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DELTA STAR, INC. v. PATTON

June 10, 1999

DELTA STAR, INC., PLAINTIFF AND COUNTERCLAIM DEFT.,
v.
ANDREW W. PATTON, DEFENDANT AND COUNTERCLAIM PLTF., V. THE DELTA STAR BENEFIT RESTORATION PLAN, THE DELTA STAR SUPPLEMENTAL EXECUTIVE RETIREMENT PLAN, THE DELTA STAR EMPLOYEE STOCK OWNERSHIP PLAN, AND THE TRUSTEES OF THE DELTA STAR EMPLOYEE STOCK OWNERSHIP PLAN, ADD'L. COUNTERCLAIM DEFENDANTS.



The opinion of the court was delivered by: Bloch, District Judge.

        FINDINGS OF FACT

I. Parties

1. Plaintiff, Delta Star, Inc. (Delta Star), is a Delaware corporation engaged in the business of manufacturing medium power transformers and other electrical equipment.

2. Defendant, Andrew W. Patton (Patton), is the former President of Delta Star and the former Chairman of the Delta Star Board of Directors (Delta Star Board).

3. The additional parties to this action are: (1) the Delta Star Employee Stock Ownership Plan (Delta Star ESOP); (2) the current members of the Delta Star ESOP Board of Trustees (ESOP Board of Trustees); (3) the Delta Star Benefit Restoration Plan (BRP); and (4) the Delta Star Supplemental Executive Retirement Plan (SERP).

4. At all times relevant hereto, Patton was a participant in the Delta Star ESOP and a member of the ESOP Board of Trustees. Patton is also a beneficiary under the BRP and SERP.

II. Formation of Delta Star

5. Prior to its incorporation, Delta Star was a wholly-owned subsidiary of H.K. Porter Company (H.K.Porter), a large corporation with offices in Pittsburgh, Pennsylvania.

6. As H.K. Porter's subsidiary, Delta Star maintained two manufacturing plants; one in Lynchburg, Virginia, and one in Belmont, California.

7. During the late 1980's, H.K. Porter began to encounter asbestos liability problems. Rather than risk losing Delta Star as a result of such problems, H.K. Porter decided to spin-off Delta Star as a separate entity.

8. To effectuate the spin-off, H.K. Porter decided to use an employee stock ownership plan (ESOP).

9. An ESOP is a plan governed by the Employee Retirement Income Security Act of 1974 (ERISA), 29 U.S.C. § 1001 et seq., that invests primarily in "qualifying employer securities," which, typically, are shares of stock in the employer that created the ESOP. 29 U.S.C. § 1107(d)(6)(A).

10. The use of an ESOP makes it possible for ESOP participants to acquire stock of the sponsoring employer, thereby giving them an ownership interest in the employer.

11. Typically, an ESOP obtains financing from an outside source such as a bank and, as an ESOP loan is paid down, shares of the sponsoring employer's stock are released from a suspense account and allocated to the ESOP participants in accordance with a particular formula.

12. H.K. Porter initially offered the opportunity to form the Delta Star ESOP to Christian Pany (Pany). At the time, Pany was the general manager of Delta Star's Belmont, California plant.

13. While Pany was in the process of seeking financing for the Delta Star ESOP, H.K. Porter took the opportunity away from him and offered it to Patton. At the time, Patton was the Vice President of Operations for H.K. Porter's electrical division.

14. Patton accepted the offer and eventually formed the Delta Star ESOP.

15. The participants in the Delta Star ESOP consisted of all salaried employees of Delta Star from both the Lynchburg, Virginia and Belmont, California plants.

16. Once the Delta Star ESOP was formed, Patton, Pany and James Austin (Austin) were named as the sole members of the ESOP Board of Trustees. As counterpart to Pany, Austin was the general manager of the Lynchburg, Virginia plant.

