SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Schedule 13D
Under the Securities Exchange Act of 1934
(Amendment No. 3)*
MAXXAM, INC.
(Name of Issuer)
Common Stock, $0.50 par value
(Title of Class of Securities)
577771108
(CUSIP Number)
STEVEN L. WATSON
THREE LINCOLN CENTRE
SUITE 1700
5430 LBJ FREEWAY
DALLAS, TEXAS 75240-2694
(972) 233-1700
(Name, Address and Telephone Number of Person
Authorized to Receive Notices and Communications)
April 15, 1997
(Date of Event which requires Filing
of this Statement)
If the filing person has previously filed a statement on Schedule 13G to
report the acquisition which is the subject of this Schedule 13D, and is filing
this schedule because of Rule 13d-1(b)(3) or (4), check the following box. [ ]
*The remainder of this cover page shall be filled out for a reporting
person's initial filing on this form with respect to the subject class of
securities, and for any subsequent amendment containing information which would
alter disclosures provided in a prior cover page.
The information required on the remainder of this cover page shall not be
deemed to be "filed" for the purpose of Section 18 of the Securities Exchange
Act of 1934 ("Act") or otherwise subject to the liabilities of that section of
the Act but shall be subject to all other provisions of the Act (however, see
the Notes).
(Continued on following pages)
CUSIP No. 577771108
1 NAME OF REPORTING PERSON
S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON
The Combined Master Retirement Trust
2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP (SEE
INSTRUCTIONS)
(a) [ ]
(b) [ ]
3 SEC USE ONLY
4 SOURCE OF FUNDS (SEE INSTRUCTIONS)
Not Applicable
5 CHECK IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [ ]
6 CITIZENSHIP OR PLACE OF ORGANIZATION
Texas
7 SOLE VOTING POWER
-0-
NUMBER OF
SHARES 8 SHARED VOTING POWER
BENEFICIALLY
OWNED BY 1,277,250
EACH
REPORTING 9 SOLE DISPOSITIVE POWER
PERSON
WITH -0-
10 SHARED DISPOSITIVE POWER
1,277,250
11 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING
PERSON
1,277,250
12 CHECK IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES
CERTAIN SHARES (SEE INSTRUCTIONS) [ ]
13 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
14.8%
14 TYPE OF REPORTING PERSON(SEE INSTRUCTIONS)
EP
CUSIP No. 577771108
1 NAME OF REPORTING PERSON
S.S. OR I.R.S. IDENTIFICATION NO. OF ABOVE PERSON
Harold C. Simmons
2 CHECK THE APPROPRIATE BOX IF A MEMBER OF A GROUP(SEE
INSTRUCTIONS)
(a) [ ]
(b) [ ]
3 SEC USE ONLY
4 SOURCE OF FUNDS(SEE INSTRUCTIONS)
Not applicable
5 CHECK IF DISCLOSURE OF LEGAL PROCEEDINGS IS REQUIRED
PURSUANT TO ITEMS 2(d) OR 2(e) [ ]
6 CITIZENSHIP OR PLACE OF ORGANIZATION
USA
7 SOLE VOTING POWER
-0-
NUMBER OF
SHARES 8 SHARED VOTING POWER
BENEFICIALLY
OWNED BY 1,278,250
EACH
REPORTING 9 SOLE DISPOSITIVE POWER
PERSON
WITH -0-
10 SHARED DISPOSITIVE POWER
1,278,250
11 AGGREGATE AMOUNT BENEFICIALLY OWNED BY EACH REPORTING
PERSON
-0-
12 CHECK BOX IF THE AGGREGATE AMOUNT IN ROW (11) EXCLUDES
CERTAIN SHARES (SEE INSTRUCTIONS) [ X ]
13 PERCENT OF CLASS REPRESENTED BY AMOUNT IN ROW (11)
0.0%
14 TYPE OF REPORTING PERSON(SEE INSTRUCTIONS)
IN
AMENDMENT NO. 3
TO SCHEDULE 13D
This amended and restated statement on Schedule 13D (this "Statement") is
the initial electronic filing by the Reporting Persons, as defined below.
Item 1. Security and Issuer
This Statement relates to the common stock, $0.50 par value per share (the
"Shares"), of MAXXAM, Inc., a Delaware corporation (the "Company"). The
principal executive offices of the Company are located at 5847 San Felipe, Suite
2600, Houston, Texas 77057.
Item 2. Identity and Background
(a) This Statement is filed by (i) The Combined Master Retirement Trust
(the "CMRT"), as the direct holder of Shares and (ii) by virtue of his position
with the CMRT and certain of the other entities (as reported on this Statement),
Harold C. Simmons (collectively, the "Reporting Persons"). By signing this
Statement, each Reporting Person agrees that this Statement is filed on its or
his behalf.
The CMRT is the direct holder of 1,027,250 Shares or approximately 11.9%,
respectively, of the 8,655,773 Shares outstanding as of March 1, 1997 according
to the Company's Annual Report on Form 10-K for the fiscal year ended December
31, 1996 (the "Outstanding Shares").
NL Industries, Inc. ("NL") is the direct holder of 250,000 Shares or
approximately 2.9% of the Outstanding Shares. Valhi, Inc. ("Valhi") and Tremont
Corporation ("Tremont") are the direct holders of approximately 55.6% and 17.7%,
respectively, of the outstanding common stock of NL. Valhi and Tremont together
may be deemed to control NL. Valhi Group, Inc. ("VGI"), National City Lines,
Inc. ("National"), the Contran Deferred Compensation Trust No. 2 (the "CDCT No.
2"), NL and Valmont Insurance Company ("Valmont") are the direct holders of
approximately 31.6%, 4.7%, 3.2%, 0.5% and 0.4%, respectively, of the outstanding
common stock of Tremont. Together, VGI, National and Contran Corporation
("Contran") may be deemed to control Tremont. Valhi is the holder of 100% of
the outstanding common stock of Valmont and may be deemed to control Valmont.
VGI, National and Contran are the direct holders of approximately 74.9%, 10.0%
and 6.7%, respectively, of the outstanding common stock of Valhi. Together, VGI,
National and Contran may be deemed to control Valhi. National, NOA, Inc. ("NOA")
and Dixie Holding Company ("Dixie Holding") are the direct holders of
approximately 73.3%, 11.4% and 15.3%, respectively, of the outstanding common
stock of VGI. Together, National, NOA and Dixie Holding may be deemed to control
VGI. Contran and NOA are the direct holders of approximately 85.7% and 14.3%,
respectively, of the outstanding common stock of National and together may be
deemed to control National. Contran and Southwest Louisiana Land Company, Inc.
("Southwest") are the direct holders of approximately 49.9% and 50.1%,
respectively, of the outstanding common stock of NOA and together may be deemed
to control NOA. Dixie Rice Agricultural Corporation, Inc. ("Dixie Rice") is the
holder of 100% of the outstanding common stock of Dixie Holding and may be
deemed to control Dixie Holding. Contran is the direct holder of approximately
88.7% and 54.3% of the outstanding common stock of Southwest and Dixie Rice,
respectively, and may be deemed to control Southwest and Dixie Rice.
Mr. Harold C. Simmons is chairman of the board, president and chief
executive officer of Valhi, VGI, National, NOA, Dixie Holding and Contran. Mr.
Simmons is also chairman of the board and chief executive officer of Dixie Rice
and Southwest. Additionally, Mr. Simmons is chairman of the board of NL and a
director of Tremont.
Substantially all of Contran's outstanding voting stock is held by two
trusts, the Harold C. Simmons Family Trust No. 1 dated January 1, 1964 and the
Harold C. Simmons Family Trust No. 2 dated January 1, 1964 (together, the
"Trusts"), established for the benefit of Mr. Simmons' children and
grandchildren, of which Mr. Simmons is the sole trustee. As sole trustee of
each of the Trusts, Mr. Simmons has the power to vote and direct the disposition
of the shares of Contran stock held by each of the Trusts. Mr. Simmons,
however, disclaims beneficial ownership of such shares.
By virtue of the holding of the offices, the stock ownership and his
service as trustee, all as described above, (a) Mr. Simmons may be deemed to
control such entities and (b) Mr. Simmons and certain of such entities may be
deemed to possess indirect beneficial ownership of Shares directly held by
certain of such other entities. However, Mr. Simmons disclaims such beneficial
ownership of the Shares beneficially owned, directly or indirectly, by any of
such entities.
The CDCT No. 2 directly holds approximately 3.2% of the outstanding common
stock of Tremont and 0.2% of the outstanding common stock of Valhi. Contran
established the CDCT No. 2 pursuant to an agreement (the "Trust Agreement"),
dated as of October 1, 1995, between Contran and NationsBank of Texas, N.A., a
national banking association ("NationsBank"). NationsBank serves as the trustee
of the CDCT No. 2 (the "Trustee"). The CDCT No. 2 was established in connection
with the Amended Deferred Compensation Agreement, dated as of October 1, 1995,
between Contran and Harold C. Simmons. Pursuant to the Trust Agreement, Contran
retains the right to vote the shares held by the CDCT No. 2. Except to fund
withholding obligations with respect to payments to Mr. Simmons, the Trustee may
not sell the shares it holds without Contran's consent. Contran retains the
right at anytime, in its sole discretion, to substitute assets of equal fair
market value for any shares that the CDCT No. 2 holds. As a result of the
relationship between Contran and the CDCT No. 2, Contran (i) retains sole power
to vote the shares that the CDCT NO. 2 holds, (ii) shares dispositive power with
the Trustee over such shares and (iii) may be deemed the indirect beneficial
owner of such shares.
The CMRT directly holds approximately 11.9% of the Outstanding Shares and
less than 1.0% of the outstanding common stock of Tremont and Valhi,
respectively. The CMRT is a trust formed by the Company to permit the
collective investment by trusts that maintain the assets of certain employee
benefit plans adopted by the Company and related companies. Mr. Simmons is sole
trustee of the CMRT and sole member of the trust investment committee for the
CMRT. Mr. Simmons is a participant in one or more of the employee benefit plans
that invest through the CMRT. Mr. Simmons, however, disclaims beneficial
ownership of the Shares held by the CMRT, except to the extent of his vested
beneficial interest therein.
Harold C. Simmons' spouse is the direct beneficial owner of 1,000 Shares
(less than 0.1% of the Outstanding Shares) and less than 0.1% and approximately
0.1% of the outstanding shares of common stock of Tremont and Valhi,
respectively. Mr. Simmons may be deemed to share indirect beneficial ownership
of such shares. Mr. Simmons disclaims all such beneficial ownership.
