In a very detailed decision, a district court found that members of Antioch Company’s Board and ESOP Advisory Committee (EAC) did not violate their fiduciary duties during a transaction to make the employee stock ownership plan (ESOP) 100% employee-owned years before the company declared bankruptcy.

Defendant GreatBanc & Trust Company was the ESOP’s transactional trustee in 2003. The Antioch Board gave GreatBanc the independent discretion to determine whether to tender the ESOP’s shares in the transaction. Because the transaction would not close if GreatBanc tendered the ESOP shares, GreatBanc was given effective veto power over the transaction. GreatBanc exercised its discretion to decline the tender offer and it thereby allowed the transaction to close. GreatBanc and plaintiffs settled shortly before trial, so GreatBanc is no longer a defendant in the suit.

Plaintiffs claim that, based on the actions defendants took in connection with the 2003 tender offer transaction, defendants are liable for breaching their fiduciary duties to the ESOP, enabling other fiduciaries’ breaches, and causing a prohibited transaction, in violation of sections 404, 405 and 406 of the Employee Retirement Income Security Act (ERISA). However, U.S. District Judge Jorge Alonso in the U.S. District Court for the Northern District of Illinois, first determined that members of the EAC were not fiduciaries, so they did not violate any fiduciary duties. Since GreatBanc had discretion over the transaction, it was a fiduciary.

As far as the duty to monitor fiduciaries claim, the court noted that the Antioch Board of Directors, not the EAC, possessed the power to appoint and remove GreatBanc. Plaintiffs contend that whether the duty to monitor is breached depends on the facts and circumstances of each case, and their duty to monitor claim is not derivative of an underlying breach of fiduciary duty by the appointed fiduciary, nor does it depend directly on whether the appointed fiduciary committed an underlying breach. Defendants say the duty to monitor does depend on whether the appointed fiduciary committed a breach.

Regardless of who has the better of this argument, Alonso said the court must analyze whether GreatBanc breached its fiduciary duty anyway, in order to resolve plaintiffs’ co-fiduciary claim under section 405 of ERISA. He assumed for the sake of argument that defendants are correct that plaintiffs must prove an underlying breach of fiduciary duty by GreatBanc to prevail in their duty to monitor claim against defendants under section 404.

But Alonso found that, far from demonstrating a breach of fiduciary duty by GreatBanc, the record shows that GreatBanc conducted a thorough and vigorous review of the transaction and worked diligently to protect the ESOP’s interests by negotiating better transaction terms. He added that, even assuming that plaintiffs did establish an underlying breach by GreatBanc, or that, as plaintiffs have argued, the law does not require them to do so to prevail on their section 404 claim, they have still failed to prove that defendants breached their duty to monitor GreatBanc.

Alonso noted that the duty to monitor requires only monitoring “at reasonable intervals” to ensure that “performance has been in compliance with the terms of the plan and statutory standards, and satisfies the needs of the plan.” There were only four months between GreatBanc’s retention and the closing of the 2003 transaction. In that time, the evidence shows that GreatBanc representatives met with the Board of Directors on two separate occasions. In addition, at the Board meeting on October 16, 2003, the management team presented the Board with a written and verbal report about GreatBanc’s negotiating positions and GreatBanc’s financial and analytical rationales supporting its position (which at the time was that the transaction was not fair to the ESOP). Moreover, Antioch’s Board supplemented this monitoring by utilizing members of Antioch’s management team as contact points with GreatBanc. Nancy Blair was in frequent communication with GreatBanc and its advisers during the negotiation of terms extrinsic to the tender offer that would allow for a fairness opinion, and reported to Board members about those communications.

Alonso said the court need not decide whether ERISA imposes a duty to inform because, even if there is such any such duty, plaintiffs have not proved that defendants breached it.

In addition, co-fiduciary liability claims under ERISA section 405 are derivative of an underlying breach of fiduciary duty, meaning that plaintiffs must prove a breach of fiduciary duty by GreatBanc in order to impose liability on defendants. Because plaintiffs failed to prove that GreatBanc breached any duty to the ESOP, no co-fiduciary claim against defendants exists, so Alonso entered judgment for defendants on plaintiffs’ section 405 claim.