17. Although Patton was advised to have at least one outside trustee appointed to the ESOP Board of Trustees, particularly, someone who was familiar with the workings of an ESOP, Patton did not want any outside trustees and, thus, none were appointed.

18. To effectuate the Delta Star ESOP's purchase of Delta Star from H.K. Porter, a new corporation called Delta Star Acquisition Corporation (Delta Star Acquisition) was formed, which was to be controlled by the Delta Star ESOP.

19. Patton obtained financing for the Delta Star ESOP through the Pittsburgh National Bank (PNB).

20. Pursuant to a commitment letter dated October 7, 1988, and a Credit Agreement dated November 23, 1988, PNB loaned a total of $8.2 million to Delta Star Acquisition. This amount consisted of the following three items: (1) a revolving credit line of $1 million; (2) a term loan in the amount of $5,133,000; and (3) a term loan in the amount of $2,067,000.

21. Thereafter, Delta Star Acquisition loaned $7.2 million of the total $8.2 million PNB loan amount to the Delta Star ESOP. This amount consisted of the proceeds from the two PNB term loans.

22. Thereafter, the Delta Star ESOP paid this $7.2 million back to Delta Star Acquisition, in exchange for approximately 98.63% of Delta Star Acquisition's stock. The remaining 1.37% of Delta Star Acquisition's stock was purchased by nine key management individuals from Delta Star; specifically, by Patton, the two general managers (Pany and Austin), the two engineers, the two accountants and the two marketing directors from the Belmont, California and Lynchburg, Virginia plants.

23. Patton convinced H.K. Porter to pay a bonus to these key management individuals to enable them to purchase the shares of Delta Star Acquisition's stock set aside for management without having to incur personal expense.

24. The total bonus from H.K. Porter was $100,000, of which Patton received the largest amount ($30,000) Patton consequently obtained the largest amount of management shares of Delta Star Acquisition's stock.

25. Once all of the shares of Delta Star Acquisition's stock had been allocated, Delta Star Acquisition paid $8.3 million to H.K. Porter. This amount consisted of the following: (1) the $7.2 million received from the Delta Star ESOP; (2) the $100,000 received from the nine key management individuals; and (3) the $1 million revolving line of credit from PNB.

26. The amount of $8.3 million was said to represent the book value of Delta Star, plus an additional $1 million. In this regard, the book value of Delta Star was indeed listed as $7.3 million at the time of the transaction. The overall value of Delta Star, however, was much greater than $7.3 million. For example, despite their great value, the fixed assets of Delta Star were listed as having a zero value at the time of the transaction. The practical effect of this was that H.K. Porter sold Delta Star to the Delta Star ESOP for a price well below the value of the company.

27. In exchange for the $8.3 million, H.K. Porter delivered 100% of Delta Star's stock to Delta Star Acquisition, thereby rendering Delta Star a wholly owned subsidiary of Delta Star Acquisition.

28. Once the sale was complete, Delta Star Acquisition merged with Delta Star, leaving Delta Star Acquisition as the surviving corporation, and thereafter officially changed its name to Delta Star, Inc.

III. Management of Delta Star

29. As the sole members of the ESOP Board of Trustees, with the power and authority to vote the shares of Delta Star common stock held by the Delta Star ESOP, Patton, Pany and Austin voted in favor of their election as the sole members of the Delta Star Board.

30. Attorney William Cullen, a partner with Kirkpatrick & Lockhart, LLP, periodically served as legal consultant to Delta Star throughout the relevant years.

31. Although Attorney Cullen advised Patton to have one or more outside directors serve on the Delta Star Board, Patton did not want any outside directors and, thus, none were appointed.

32. At an initial meeting of the three-member Delta Star Board, Patton was appointed Chairman and President of Delta Star and Pany and Austin were appointed Vice-Presidents. John Balsley (Balsley), the Chief Financial Officer (CFO) of Delta Star, was appointed Secretary and Treasurer of the Delta Star Board. In this capacity, Balsley was to attend board meetings and maintain the minutes book.