The Reporting Persons understand that NL and Valmont directly hold
1,186,200 shares and 1,000,000 shares, respectively, of the common stock of
Valhi. The Reporting Persons further understand that, pursuant to Delaware law,
Valhi treats the shares of Valhi common stock that Valmont and NL hold directly
as treasury stock for voting purposes. For the purposes of this Statement, such
shares that Valmont and NL hold directly are not deemed outstanding.
(b) The business address of the CMRT and Harold C. Simmons is Three
Lincoln Centre, 5430 LBJ Freeway, Suite 1700, Dallas, Texas 75240-2697.
(c) The CMRT is a collective investment trust formed by Valhi to permit
the collective investment by trusts that fund various qualified pension and
profit sharing plans maintained by Valhi and related companies. The employee
benefit plans funded by the trusts participating in the CMRT are subject to the
provisions of the Employee Retirement Income Security Act of 1974, as amended.
(d) Neither of the Reporting Persons has been convicted in a criminal
proceeding in the past five years (excluding traffic violations or similar
misdemeanors).
(e) Neither of the Reporting Persons was a party to a civil proceeding of
a judicial or administrative body of competent jurisdiction as a result of which
such person was or is subject to a judgment, decree or final order enjoining
future violations of, or prohibiting or mandating activities subject to, federal
or state securities laws or finding any violation with respect to such laws.
(f) The CMRT is governed by the laws of the State of Texas, except as
those laws are superseded by federal law. Harold C. Simmons is a citizen of the
United States.
Item 3. Source and Amount of Funds or Other Consideration
The total amount of funds required by the CMRT to acquire the Shares it
directly holds was $19,675,528 (including commissions). Such funds were
provided by the CMRT's cash on hand and no funds were borrowed for such purpose.
Funds for any future purchases of Shares by the CMRT are expected to be
provided from cash on hand.
Item 4. Purpose of Transaction
The CMRT acquired Shares solely for the purpose of investment. The
Reporting Persons intend to review continuously their equity interest in the
Company. Depending upon their evaluation of the Company's business and
prospects, and upon future developments (including, but not limited to,
performance of the Shares in the market, availability of funds, alternative uses
of funds, and money, stock market and general economic conditions), the
Reporting Persons or other entities that may be deemed to be affiliated with
Contran may from time to time purchase Shares, and any of the Reporting Persons
or other entities that may be deemed to be affiliated with Contran may from time
to time dispose of all or a portion of the Shares held by such person, or cease
buying or selling Shares. Any such additional purchases or sales of the Shares
may be in open market or privately negotiated transactions or otherwise.
Except as described in this Item 4, neither of the Reporting Persons has
formulated any plans or proposals that relate to or would result in any matter
required to be disclosed in response to paragraphs (a) through (j) of Item 4 of
Schedule 13D.
On November 13, 1991, NL and Mr. Simmons, as trustee of the CMRT, filed a
complaint against the Company, its directors and other parties in the Delaware
Court of Chancery alleging breach of fiduciary duty, seeking rescission of
certain transactions regarding real property located in Rancho Mirage,
California (the "Mirada") between the Company and Federated Development Company
("Federated"), which, the Reporting Persons understand, controls the Company,
and seeking damages and other relief. NL, Mr. Simmons and other plaintiffs
claimed that a loan by the Company in 1987 to Federated and the forgiveness of
that loan in 1991, as a result of which the Company acquired the Mirada from
Federated, were unfair to the Company and constituted breaches of the
defendants' fiduciary duties to the Company. The case was tried before the
court in early 1996. On April 4, 1997, the court issued its opinion and found
in favor of NL, the CMRT and the other plaintiffs, and ruled that the defendants
had failed to prove that both transactions were fair to the Company. The court
further ruled that the matter of an appropriate remedy to be entered in favor of
the Company should await further proceedings regarding, among other things, the
feasibility of rescission of the transactions. The foregoing summary of the
complaint and the court's decision are qualified in their entirety by reference
to Exhibits 1 and 2, which are incorporated herein by reference.
Item 5. Interest in Securities of the Issuer.
(a) NL is the direct beneficial owner of 250,000 Shares, or approximately
2.9% of the Outstanding Shares. By virtue of the relationships reported under
Item 2 of this Statement, Tremont, Valhi, VGI, National, NOA, Southwest, Dixie
Holding, Dixie Rice, Contran, the CMRT and Harold C. Simmons may be deemed to
share indirect beneficial ownership of the Shares directly held by NL.
The CMRT is the direct beneficial owner of 1,027,250 Shares or
approximately 11.9% of the Outstanding Shares. NL is the direct beneficial
owner of 250,000 Shares. By virtue of the relationships reported under Item 2
of this Statement, the CMRT may be deemed to be the beneficial owner of the
1,277,250 Shares (approximately 14.8% of the Outstanding Shares) directly held
by NL and itself. By virtue of the relationships reported under Item 2 of this
Statement, Harold C. Simmons may be deemed to share indirect beneficial
ownership of the Shares directly and indirectly held by the CMRT.
Harold C. Simmons does not directly own any Shares. NL, the CMRT and Mr.
Simmons' spouse are the direct beneficial owners of 250,000, 1,027,250 and 1,000
Shares, respectively. By virtue of the relationships described under Item 2 of
this Statement, Harold C. Simmons may be deemed to share indirect beneficial
ownership of the 1,278,250 Shares (approximately 14.8% of the Outstanding
Shares) directly held by NL, the CMRT and Mr. Simmons' spouse. Except to the
extent of his vested beneficial interest in Shares directly held by the CMRT,
Mr. Simmons disclaims beneficial ownership of all Shares.
(b) Each of NL, the CMRT and Mr. Simmons' spouse has the direct power to
vote and direct the disposition of the Shares directly held by it or her. By
virtue of the relationships described in Item 2:
(1) the CMRT and Harold C. Simmons may be deemed to share the
indirect power to vote and direct the disposition of the Shares directly
held by NL; and
(2) Harold C. Simmons may be deemed to share the indirect power to
vote and direct the disposition of the Shares directly held by NL, the CMRT
and his spouse.
(c) None.
(d) Each of NL, the CMRT and Harold C. Simmons' spouse has the right to
receive and the power to direct the receipt of dividends from, and proceeds from
the sale of, the Shares directly held by such entity or person.
(e) Not applicable.
Item 6. Contracts, Arrangements, Understandings or Relationships With Respect
to Securities of the Issuer.
Neither of the Reporting Persons has any contract, arrangement,
understanding or relationship (legal or otherwise) with any person with respect
to securities of the Company, including, but not limited to, transfer or voting
of any such securities, finder's fees, joint ventures, loans or option
arrangements, puts or calls, guarantees of profits, division of profits or
losses, or the giving or withholding of proxies.
Item 7. Material to be Filed as Exhibits.
Exhibit 1 Complaint dated November 13, 1991 filed in the Delaware Court of
Chancery in the matter of NL Industries, Inc., et al. v. MAXXAM,
INC., et al. (C.A. No. 12353) (incorporated by reference to
Exhibit 1 to Amendment No. 2 to this Statement).
Exhibit 2* Memorandum Opinion of the Court of Chancery of the State of
Delaware dated April 4, 1997 in the matters of MAXXAM,
Inc./Federated Development Shareholders Litigation and NL
Industries, Inc., et al. v. MAXXAM, INC., et al. (Consolidated
C.A. Nos. 12111 and 12353).
- ----------
* Filed herewith.
Signature
After reasonable inquiry and to the best of my knowledge and belief, I
certify that the information set forth in this Statement is true, complete and
correct.
Date: April 15, 1997
/s/ Harold C. Simmons
--------------------------------
Harold C. Simmons
Signing in the capacities listed on Schedule
"A" attached hereto and incorporated herein by
reference.
SCHEDULE A
Harold C. Simmons, INDIVIDUALLY and as Trustee of THE COMBINED MASTER RETIREMENT
TRUST.
EXHIBIT INDEX
Exhibit 1 Complaint dated November 13, 1991 filed in the Delaware Court of
Chancery in the matter of NL Industries, Inc., et al. v. MAXXAM,
INC., et al. (C.A. No. 12353) (incorporated by reference to
Exhibit 1 to Amendment No. 2 to this Statement).
Exhibit 2* Memorandum Opinion of the Court of Chancery of the State of
Delaware dated April 4, 1997 in the matters of MAXXAM,
Inc./Federated Development Shareholders Litigation and NL
Industries, Inc., et al. v. MAXXAM, INC., et al. (Consolidated
C.A. Nos. 12111 and 12353).
- ----------
* Filed herewith
IN THE COURT OF CHANCERY OF THE STATE OF DELAWARE
IN AND FOR NEW CASTLE COUNTY
In Re MAXXAM, Inc./Federated )
Development Shareholders ) Consolidated
Litigation ) Civil Action No. 12111
)
NL INDUSTRIES, INC., et al., )
)
Plaintiffs, )
) Consolidated
v. ) Civil Action No. 12353
)
MAXXAM, INC., a Delaware )
corporation, MCO PROPERTIES, )
INC., a Delaware corporation, )
FEDERATED DEVELOPMENT CO., a )
New York business trust, )
CHARLES E. HURWITZ, BARRY )
MUNITZ, JOHN M. SEIDL, WILLIAM)
C. LEONE, and STANLEY D. )
ROSENBERG )
)
Defendants. )
MEMORANDUM OPINION
------------------
DATE SUBMITTED: AUGUST 16, 1996
DATE DECIDED: APRIL 4, 1997
-----------------------------------
Joseph A. Rosenthal, Esquire, of ROSENTHAL, MONHAIT, GROSS & GODDESS,
Wilmington, Delaware; Sidney B. Silverman and John F. Harnes, Esquires, of
SILVERMAN, HARNES & HARNES, New York, New York; and Stephen Lowey, Esquire, of
LOWEY DANNENBERG BEMPORAD & SELINGER, New York, New York; Attorneys for
Shareholder Plaintiffs.
Henry N. Herndon, Jr. and Joseph C. Schoell, Esquires, of MORRIS, JAMES,
HITCHENS & WILLIAMS, Wilmington, Delaware; and Donald E. Scott and Lester C.
Houtz, Esquires, of BARTLIT, BECK, HERMAN, PALENCHAR & SCOTT, Denver, Colorado;
Attorneys for Plaintiff NL Industries, Inc. et al.
A. Gilchrist Sparks, III, R. Judson Scaggs, Jr. and R. Judson Scaggs, Jr.,
Esquires, of MORRIS, NICHOLS, ARSHT & TUNNELL, Wilmington, Delaware; David C.
McBride, Esquire, of YOUNG, CONAWAY, STARGATT & TAYLOR; Lawrence C. Ashby,
Stephen E. Jenkins, Richard D. Heins, and John S. Grimm, Esquires, ASHBY &
GEDDES, Wilmington, Delaware, Attorneys for Defendants.