As for the ERISA section 406 claims, Alonso assumed the transaction was, if not an indirect sale or exchange between the plan and a party in interest within the meaning of section 406(a)(1)(A), at least an indirect use of plan assets for the benefit of a party in interest within the meaning of 406(a)(1)(D). The whole purpose of engaging GreatBanc as an independent trustee was to remove defendants from the ESOP’s decision as to whether or not to tender its shares in the transaction because defendants had conflicts of interest. “It would be a bizarre logic that would hold them accountable for ‘causing’ the ESOP to engage in a transaction when they hired an independent trustee for the specific purpose of deciding whether to cause the ESOP to engage in the transaction (by declining to tender its shares) or not, in accord with the independent trustee’s independent determination of which alternative was in the ESOP’s best interests,” Alonso wrote in his opinion. “The parties cite little law to help the court decide this question. In the end, it need not do so because defendants have clearly established that the company purchased the outside shareholders’ shares for ‘adequate consideration’ within the meaning of the statutory exemption of section 408(e), so the defendants cannot be liable for causing a prohibited transaction under section 406(a).”

In the years preceding the transaction, Antioch had experienced dynamic growth in sales and virtually every other financial metric, including its share price. In the years following the transaction, however, sales dropped precipitously, and the share price dropped along with them. In late 2008, Antioch reorganized its capital structure through a Chapter 11 bankruptcy, and the new capital structure did not include an ESOP.

Contending that the ESOP’s shares of Antioch stock became worthless due to the transaction, plaintiffs filed a lawsuit against defendants Lee Morgan, Asha Morgan Moran and Chandra Attiken, all of whom were either former members of the Board of Directors at Antioch and/or Antioch’s internal EAC.

Between 1999 and 2002, the Antioch ESOP allocated any dividends or distributions paid on the common stock held in the Antioch ESOP 75% based on the annual compensation of each participant and 25% based on the account balances of each participant. The allocation method fit with Antioch’s corporate culture because it allowed newer employees at its subsidiary Creative Memories, who had smaller account balances, to share more in Antioch’s increasing revenue and profits. The IRS approved the amended plan and method of allocation, and the change was implemented in January 1999.

At some point in late 2002, however, Antioch became aware of an IRS Technical Advice Memorandum (TAM), in which the IRS ruled that a similar method of allocating subchapter S distributions was improper and, instead, distributions must be allocated 100% on account balance—a method of allocation that, in the case of Antioch, would enrich long-tenured employees at the expense of the newer employees who were driving the company’s recent success.

While a TAM describes the IRS’s position only with respect to a specific taxpayer, and this particular TAM did not address or bind Antioch, Antioch’s advisers agreed that it was nevertheless prudent for Antioch to reconsider its practices. In January 2003, Antioch held a meeting to explore its options related to the ESOP in light of the legal issues with its allocation method, including the IRS position on dividend allocation. At the meeting, company representatives, lawyers, and professionals from Deloitte & Touche discussed different concepts that would resolve the apportionment problem caused by the IRS ruling. Under one of Deloitte’s proposals, the ESOP would become the 100% owner of Antioch’s stock.

Deloitte created the outline for the general structure of the transaction. As structured by Deloitte, the company—not the ESOP—would purchase the shares sold in the transaction.

According to the court opinion, Antioch’s board amended the plan to give GreatBanc authority to decide how to vote ESOP shares with respect to the transaction. The company and its advisers engaged in due diligence, and the company provided financial projections to the advisers.  Ultimately, approximately 90% of ESOP participants voted in favor of the transaction and the transaction closed.

At the time that the transaction reached the due diligence stage, the company was aware of some risks and threats to the business. For example, a 2001 Annual Report stated, “The biggest cloud over our organization, in my opinion, is our obligation to repurchase our stock from both ESOP participants as they retire and from other stockholders . . . The potential impact on our cash position is huge.” Also, Creative Memories growth was being threatened by the competition of digital photos.

The company disclosed the threats facing Antioch to GreatBanc and its advisers. There was no evidence that the Board did not properly consider or account for those concerns, nor did plaintiffs introduce any expert or fact evidence that the concerns should have caused the Board or GreatBanc to abandon the transaction, the opinion noted.

In the years after the transaction, the company experienced much larger than predicted levels of share redemptions. In 2004 alone, departing ESOP employees put approximately $109 million in ESOP shares to the company. But, no evidence exists that the increased number of shares put were caused by any transaction term.

In 2006, the company experienced a double-digit sales decline for the first time, which continued in 2007. No testimony or evidence in the trial links this sales decline to the transaction, while numerous witnesses testified that the sales decline was in no way linked to the transaction. During the 2006 through 2008 timeframe, several unforeseeable (as of 2003) systemic market factors unrelated to the transaction contributed to the company’s decline and ultimate bankruptcy. Despite the company’s decline in sales, Antioch made all scheduled periodic payments on all of its debt—including its secured bank debt and the newly issued promissory notes to former Antioch ESOP participants—in a timely manner from the date of the transaction through June 2008.