysis showed that if WCI kept the liabilities and sold the assets of the BK Businesses "as is" for $47.4 million, that deal would produce a savings of $30.7 million over the discontinued operations reserve. (P910) This was not even half of the economic benefit ($67.6 million) produced by the Tomsich deal.
78. WCI offered evidence to attempt to prove that the economic benefit that flowed to WCI from the Tomsich deal was about the same as would have been produced by a conventional sale in which WCI kept the pension and retiree liabilities and the buyer paid WCI $38 million in cash. A letter dated June 21, 1985 from Wyatt to WCI states this conclusion. (P405) Reynolds, who wrote the letter, could not explain the calculations or how he arrived at $38 million. (3/11/97 Tr. 223:16-224:13 Reynolds Depo.) In addition, the conclusion in the June 21 letter, i.e. that the value to WCI of the Tomsich deal was equivalent to a conventional sale in which a buyer paid $38 million in cash cannot be reconciled with the analysis presented to senior management in the June 18 memorandum; that memo, written just three days earlier, compares the Tomsich deal to a cash sale for $32 million and concludes that the Tomsich deal makes WCI better off by $68 million. We conclude that the June 21 letter, although contemporaneous, is self serving and contrary to sound economic analysis and we give it little weight.
79. Moreover, it is important to note that there was no buyer willing to pay $38 million or $46 million for the BK Businesses. Only two potential buyers ever expressed a serious interest in the BK Businesses — neither of which offered to purchase the businesses for cash. (3/13/97 Tr. 118:15-119:4 Hunt; 3/14/97 Tr. 93:15-94:17 Elliott; 3/10/97 Tr. 56:4-58:7 Jarrell; P40 at ¶ 14) In the summer of 1985, WCI had a choice between the Tomsich deal and liquidating all the Businesses. It chose the Tomsich deal because it was $68 million better than its only alternative.
3) The Decision Of The Board
80. On July 26, 1985, Tomsich came back to WCI with what Reynolds characterized as "a bargaining ploy." (P447) Tomsich said that the "BK Businesses were not worth what he originally thought, that equipment was in poor shape, that prospects for turn-around were poor" and that he wanted WCI to do something about it. (P447; 3/13/97 Tr. 135:23-138:23 Hunt)
81. Four days later, on July 30, 1985, the WCI Board of Directors approved the deal as proposed in the letter of intent on the condition that the definitive agreement not reflect more than a $10 million adverse variance from the projected $68 million in savings from the originally booked pre-tax loss. (P24) Saving at least $58 million was the sine qua non of the Board's approval. (P24)
82. At trial, a member of the Board who participated in the decision testified that one of the Board's goals in approving the deal was to realize the significant economic benefit that resulted from BKC assuming the unfunded pension liabilities. (3/13/97 Tr. 109:22-111:11 Cyert) He did not disagree with the characterization of Hunt and Elliott in their June 18 memorandum that the "principal" economic benefit was BKC's assumption of the liabilities. (3/13/97 Tr. 109:22-111:11 Cyert)
4) Implementation Of The Board's Decision
83. After the Board made its decision to save money by transferring the pension obligations, senior officers of WCI implemented that decision. On August 6, 1985, Tomsich proposed a significant change in the deal because of his concerns about cash flow and the annual pension contribution of $7,809,000. (P421; Tomsich, 223:23-225:5) In this modified deal, Tomsich would have assumed substantially less pension liability than he had previously agreed to assume. (P458; P464; Hunt, 246:21-247:13, 248:20-249:22) He would also require WCI to keep BK Foundry Mill Machinery. (P421) Hunt testified that at this time in early August the deal was "limping very, very badly." (3/13/97 Tr. 138:20-22 Hunt)
84. At the request of Hunt, Wyatt prepared the August 13, 1985 actuarial study of the BK Plans as of July 31, 1985, assuming that WCI would retain the pension obligation for all retired and vested terminated employees and all participants employed at East Chicago. Under Hunt's scenario, Wyatt concluded that the aggregate unfunded liability of the BK Plans was $40.2 million, of which $32.8 million would remain with WCI and $7.4 million would transfer to the buyer. (P458)
85. On August 13, 1985, Hunt prepared an analysis of the deal, comparing: (1) the discontinued operations reserve as recorded in December 1984; (2) the deal presented to the Board of Directors on July 30, 1985; (3) a deal in which Tomsich would not take East Chicago or retiree liabilities (Tomsich's proposal as of 8/6/85); and (4) a deal in which Tomsich would take East Chicago and all retiree liabilities. (P25) As calculated by Hunt on August 13, 1985, the deal without the buyer taking East Chicago or assuming retiree liabilities (Tomsich's proposal as of 8/6/85) only produced an estimated reduction to the originally estimated pre-tax loss of $43,157,000, and thus did not fit within the parameters established by the Board of Directors on July 30, 1997. (P25)
86. Hunt knew that he had to get the deal back within the board's parameters. (3/13/97 Tr. 138:5-8 Hunt) Thus, on August 14, 1985, Hunt met with Tomsich, on Tomsich's yacht, and convinced Tomsich to take East Chicago and the retiree liability. (P464; Hunt, 234:14-235:3) Hunt told Tomsich that even with the East Chicago shutdown the Army would be obligated to pay all of East Chicago's shut-down expenses, unfunded pension and medical benefits, plus the equipment which would result in a $5 million gain. (3/3/97 Tr. 186:15-24 Tomsich Depo.; Tomsich, 242:22-243:17) Tomsich believed, therefore, that the payment by the Army for pensions was going to cover the entire unfunded liability at East Chicago. (Tomsich, 242:18-22) Thus, Tomsich agreed that he would again take East Chicago and assume the retiree liabilities. (Hunt, 358:2-359:9)
5) August 21 Memorandum
87. Shortly thereafter, in an August 21, 1985 memorandum from Hunt and Ware to certain WCI Board members, Hunt and Ware stated that the deal as agreed upon with Tomsich was "the highest practical value obtainable for the operating units included in this package and is in excess of the values estimated by Lehman." (P27) They also stated that the Tomsich deal is "within the guidelines established by the Board of Directors at its July 30, 1985 meeting." (P27)
J. WCI's Structuring Of The Transaction
88. WCI was aware of the International Harvester case and of proposed legislation which contained provisions whereby a seller would have contingent liability for a five year period following the sale of assets and transfer of pension liabilities. (P327) SSD advised WCI that, although not enacted, this proposed legislation could reflect PBGC's current position. (P327)
89. SSD advised WCI that PBGC's current position in 1985 was that predecessor liability could be imposed for five years after a transaction. (3/14/97 Tr. 31:18-35:1 Elliott; P327) Thus, WCI designed the transaction to keep BKC afloat for five years, and to protect WCI in the event that BKC failed despite its plan to keep it going during this time period. (3/5/97 Tr. 159:3-12 Hunt Depo.; 3/14/97 Tr. 62:16-69:8 Elliott; 3/4/97 Tr. 41:10-46:7 Zimmerman)
90. Tomsich must be presumed to be a rational economic actor. No rational economic actor would buy the assets of the BK Businesses (worth no more than $32-36 million) for $98.3 million (the total $74.6 million in unfunded pension liabilities and $23.7 million in health and welfare benefits we find that BKC assumed in September, 1985) if that buyer actually had to pay the liabilities. (P37; FF 59-61) Therefore, the predominant source of economic gain to WCI and Tomsich in the transaction was the high likelihood that the $74.6 million in unfunded pension liabilities of the BK Plans would eventually be transferred to PBGC. (3/4/97 Tr. 23:18-23 Zimmerman; 3/5/97 Tr. 162:8-163:22 Tomsich Depo.; 3/6/97 Tr. 50:6-51:20 Hunt Depo.; P1; P39; P839)
91. WCI knew that it could be exposed to potential liability to PBGC for the BK Plans' unfunded liabilities, but believed that this risk was minimized if the Plans were ongoing for five years after the closing of the WCI-BKC sales transaction. (3/14/97 Tr. 31:18-35:1 Elliott) Therefore, WCI had strong economic incentives to make sure BKC survived for five years. (3/4/97 Tr. 36:9-46:21 Zimmerman; P39) WCI was gambling that, if the Plans terminated after five years, PBGC would not pursue WCI, the predecessor employer. (P1; P10)