JACOBS, VICE CHANCELLOR
Under challenge in these consolidated shareholder derivative actions are
two self-dealing transactions between MAXXAM, Inc., a Delaware corporation
("MAXXAM"), and its majority stockholder, Federated Development Company
("Federated"). The plaintiffs, who are MAXXAM public shareholders, claim first
that in 1987 Federated caused MAXXAM to loan Federated up to $25 million on
terms that were unfair to MAXXAM (the "1987 Loans transaction"). Second, the
plaintiffs claim that in 1991, when those loans (none of which had been repaid)
became troubled, Federated caused MAXXAM to forgive the $34.3 million accrued
indebtedness by selling the underlying collateral to MAXXAM for the amount of
that debt plus $7.3 million of additional consideration. That transaction, the
parties contend, was also unfair to MAXXAM (the "1991 Exchange Transaction").
As a consequence of these two transactions, the plaintiffs seek significant
money damage relief against all defendants other than MAXXAM.
The parties attempted to settle the case before trial, but this Court
rejected the proposed settlement as inadequate. See In re MAXXAM, Inc./Federated
--- ----------------------------
Development Shareholders Litig., Del. Ch., 659 A.2d 760 (1995). Thereafter, the
- -------------------------------
Court denied the defendants' motions to dismiss the 1987 Loan claims on
limitations and standing grounds made both before and after the trial. See In re
--- -----
MAXXAM, Inc./Federated Dev. Shareholders Litig., Del Ch., C.A. Nos. 12111 &
- -----------------------------------------------
12353, Jacobs, V.C. (June 21, 1995); and In re MAXXAM, Inc./Federated Dev.
---------------------------------
Shareholders Litig., C.A. Nos. 12111 & 12353, Jacobs, V.C. (September 10, 1996).
- -------------------
A nine day trial was held from January 29 through February 2, 1996, and
from February 5 through 8, 1996. This is the decision of the Court, after
trial, on the merits of these consolidated derivative actions.
I. FACTS
-----
Many of the underlying facts are undisputed, but where disputed, the facts
are as found herein.
A. Federated Acquires the Mirada
and Begins Development.
----------------------------
Federated is a New York business trust that is privately owned by defendant
Charles Hurwitz ("Hurwitz") and members of his family. Federated, in turn,
holds a majority of the voting stock of MAXXAM, a publicly-owned Delaware
corporation that is the beneficial plaintiff (and nominal defendant) in these
actions.[1] At all relevant times, Federated nominated and elected MAXXAM's
board of directors.
In 1972, Federated acquired property located in Rancho 1Mirage, California.
(PX 83 at 3). In 1982, while that property was still zoned for open space,
Federated attempted to persuade the City of Rancho Mirage to amend its zoning
ordinance to enable the property to be developed as a luxury residential
development. Federated's efforts generated two public referenda, as well as
several lawsuits, over whether to permit that development. In August 1983, these
referenda and lawsuits culminated in a Development Agreement under which
Federated donated a substantial portion of its acreage for use as a nature
preserve for Big Horn sheep. In return, the City of Rancho Mirage permitted
Federated to build a hotel and a residential development on the remaining land.
(PX 39; DX 13; Munitz Tr. 12).
Thereafter, in 1986, Federated formed a partnership with the Ritz-Carlton
to build a resort hotel. (Tr. 1311; DX 156). That same year, as part of the
development of the Rancho Mirage property, Federated obtained options to acquire
several hundred acres of adjoining land located in the neighboring town of
Cathedral City. Federated planned to build a golf course and residential
development on that land. (Munitz Tr. 18-19). At that time Federated did not
have the government approvals required to build a golf course, but Federated
hoped to obtain them and to carve a golf course into the Santa Rosa mountains.
(Munitz Tr. 18).
By early 1987, the development project, then called "the Mirada," consisted
of (i) 46 developed lots ("Phase I"), (ii) 2 undeveloped sites approved for
attached housing (the "villa site" and the "townhouse site"), and (iii) options
to acquire 1,028 acres of hillside land planned--but not yet approved--for a
golf course and residential development (the "golf course property"). Because
it was separately financed and under construction, the Ritz-Carlton hotel, which
was located at the site, was not included in the Mirada project that MAXXAM
ultimately financed in 1987. (Munitz Tr. 25).
B. Federated Seeks Outside Financing.
----------------------------------
By April 1987, Federated had invested over $10 million in the Mirada. By
then it was clear that significantly more capital would be required to complete
the project. Federated decided that it did not want to invest any more of its
own money in the project, and it began a search for outside financing. During
that search, Hurwitz and Dr. Barry Munitz ("Munitz"), Federated's President,
contacted over 15 potential lenders. (Munitz Tr. 25-26, 105-07).
At that particular time, according to one of the defense experts, there was
"more money available chasing deals in southern California than there was
product to be financed." (Tr. 656). Despite this availability of funds, only
three lenders -- San Jacinto Savings & Loan, Gibraltar Savings & Loan, and
Columbia Savings & Loan ("Columbia") -- were willing to consider the loan terms
that Federated and Hurwitz were proposing. (PX 83 at 4, Munitz Tr. 107-08). Of
these, only the discussions with Columbia reached the stage where a draft "term
sheet" was created. (PX 83 at 5; Munitz Tr. 115-24). By June 1987, however,
even Columbia had ceased pursuit of a joint venture with Federated. (PX 83 at
5).
C. Federated Approaches MAXXAM.
----------------------------
In May 1987, Federated turned to its majority-controlled subsidiary MAXXAM
(then called MCO Holdings, Inc.).[2] Federated wanted MAXXAM to serve as the
project lender, with Federated being the developer. (Tr. 1376). Federated
presented its loan proposal to the MAXXAM Board at its June 15, 1987 meeting.
At that meeting all three of the Federated designees to MAXXAM's Board (Messrs.
Hurwitz, Munitz, and Levin) were present, with Mr. Hurwitz presiding. Although
Federated's discussions with outside lenders were still in the preliminary
stages, Dr. Munitz represented to the MAXXAM Board that Federated had other
financing alternatives. (PX 13 at 14592-93, Tr. 1378-79).
Dr. Munitz then proposed to the MAXXAM Board loan terms that were more
favorable to Federated than those which Federated had proposed to Columbia.
Munitz requested that MAXXAM grant to Federated an initial term loan of $15
million at 12% interest (as contrasted with a $12 million loan proposed to
Columbia), plus a $5 million revolving loan with interest at the prime rate plus
1%. (Tr. 1722-27). All loans would be for five years, with allowance for a
three-year extension if MAXXAM consented. (In contrast a four to five year term
had been proposed to Columbia). In return, MAXXAM would receive a 25% profit
participation. (PX 18 at 3-5; Tr. 1722-27; Munitz Tr. 117-20).
With respect to the golf course property, MAXXAM would loan Federated $2.5
million (representing the entire purchase price of that property) on the same
terms, and would receive back a 25% profit participation. In contrast,
Federated had proposed that Columbia loan to it only half of the purchase price,
with Federated to contribute the remainder. (PX 18 at 5).[3]
All loans would be non-recourse, to be secured only by the Mirada property,
excluding 6 lots that Federated would retain for itself. That is, 6 of the 46
Mirada Phase I lots would be excluded from the collateral that would be MAXXAM's
only source for the repayment of the loans. In addition, interest would accrue
and be deferred for the entire term of the loans.
Unlike Federated's proposal to Columbia, MAXXAM had no requirement that the
net cash flow from the lot sales would be used to pay down the loans from
MAXXAM. Instead, the net cash proceeds would be deposited into an account from
which all disbursements would be authorized by an "Approval Committee,"
consisting of one MAXXAM representative and one representative of Federated. (PX
1 at Section 1.5(b)). Those disbursements could be used to pay the project's
operating expenses; there was no requirement that they be used to repay the
loans to MAXXAM. Finally, the proposal to Columbia guaranteed Columbia a $3
million return, whereas MAXXAM would have no guaranteed return.
D. The MAXXAM Board Accepts Federated's
Proposal Subject to Certain Conditions.
------------------------------------------
At its June 15 meeting, the MAXXAM Board did not seriously explore or
consider the terms of the 1987 Loans from the standpoint of whether their terms
were fair or adequate from MAXXAM's perspective. Before the June 15 meeting,
MAXXAM's Chief Financial Officer, James Iaco, analyzed Federated's initial
proposed terms and found them inadequate. In an internal memorandum, Iaco
argued that a 20% profit participation for a $12 million term loan was too low,
and that any loan reimbursing Federated's entire investment should command at
least a 40% profit participation. Iaco concluded that if MAXXAM's profit
participation would be only 20%, its up front cash contribution should be only
$6 million, and the collateral should include all 46 lots, rather than allowing
Federated to carve out 6 lots for itself. (PX 9 at 23867-69). There is no
evidence that the Board was ever informed of or saw Iaco's memorandum, although
Mr. Iaco was present at the June 15 meeting.[4]
There is no evidence that any director inquired why Federated should be
permitted to exclude 6 lots from the collateral, or why Federated should not be
required to devote the $15 million loan proceeds to develop and market the
Mirada. (Tr. 1445-47, 1569-70). Nor was it proposed that MAXXAM choose its own
appraiser to value the property. (Tr. 1443), and there is no evidence that the
Board discussed whether, given MAXXAM's current outstanding debt levels, it was
appropriate to loan $20 million on a project MAXXAM was not developing as part
of its regular business. (Tr. 1424-25).
What the record does reflect is that the MAXXAM Board agreed to approve the
loans on Federated's proposed terms subject to three conditions: (i) an M.A.I.
appraisal valuing the property in excess of $30 million, (ii) a completed
marketing study by the Robert C. Lesser Company, and (iii) approval of the
proposed loans by MAXXAM's staff. (PX 13 at 14594-95; Tr. 1441).
The precise appraisal amount the Board had required for the loan to be
approved is unclear from the record. The June 15 Board minutes reflect a $30
million appraisal requirement, but the actual loan document specified that the
property be appraised for at least $34 million. (Compare PX 13 at 14594 with PX
-------
1 at 1493). Regardless, that requirement was deemed satisfied by an appraisal
prepared and submitted by Blee & Stark, which Dr. Munitz, on behalf of
Federated, had requested. (PX 5). Blee & Stark valued the project, excluding
the golf course property, at $34.9 million.
The Blee & Stark appraisal was problematic in several respects. First, its
$34.9 million valuation did not include a discount to reflect that the lots
would be sold over time. Although Blee & Stark did separately calculate two
"discounted" values for the lots, those values ($15,300,000 and $14,700,000),
when combined with the values attributed to the villa and townhome sites,
yielded overall values of only $27,100,000 and $26,500,000.[5] Second, Blee &
Stark assumed an absorption (i.e., a "sell-off") rate of 24 lots per year at an
----
average price of $504,000. (PX 5 at 2241, 2244). But the marketing study that
the Robert C. Lesser Company conducted for MAXXAM (the "Lesser study") predicted
an absorption rate of 15 lots per year, and an average sales price of $436,000.