33. During the relevant years, Pany was in charge of the Belmont, California plant and Austin was in charge of the Lynchburg, Virginia plant. Patton maintained a separate one-room office for himself in Pittsburgh, Pennsylvania, which served as Delta Star's headquarters.

34. Because the directors were stationed in different cities, the Delta Star Board rarely had face-to-face meetings during Patton's term as President. More frequently, the Delta Star Board would hold telephone meetings or enter into unanimous consents.

35. Typically, upon Patton's request, or upon Balsley's request at Patton's direction, unanimous consent forms were prepared by Attorney Cullen. Once prepared, Attorney Cullen would forward the unsigned unanimous consent forms to Balsley, who would circulate the forms to all members of the Delta Star Board for their signatures. If signed, the unanimous consent forms were sent back to Balsley for placement in the minutes book.

IV. Financial performance of Delta Star

36. The electrical transformer industry is cyclical in nature, in that there are periods of growth and periods of decline which affect the industry as a whole.

37. Historically, the cycle of the small to medium power electrical transformer industry is seven years — four down years and three up years. During the down years, there is a lower demand for electrical transformers, and during the up years there is a greater demand.

38. The cycle of the electrical transformer industry is determined by the construction industry in the United States.

39. During the early years of Delta Star's existence as a separate entity, it performed well financially.

40. In its first year, 1989, Delta Star reported net sales of $41,618,390 and a net income of $2,578,545.

41. In 1990, Delta Star reported net sales of $49,572,312 and a net income of $2,724,305.

42. In 1991, Delta Star's financial performance began to decline. In that year, although Delta Star's net sales rose to $59,847,343, its net income stayed somewhat flat, at $2,911,112.

43. In 1992, Delta Star's net sales dropped to $45,519,755 and its net income dropped to $2,759,229.

44. In 1993, Delta Star's net sales dropped dramatically to $27,313,080 and its net income dropped to $823,391.

45. In 1994, although Delta Star's net sales rose slightly, to $28,030,681, for the first time, it reported a loss in net income of $129,386.

46. The financial performance of Delta Star during the years 1989 through 1994 was consistent with the business cycle of the electrical transformer industry as a whole.

47. The ups and downs of Delta Star's financial performance during the years 1989 through 1994 were attributable primarily to the business cycle of the electrical transformer industry as a whole.

48. Patton's management skills and talents made, at most, a five percent difference in Delta Star's financial performance during the years 1989 through 1994.

49. Despite the fact that Delta Star had greater net sales in some years than others, Delta Star's yearly net income stayed somewhat flat throughout the years 1989 through 1994. This was due, primarily, to the fact that excess money from sales was paid out to key management individuals in the form of salary increases and bonuses.

V. Salary increases

50. In 1989, at the time Delta Star became a separate entity, Patton's base salary was $201,400. This amount had previously been set by officials from H.K. Porter.

51. During the years 1989 through 1994, Patton unilaterally determined increases in base salaries for all senior managers, including himself.

52. The base salaries that Patton received during the years 1989 through 1994 were as follows: (1) 1989 — $201,400; (2) 1990 — $222,875; (3) 1991 — $277,211; (4) 1992 — $301,570; (5) 1993 — $301,320; and (6) 1994 — $301,320.

53. The procedure by which Patton caused himself and others to be paid salary increases was never approved by the Delta Star Board.

54. There were no formal documents in place which laid out the criteria which Patton considered in determining salary increases.

55. Patton did not explain or provide documentation to anyone, including the other members of the Delta Star Board, as to how he calculated any salary increases, including his own.

56. Patton did not invite input from others regarding salary increases.

57. Patton did not seek the advice or review of an independent outside consultant concerning the fairness or legality of the salary increases that he caused to be paid to himself and others, or the effect that such salary increases would have on the Delta Star ESOP or its assets.