92. Indeed, WCI and Tomsich in effect financed the transaction with PBGC's funds.
93. Many provisions of the WCI-BKC Agreement were designed to reduce the likelihood of BKC failing or the BK Plans terminating in the five years after the sale. WCI's payment of $20 million to the pension plans over five years insured that minimum contributions would be made for five years regardless of BKC's ability to generate the cash to pay them. (P30 at ¶ 5.1.8; P36 at p. 7)
94. WCI monitored BKC's finances for five years after the sale. (P30 at ¶ 5.2.14-5.2.16) It also retained substantial decision making control over BKC's dividend policy, incentive contracts, investment strategy, financing policy and administration of the BK Plans. WCI's control strangled Tomsich's ability to make independent entrepreneurial decisions but allowed WCI to manage its risk. (3/4/97 Tr. 32:1-33:25, 41:17-42:5, 56:1-23 Zimmerman)
95. The letter of credit was a device whereby WCI could police BKC's compliance with the covenants contained in the WCI-BKC Agreement for five years. If BKC failed to make pension plan contributions or took actions to jeopardize the viability of the WCI-BKC Agreement, then WCI could withdraw money from the letter of credit, thereby making BKC liable for those funds. (3/4/97 Tr. 41:10-46:21 Zimmerman; P39 at p. 10)
96. The legal and other costs associated with the creation of the various Ameritrust agreements came to approximately $450,000 — about half the equity contributed by Tomsich's buying group. (3/4/97 Tr. 41:17-44:8 Zimmerman) There were less expensive ways of structuring this deal if WCI only wanted to dispose of the BK Businesses. (3/4/97 Tr. 41:17-45:23 Zimmerman) WCI knew that it could be liable for the pension liabilities, however, so it bought a lot of security and insurance to make sure that BKC survived for five years and the pension liabilities did not revert back to WCI pursuant to either International Harvester or the proposed legislation. (3/4/97 Tr. 42:18-46:7 Zimmerman)
K. The $20 Million Payable By WCI Over 5 Years Was Not Designed To "Equalize" The Values In The Transaction
97. WCI attempted to legitimize the economics of the transaction by taking the position that the assets and liabilities transferred to BKC were equal. WCI presented evidence attempting to demonstrate that WCI witnesses testified that the total liabilities exceeded the assets only by $20 million and that was the reason for WCI's $20 million payment to the plans over five years. WCI's evidence was unconvincing.
98. For example, WCI's theory depends upon using the numbers that were supposedly used by the parties in August and September of 1985 when the deal was finalized. (3/12/97 Tr. 198:11-19 Stillman) WCI therefore claims that the assets plus WCI's $20 million contribution equal the liabilities IF the pension liabilities were $35 million. As previously noted, however, the value of the unfunded pension liabilities transferred to BKC was approximately $74.6 million. (3/5/97 Tr. 22:22-35:15 Logue; P37)
99. An analysis of the WCI-Tomsich June 18, 1995 letter of intent also casts substantial doubt on WCI's claim that the payments to the pension plans were always designed to equalize values, even at the time the letter of intent was signed.
100. Pursuant to WCI's claim, the value of the BK Businesses' assets at the time of the June 18, 1995 letter of intent was $61 million, as shown below.) 17 (millions) (millions) 8
Items going to BKC (a) Assets $61 (b) WCI payments to pension plans l i a b i l $78 i t i e s ( P. V. Items benefiting WCI (c) Pension liabili ties assumed by BKC $47 (d) Health welfare liabili ties assumed by BKC 23 (e) Cash and notes from Tomsich $78 (a) Because all other numbers in this chart are known, the value of the assets is derived mathematically. (b) Present value of the WCI pension payments. (P1 at 76277) The letter of intent did not provide for WCI to make payments for health and welfare benefits. (P1 at 76263-69; 3/12/97 Tr. 204:22-205:2 Stillman) (c) (P23 (6/24/85); P22 (notes recording 6/19/85 meeting)) (d) Adjusted from incorrect estimate of $36 million. (3/12/92 Tr. 203:3-7 Stillman) (e) (P1 at 76277) 101. The $61 million value for the assets is far outside the range of $30-40 million used by the experts from both sides and well above the high end of the Lehman range. (3/4/97 Tr. 35:7-39:5 Zimmerman)
L. Contemporaneous Documents Indicate That WCI Structured The Transaction To Keep BKC Alive For Five Years
102. Further evidence that WCI structured the transaction in order to keep BKC alive for five years to evade the pension liabilities to PBGC is shown in other memoranda and written notes prepared at the time of the WCI-BKC sales transaction.
103. On June 10, 1985, WCI executive Ware told Ralph Nehrig, an associate of Tomsich, that WCI was "concerned about getting the five year period behind them." (P16)
104. The day after WCI and Tomsich signed the June 18, 1995 letter of intent, Ransom met with WCI executives, its in-house counsel, and its actuaries, and noted that WCI wanted the buyer to maintain the plans for at least five years. (P19) Ransom recognized that one advantage to this approach was that the deal "may look better to PBGC" and "doesn't look as much like a dumping." (P19)
But Ransom also recognized that the five year limit could look more like an evasion. (P19; Ransom, 423:9-425:14) Ransom further noted that WCI gained an advantage by the buyer maintaining the BK Plans for at least five years because "it should take WCI off statutory hook (except for new legislation)." (P19) Ransom identified other advantages to WCI if the buyer maintained the plans for at least five years noting that:
"(4) net worth might increase and give WCI more protection for that reason — even before end of 5 year period — than immediate termination.
(5) [except] for reportable event filing, would not invite PBGC in." (P19)
105. At this meeting, Hunt directed the participants to "push aside" any thought of immediate termination of the Plans. (P22) Hunt said that the first draft of the WCI-BKC Agreement should require continuation of the BK Plans until 1990 (or five years). (P22)
106. When drafting the WCI-BKC Agreement, Ransom struggled over the issue of where to place the obligation of the buyer to maintain the BK Plans for at least five years. (P23) Ransom recognized that "although such commitment could be included in paragraph A.4," "it might withstand PBGC's scrutiny better if it were placed in a separate section." (P23)
107. Shortly before the final agreement, BKC requested financing from Ameritrust. In the course of evaluating the credit request, Ameritrust was informed that "WCI feels it could be obligated on the past unfunded pension obligation . . . for up to five years (the PBGC can go after them) if BKC does not fund the required payments annually." (P29)
108. Tomsich also understood that the five year period was important to WCI because its potential liability to PBGC would disappear five years after the transfer of the liabilities. (3/6/97 Tr. 165:21-169:9 Tomsich Depo.)
109. Nonetheless, several WCI witnesses testified during trial that the deal ultimately struck between WCI and Tomsich was structured as it was to protect WCI from strict liability under section 4064. Specifically, WCI asserted that the letter of credit was structured to decline over five years to follow the declining liability provided for in section 4064. Such testimony was not credible. The letter of credit did not decline in even increments over five years. (P510) In fact, WCI initially did not agree to release any portion of the letter of credit until 3 1/2 years after the close of the transaction. (P510; 3/11/98 Tr. 140:3-143:25 Ransom) Additionally, the original draft letter of intent which was sent to Tomsich and Cvengros provided for a 10 year declining letter of credit. (3/11/97 Tr. 142:12-25 Ransom) Moreover, in a key memorandum which described the letter of intent that WCI ultimately executed with Tomsich, Hunt and Elliott told senior management that the transaction posed some risk to WCI of liability under International Harvester. (P1) The memorandum does not even mention § 4064. (P1) If the architects of the deal had structured the transaction to avoid liability under § 4064, one would expect that they would have conveyed this to senior management and WCI's Board.
M. WCI Knew That BKC Could Not Satisfy The Pension Obligations
110. WCI witnesses testified that at the time of the transaction, WCI believed that BKC would succeed. WCI offered this testimony to respond to PBGC's evidence that WCI intended to evade pension liability. WCI contends that because it reasonably believed that BKC could survive long-term and satisfy the pension obligations, it did not intend to use BKC as a conduit to dump the BK Plans' unfunded pension liabilities on PBGC. The testimony of WCI witnesses that they believed BKC would succeed, is contrary to the objective facts and is not credible. Sophisticated, reasonable business people, such as Hunt and Elliott, could not reasonably have expected BKC to survive and to satisfy $74.6 million in pension liabilities along with all the other debts transferred.
1) BKC Was Insolvent
111. One reason why WCI could not reasonably have expected BKC to survive and satisfy the transferred pension obligations was that BKC was materially insolvent as of September 27, 1985. (3/10/97 Tr. 43:14-44:10 Jarrell; P40 at ¶ 54) PBGC expert witness Gregg A. Jarrell, Ph.D., ("Professor Jarrell") performed an analysis which showed that the negative net worth of BKC as of September 27, 1985 was somewhere between $22 and $51 million. (3/10/97 Tr. 17:19-18:13 Jarrell)
112. Professor Jarrell's discounted cash flow analysis placed a value of approximately $36 million on the assets of BKC. (3/10/97 Tr. 40:9-42:8 Jarrell) The 13.2% discounted rate which he chose for this analysis was very conservative. (3/10/97 Tr. 20:1-18 Jarrell.)