(PX 6 at 2344, 2346; PX 7 at 2179-80).
Regardless, on August 25, 1987, the MAXXAM Board authorized the August 1987
Loans by unanimous written consent. (PX 14; Tr. 1452-55). There is no evidence
of what consideration, if any, the board gave to the problems relating to Blee &
Stark's appraisal, which together with the Lesser marketing study, had been
received before the consent was executed.
In a separate unanimous written consent executed three months later on
November 17, 1987, the MAXXAM Board authorized an additional $3 million term
loan to Federated to develop a golf course and residential development on the
adjoining Cathedral City property. (PX 15). MAXXAM also committed to loan
Federated up to an additional $2 million if that property were sold, to pay off
the existing mortgage on that property. (PX 2 at Section 4.2).
E. The Mirada Fails to Meet Expectations.
--------------------------------------
The Blee & Stark appraisal upon which the MAXXAM Board relied assumed
projected sales of 24 lots per year. In fact, only 15 lots were sold during the
entire four year period between the summer of 1987 and the summer of 1991: 4
lots in 1988, 5 in 1989, and 6 in 1990. (PX 29 at Appendix C). Four of those 15
sales were of the 6 lots Federated had retained for itself. Thus, Federated
sold 67% of the lots that it retained for itself, but sold only 27% of the lots
that constituted MAXXAM's collateral for the 1987 Loans. Federated was able to
sell 4 lots by lowering their list price, but Federated did not lower the listed
price for the remaining 40 lots.[6] (PX 46 at 17799-802).
In early 1988, Federated became embroiled in litigation with the Cities of
Rancho Mirage and Cathedral City. (Tr. 1317-18; 1530; Munitz Tr. 18-19; PX 39 at
5-9). The dispute was resolved in January 1989, when Federated agreed to
transfer over 900 acres of its golf course land to the City of Rancho Mirage,
and to abandon its plan to develop a golf course. In exchange, Federated
received permission to build 50 additional residential units at the Mirada. (Tr.
1536-38; Munitz Tr. 22-23; DX 79; DX 80). Those additional units, which now
would be unaffiliated with a golf course, are referred to in this Opinion as the
"Phase II lots."
The litigation also cost Federated the only potential buyer it could locate
for the villa site. Mitsui made an offer to purchase the villa site on August
5, 1988, the same day the City of Rancho Mirage sued Federated to rescind the
Development Agreement. (DX 145). Mitsui's concern over that litigation caused
it to withdraw its offer in November 1988, and to refuse to consider Federated's
overture to renegotiate.[7] Federated found only one potential joint venture
partner for the townhome site (Swank), but no deal ever resulted (Munitz Tr.
148-49). Thereafter, no other bids were made for either site. (Munitz Tr. 148-
49; 1572-73).
Throughout this entire period Federated made no payments of principal or
interest on the 1987 Loans. Thus, by early 1991, Federated knew that the Mirada
project faced many problems, including "the state of the economy, the newness of
the project, the expense of the project, the sporadic political problems ...
[and] an underinvestment in the promotional side." (Munitz Tr. 152).
F. Federated Approaches MAXXAM to
Buy the Mirada; MAXXAM Forms
the Special Committee
-------------------------------------
By September 30, 1990, the outstanding principal and accrued interest
balance on the 1987 Loans had climbed to $31.4 million. (DX 31). Within a year
and a half those loans would fall due. Moreover, the Mirada was performing
poorly. (DX 31; Munitz Tr. 153-57). At this time Federated was also being told
by its consultants that the asking prices on its lots were too high. (See supra
--- -----
n.6; PX 33D). In these circumstances, Federated was unwilling to put any more
of its own money into the project. Seeking a solution to its problem, Federated
inquired whether MAXXAM would consider purchasing all or any part of Federated,
including specifically the Mirada. (Tr. 1544-45).
On November 6, 1990, MAXXAM's Board of Directors formed a Special Committee
to consider what course of action MAXXAM should take in response to Federated's
proposal. (Tr. 1601-02; PX 32A at 2). The Special Committee consisted of five
MAXXAM Board members who were not employees or Trustees of Federated -- John
Connally (a former Governor of Texas), John Seidl, William Leone, Stanley
Rosenberg, and C.V. Wood, Jr. All five persons had significant financial or
personal ties to Hurwitz. (PX 55C - 55F).
The Committee first met on November 6, 1990, and Governor Connally was
elected chairman. Connally played a dominant role in interviewing and selecting
the Committee's advisors. At the Committee's first meeting, its members
instructed MAXXAM's general counsel to arrange for Governor Connally to
interview at least three law firms. (PX 32A at 4). Based on those interviews,
the Committee retained the law firm of Johnson & Gibbs. (PX 32B at 1).
The Committee also interviewed and retained various real estate and finance
expert advisors, the first being Cushman & Wakefield of California, Inc.
("Cushman"). The minutes of the Special Committee's initial November 6, 1990
meeting recite that the Committee deliberated over the selection of a real
estate appraiser, but the evidence indicates that Connally had already decided
to hire Cushman before then.[8]
In February 1991, the Special Committee engaged KPMG Peat Marwick to review
the lot absorption rate assumptions made in Cushman's preliminary appraisal, and
to prepare a marketing report on the Mirada. (DX 81 at 12; PX 32E at 12276; Tr.
1658). The Special Committee then hired a third real estate firm, Lewis &
Howard, to critique both the Cushman appraisal and the Peat Marwick study.
Governor Connally, who knew Lewis & Howard from other projects, had already
engaged that firm the month before the March 15 meeting at which the Committee
"considered engaging" Lewis & Howard. (Tr. 1632, DX 30; PX 32F, 32G).
Lastly, on March 15, 1991, the Committee authorized the retention of First
Boston as its investment banker "if it seem[ed] likely an agreement could be
reached with Federated." (PX 32F at 12286).
G. The Special Committee's Process
-------------------------------
The Special Committee first considered, and rejected, Federated's proposal
that MAXXAM purchase the entirety of Federated. A purchase of Federated would
have included a stock portfolio and stock trading operations, commercial
property, the Ritz-Carlton Hotel, and the Mirada. The Committee rejected the
stock portfolio and stock trading operation as inconsistent with MAXXAM's real
estate business (Tr. 1608), and it rejected the commercial property because it
was not located near the Mirada or tied to the Ritz-Carlton. (Tr. 1609-1610).
Finally, the Committee rejected the Ritz-Carlton because it was burdened by an
excessive debt load. (Tr. 1610-11). From that point on, the Committee focused
exclusively on a possible purchase of the Mirada.
At Committee meetings held on January 15 and February 4, 1991, Cushman
presented its preliminary appraisal, which valued the Mirada at $47,877,000. (PX
32D-E). The Committee concluded that Cushman's absorption rates were too
aggressive, and instructed Cushman to re-examine them. (Tr. 1625-26). Cushman
did that, and in its final appraisal, lowered its valuation to $43,560,000.
On March 14, 1991, the Committee received Peat Marwick's marketing report.
(DX 81-84). Based on the assumption that there would be no management change,
Peat Marwick found a 60% probability that sales would be only 3-4 lots per year;
a 30% probability that sales would be 5-6 lots per year, and a 10% probability
that sales would be 8-10 lots per year. Under improved management the odds
increased somewhat: a 25% probability of 3-4 sales per year, a 50% probability
of 5-6 sales, and a 25% probability of 8-10 sales. (PX 29 at 2).
The Committee next met on March 15, 1991, the day after it had received
Peat Marwick's report. At that meeting, Governor Connally expressed his belief
that MAXXAM needed to "acquire the property and fully take charge." (PX 32F at
12284). Some Committee members expressed the concern that to negotiate a
purchase transaction was premature; nonetheless, Governor Connally persuaded the
Committee to authorize him to begin discussions with Federated on a "possible
range of value for the acquisition." (PX 32F at 12285-86).
On March 27, 1991, Cushman submitted to the Special Committee its final
appraisal which valued the Mirada at $43,560,000 as of February 1, 1991. (PX
25).
H. The April 17 Special Committee Meeting
--------------------------------------
At its April 17, 1991 meeting, the Committee received presentations from
all its advisors. A Peat Marwick representative made a short presentation of
his firm's conclusions. The Committee next heard (by teleconference) from a
Cushman representative, who confirmed that its revised appraisal was accurate.
(PX 32J).
The Committee then received an oral report from Lewis & Howard, the
appraisal firm Connally had selected.[9] Lewis & Howard opined that both the
Cushman and Peat Marwick forecasts were too negative. Nonetheless, Lewis &
Howard concluded that Cushman's $43,560,000 appraisal value was reasonable.
(Id., at 6).
---
Finally, First Boston presented its conclusions. Although defendants argue
in their brief that First Boston had made an independent valuation of the Mirada
(Def. Answering Post-Trial Br., at 21), First Boston's report explicitly stated
that the firm "did not conduct an independent valuation or appraisal of the Real
Estate Assets" (PX 30D at 120-21). Rather, First Boston relied on the Cushman
appraisal and the earlier expert presentations made to the Special Committee.
First Boston criticized various aspects of Cushman's methodology, and opined
that Cushman's appraisal was "more towards the higher end of the current range
of reasonable values." (PX 32J at 7). First Boston concluded that a reasonable
range of values for the Mirada would be from $35,639,000 to $45,884,000 (DX 53
at FBC002498), as contrasted with Cushman's valuation, which ranged from
$39,985,000 to $46,890,000.
After discussing these matters, the Special Committee voted to adopt a
resolution that "MAXXAM make an offer to purchase the property from Federated on
terms which were no more than the [Cushman] appraised value." (PX 32J at 12296-
97).
