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DELTA STAR, INC. v. PATTON
June 10, 1999
DELTA STAR, INC., PLAINTIFF AND COUNTERCLAIM DEFT.,
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.
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
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
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).
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
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
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
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
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
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
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
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
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
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
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
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,
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
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
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
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
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.
71. In addition to salary increases and other items of
compensation, Patton received bonuses during his employment at
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
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.
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 ...