113. Professor Jarrell, in performing his discounted cash flow analysis, took into account several possibilities for levels of capital expenditure by BKC and also whether the cost savings measures projected in the BKC business plan (P3) were achieved. (3/10/97 Tr. 32:13-42:8 Jarrell) At the mid-point of these calculations, was approximately a $36 million value for the assets of BKC. (Id.)
114. Even after a $5 million annual level of capital expenditures from the period 1988 through 1991, the fixed asset turnover is 5.7 for 1991, up from 4.0. (3/10/97 Tr. 47:1-5 Jarrell) That is still a conservative assumption.
115. Professor Jarrell performed a number of "ballpark checks" for the reasonableness of his asset calculation. (3/10/97 Tr. 47:7-14 Jarrell) Professor Jarrell's valuation of the assets was consistent with the number used by Lehman Brothers at the time it was attempting to market the divisions. (3/10/97 Tr. 47:17-48:21 Jarrell)
116. In addition, the BKC business plan (P3) placed a liquidation value of $37.5 million on the assets. (3/10/97 Tr. 49:5-52:3 Jarrell) This $37.5 million figure used in the BKC business plan (P3) did not include the industrial revenue bond amount of approximately $8 million. (3/10/97 Tr. 51:11-18 Jarrell) WCI's expert, Dr. Stillman, conceded this point. (3/12/97 Tr. 190:4-9 Stillman)
117. The efforts by Lehman Brothers to sell the Blaw Knox divisions further confirmed the asset value calculated by Professor Jarrell. (3/10/97 Tr. 56:2-61:1 Jarrell)
118. Professor Jarrell's analysis showed that BKC had just enough cash to make it through 1990. (3/10/97 Tr. 67:4-21 Jarrell) In 1991, the first year in which WCI did not contribute to the pension plans, the cash flow of BKC would be negative. (3/10/97 Tr. 67:17-70:2 Jarrell; P40 at Exh. I.) Thus, the capital structure of BKC was designed to get it through the first five years.
119. Professor Jarrell also showed convincingly that the capital structure of BKC was insufficient to withstand a reasonably likely economic downturn. His calculations showed that, based upon the Tomsich projections, plus an assumed $5 million of "steady state" capital investment for the period 1988 through 1991 (excluding any cost savings), BKC had just enough cash to make it through 1990. (3/10/97 Tr. 67:4-68:1 Jarrell)
120. Professor Jarrell demonstrated that the analysis of WCI's expert, Dr. Stillman, showed that BKC was insolvent by at least $34 million by mid-1987. (3/10/97 Tr. 70:5-72:20 Jarrell)
121. WCI's expert Mr. Monheit criticized Professor Jarrell's analysis contending that he did not take into account that BKC could increase its cash flow by borrowing money. 3/10/97 Tr. 86:9-87:18 Jarrell)
122. First, there was no credible evidence that BKC had the ability to obtain additional credit. Indeed, Ameritrust canceled BKC's line of credit in September 1990. (P735)
123. More importantly, BKC's potential ability to borrow more money in 1991 is not probative on the issue of BKC's insolvency. (3/10/97 Tr. 86:9-87:18 Jarrell)
124. As Professor Jarrell pointed out, the ability "to go out and borrow money does not make the company not insolvent. It's like the family that's insolvent. If your family is insolvent on your own personal financial balance sheet, your asset values are insufficient to meet your liabilities, including credit card debt. Observing that you might be able to go out and get some additional credit cards against which you can borrow money does not magically make you become solvent. What that does is, even if it's true that you could get those credit cards, what that does is it puts off the inevitable, and it makes the consequences even worse." (3/10/97 Tr. 87:7-18 Jarrell)
125. In any event, Ameritrust in fact canceled BKC's line of credit in September 1990. (P735)
126. WCI also attempted to show that external factors such as unexpected deterioration of the steel industry caused BKC to fail. This showing was also unpersuasive, however, as there was no significant deterioration in the market value of the equity of steel companies in the period 1985 through 1987. (3/10/97 Tr. 89:8-90:13 Jarrell)
2) BKC Could Not Meet Its Pension Contribution Requirements
127. Prior to the transaction, WCI contributed approximately $10 to $12 million to the BK Plans for each plan year from 1980 through 1984, and the Plans paid out approximately $10 to $12 million in benefits each year. (P93-138; Joint Statement of Uncontested Facts (Doc. No. 171) at paras. 289-298) WCI had to know that WCI's $4 million annual contribution plus whatever minimal amount BKC could generate would be (1) significantly less than WCI had paid in recent years; (2) insufficient to pay the accruing interest on the liability; and (3) far less than the amount of benefits being paid out. (P93-138; 3/5/97 Tr. 39:1-44:15 Logue; P36; P38)
128. After the transaction, the combined contributions by WCI and BKC were, in fact, dramatically less than WCI's historical contributions. For plan year 1985, BKC was not able to make any contributions, and the total amount of benefits paid out equaled at least $12 million. For plan year 1986, BKC contributed $2.3 million, and the total amount of benefits paid out equaled $19.1 million. For plan year 1987, BKC contributed $2.4 million, and the total amount of benefits paid out equaled $20.5 million. For plan year 1988, BKC contributed $887,000, and the total amount of benefits paid out equaled $20.5. For plan year 1989, BKC contributed $6.6 million, and the total amount of benefits paid out equaled $24.5 million. For plan year 1990, BKC contributed $517,000, and the total amount of benefits paid out equaled $20.7 million. (P36 at Table 2)
129. For plan years 1985 through 1990, BKC was required to contribute a total of $29.6 million under the WCI-BKC Agreement; it actually contributed only $12.7 million. (P36 at 10) WCI was aware of, and agreed to these reductions because it knew that BKC could not afford to make the contractually-required contributions. (P651; P657; P667; P670; P677)
3) Post-Sale Dispute
130. Shortly after the sale, a dispute developed between WCI and BKC over inter alia, the amount of unfunded pension liabilities BKC had assumed in the transaction (the "post-sale dispute"). (3/13/97 Tr. 123:24:-124:11 Hunt; Kuendig, 79:23-80:23; P559) BKC complained that WCI had made misrepresentations about, and had understated, the pension liabilities assumed by BKC. (P602)
131. In an attempt to resolve the post-sale dispute, BKC's actuary, Kuendig, requested access to critical information from WCI and its actuary, Reynolds, but did not receive such information. (P764; Kuendig, 70:11-15 (1/1/85 employee data); P580 (amount of dedicated assets in each plan over the years); P587 (photocopies of Wyatt's worksheets)) WCI was aware of, and actively participated in, the post-sale dispute and the exchange or non-exchange of requested information. (P558; P575; P593, P562) Elliott negotiated the post-sale dispute on behalf of WCI and Hunt negotiated for BKC. (3/13/97 Tr. 123:24-124:6 Hunt; P32) Elliott was glad that Hunt was involved in the post-sale dispute so Hunt could "influence Lantz to abandon his ridiculous positions." (P32; 3/13/97 Tr. 124:25-125:6 Hunt)
132. Elliott sent Hunt a letter dated July 25, 1986 which outlined WCI's position on the issues involved in the post-sale dispute. (P602) Elliott wrote, "it is in both our interests to get this matter behind us. Litigation or any other public airing of the dispute would bring unwanted attention from the government and jeopardize all of Blaw Knox." (P602)
133. Hunt, Elliott and Reynolds participated in a conference call on July 31, 1986 about the dispute. (P 32; 3/13/97 Tr. 126:16-24 Hunt) Hunt read Elliott and Reynolds a letter he had drafted in response to Elliott's July 25, 1986 letter, which stated, inter alia that "[o]nly by determining the net unfunded liability for the employees, other than the Retirees, can you really get back to the economic basis on which the [WCI-BKC] transaction was concluded." (P32; P606; 3/13/97 Tr. 125:11-129:17 Hunt)
134. Even though Elliott and Reynolds agreed that Hunt's draft letter was accurate, Elliott told Hunt not to share the letter with people from BKC if it was a "smoking gun" and would damage WCI. (P32; P606; 3/13/97 Tr. 129:18-22, 131:11-13 Hunt)