I. The Negotiation of the Exchange
-------------------------------
The evidence of the actual negotiations between Federated and MAXXAM is
sparse, and the documentation is even more so. The defendants claim that
Hurwitz demanded a price higher than Cushman's appraised value, and that only
after intensive negotiations over price did Connally and Seidl give Hurwitz an
ultimatum either to agree to the Exchange at the Cushman appraisal price or
forget the entire transaction. At trial, Mr. Seidl could not recall how many
times he met with Hurwitz to discuss price, but he was sure it was more than
once. In his deposition, however, Seidl could not recall if it was more than
once. (Tr. 1636, 1681). Mr Seidl could not remember what his opening position
was, other than probably "something close to the debt and maybe some sort of
splitting arrangement going forward." (Tr. 1636). Nor could he recall the
dollar difference between his initial proposal and the ultimate purchase price,
except that the parties were initially "a long way apart" and there was a lot of
back and forth on the price. (Tr. 1680). The one aspect of the negotiation
Seidl claimed he definitely could recall was that he and Governor Connally made
a "take-it-or-leave-it" offer at the full Cushman appraisal value, and that
Hurwitz "took it." (Tr. 1548, 1637).[10]
MAXXAM and Federated executed the Exchange Agreement on May 20, 1991. (PX
3). The transaction closed on July 12, 1991. (PX 26; PX 27). Under the terms
of the Exchange Agreement, MAXXAM purchased the Mirada for the full Cushman
appraisal value of $42,892,000,[11] allocated as follows:
. MAXXAM forgave Federated's accrued $34.3 million debt on the 1987
loans;
. MAXXAM assumed Federated's $2 million obligation to pay off promissory
notes issued to the original owners of the golf course property;
. MAXXAM advanced $1.4 million in cash to pay off Federated's commitment
to third parties (the "Fireford interests") who owned an interest in
the Mirada;
. MAXXAM issued to Federated $3.9 million of preferred stock in a
subsidiary, MCO Properties Inc. (which was convertible into MAXXAM
common stock); and
. MAXXAM's 25% interest in the profits of the project under the 1987
Loans, valued for the purpose of the Exchange at $1.3 million, was
extinguished.
(PX 4; PX 36A; PX 36B). That is, MAXXAM forgave the $34.3 million in principal
and accrued interest balance due under the 1987 Loans, and in addition, paid
$7.3 million by assuming certain obligations of, and issuing stock to,
Federated.[12]
J. The Mirada's Continued Poor Performance
---------------------------------------
After the closing, the Mirada continued to fail the performance predictions
contained in the various appraisals and reports upon which the Special Committee
had relied. By the time of the January, 1996 trial, only 9 additional Phase I
lots had been sold,[13] the Phase II lots and the villa and townhouse sites
remained undeveloped and unsold. This substandard performance persisted, even
though during 1992 MAXXAM lowered its asking prices on Phase I lots by an
average of 28%. In addition, the Ritz-Carlton Hotel had defaulted on its
mortgage and had deeded the hotel property to the mortgagee in lieu of
foreclosure. (Tr. 1207-08).
* * * * *
In Part II, infra, of this Opinion, the Court addresses the merits of the
-----
1987 Loan transaction claims. Preliminarily, the Court considers, and rejects,
the threshold defense that the 1987 Loan claims are barred by the statute of
limitations. The Court next considers what standard of review applies to the
1987 Loan transaction claims, and determines that the defendants have the burden
of demonstrating the entire fairness of that transaction. Finally, the Court
considers the fairness of the process by which the 1987 loans were approved and
of their substantive terms, and concludes that defendants have failed to prove
that the 1987 Loans were fair to MAXXAM.
In Part III, the Court decides the validity of the 1991 Exchange
transaction claim. First, the Court considers (and rejects) the defendants'
argument that the plaintiffs must bear the burden of showing that the
transaction was unfair, because the transaction was negotiated and approved by
an independent committee of MAXXAM directors. Determining that the defendants
have the burden of proving the transaction's entire fairness, the Court then
addresses the fairness of the approval process and of the substantive
transaction terms to which MAXXAM agreed, and concludes that the defendants have
failed to meet that burden.
Finally, in Part IV, the Court addresses issues relating to remedy, and
concludes that the remedy determination must await a later stage.
II. THE 1987 LOAN CLAIM
-------------------
A. THE STATUTE OF LIMITATIONS DEFENSE
----------------------------------
Before addressing the merits of the 1987 Loan transaction claim, the Court
first must decide the threshold question of whether that claim is barred by the
statute of limitations. All parties agree that unless the Court finds that the
applicable three year statute of limitations was tolled, plaintiff's 1987 Loan
claim will be time-barred. See In re MAXXAM, Inc./Federated Development
--- ----------------------------------------
Shareholders Litig., supra, Mem. Op. at 13 (June 21, 1995). In the cited
- ------------------- -----
pretrial Opinion denying the defendants' motion to dismiss on limitations
grounds, the Court determined that "the complaint supports the plaintiffs'
position that the disclosures relating to the 1987 loans obfuscated and
concealed, rather than clearly disclosed, material facts relating to the
riskiness of the loan terms." Id., at 17. That is, the plaintiffs had alleged
---
facts that, if proven, would toll the statute of limitations under the doctrines
of fraudulent concealment and/or equitable tolling. Id., at 13-15.
---
Now that the case has been tried, the defendants urge that the plaintiffs
have failed to prove the facts they alleged in their complaint and that this
Court found legally sufficient. Therefore, defendants conclude, the plaintiffs
have failed to establish the facts essential to their claim that the statute of
limitations was tolled.
Specifically, the defendants argue that the trial record establishes that
the plaintiff shareholders knew or should have known all the material facts
concerning the 1987 Loan transaction at the time they received MAXXAM's February
11, 1988 Proxy Statement. That is because (defendants urge) (i) the public
disclosures of the 1987 Loan terms were sufficient to put the plaintiffs on
inquiry notice of any potential unfairness in their terms; and, (ii)
alternatively, the terms that the plaintiffs claim should have been (but were
not) disclosed were not material. In addition, the defendants contend that
(iii) there is no showing that the doctrine of equitable tolling applies to
Messrs. Leone and Rosenberg, for which reason the 1987 Loan claims against Leone
and Rosenberg must be dismissed in all events.
1. Whether Plaintiffs Were Put
On Inquiry Notice.
-----------------------------
As summarized in the Court's June 21, 1995 Opinion, as of May 28, 1988 the
defendants had publicly disclosed the following information: "(1) the total
principal amount of the 1987 loans; (2) the fact that the loans were non-
recourse, secured only by the Mirada real estate; (3) the fact that the loans
were to Federated, MAXXAM's controlling stockholder; (4) the fact that MCOP
would receive, in addition to interest on the loans, a contingent 25% interest
in net profits from the project; and (5) the fact that interest and principal on
the loans would be repaid solely from net proceeds from lot sales." Id., at 8-9.
---
Those conclusions, which at that stage were based upon the pleaded facts.
They are now supported by facts established in the trial record.
The defendants rely upon no new or different facts to support their
contention that the plaintiffs had inquiry notice of the potential unfairness of
this transaction as of May, 1988, other than the testimony of the plaintiffs'
----------
trial expert, Mr. Opperman, that disclosure of those terms would have raised
"strong doubts" as to whether the loans were prudent. (Tr. 253-54). This
testimony does not help the defendants. To begin with, the issue of inquiry
notice is a question for the Court, not an expert witness, to decide. Moreover,
the witnesses' testimony is misconstrued. Mr. Opperman repeatedly emphasized
that he was responding "as a lender." (Tr. 249). But here the lender was not
the MAXXAM stockholder plaintiffs; it was MAXXAM acting through its Board of
Directors. Unlike a third party or outside lender, MAXXAM's stockholders were
entitled to view the limited information they received with the presumption that
it reflected a loan whose terms were fair. The Board, which was aware of all
---
the facts, was in a far better position to determine the loan risk than were the
"stockholders [who were] entitled to rely on the good faith of the directors
when they act with respect to the corporation's property or processes." Kahn v.
-------
Seaboard Corp., Del. Ch., 625 A.2d 269, 275 (1993).
- --------------
In short, the defendants have shown nothing new, factually or legally, that
persuades the Court to alter its earlier conclusion that the "facts [that] were
disclosed before May, 1988 did not, in these circumstances, impose upon the
plaintiffs a duty to make further inquiry or conduct an independent
investigation." In Re MAXXAM, Inc./Federated Div. Shareholders Litigation, Del.
---------------------------------------------------------
Ch., C.A. Nos. 12111 & 12353, Jacobs, V.C. (June 21, 1995) Mem. Op., at 18.
2. Whether Defendants Failed to
Disclose Material Information
About the Loans.
------------------------------
The defendants next contend that the information that was omitted from the
public disclosures about the 1987 loans was not material. The omitted facts
were that: 1) there were no restrictions on Federated's use of the initial $15
million term loan; 2) interest would be permitted to accrue rather than having
to be paid out of the proceeds from lot sales; 3) there was no government
approval for the proposed golf course; 4) there was strong local opposition to
development of the Mirada; 5) Federated had retained 6 of the 46 estate lots for
itself, thereby excluding those lots from the collateral for the loans; and 6)
except for a portion of the funds borrowed from MAXXAM, Federated had invested
none of its own money in the Mirada project.
The defendants claim that the absence of any restrictions upon the use of
the loan proceeds, and the fact that interest would accrue, were immaterial,
because they were commonplace terms in joint venture loan transactions. That
argument lacks merit. Those terms may have been commonplace, but that does not
make them immaterial. Moreover, this transaction was not commonplace. It was
not an arm's length transaction. Rather, it was one between a corporation and
its controlling shareholder, in which Federated, the borrower and the lender's
controlling stockholder, was not required to use any of the borrowed funds to
develop the property that would be the only repayment source for the loans.
Instead, Federated could use the proceeds as it wished. That fact, if
disclosed, would have alerted the shareholders to the possibility that Federated
was exploiting MAXXAM.
Moreover, the fact that Federated was not required to pay interest
currently--indeed, could postpone paying any interest for at least five years--
would, if disclosed, have signaled the possibility that Federated had shifted a
disproportionate share of the project's risk of failure onto MAXXAM. The
defendants have failed to persuade the Court that those terms were immaterial.
The defendants next argue that the fact that the loans were secured by only
40 (as opposed to 46) lots would, if disclosed, have lacked significance to
MAXXAM's shareholders. But the materiality point is not that the collateral
consisted of only 40 lots. Rather, it is that 6 of the 46 lots comprising Phase
I of the Mirada project had been excluded from the collateral because they were
retained by the borrower which was also the lender's controlling stockholder.
Disclosure of the fact that the controlling shareholder intended to sell, for
its own account, prize lots that would otherwise have been part of the
collateral that was the only source for the loan repayment, would have alerted
shareholders to the possibility that the loan transaction was unfair.
Finally, the defendants contend that the community opposition to the golf
course proposal was immaterial, because community opposition to development was
commonplace and Federated did not believe that the opposition would
significantly impede its ability to obtain permission to build the golf course.
As discussed below, while Federated may have been optimistic, its principals
did anticipate opposition to the golf course. They had good reason: Federated
had just recently emerged from a lengthy, contentious entitlement process for
the adjoining land. As a result of that dispute, Federated ended up forfeiting
a substantial part of its Rancho Mirage property to obtain the right to develop
the remaining portion. Because one purpose of the 1987 Loans was specifically
to facilitate the development of a golf course, the absence of government
approvals for development of that golf course property had to be a material fact
requiring disclosure.
3. Whether Plaintiffs Failed to Show
That Defendant Rosenberg
Fraudulently Concealed Material Facts.