58. Patton's average base salaries from 1991 through 1993 were above the 75th percentile of base salaries paid to CEOs of other companies in the electrical equipment industry with $60 million in sales.

59. Patton's average base salaries from 1991 through 1993 were competitive with the base salaries paid to the CEO of Kuhlman Corporation, a company much larger than Delta Star in the electrical equipment industry.

60. Patton's average base salaries from 1991 through 1993 were at the 75th percentile of base salaries paid to CEOs of companies in the electrical equipment industry with sales of under $200 million.

61. Patton's average base salaries from 1991 through 1993 were at the 50th percentile of base salaries paid to CEOs of S & P Small Cap companies in the electrical equipment industry.

62. Patton's average base salaries from 1991 through 1993 were below the 50th percentile but above the 25th percentile of base salaries paid to CEOs of all S & P 500 companies in the electrical equipment industry.

63. Because companies in the electrical equipment industry with $60 million in sales, Kuhlman Corporation, companies in the electrical equipment industry with sales of under $200 million, S & P Small Cap companies in the electrical equipment industry and S & P 500 companies in the electrical equipment industry are all substantially larger than Delta Star, it would be reasonable to expect that the base salaries paid to the CEOs of such companies would exceed the base salaries paid to Patton.

64. The salary increases that Patton unilaterally determined during the years 1989 through 1994 benefitted Patton and resulted in a diminution in the value of Delta Star's common stock, the sole asset held by the Delta Star ESOP.

VI. Other items of compensation

65. In addition to base salary, Patton received other items of compensation during his employment at Delta Star.

66. Patton received a meal allowance during the time that he was stationed in Pittsburgh, Pennsylvania.

67. Patton received reimbursement for a country club membership in Mansfield, Ohio, where his home was located, as well as two city club memberships in Pittsburgh, Pennsylvania.

68. Patton received reimbursement for lawn care of his Mansfield, Ohio residence.

69. Delta Star leased vehicles for Patton's use for two year periods. At the end of each two year lease, Patton was given the option to purchase the vehicles for $2,000. During his five years with Delta Star, Patton exercised this option three times and purchased two Cadillacs and a Mercedes for $2,000 each.

70. Each of these additional items of compensation was provided to Patton at his suggestion and/or direction.

VII. Bonuses

71. In addition to salary increases and other items of compensation, Patton received bonuses during his employment at Delta Star.

72. The PNB Credit Agreement contained a document entitled Exhibit S, which discussed, inter alia, a proposed Annual Bonus Plan for Delta Star's officers and senior managers.

73. The proposed Annual Bonus Plan contained in Exhibit S described a formula under which an annual bonus pool for Delta Star's officers and senior managers was to be determined. The annual bonus pool was defined as equaling 40% of Delta Star's excess cash flow for any given calendar year.

74. Although a draft Annual Bonus Plan was prepared by Attorney Cullen in May, 1989, the Delta Star Board never adopted an Annual Bonus Plan similar to the one proposed in Exhibit S to the Credit Agreement.

75. At or around the time the Delta Star ESOP was formed, Attorney Cullen also prepared a document entitled "Delta Star, Inc. Incentive Compensation Procedures." This document was likewise never adopted by the Delta Star Board.

76. During the years 1989 through 1994, Patton unilaterally determined bonus amounts to be awarded to all senior managers, including himself.

77. The bonuses which Patton received during the years 1989 through 1994 were as follows: (1) 1989 — $162,000 (80% of base salary); (2) 1990 — $644,000 (281% of base salary); (3) 1991 — $1,040,000 (375% of base salary); (4) 1992 — $700,000 (232% of base salary); (5) 1993 — $180,000 (60% of base salary); and (6) 1994 — $0.

78. The bonus amounts determined by Patton were taken from a bonus pool. As CFO of Delta Star, Balsley kept track of how much money was available in the bonus pool. This amount, however, was dictated unilaterally by Patton. In this regard, Patton would contact Balsley ...


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