135. The real value of the liabilities of the nonretiree pension plans would be a "smoking gun".
136. Elliott stated that disclosure of such information would violate Hunt's confidentiality agreement with WCI. (P606; 3/13/97 130:1-5 Hunt) Elliott instructed Hunt to send him and Reynolds a copy of his draft letter and "not to discuss it with [Tomsich] or his team." (P32; 3/13/97 130:10-14 Hunt)
137. Elliott informed Hunt that if he had knowledge of a "smoking gun" he was to participate in a cover-up. (P32) Hunt was "so angry" that he wrote five pages of notes regarding his conversations with Elliott. (P32; 3/13/97 Tr. 130:15-131:13 Hunt) Specifically, Hunt wrote, "It was `not okay' and with [Elliot's] threat of violating a confidentiality agreement to tell the truth re pension issue if it reveals that BK was harmed." (P32) Hunt further wrote, "If I had knowledge that was in effect a `smoking gun,' I was to participate in a cover up." (P32) Hunt testified, "I felt threatened [by Elliott]." (3/13/97 Tr. 133:2-4 Hunt)
138. A few weeks later, Elliott (on behalf of WCI) and Hunt (on behalf of BKC) settled the dispute. (P738) The settlement agreement signed by Hunt and Elliott restricted both BKC and WCI from suggesting, alleging, or asserting that either BKC or WCI had "engaged or acquiesced in any action, policy or practice that would constitute a violation of any statute or any regulation or ruling of a governmental agency, department or entity." (P738) If either BKC or WCI went to PBGC, the entire settlement agreement was off. (P738; 3/14/97 Tr. 19:15-20:20 Hunt)
4) Ameritrust Knew BKC Was Failing
139. The evidence establishes that Ameritrust's extension of credit to BKC was not an indication of BKC's financial viability or creditworthiness. (3/14/97 Tr. 98:15-108:14 Elliott)
140. Ameritrust knew that BKC was financially distressed, and between 1985 and 1990, reduced and eventually canceled the credit extended to BKC. (3/14/97 Tr. 98:15-108:14 Elliott)
141. Ameritrust's main concern in making a loan to BKC was to be sure that, if a pension plan terminated, it could be repaid in cash before PBGC asserted a superior lien against BKC's fixed assets. (3/14/97 Tr. 98:15-108:14 Elliott)
142. Ameritrust set-up a lock box arrangement for collection of all BKC's receivables. (3/14/97 Tr. 98:15-108:14 Elliott)
143. Indeed, Ameritrust was confident that it would be repaid in full from cash in the lock box plus current receivables before PBGC could take any action. (3/14/97 Tr. 98:15-108:14 Elliott)
144. Moreover, in January 1987, BKC asked Ameritrust to increase its credit facility from $15 million to $25 million. (P636) After reviewing BKC's financial condition, Ameritrust concluded that BKC's "operating performance is terrible," and denied BKC's request. (P634)
145. By May 1987, BKC was on Ameritrust's "watch list," and considered "Blaw Knox to be in a liquidation mode." (P641; P644)
146. By June 1987, Ameritrust advised BKC of its concern with BKC's continuing losses "which show no sign of abating," the inability of BKC to make "accurate financial forecasts and projections," and the "continued deterioration" of BKC's balance sheet. (P646)
147. Even after BKC reduced its outstanding loan amount with proceeds from the sale of its gratings operations in Broadview, Illinois and Jackson, Mississippi, Ameritrust still graded BKC's credit performance as "substandard." (P694; P696)
148. In August 1989, Ameritrust noted that BKC's current cash flow would be "insufficient" to pay the additional $4 million annual pension contributions once WCI ceased its payments in 1990. (P712)
149. On August 1, 1990, Ameritrust advised BKC that it was terminating its credit facility as of September 30, 1990. (P735) Ameritrust noted that "[t]he approval of loans facility, which is intended to help finance Blaw Knox's working capital needs, has instead been used to fund cash losses." (P735)
5) WCI Released Its Liens So BKC Could Sell Its Assets And Pay Its Debts
150. As the BK Businesses continued to fail, WCI, notwithstanding its security interests, allowed Tomsich to liquidate the BK Businesses over a five year period.
151. In July 1986, WCI released the lien on the Broadview, Illinois Blaw Knox Equipment plant. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
152. In June 1987, WCI released the lien so BKC could sell Aetna Standard. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
153. In 1987 and 1988, the equipment and machinery at East Chicago was sold, and eventually WCI released the lien on East Chicago's real estate. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
154. In January 1988, WCI released the lien on the Blaw Knox Equipment grating plant in Jackson, Mississippi.
155. In January 1988, WCI released the lien on the Blaw Knox facility in Blaw Knox, Pennsylvania. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
156. Ultimately, WCI released the lien on the Warwood facility. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
157. Based on our review of the evidence, we find that WCI released its liens on the BK Businesses, thereby permitting BKC to liquidate these businesses, so BKC could survive for five years. (3/14/97 Tr. 76:13-16, 86:1-87:9 Elliott)
II. Conclusions Of Law
A. Count One — Sham Transaction Under Section 1362
Count One of PBGC's amended complaint alleges that the sale to BKC was a sham transaction designed to avoid pension liability. PBGC argues, therefore, that the sale should be disregarded and WCI should be held liable for the pension liabilities under Section 1362 as the employer on the date the plans terminated.
Section 1362 reads in relevant part:
Liability for termination of single-employer plans under a distress termination or a termination by corporation
(a) In general
In any case in which a single-employer plan is terminated in a distress termination under section 1341(c) of this title or a termination otherwise instituted by the corporation under section 1342 of this title, any person who is, on the termination date, a contributing sponsor of the plan or a member of such a contributing sponsor's controlled group shall incur liability under this section. The liability under this section of all such persons shall be joint and several. . . .29 U.S.C. § 1362.
PBGC's amended complaint asserted two independent theories of liability under Section 1362, the sham transaction doctrine at Count One and the implicit predecessor liability rule, as recognized in In re Consol. Litig. Concerning Int'l Harvester's Disposition of Wis. Steel, 681 F. Supp. 512 (N.D.Ill. 1988), at Count Three. As we discuss infra, the Third Circuit dismissed Count Three based on its conclusion that Section 1369 now specifically governs predecessor liability, making it improper to apply the implicit predecessor liability rule of International Harvester.
The Third Circuit has defined a sham transaction as "one that `is fictitious or . . . has no business purpose or economic effect.'" PBGC v. WCI, 998 F.2d at 1201 (quoting Lerman v. Commissioner of Internal Revenue, 939 F.2d 44, 53 (3d Cir. 1991) (quoting DeMartino v. Commissioner of Internal Revenue, 862 F.2d 400, 406 (2d Cir. 1988))). The Court noted that "[t]he sham transaction doctrine, originally developed in the context of tax cases, dictates that the substance and not the form of a transaction controls the tax consequences triggered by an event." PBGC v. WCI, 998 F.2d at 1201 (citing Diedrich v. Commissioner of Internal Revenue, 457 U.S. 191, 196 (1982); Knetsch v. United States, 364 U.S. 361, 367 (1960)).
The exact meaning and practical application of this definition has been the subject of much debate among the parties. Citing to Gregory v. Helvering, 293 U.S. 465 (1935), one of the originating cases of the sham transaction doctrine, PBGC argued on its previous appeal that a transaction may qualify as a sham even if it has a purpose and effect in addition to tax avoidance. PBGC contended PBGC v. WCI, 998 F.2d at 1201 (citing Gregory, 293 U.S. at 469). that the transaction in Gregory had dual objectives, to obtain personal profit from the sale of stock and to avoid personal income tax, yet the Supreme Court held that it was a sham. PBGC v. WCI, 998 F.2d at 1201. WCI argued in response that a transaction that is even partially motivated by a legitimate business purpose, such as a desire to dispose of an unprofitable business, does not qualify as a sham.
In Gregory, the taxpayer was the sole shareholder of Corporation A, which held some shares of Corporation B. The taxpayer wanted to transfer the shares of Corporation B to herself, and sell them for a profit. If Corporation A distributed the shares to the taxpayer as a dividend, their value would be taxable as ordinary income. To achieve the same result but receive preferential capital gain tax treatment, the taxpayer formed Corporation C, to receive the shares and then dissolve. Upon dissolution, Corporation C distributed its only asset, the Corporation B shares, to the taxpayer. The taxpayer argued that the transaction should be treated as a corporate reorganization. The Supreme Court held that the transaction was a sham and should be ignored to calculate the resulting income tax.
The Third Circuit concluded that its definition of a sham transaction was consistent with Gregory because in that case, the Supreme Court held that "`the sole object and accomplishment of [the transaction] was the consummation of a preconceived plan, not to reorganize a business or any part of a business, but to transfer a parcel of corporate shares to the petitioner.'" PBGC v. WCI, 998 F.2d at 1202 (quoting Gregory, 293 U.S. at 469). The Court concluded, therefore, that the structure of the transaction in Gregory — "the creation of Corporation C and the elaborate indirect method utilized to move the shares from Corporation A to the taxpayer accomplished nothing other than tax avoidance." PBGC v. WCI, 998 F.2d at 1202.
The Court stated that PBGC had acknowledged that BKC had been losing a significant amount of money each year and that "[d]isposing of an unprofitable operation is a legitimate business purpose." Id. The Court noted, however, that it was unclear from the pleadings whether disposing of operating losses was a factor in WCI's decision to sell the BK Businesses and accompanying BK Plans. Id. The Court reversed the district court's dismissal of PBGC's sham transaction claim because PBGC had asserted in its amended complaint that "WCI was motivated solely by a desire to be relieved of pension liabilities. . . ." Id.