--------------------------------------
Lastly, the defendants argue that even if the statute of limitations is
found to have been equitably tolled as to certain defendants, it was not tolled
as to defendants Leone and Rosenberg, because there is no showing that they
engaged in actionable self-dealing or fraudulent concealment. The plaintiffs do
not explicitly respond to this argument. Instead, they summarily assert that
they established fraudulent concealment by all defendants collectively. The
defendants' position has merit as to Mr. Rosenberg, who was both disinterested
and independent of the controlling shareholder in this self-dealing transaction,
but not as to Mr. Leone, who was not independent.[14]
The equitable tolling doctrine applies to claims against a disinterested
party who conspires with a self-dealing fiduciary to defraud the beneficiary.
See Laventhol, Krekstein, Horwath & Horwath v. Tuckman, Del. Supr., 372 A.2d
- --- --------------------------------------------------
168, 170-71 (1976). That doctrine may also be applied to a claim involving an
abuse of the fiduciary relationship through actionable self-dealing. See Litman
--- ------
v. Prudential-Bache Properties, Inc., Del. Ch., C.A. No. 12137, Chandler, V.C.
- ------------------------------------
(Jan. 14, 1994), Mem. Op. at 6-7. Here, the plaintiffs have not claimed or
demonstrated that Leone and Rosenberg conspired with the controlling shareholder
to defraud MAXXAM's stockholders. Nor do they claim that Leone and Rosenberg
personally received any benefits from the 1987 Loans.
But equitable tolling may also apply to claims against directors who are
controlled by, or are not independent of, the controlling shareholder that does
benefit from the self-dealing transaction. In Litman v. Prudential-Bache
--------------------------
Properties, Inc., supra,[15] the Court held that equitable tolling would apply
- ---------------- -----
even "absent allegations of affirmative acts of concealment by the defendants,
where the parties to the litigation stand in fiduciary relationship to each
other and where the plaintiff alleges self-dealing." In Litman that principle
--- ------
was brought into play because the alleged self-dealing had "implicate[d] serious
breaches of loyalty and ... raised the legal analysis to a higher level than
ordinary breaches of care." Id., at 6.
---
Those same concerns justify equitably tolling claims against directors who
are not independent of the self-dealing controlling shareholder. A director who
lacks such independence because he is controlled by the person who dictates the
terms of the self-dealing transaction, is necessarily subject to a divided
loyalty. For equity tolling purposes there is no coherent basis to distinguish
between a self-dealing controlling shareholder and the directors whom that
shareholder controls. In this case, because Leone lacked independence from
Federated, the statute of limitations was equitably tolled as to the claims
against him.
Mr. Rosenberg, however, was independent, and for that reason the claims
against him stand on a different footing. The plaintiffs' only argument for
tolling the statute as to Rosenberg is that the defendants collectively
concealed and misrepresented material facts. (POB at 36). The contention
appears to be that Mr. Rosenberg's approval of the disclosures made in the
various proxy disclosures and other SEC filings constituted participation in a
fraudulent concealment.
That argument lacks merit. "Fraudulent concealment requires that something
affirmative be done by a defendant, some 'actual artifice' which prevents a
plaintiff from gaining knowledge of the facts, or some misrepresentation which
is intended to put the plaintiff off the trail of inquiry." Halpern v. Barran,
-----------------
Del. Ch., 313 A.2d 139, 143 (1973). That is, fraudulent concealment requires
some affirmative steps by a corporate director to conceal a wrong. See In re
--- -----
USACafes, L.P. Litigation, Del. Ch., Cons. C.A. No. 11146, Allen, C. (January
- -------------------------
21, 1993), Mem. Op. at 10; Boeing Co. v. Shrontz, Del. Ch., C.A. No. 11273,
---------------------
Berger, V.C. (April 20, 1992), Mem. Op. at 6. Rosenberg's approval of the
disclosures, without more, does not constitute the kind of affirmative conduct
that amounts to participation in a scheme actively to conceal the wrongdoing of
others.[16]
Therefore, the Court will dismiss, as time-barred, the 1987 Loan claims as
to defendant Rosenberg. As to all other defendants, the statute of limitations
defense is rejected.
B. THE MERITS OF THE 1987 LOAN CLAIMS
----------------------------------
Having rejected (except as to one director) the threshold limitations
defense, the Court turns to the merits of the 1987 Loan claims.
1. The Standard of Review
----------------------
The first issue concerns the standard of review applicable to the 1987 loan
claims. Where a controlling shareholder stands on both sides of a transaction,
the standard ordinarily is that the controlling shareholder (and the directors
who are subject to that control) will bear the burden of proving the entire
fairness of the transaction. See Weinberger v. UOP, Inc., Del. Supr., 457 A.2d
--- -----------------------
701, 703, 710 (1983); Rosenblatt v. Getty Oil Co., Del. Supr., 493 A.2d 929, 937
---------------------------
(1985). There are exceptions to that principle. One such exception arises
where a truly independent, disinterested, and informed special committee of
outside directors negotiates the transaction on behalf of the minority
stockholders. In those circumstances the review standard remains entire
fairness, but the burden shifts to the plaintiff to prove that the transaction
was unfair. See Kahn v. Lynch Communications Systems, Del. Supr., 638 A.2d 1110,
--- ------------------------------------
1117 (1994); Kahn v. Tremont Corp., Del. Ch., C.A. No. 12339, Allen, C., slip
---------------------
op. at 16-18 (March 21, 1996).
That exception does not apply in this case, because no independent
committee negotiated or approved the 1987 Loans. The decision to approve the
1987 Loans was made by the entire MAXXAM Board, and of the five directors who
voted to approve those loans, only two were "deemed independent." (PX 13 at
14594; PX 14 at 14361; PX 15 at 14364). Of the three remaining directors,
Hurwitz and Munitz were Federated Trustees, and Leone depended on Hurwitz for
his positions and income as President of MAXXAM, CEO of Pacific Lumber Company,
and as a director of Kaiser Aluminum--all entities that Hurwitz controlled.
(Stip. Facts 10, 17). The Court therefore concludes (and the defendants do not
dispute), that the defendants have the burden to demonstrate that the 1987 Loan
transaction was entirely fair to MAXXAM.
An entire fairness analysis has two aspects: fair dealing and fair price.
Weinberger v. UOP, Inc., 457 A.2d at 711. The test is not bifurcated, and all
- -----------------------
aspects of the transaction must be considered before making a unitary
determination. This Court therefore examines both the process by which the
transaction was approved, and its substantive terms, in determining whether the
1987 Loan transaction was fair.
2. Fairness of the Decisionmaking Process
--------------------------------------
The analysis of whether the Board's decisionmaking process was fair
"embraces questions of when the transaction was timed, how it was initiated,
structured, negotiated, disclosed to the directors, and how the approvals of the
directors and the stockholders were obtained." Weinberger v. UOP, Inc., supra.
----------------------- -----
I conclude, for the reasons next discussed, that the defendants have failed to
establish that the process utilized to negotiate and approve this loan
transaction was fair, in the sense that it was calculated to result in loan
terms comparable to what a true arm's length transaction would have yielded.
See, Marciano v. Nakash, Del. Supr., 535 A.2d 400, 405 (1987).
- --- ------------------
a) Initiation and Timing of the Loan
----------------------------------
The 1987 Loan transaction was initiated by Federated after it decided that
it did not want to invest any further in the Mirada. Plaintiffs contend that
Federated approached MAXXAM as a lender of last resort after it was unable to
obtain debt capital in the marketplace on the terms it desired. The defendants
deny this. They say that the loans were a good investment opportunity that
commercial lenders would have favorably considered. But, the only documentary
support for their position consists of handwritten notes of discussions with San
Jacinto Savings & Loan (PX 21; PX 23), and a proposed "term sheet" with Columbia
that reflects terms more favorable (from a lender's standpoint) than those which
the MAXXAM Board accepted. (PX 18). By the time the 1987 Loans were made,
Columbia had ceased negotiations.[17] Thus, there is no evidence that any
commercial lender was willing to invest in the project on terms comparable to
those accepted by MAXXAM's Board. That is, defendants have not shown that the
loan terms ultimately accepted by MAXXAM were obtainable in the credit
marketplace.
Of significance also is that Federated initiated these loans before it had
obtained any entitlements to build the golf course. The defendants argue that
that fact should not impact the fairness analysis because (i) the golf course
was never considered necessary to the Mirada's success, (ii) Federated was
reasonably confident that it would obtain the required permits, (iii) the Mirada
offered its homeowners an affiliation with 29 nearby golf courses, and (iv) the
Lesser study concluded that while the absence of a golf course was both a
positive and a negative, the negative aspects could be mitigated. (Tr. 1258-59,
PX 6 at 2336).
This post-hoc explanation cannot alter the undisputed fact that the
---- ---
November 1987 loan was made specifically to facilitate Federated's plan to
develop a golf course. (Def. Reply Brief at 2, Tr. 1313-14). Although
defendants argue that the risk of non-approval was significantly less than that
which Federated had confronted when it obtained the entitlements for the Rancho
Mirage property, Dr. Munitz believed that there would be a public battle in
Cathedral City and that the golf course proposal did involve political risk.
(Munitz Tr. 91-95). At trial, Mr. Hurwitz went even further, testifying that "I
don't know that we ever had the perception that we could build a golf course."
(Tr. 1529).
In any event, by causing MAXXAM to grant a non-recourse loan to fund the
purchase of the golf course property with no requirement that the appropriate
government approvals be first obtained, Federated shifted onto MAXXAM the risk
that those approvals might not materialize.
For these reasons, the initiation and timing of the transactions evidence
that the 1987 loans were not fair to MAXXAM.
b) The Negotiation Structure
-------------------------
After Federated approached MAXXAM to lend it the funds, neither side
structured the negotiations in a form calculated to result in loan terms fair to
MAXXAM. As Dr. Munitz conceded, all parties involved knew that the 1987 Loans
were an interested transaction, yet the MAXXAM Board never formed an independent
negotiating committee or obtained a fairness opinion from a disinterested
financial advisor. (Munitz Tr. 44). Nor did the MAXXAM Board ever insist upon a
"market check," such as (for example) evidence that an outside lender would
grant or had actually accepted comparable terms. Thus, the negotiation
structure also evidences that the 1987 Loans were not fair to MAXXAM.
c) The Disclosures to the MAXXAM Staff and Board
---------------------------------------------
The record discloses that at the June 15, 1987 Board Meeting, Federated
represented to the Board that it (Federated) had alternative sources of
financing. Given the (at best) very preliminary status of the negotiations with
the three commercial institutions, that statement was highly misleading. That
evidence weighs against a finding that Federated dealt fairly with MAXXAM.
d) The Actual Bargaining Process
-----------------------------
Also relevant to the issue of procedural fairness is the existence or non-
existence of true arm's length bargaining. The defendants claim that there were
intense negotiations between MAXXAM and Federated. Dr. Munitz testified that
MAXXAM's "strategy" for negotiating the loan was to compare the terms Federated
proposed to MAXXAM with those Federated had proposed to Columbia and San
Jacinto, and to conduct "due diligence." (Munitz Tr. 44-45). Had that
comparison in fact been made, it would have disclosed that the terms Federated
-- ----
was proposing to MAXXAM were less favorable than those Federated was proposing
to the commercial lenders.
Munitz also testified that there was significant "give and take" between
Federated and the representatives of MAXXAM, yet he could not identify any
specific term that Federated proposed and that the MAXXAM Board rejected (Munitz
Tr. 45-46). The defendants did not show how specifically the negotiations were
conducted or what concessions, if any, MAXXAM obtained from Federated during the
course of those negotiations.
The defendants argue that intense bargaining should be inferred from the
fact that Munitz's original proposal differed from that which the MAXXAM Board
ultimately approved. (See PX 9). It is true that under Federated's original
---
proposal MAXXAM's participation was only 20%, as opposed to 25% in the completed
transaction with Federated. However, that original proposal was preliminary (at
that point no interest rate had been set). Moreover, Federated's original
proposal was for only a $12 million (as opposed to $15 million) loan.
Federated's original proposal also would have required the proceeds of lot sales
to be used to pay off the loan, and MAXXAM to fund only half of the acquisition
costs of the golf course property. In these respects, it appears that MAXXAM
ended up worse off than it would have been under Federated's original proposal.
Given the other more advantageous terms Federated ultimately extracted, the
increase of MAXXAM's profit participation to 25% (which the defendants' own
expert testified was at the low end of the range of typical transactions) is
hardly sufficient to establish that there were true arm's length negotiation.
(Tr. 688). The evidence tends to establish the opposite.
e) The MAXXAM Board Approval
-------------------------
Finally, and of considerable importance, is the quality of the board's
actual decisionmaking process, a factor that also compels a finding adverse to
the defendants. The defendants rely upon the recital in the Minutes of the June
15, 1987 MAXXAM Board meeting, that there was a "lengthy discussion of the
merits of the proposed transaction." (PX 13 at 14593-94). Other than that
conclusory statement, there is no evidence that any MAXXAM director questioned
any material term of the proposal. Specifically, there is no evidence that the
directors were ever told of the more favorable terms Federated had proposed to
Columbia, the terms Federated had originally proposed to the MAXXAM staff, or
Mr. Iaco's documented concerns that even that original proposal was inadequate.
Nor was it shown that the MAXXAM Board attempted to--or did--ascertain whether
the proposed terms could be improved. Instead, the Board simply "approved those
loans on substantially the terms as outlined by Munitz..." (Tr. 1441).
To be sure, the Board did condition its acceptance on Federated satisfying
three requirements: (1) an M.A.I. appraisal in excess of $30 million, (2) a
completed marketing study by Robert C. Lesser Company, and (3) approval of the
loans by MAXXAM's staff. (PX 13 at 14594-95). But, in determining whether those
conditions were met, the Board appears to have performed only a perfunctory
review. The MAXXAM directors approved the loans by unanimous written consent
without satisfying themselves that the loan documents reflected their intent.
That is significant because the documents were unclear as to what the
preconditions to the loan actually were. The Board minutes stated that the loan
was conditioned on a $30 million appraisal, yet the loan documents required a
$34 million appraisal. The defendants assert, without supporting evidence, that
the $34 million figure was a scrivener's error, but even if that is true, it
only reinforces the impression that the Board did not cause the loan documents
to be carefully reviewed before approving them.
Also significant is the MAXXAM Board's decision not to insist upon its own
appraisal, and to rely upon the appraisal commissioned by Federated.[18] (PX
5). That appraisal, by Blee & Stark, valued the project at $34.9 million, based
on a highly optimistic prediction that all 46 lots would be sold in 23 months.
A cursory review of that appraisal would have revealed an assumption that the
entire 46 lots would be included in the collateral, which was incorrect since
only 40 lots were ultimately included. A review of the appraisal would also
have shown that the $34.9 million valuation was arrived at by simply adding the
estimated value of each of the lots (including the 6 excluded lots), without
discounting those values to reflect that the lots would be sold over time.
Finally, there is no evidence that the Board considered Blee & Stark's
$15,300,000 "discount value," which represented the appraised value of the
finished lots if sold in bulk. Because those lots formed most of the collateral
for the loan, that value would have been important to a board attempting
rationally to assess whether the Loans were adequately secured. The board's
decisionmaking process, which rested on a flawed appraisal, was necessarily
flawed as well.[19]
These process deficiencies are also evidenced by the November golf course
loan. At its June 1987 meeting, the Board approved a $2.5 million loan to
purchase the golf course property, without obtaining or requiring an appraisal.
The defendants respond that no appraisal was needed because the loans were
cross-collateralized. That argument overlooks the fact that MAXXAM would be
adding $2.5 million to a $15 to $20 million loan (plus potentially $2 million
more if Federated paid off the first mortgage before selling the property), with
no reliable evidence of the value of the land being added to the collateral
pool. The Court is unable to conclude that a truly independent board would have
proceeded in this fashion.
* * *
For these reasons, the Court concludes that the defendants have not
satisfied their burden of demonstrating that the loans were the product of fair
dealing.
C. THE SUBSTANTIVE FAIRNESS OF THE 1987 LOANS
------------------------------------------
Having addressed the fair dealing issues, the Court next considers whether
the substantive terms of the 1987 Loans were fair. The plaintiffs rely upon the
testimony of their trial expert, Mr. John C. Opperman, to support their claim
that (i) the effect of the 1987 Loan terms was to transfer an inordinate amount
of risk to the lender without adequate return, and, (ii) as a consequence, the
loans would not have been acceptable to an outside independent lender. The
defendants respond that if the loans were viewed as conventional loans, Mr.
Opperman's criticisms might be valid, but in this case the 1987 Loans were
"joint venture loans" and their terms were typical of joint venture loans at
that time. The defendants also rely upon an appraisal that was prepared in
November, 1995 by Buss-Shelger Associates for purposes of this litigation (the
"1987 Buss Appraisal"). In that appraisal Buss-Shelger valued the Mirada as of
November 1, 1987 Loans at $33,800,000, which, defendants argue, demonstrates
that the 1987 Loans terms were substantively fair to MAXXAM.
These contentions are now addressed.
1. The Plaintiff's Expert's Opinion
--------------------------------
The plaintiff's expert, Mr. Opperman, testified that the critical features
of the 1987 Loans would have been unacceptable to an independent outside lender
in 1987, because they would transfer inordinate risk to the lender (MAXXAM)
without adequate return.[20] The defendants do not dispute Mr. Opperman's
conclusion, but argue that it is irrelevant, because he was analyzing the loans
as conventional loans, rather than as a joint venture loans. Those two types of
financing, defendants insist, are quite different.
To support that argument, the defendants rely upon an article published in
the Federal Home Loan Bank Board Regulatory Handbook, that distinguishes
conventional and joint venture loans for bank accounting purposes. (DX 129 at
3). During cross examination Mr. Opperman admitted that the 1987 Loans
possessed the characteristics of a "joint venture" loan described in that
article,[21] (Tr. 189-92), and conceded that he did not view the 1987 Loans as
joint venture loans when he analyzed them. (Tr. 187). The Court agrees that to
the extent that Mr. Opperman failed to evaluate the 1987 Loans as "joint
venture" loans, his testimony was incomplete. But that does not carry the day
for the defendants. As discussed more fully below, the 1987 Loans were
substantively unfair, and cannot suddenly become fair because one is able to
affix to them the label "joint venture."
2. The Defendants' Expert Opinion
------------------------------
As earlier noted, the defendants argue that even if the 1987 Loan terms
were not fair if analyzed as conventional loans, they were fair if viewed as
joint venture loans. That position rests critically upon the testimony of Mr.
George Smith, the defendants' trial expert, that the 1987 Loan terms were fair
because they were typical of joint venture financing at that time. (Tr. 691-
92.).
Mr. Smith's testimony is problematic for several reasons. At the time Mr.
Smith formed his opinion, he was unaware that the borrower (Federated)
controlled the lender (MAXXAM). (Tr. 722). He also had never encountered a loan
arrangement where the persons administering the loan included a borrower's
representative. (Tr. 851). That information is significant because only the
Approval Committee was authorized to disburse the proceeds of lots sales from
the deposit account into which they would be placed. If it so chose, that
Committee could disburse the funds to pay for operating expenses rather than pay
down the MAXXAM loans. (PX 1 at Section Section 1.5(b), 4.1(b)). Even if it
could be assumed that MAXXAM's Approval Committee representative would be free
to act independently of Federated's controlling shareholder, Federated's
representative could still veto any proposal by MAXXAM to disburse funds. Thus,
MAXXAM, the lender, had no ability to compel the repayment of its loans from the
deposit account without the consent of Federated, the borrower.[22]
Mr. Smith's testimony is also unpersuasive because he was specifically
instructed not to consider the Blee & Stark appraisal upon which the MAXXAM
Board had relied, and to accept the 1987 Buss valuation without independently
reviewing its analysis.[23] (Tr. 666, 717). Nor, at the time he formed his
opinion, did Mr. Smith know that Federated had retained 6 of the lots, thereby
excluding them from the collateral that would constitute MAXXAM's only source of
repayment, and placing Federated in direct competition with MAXXAM in selling
those lots. (Tr. 691).
Similarly problematic is Mr. Smith's testimony concerning the golf course
loan, because he was unaware that the loan was subject to a $2 million first
mortgage, and was potentially subject to another $2 million being added to the
loan principal. (Tr. 728-29). Although Mr. Smith explained that a $2 million
mortgage was not material in relation to the value of the entire collateral, he
conceded that as a general matter the existence of a first mortgage would be
important in determining whether the loans were fair. (Tr. 728-29). Finally, at
the time he was designated as an expert witness, Mr. Smith had also not been
told that Federated had failed to obtain the required government approvals to
develop the golf course. (Tr. 731).
For these reasons, the Court finds Mr. Smith's testimony concerning the
fairness of the 1987 Loans unpersuasive.
3. The 1987 Buss Appraisal
-----------------------
The defendants also rely on an appraisal prepared by Buss-Shelger
Associates in 1995 solely for purposes of this litigation (the "1987 Buss
appraisal"). (DX 92). The 1987 Buss Appraisal concluded (and Mr. Buss, one of
the firm's principals, testified) that as of November 1987, the discounted fair
market value for the Mirada was $33,800,000.[24]
The plaintiffs contend, and I agree, that that valuation was significantly
inflated, because 1) it did not reflect the a $2 million first mortgage on the
golf course property, 2) it assumed an excessively high average sales price for
the Phase I lots, and 3) it failed to include any discount for the possibility
that the golf course approvals might not be obtained. Finally, 4) Buss made
assumptions that while perhaps within the outer bounds of reasonableness, were
consistently generous and more reflective of the position of an advocate for a
high appraisal value.