Other than providing a blanket definition and a brief recitation of Gregory's facts, the Third Circuit provided little guidance as to the practical application of the sham transaction doctrine. WCI argues that the rule to be taken from the Court's decision is that as long as a desire to dispose of unprofitable operations played some role, no matter how small, in WCI's decision to sell the BK Businesses and divest itself of the BK Plans, the WCI-BKC transaction cannot be considered a sham because it would not have been motivated solely by a desire to shed pension liabilities. We disagree.
Although the Third Circuit has not applied the sham transaction doctrine in the context of an ERISA case, the Court relied on the tax case definition when defining the doctrine for the instant action. The Court most recently applied the doctrine in ACM Partnership v. Commissioner of Internal Revenue, 157 F.3d 231 (3d Cir. 1998). In ACM, the Court reviewed a Tax Court decision disallowing Appellant ACM's recognition of a large capital loss which the Tax Court had characterized as a "phantom loss from a transaction that lacks economic substance." 157 F.3d at 245. The Court recognized that even though ACM's activities satisfied the literal requirements of the pertinent statutory language, the relevant inquiry was whether the substance of ACM's transaction was consistent with its form. Id. at 246.
The Court explained that,
pursuant to Gregory, we must "look beyond the form of [the] transaction" to determine whether it has the "economic substance that [its] form represents," Kirkman v. Commissioner, 862 F.2d 1486, 1490 (11th Cir. 1989), because regardless of its form, a transaction that is "devoid of economic substance" must be disregarded for tax purposes and "cannot be the basis for a deductible loss." Lerman, 939 F.2d at 45; accord United States v. Wexler, 31 F.3d 117, 122 (3d Cir. 1994).
In applying these principles, we must view the transactions "as a whole, and each step, from the commencement . . . to the consummation . . . is relevant." Weller v. Commissioner, 270 F.2d 294, 297 (3d Cir. 1959); accord Commissioner v. Court Holding Co., 324 U.S. 331, 334, 65 S.Ct. 707, 708, 89 L.Ed. 981 (1945). The inquiry into whether the taxpayer's transactions had sufficient economic substance to be respected for tax purposes turns on both the "objective economic substance of the transaction" and the "subjective business motivation" behind them. Casebeer v. Commissioner, 909 F.2d 1360, 1363 (9th Cir. 1990); accord Lerman, 939 F.2d at 53-54 (noting that sham transaction has been defined as a transaction that "has no business purpose or economic effect other than the creation of tax deductions" and holding that taxpayer was not entitled "to claim `losses' when none in fact were sustained"). However, these distinct aspects of the economic sham inquiry do not constitute discrete prongs of a "rigid two-step analysis," but rather represent related factors both of which inform the analysis of whether the transaction had sufficient substance, apart from its tax consequences, to be respected for tax purposes. Casebeer, 909 F.2d at 1363; accord James v. Commissioner, 899 F.2d 905, 908-09 (10th Cir. 1990); Rose v. Commissioner, 868 F.2d 851, 854 (6th Cir. 1989).
ACM, 157 F.3d at 247.
1. Objective Economic Substance
When assessing the economic substance of a taxpayer's transaction, "courts have examined whether the transaction has any practical economic effects other than the creation of income tax losses and refused to recognize the tax consequences of transactions that were devoid of nontax substance because they did not appreciably affect the taxpayer's beneficial interest except to reduce his tax." ACM, 157 F.3d at 248 (quotations omitted). When the transaction at issue involves the disposition of property, the Third Circuit noted the following:
In the context of property dispositions, the courts have applied the economic substance doctrine in a similar manner to disregard transactions which, although involving actual transactions disposing of property at a loss, had no net economic effect on the taxpayer's economic position, either because the taxpayer retained the opportunity to reacquire the property at the same price, or because the taxpayer offset the economic effect of the disposition by acquiring assets virtually identical to those relinquished. See, e.g., Lerman, 939 F.2d at 48; Merryman v. Commissioner, 873 F.2d 879 (5th Cir. 1989); Kirchman, 862 F.2d at 1488, 1492-93; Yosha v. Commissioner, 861 F.2d 494, 501 (7th Cir. 1988). Although the taxpayers in these cases actually and objectively disposed of their property, the courts examined the dispositions in their broader economic context and refused to recognize them for tax purposes where other aspects of the taxpayers' transactions offset the consequences of the disposition, resulting in no net change in the taxpayer's economic position.
ACM, 157 F.3d at 249. In the context of the instant case, therefore, we must consider whether the WCI-BKC transaction had any practical economic effect other than the shifting of pension liabilities when examining the transaction in its broader economic context.
With the exception of Merryman v. Commissioner, 873 F.2d 879 (5th Cir. 1989), each of the cases the Court cites in ACM as an example of taxpayer transactions that have been found to be lacking in economic substance involve a unique transaction engaged in on various commodity exchanges, the option-straddle transaction. See Lerman, 939 F.2d at 48; Kirchman, 862 F.2d 1486; Yosha, 861 F.2d 494 (all finding that option-straddle transactions lacked economic substance). Similarly, the transaction in ACM involved the purchase of private placement notes with an almost immediate exchange for payment installment notes.
Merryman, on the other hand, involved a partnership which was formed to operate an oil rig sold to it by a corporation. The Court concluded that the partnership lacked economic substance and refused to recognize it for tax purposes. In reaching its conclusion, the Court noted that the corporation from which the partnership received the oil rig was also the managing partner of the corporation; that on the day of its formation, the partnership purchased the rig from the corporation and simultaneously entered into a management agreement whereby it surrendered control of the rig to the corporation; the partners failed to make required capital contributions; despite a substantial purchase price of $2,250,000 for the rig, a promissory note was executed for the entire amount with no required down payment; throughout the partnership's existence, money flowed back and forth, but the economic positions of the parties was not altered in that the corporation operated rig, collected revenue, remitted revenue to partnership which was returned to the corporation in the form of note payments; the partnership had no office or employees, paid no salaries, and carried on no other business; and the partnership and corporation failed to follow the terms of both the management agreement and sales contract. Merryman, 873 F.2d at 882-83.
When compared to the instant case, Merryman presents a sharper example of a transaction which lacks economic substance. However, the cases have some important similarities. At the time of the transaction, WCI was aware of the International Harvester case and the then proposed Section 1369, whereby a seller would have contingent liability for a failed pension plan for a five year period following the sale of assets and transfer of pension liabilities. (FF 87) This awareness is reflected in the WCI-BKC Agreement which focuses primarily on insulating WCI from any potential liability associated with the transferred BK Plans by reducing the likelihood of BKC failing or the BK Plans terminating in the first five years after the sale.
The court's Finding of Facts are cited as (FF x).
For example, WCI was to pay BKC $4 million a year for five years which was designated under an irrevocable assignment to go to the pension trusts (FF 71(e)); BKC was to obtain a letter of credit in favor of WCI which could be drawn on by WCI if PBGC threatened to terminate the BK Plans or if BKC went into bankruptcy (FF 71(g)); $15 million of the $20 million WCI paid at closing was paid to Ameritrust to purchase the letter of credit and the letter of credit was to be incrementally released over a five year period (FF 71(g) and (q)); BKC had to contribute to the BK Plans for five years to satisfy the minimum funding required by ERISA and the various plan documents but in no event could contributions be less than $1.2 million (FF 71(l)); if an overfunded plan terminated within six years, BKC had to use the excess funds to reduce unfunded liabilities in underfunded plans (FF 71(n)); BKC and WCI entered into a security agreement with WCI which granted WCI a security interest in all of BKC's assets (FF 71(s)); BKC would be in default of the security agreement if a claim arising from the BK Plans was made against WCI or if PBGC or BKC initiated a plan termination. (FF 71(s)).
The structure of the WCI-BKC Agreement, the drafting of which was controlled by WCI, takes on added significance when considering the financial health of BKC. WCI could not have reasonably expected BKC to survive after the fifth year. BKC was insolvent at the time of closing (FF 110) and had just enough cash, with WCI's $4 million a year payments, to make it through five years. (FF 117)
Also, BKC was structured so that no one, including Tomsich, was at risk. Tomsich intentionally limited his ownership interest in BKC to 78 percent, which insulated him and his principal business, NESCO, from the pension liabilities. (FF 50) Moreover, Tomsich's buying group contributed a mere $1,000,000 to BKC's equity, barely twice the costs associated with the $450,000 needed to create the Ameritrust agreements. (FF 95) In sum, WCI's transfer of the BK Businesses and BK Plans to BKC, an economic shell that WCI could not have reasonably expected to survive beyond five years, while structuring the transaction to keep BKC afloat for five years, indicates a transaction which lacks economic substance other than the shifting of pension liabilities.
Other aspects of the Agreement also indicate a transaction lacking in economic substance. WCI was in many ways in the same position for the first five years after the sale as it was prior to the WCI-BKC transaction. For example, WCI still retained control over the disposition of BKC's assets and was still required to make significant pension contributions. If BKC failed within this five year period, substantially all of BKC's assets would revert back to WCI.
The parties' failure to adhere to the WCI-BKC Agreement is another indication that the transaction lacks economic substance. See ACM, 873 F.2d at 881 ("The low degree of adherence to the entities' contractual terms indicates lack of substance."). For example, BKC was required to contribute a total of $29.6 million under the WCI-BKC Agreement for plan years 1985 through 1990 but it only contributed $12.7 million during this period. WCI also gradually released its liens on BKC's assets over the five-year period despite BKC's continued decline. Having heard the evidence, we find that WCI released its liens on BKC's assets so that BKC could liquidate its assets and limp along for five years.
Although there are several indicators that the transaction lacks economic substance, we recognize that there were other aspects of the deal that had economic substance other than the shifting of pension liabilities, such as getting rid of operating losses. Also, the parties did effectuate a transfer of the BK Businesses' assets to a non-related corporation even though WCI retained significant control over the disposition of such assets. Thus, we cannot conclude that the transaction fully satisfies the first prong of the analysis as the transaction had some economic substance other than the shifting of pension liabilities.
2. Subjective Business Motivation
Next, we examine the subjective business motivation behind the WCI-BKC transaction. WCI contends that it sold the BK Businesses because they were unprofitable and not part of their core business. WCI further contends that it structured the WCI-BKC Agreement the way it did because the assumption of pension liabilities was the consideration BKC gave in the transaction. Therefore, WCI wanted to be sure that it did not pay for the pension liabilities twice by having them revert back to it.
There is ample evidence which indicates that WCI's initial motivation for selling the BK Businesses was to rid itself of unprofitable businesses. For example, the BK Businesses had been losing money in recent years. (FF 10) WCI hired McKinsey to conduct a strategic study to evaluate the impact of the BK Businesses on the value of WCI. (FF 14) McKinsey categorized the BK Businesses as Exit Businesses and recommended that they be sold. (FF 15) WCI then retained Lehman Brothers to find a buyer for the BK Businesses. (FF 29)
Lehman Brothers shopped the BK Businesses with the understanding that the BK Businesses would be sold for cash with WCI retaining the pension liabilities. (FF 30) After shopping the BK Businesses for over a year, Lehman Brothers identified only one potential purchaser, Cvengros. (FF 30) Cvengros proposed a deal whereby he would receive a cash payment and assume the pension liabilities in exchange for the BK Businesses' assets. (FF 38) Cvengros then planned on terminating the pension plans either immediately before or after closing. (FF 38)
The evidence indicates that WCI's motivations began to shift around this time. WCI was aware that it could be liable for the pension liabilities under the theories advanced by PBGC in International Harvester. (FF 39) Because the termination of the BK Plans would create a significant risk to WCI, WCI's legal counsel, Ransom, advised WCI that it should not construct a deal in which the buyer was to terminate the BK Plans as part of the transaction. (FF 40) Around the same time, WCI identified Tomsich as a potential purchaser who might be convinced to enter into a deal more favorable than Cvengros' proposal. (FF 43)
WCI then sent Tomsich and Cvengros two proposed letters of intent. Version #1 provided for the purchase of the BK Businesses through the assumption of liabilities with terms substantially different from the Cvengros deal. (FF 47) Version #2 proposed a purchase of the BK Business's assets for a cash payment of an undisclosed amount. (FF 47) Tomsich and his advisors concluded that the buyer was being asked to assume approximately $67 million in pension liabilities in Version #1. (FF 48) Although Version #2 did not specify an amount of cash consideration, there is evidence that Tomsich thought that the assets were worth approximately $20 million and that the expected purchase price was very high and substantially above the book value and net worth of the BK Businesses. (FF 48) Tomsich chose Version #1 knowing that as long as he owned only 78% of the stock of BKC neither he personally nor his company NESCO would be liable for the pension liabilities. (FF 51)
WCI began to focus on the savings that could be realized on the deal where the buyer would assume the pension liabilities. In a June 18, 1995 memorandum, Hunt and Elliot compared the scenario where WCI would retain the pension plans versus the Tomsich deal and recognized that the "principal economic benefit" to WCI under the Tomsich plan was the assumption of pension liabilities by the buyer. (FF 72-73)
They compared, for example, the cost to WCI of doing the Tomsich deal with the reserves established at year end 1984 for discontinuing operations of the BK Businesses. (FF 72) The analysis showed that WCI saved $68 million, the largest portion of which would be savings on the pension liabilities, by doing the Tomsich deal as compared with the disposition accounted for in the discontinued operations reserve. (FF 72)
Hunt and Elliot also compared the cash flows under the two scenarios. WCI had estimated that it would have to pay out $184 million over 30 years, if it kept all the obligations for retiree benefits in connection with BK Businesses after a cash payment of $32.5 million in proceeds. (FF 74) Under the proposed Tomsich deal, however, WCI would have to pay out only $25 million relating to the BK Plans. (FF 74)
Hunt and Elliot also stated, however, that the economic benefit of the deal outweighed the risk. (FF 75) They included calculations which showed that WCI would be in substantially the same position on a cash flow basis if the buyer failed within the first seven years after the sale and WCI ended up paying the transferred retiree liabilities. (FF 75) Around the same time, WCI also prepared an analysis that compared the Tomsich deal and a cash sale "as is, where is" to estimates recorded in the discontinued operations reserve. (FF 76) The analysis showed that if WCI kept the liabilities and sold the assets of the BK Businesses "as is" for $47.4 million, WCI would save $30.7 million over the discontinued operations reserve which was less than half of the $67.6 million economic benefit produced by the Tomsich deal. (FF 76) WCI's Board of Directors ultimately approved the Tomsich deal as presented in the proposed letter of intent so long as the final agreement did not reflect more than a $10 million adverse variance from the projected $68 million in savings from the originally booked pre-tax loss. (FF 80)
During the negotiations with Cvengros and Tomsich, WCI had its actuaries at Wyatt recalculate the estimated unfunded liabilities associated with the BK Plans. (FF 57) Wyatt's recalculated numbers for the negotiations were unreasonable and substantially less than its pre-negotiation numbers. (FF 65) As we have already discussed, WCI then proceeded to transfer the BK Plans to an entity that it could not have reasonably believed could survive on its own under the weight of the pension liabilities. With International Harvester in mind, however, WCI then structured the WCI-BKC Agreement to keep BKC alive for five years.
We find, based on this evidence, that although WCI's initial intent was to sell the BK Businesses to get rid of unprofitable operations, it ultimately became solely motivated by a desire to unload the BK Plans. When considering WCI's subjective intent in conjunction with the economic substance of the transaction, we conclude that the WCI-BKC Sale was a sham, as the transaction did not have sufficient substance apart from the shifting of pension liabilities.
Accordingly, we find in favor of PBGC on Count One of the Amended Complaint.
B. Count Four — Principal Purpose to Evade Under Section 1369
Count Four of PBGC's amended complaint alleges that a principal purpose of WCI's decision to consummate the WCI-BKC sale was to evade pension liabilities. PBGC argues, therefore, that the sale should be disregarded and WCI should be held liable for the pension liabilities under Section 1369 as the employer on the date the plans terminated.
Section 1369 reads in pertinent part:
Treatment of transactions to evade liability; corporate reorganization
(a) Treatment of transactions to evade liability
If a principal purpose of any person in entering into any transaction is to evade liability to which such person would be subject under this subtitle and the transaction becomes effective within five years before the termination date of the termination on which such liability would be based, then such person and the members of such person's controlled group (determined as of the termination date) shall be subject to liability under this subtitle in connection with such termination as if such person were a contributing sponsor of the terminated plan as of the termination date. This subsection shall not cause any person to be liable under this subtitle in connection with such plan termination for any increases or improvements in the benefits provided under the plan which are adopted after the date on which the transaction referred to in the preceding sentence becomes effective.29 U.S.C. § 1369(a).
WCI denies that the evading of pension liabilities ever played a role in its decision to sell the BK Businesses and accompanying BK Plans. In any event, WCI argues, Section 1369 does not apply in the instant case because the WCI-BKC sale closed in September 1985, approximately three months prior to Section 1369's January 1, 1986 effective date. We will first address the issue regarding Section 1369's effective date.
1) Section 1369's Effective Date
The Court of Appeals for the Third Circuit concluded that Section 1369 applies to the WCI-BKC sale holding that "a transaction does not become effective for purposes of section 1369 until the company that transferred a pension plan no longer makes substantial pension contributions." PBGC v. WCI, 998 F.2d at 1199. The Court noted that "[o]nly then is the financial strength of the new employer tested. If the new employer, primarily on its own, is able to sustain the pension obligations for five years, then section 1369 immunizes the previous employer from ERISA liability." Id. The Court went on to conclude that
Section 1369 applies "with respect to transactions becoming effective on or after January 1, 1986." Pub.L. No. 99-272 § 11013(b), 100 Stat. 82, 261 (1985). Since we hold that the transaction did not become effective until WCI made the last pension contribution in 1990, section 1369 is applicable to this transaction.
Id. at 1199 n. 2.
WCI contends that the Third Circuit improperly ruled that Section 1369 applies to the WCI-BKC sale because the sale closed prior to the statute's January 1, 1986 effective date. Citing to Landgraf v. USI Film Prods., 114 S.Ct. 1483 (1994), a decision issued after the Third Circuit's ruling in this case, WCI insists that there must be clear evidence of Congressional intent to apply a statute retroactively. WCI maintains that there is no clear evidence that Congress intended Section 1369 to be retroactively applied.
More specifically, WCI contends that there is a distinction in the phrase "becomes effective", which appears in Section 1369's text, and the phrase "becoming effective", which appears in the statute's stated effective date. WCI maintains that the phrase appearing in the Section 1369's text, "becomes effective", is part of the language which sets forth the statute's five-year safe harbor provision. WCI contends that the Third Circuit assumed, without analysis, that its interpretation of the effective date of the transaction for applying Section 1369's five-year safe harbor provision also properly established the effective date of the WCI-BKC sale for determining whether Section 1369 could be retroactively applied to the sale. Thus, WCI argues, the Third Circuit never considered whether there was clear evidence that Congress intended Section 1369 to apply to a transaction, like the WCI-BKC sale, which closed prior to January 1, 1986.
PBGC argues in response that the Third Circuit has already ruled that Section 1369 applies to the WCI-BKC sale, therefore, WCI's argument is foreclosed by the law of the case doctrine.
Law of the case rules function to maintain consistency and avoid reconsideration of matters once decided during the course of a single continuing lawsuit. Although commonly labeled the law of the case doctrine, the rules apply to at least four distinctive situations, (1) a single court adhering to its own prior ruling; (2) one judge or court adhering to the rulings of another judge or court in the same case or closely related cases; (3) a court adhering to the rulings of a higher court; and (4) failure to appeal an issue or to preserve it for appeal. See 18 Charles Alan Wright, et. al., Federal Practice and Procedure, Section 4478 (1981 1998 Supp.) (collecting cases). The instant case falls within the third category.
The Third Circuit has explained the district court's duty on a remand for further proceedings as follows:
It is axiomatic that on remand for further proceedings after decision by an appellate court, the trial court must proceed with the mandate and the law of the case as established on appeal. A trial court must implement both the letter and spirit of the mandate, taking into account the appellate court's opinion and the circumstances it embraces. "Where the reviewing court in its mandate prescribes that the court shall proceed in accordance with the opinion of the reviewing court, such pronouncement operates to make the opinion a part of the mandate as completely as though the opinion had been set out at length."
Blasband v. Rales, 979 F.2d 324 (3d Cir. 1992) (quoting Bankers Trust Co. v. Bethlehem Steel Corp., 761 F.2d 943, 949 (3d Cir. 1985 (citations omitted)); see Delgrosso v. Spang Co., 903 F.2d 234, 240 (3d Cir. 1990) ("When an appellate court directs the district court to act in accordance with the appellate opinion . . . the opinion becomes part of the mandate and must be considered together with it." (citation omitted)).
The Third Circuit quoted Section 1369's effective date provision and specifically held that Section 1369 was applicable to the WCI-BKC sale. PBGC v. WCI, 998 F.2d at 1199 n. 2. The Court then remanded the action to the district court "for further proceedings consistent with [its] opinion." Id. at 1202. Therefore, we are bound by the Third Circuit's ruling that Section 1369 is applicable to the WCI-BKC sale.
Although WCI is correct in that the Third Circuit provided little explanation for its decision, the absence of court analysis would not permit a district court to disregard a ruling already made by its court of appeals. We note, however, that the Third Circuit stated its ruling on Section 1369's effective date after having engaged in an extensive analysis of whether the WCI-BKC sale became effective within the statute's five-year safe harbor provision. As part of its analysis, the Court referenced the facts relevant to the effective date issue recognizing, for example, that "WCI and Blaw Knox clearly entered into this transaction on September 27, 1985, the day the deal closed." PBGC v. WCI, 998 F.2d at 1198. Moreover, WCI apparently argued in its brief to the Third Circuit that "WCI is not subject to any liability as a predecessor sponsor under section 4069 of ERISA, 29 U.S.C. § 1369, because WCI sold the Blaw Knox Businesses and transferred sponsorship of the Plans covering their employees prior to the January 1, 1986 effective date of that statute. . . ." PBGC's Surreply To WCI's Reply Brief (Doc. No. 200) at p. 1. Thus, it appears that the Third Circuit was aware of the issue and the relevant facts at the time it rendered its decision.
Even so, WCI argues that Landgraf constitutes an intervening change in the law which allows the court to revisit the issue of Section 1369's effective date.
There is disagreement as to whether a lower court may depart from an appellate court's mandate, without the appellate court's permission, on the grounds that an intervening change in the law requires reexamination of issues already decided. See 18 Charles Alan Wright, et. al., Federal Practice and Procedure, Section 4478 (1981 1998 Supp.) (collecting cases). We need not resolve this issue, however, as Landgraf did not constitute an intervening change in the law.
As PBGC correctly points out, the Supreme Court stated in Landgraf that its standards for retroactive application of new legislation had been in place "[s]ince the early days of the Court." 114 S.Ct. at 1499. The Court stated that although there was an apparent tension between its holding in Bradley v. School Bd. of City of Richmond, 416 U.S. 696 (1974), that "a court is to apply the law in effect at the time it renders its decision," and its holding in Bowen v. Georgetown Univ. Hosp., 488 U.S. 204 (1988), that "congressional enactments and administrative rules will not be construed to have retroactive effect unless their language requires this result," there is no tension between these holdings both of which were unanimous decisions. Id. at 1496. The Court explained that "the presumption against retroactive legislation is deeply rooted in our jurisprudence, and embodies a legal doctrine centuries older than our Republic." Id.
Accordingly, we find that Section 1369 applies to the WCI-BKC sale.
PBGC also argues that WCI has waived its right to assert this argument because it is more in the nature of an affirmative defense which was raised for the first time at trial. We need not address this argument as we have already held that under the law of the case doctrine we must follow the Third Circuit's ruling that Section 1369 applies to the WCI-BKC sale.
2) Liability Under Section 1369
PBGC and WCI disagree as to what is the appropriate standard of liability under Section 1369. PBGC argues that the determination of whether a principal purpose of a transaction was to evade pension liabilities is an objective substance-over-form analysis with no consideration being given to subjective intent. WCI argues, on the other hand, that the test is one of subjective intent, as a person must have the subjective intent to evade pension liabilities at the time a challenged transaction was entered into. We believe that the test is comprised of both an objective and subjective component.
To determine whether a predecessor employer such as WCI had "a principal purpose" to evade its pension obligations under Section 1369, the Third Circuit held that the court must "analyze intent at the time the parties `enter into' the challenged transaction." PBGC v. WCI, 998 F.2d at 1199. As the court discussed, prior to the enactment of Section 1369, the Northern District of Illinois had held in International Harvester that a "predecessor employer is liable when it transfers a pension plan that later terminates when: (1) the employer intended to evade pension obligations; and (2) objectively, the transferee, that assumed responsibility for the plan had economically little chance to succeed." PBGC v. WCI, 998 F.2d at 1199 (citing International Harvester, 681 F. Supp. at 525-27).
According to the Third Circuit, "by enacting section 1369, Congress codified the [International] Harvester predecessor liability test . . . with one change." PBGC v. WCI, 998 F.2d at 1199 (internal citation omitted). The court concluded that Congress had replaced the second prong of the International Harvester test with a bright line five-year test as an "easily quantifiable surrogate" for economic viability. Id. The court explained that Congress intended to both broaden the International Harvester predecessor liability rule and create a safe harbor for a predecessor employer when the new employer survives on its own for five years. Id.
Congress apparently believed that if a plan terminated within five years of being transferred, it was fair to assume that the new employer did not have reasonable chance of succeeding at the time of transfer. Congress also believed that if a plan remained viable for five years under a new sponsor, the previous employer should have the benefit of an irrebuttable presumption that the new sponsor had a reasonable chance of fulfilling the pension obligations it assumed.
Id.
The court went on to hold that "if a transferor makes substantial post-sale contributions to a pension plan to ensure its viability for five years, however, the plan's existence after five years does not reflect the transferee's economic stability at the time of the transfer." Id. Therefore, "a transaction does not become effective for purposes of section 1369 until the company that transferred a pension plan no longer makes substantial pension contributions. Only then is the financial strength of the new employer tested." Id.
Although the Third Circuit focused primarily on Section 1369's change to the objective prong of the International Harvester test, the subjective first prong of the test remained intact. This result is consistent with International Harvester's holding that predecessor liability "requires proof of two elements, one subjective and one objective. An employer who, with a sale of his business, delegates his pension obligations is liable if a principal purpose of the sale is to evade pension liability and if, objectively, his buyer lacks a reasonable chance of meeting those obligations." 681 F. Supp. at 526. See also, Santa Fe Pacific Corp. v. Central States, Southeast and Southwest Areas Pension Fund, 1993 WL 68074 at *2 (N.D.Ill., Mar. 10, 1993) (examining evidence of subjective intent to evade for purposes of liability under 29 U.S.C. § 1392).
Thus, we find that the determination of whether a principal purpose of a transaction was to evade pension liabilities pursuant to Section 1369, should proceed according to the following steps. The first step is an objective analysis which requires the court to make an initial determination of whether a transferred plan remained viable for five years under a new sponsor, beginning from the time that the predecessor sponsor no longer makes substantial pension contributions. If the answer is yes, the analysis ends here and no liability may be imposed upon the predecessor sponsor. If the plans do terminate within a five year period, the court must determine on an objective basis whether the new sponsor lacked a reasonable chance of meeting the pension obligations. The court must then examine the predecessor sponsor's subjective intent at the time of entering into the transaction and determine whether a principal purpose of entering into the transaction was to evade pension obligations. See International Harvester, 681 F. Supp. at 526 (court rejected wholly objective standard argued for by PBGC which would hold a predecessor employer liable for unfunded pension benefits regardless of whether there was an intent to evade if a reasonably informed employer would have known that the new employer did not have reasonable chance of paying for them). If a principal purpose of entering into the transaction was to evade pension obligations and the new sponsor lacked a reasonable chance of survival, then the predecessor sponsor is liable for the terminated plans.
WCI does not dispute that the safe harbor provision does not apply here as the BK Plans terminated within five years of September 1990 when WCI made its last substantial contribution. See PBGC v. WCI, 998 F.2d at 1200 ("We need not define precisely what constitutes substantial contribution by a predecessor employer. In this case, after WCI transferred the pension plans to Blaw Knox, the amended complaint alleges that WCI made annual payments of four million dollars to the plans, while Blaw Knox contributed only $1.2 million annually. This is clearly substantial support from the transferor.") Thus, we consider whether objectively BKC had little chance to succeed.
Having reviewed all the evidence, we think it clear that BKC had little to no chance to succeed after the fifth year when WCI's $4 million annual payments would cease. (FF 117) For example, BKC was materially insolvent at the time of the sale and its capital structure was insufficient to withstand a reasonably likely economic downturn. (FF 110, 118) In 1991, the first year in which WCI did not contribute to the pension, the cash flow of BKC would be negative. (FF 117) PBGC's expert, Professor Jarrell, demonstrated that the analysis of WCI's expert, Dr. Stillman, showed that BKC was insolvent by at least $34 million by mid-1987. (FF 119)
Next, we must consider WCI's intent at the time of entering into the WCI-BKC transaction and determine whether a principal purpose of entering into the transaction was to evade pension obligations. As set forth in our analysis of PBGC's sham transaction claim at Count One, we find that WCI ultimately became solely motivated by a desire to unload the BK Plans. This finding also supports a conclusion that a principal purpose of WCI in entering into the transaction was to evade pension liabilities. We need not repeat that analysis here.
WCI contends that a principal purpose means that evading pension liabilities had to be its first, chief, or primary purpose. PBGC argues, however, that evading pension liabilities need only be a major, weighty, or important purpose in WCI's decision to enter into the WCI-BKC transaction. We need not decide this issue as our finding that WCI ultimately became solely motivated by a desire to unload the BK Plans also supports a finding that evading pension liabilities was WCI's first, chief, or primary purpose in entering into the transaction.
In sum, after having heard all the evidence, we find that a principal purpose in WCI's decision to enter into the WCI-BKC transaction was to evade pension liability and that BKC had economically little chance to succeed. Accordingly, we find in favor of PBGC on Count Four of the Amended Complaint.
PBGC's amended complaint asserted two independent theories of liability under Section 1362, the sham transaction doctrine at Count One and the implicit predecessor liability rule, as recognized in International Harvester, at Count Three. The Third Circuit dismissed Count Three based on its conclusion that Section 1369 now specifically governs predecessor liability making it improper to apply the implicit predecessor liability rule of International Harvester. PBGC v. WCI, 998 F.2d at 1200. We note, however, that the facts of this case would clearly support a finding against WCI under International Harvester's implicit predecessor liability rule.
C. Determination of Amount and Collection of Liability
An issue arose during the trial regarding the calculation of the amount of liability in the event PBGC were to prevail on either of its claims. WCI contends that the court must determine the amount of liability, if any, in these proceedings. We disagree.
PBGC correctly argues that Subsection (b) of Section 1362 gives PBGC the authority to determine and collect the liability that arises automatically upon termination of an unfunded pension plan ("termination liability") without first having to go to court. See PBGC's Bench Memorandum On Determination And Collection Of Liability Under Section 1369 ("PBGC's Mem. on Liab.") (Doc. No. 183). The applicable rules are no different when termination liability arises under Section 1369. 29 U.S.C. § 1369(a) ("If a principal purpose of any person in entering into any transaction is to evade liability . . . under this subtitle . . . then such person . . . shall be subject to liability under this subtitle . . . as if such person where a contributing sponsor of the terminated plan as of the termination date.").
The termination liability of a "contributing sponsor of the plan" is defined in 29 U.S.C. § 1362(b) as "the total amount of the unfunded benefit liabilities (as of the termination date) to all participants and beneficiaries under the plan, together with interest (at a reasonable rate) calculated from the termination date in accordance with regulations prescribed by the corporation." Such liability "shall be due and payable to the corporation as of the termination date, in cash or securities acceptable to the corporation," 29 U.S.C. § 1362(b)(2)(A), although PBGC "and any person liable under this section may agree to alternative arrangements for the satisfaction of liability. . . ." 29 U.S.C. § 1362(b)(3).
PBGC's regulations provide for the procedures that must be followed when determining and collecting termination liability from contributing sponsors and their controlled group members. For example, "when the PBGC has determined the amount of the liability under part 4062 . . ., [it] shall notify liable person(s) in writing of the amount of the liability . . . [and] include a request for payment." 29 C.F.R. § 4068.3. The request for payment is an initial determination of the agency subject to administrative review under 29 C.F.R. Part 4003, which applies by its terms to PBGC's "[d]eterminations of the amount of liability under section 4062(b)(1) . . . of ERISA." 29 C.F.R. § 4003.1(9). Only after the administrative appeal process is exhausted does PBGC's determination become a final agency action, which can be challenged in court. 29 C.F.R. § 4003.59.
At this point, PBGC will issue a demand letter for payment of the liability. 29 C.F.R. § 4068.3(b)(2). Refusal to pay the liability after PBGC issues the demand letter gives rise to a lien in favor of PBGC pursuant to 29 U.S.C. § 1368(a) which states:
If any person liable to the corporation under section 4062 . . . neglects or refuses to pay, after demand, the amount of such liability (including interest), there shall be a lien in favor of the corporation in the amount of such liability (including interest) upon all property and rights to property, whether real or personal, belonging to such person, except that such lien may not be in an amount in excess of 30 percent of the collective net worth of all such persons described in section 4062(a).
See also, 29 C.F.R. § 4068.4. PBGC may then go to court to enforce its lien or otherwise collect the liability. 29 U.S.C. § 1368(d)(1), (2).
In sum, the administrative procedures set forth in PBGC's regulations must first be exhausted before either party brings a claim for judicial relief regarding the amount of liability. See e.g., Robinson v. Dalton, 107 F.3d 1018, 1020 (3d Cir. 1997) ("It is a basic tenet of administrative law that a plaintiff must exhaust all required administrative remedies before bringing a claim for judicial relief." (citing McKart v. United States, 395 U.S. 185, 193 (1969)).
An order consistent with these findings of fact and conclusions of law will be entered.
ORDER
In accordance with the accompanying findings of fact and conclusions of law, the court finds in favor of the plaintiff and against the defendant on both Counts One and Four of the Amended Complaint. Accordingly, JUDGMENT IS GRANTED in favor of the Pension Benefit Guaranty Corporation and against White Consolidated Industries Inc. on Counts One and Four of the Amended Complaint.
The parties must first exhaust the administrative procedures set forth in the Pension Benefit Guaranty Corporation's regulations before either party brings a claim for judicial relief regarding the amount of liability.