It is undisputed that the 1987 Buss appraisal does not reflect the fact
that the golf course property was subject to a $2 million first mortgage. Had
that been considered, Buss's appraisal value of the collateral would have been
reduced to approximately $31,800,000.
The defendants also failed to show that Buss's assumed $550,000 average
sales price for the 40 Mirada lots was reasonable. That price exceeded the
$505,000 average price for the lots sold at the superior Vintage development
during 1987 (DX 92 at 22),[25] exceeded the average sales price assumed in the
Lesser study, and exceeded the average sales price assumed in the Blee & Stark
appraisal. Nor have the defendants demonstrated the reasonableness of Buss's
assumption that the approvals for the golf course development would be obtained.
The defendants admit that there was a significant risk that the approvals might
not be granted, and to the extent Buss failed to discount for that risk his
appraisal overstated the Mirada's 1987 value.
The 1987 Buss appraisal is overly generous to the defendants in other
respects as well. For example, Buss assumed that 169 units would be built on
the villa site, in contrast to Blee & Stark, which adopted Federated's own
projection of 138 units. Similarly, Buss assumed that 90 units would be built
on the townhouse site, whereas Blee & Stark assumed that 80 units would be
built. (Tr. 1171-72).[26]
Finally, the defendants insist that the Court must accept Buss's
assumptions, because the plaintiffs never called an expert witness to testify
that they are unreasonable. The Court cannot agree. The defendants had the
burden to persuade the Court that the appraisals upon which they rely merit
credit. Here the infirmities in the 1987 Buss appraisal are manifest from the
existing record, which shows that Buss made highly questionable assumptions and
failed to take material facts into account. In these circumstances, the Court
is aware of no rule of evidence or law that requires it to accept a flawed
appraisal because the opposing side did not call an expert to say what the
record already shows.
* * * * *
I conclude, for these reasons, that the defendants have failed to sustain
their burden of demonstrating that the 1987 Loan transaction was fair to MAXXAM.
III. THE 1991 EXCHANGE
-----------------
A. The Standard of Review
----------------------
Before turning to the merits of the second transaction being challenged
(the 1991 Exchange), the Court must first determine the threshold issue of under
what standard the transaction is to be reviewed. As previously noted, where a
specially appointed committee of disinterested independent directors negotiates
a transaction with a controlling stockholder, that procedure will, in
appropriate circumstances, shift to the plaintiff the burden of demonstrating
that the transaction is unfair. See Kahn v. Lynch Communications Systems, supra;
--- ------------------------------------ -----
Kahn v. Tremont Corporation, supra. The defendants argue that because a special
- --------------------------- -----
committee procedure was utilized in this case, the burden should shift to the
plaintiffs to prove that the 1991 Exchange was unfair.
For the burden of proof to shift, however, "... the controlling or
dominating shareholder [must] demonstrate that it has not only formed an
independent committee but also replicated a process 'as though each of the
--------
contending parties had in fact exerted its bargaining power at arm's length.'"
Kahn v. Lynch Communication Systems, 638 A.2d at 1121 (quoting Weinberger v.
- ----------------------------------- -------------
UOP, Inc., 457 A.2d at 709-10 n.7) (emphasis added). Accordingly, in deciding
- ---------
which party has the burden of proof, the Court must determine "whether the
special committee was truly independent, fully informed, and had the freedom to
negotiate at arm's length." Id., at 1120-21.
---
The defendants claim that the Special Committee functioned independently
and effectively and that its dealings with Federated replicated a true arm's-
length transaction. The plaintiffs argue the contrary. I conclude, for the
reasons next discussed, that the evidence more persuasively supports the
plaintiffs' position, and that the burden of proving the fairness of the 1991
Exchange must remain with the defendants.
The record shows that the members of the Special Committee all had
significant financial and/or business ties with Hurwitz (PX 55C-55F). Messrs.
Seidl and Connally were the Committee members who played the dominant role in
investigating and negotiating the 1991 Exchange transaction. At that time Seidl
was receiving a salary of $450,000 a year, plus significant additional
compensation under an incentive plan, as Chairman and CEO of Kaiser Aluminum, a
Hurwitz-controlled corporation.[27] (PX 55E at 4; PX 55F at 10, 15). And
Governor Connally had been receiving $250,000 per year under a consulting
contract with a MAXXAM subsidiary since 1988, the year he emerged from personal
bankruptcy. That contract was renewed each year until Connally's death in 1993.
In addition, Connally was receiving director fees from various Hurwitz-
controlled entities. (PX 55E at 2, 27; PX 55F at 2, 24; Tr. 1580-83).
Those financial ties, while not conclusive on the issue, do raise concerns
as to whether the Special Committee lacked independence from Hurwitz. See Kahn
--- ----
v. Dairy Mart Convenience Stores, Inc., Del. Ch., C.A. No. 12489, Jacobs, V.C.
- --------------------------------------
(March 29, 1996), Mem. Op. at 14 (noting that Special Committee member was also
a paid consultant for the corporation, raising concerns that he was beholden to
the controlling shareholder); Kahn v. Tremont Corporation, Mem. Op. at 19; Rales
--------------------------- -----
v. Blasband, Del. Supr., 634 A.2d 927, 936-37 (1993).
- -----------
Also relevant to the burden of proof issue is Governor Connally's dominant
role in selecting the Special Committee's advisors. Notwithstanding the
recitals in the minutes suggesting that the Committee had retained the various
appraisal firms, the record independently indicates that Governor Connally
selected the appraisers whose retention the Committee later rubber stamped.[28]
(PX 32A). The drafting of the minutes so as to obscure or downplay Connally's
dominant role only accentuates the Court's concerns regarding the Special
Committee's independence.
Governor Connally also played a dominant role in the Special Committee's
deliberations. The minutes of the Committee's March 15, 1991 meeting show
Connally as the prime advocate of Federated's proposal that MAXXAM acquire the
Mirada. (PX 32F). Although other Committee members expressed concerns that the
decision might be premature, in the end the Committee authorized Connally to
begin negotiations with Hurwitz, even before Cushman had finalized its appraisal
of the value of the property to be acquired.
There also is evidence that the Special Committee's decision to purchase
the Mirada was not fully informed. On November 14, 1990 Munitz informed
Cushman--the appraiser retained to value the Mirada--that all Mirada lot sales
had been at the full list price. In fact, three lots were discounted. (PX 34F,
34L). Nor was Cushman told that Federated's consultants had recommended across-
the-board discounts of the Phase I lots, or that Federated had deliberately
overpriced certain lots and therefore never expected to receive the listed price
for them. (PX 33A-D). Relying on this incorrect and/or incomplete information,
Cushman valued the Mirada on the assumption that all future lots sales would be
at full list price and that no discounts were planned. The Special Committee
ultimately relied upon Cushman's appraisal in deciding to pay the highest value
determined by Cushman.
After receiving the various experts' reports, the Special Committee
designated Messrs. Connally and Seidl, the members most significantly tied to
Hurwitz, to negotiate the purchase price with him. There is no contemporaneous
documentary evidence showing that Connally and Seidl aggressively negotiated on
MAXXAM's behalf, or what positions each side took during the negotiations. At
trial, Seidl could not recall any details of the negotiation process, including
what his opening position was or how many times he met with Hurwitz. Compare
-------
Kahn v. Tremont Corporation, Mem. Op. at 13-14, 34-36 (cataloguing the extensive
- ---------------------------
negotiations between the majority shareholder and the Special Committee's
designee).
Given this evidence, the Court is unpersuaded that the Special Committee
process utilized here ought to shift the burden of proof from the defendants to
the plaintiffs. The Court recognizes that there often is economic utility in
promoting mutually advantageous transactions between corporations and those who
control them. It is also mindful of the important role played by truly
independent special committees in ensuring that those transactions are fair to
the minority.[29] But that policy presupposes a truly independent, well
informed and properly motivated bargaining representative. That policy is not
furthered by the pro forma deployment of a special committee consisting of
--- -----
persons who, although prominent, lack true independence. To justify relaxing
the strict form of judicial scrutiny that traditional entire fairness review
entails, the Court must be satisfied that the special committee was sufficiently
independent, informed, and able and willing to bargain effectively with the
interested party. The need for such qualities is most pronounced in
transactions with a controlling shareholder, where the "greatest risk of
undetectable bias may be present." Kahn v. Tremont Corporation, supra, Mem. Op.
--------------------------- -----
at 18.
Accordingly, the 1991 Exchange transaction will be reviewed under the
traditional entire fairness standard, which imposes upon the defendant
fiduciaries the burden of demonstrating that the transaction was entirely fair,
both as to process and price. In this case, those two factors are analyzed in
reverse order.
B. THE FAIRNESS OF THE 1991 EXCHANGE: FAIR PRICE
----------------------------------------------
Because the 1991 Exchange was an asset purchase transaction, price is
central to the fairness inquiry. The defendants argue that because Cushman's
approximately $42.9 million appraisal value fell within the range of values that
a third party purchaser would have paid, the purchase price was fair. I cannot
agree. MAXXAM was not in the classic position of an outside third-party
purchaser; it was a controlled entity that held a sizeable mortgage on the
property being purchased. That fact is significant because MAXXAM had at all
times the option not to purchase the property, but instead to foreclose one and
a half years later when the loans went into default, and thereby acquire the
property for near the $34.3 million outstanding loan balance. The defendants
have not shown why it was reasonable for MAXXAM to reject that approach, and
instead to purchase the Mirada for Cushman's $42.9 million valuation. Even if
it was reasonable for MAXXAM to purchase the property in 1991, the defendants
have not shown that the $42.9 million purchase price was entirely fair to
MAXXAM. Finally, the defendants' effort to prove the fairness of the Exchange
price by submitting a trial expert's appraisal at $3 million dollars less than
----
what MAXXAM paid, only buttresses the conclusion that the price MAXXAM was
caused to pay for the Mirada was too high.
1. The Decision not to Foreclose
-----------------------------
The defendants claim that the Committee considered and rejected the option
of not purchasing the Mirada, and of foreclosing when the loans fell due, for
three reasons: 1) the possibility that Federated might extend for another three
years its obligation to pay the 1987 Loans; 2) the Committee's belief that
foreclosure would have shattered the Mirada's image as a high-end luxury
development (Tr. 1408; 1617-18); and 3) MAXXAM's desire to assume control of the
property, as part of its plan to hire a respected real estate executive to turn
the property around. (PX 32J at 2). In my view, none of these "reasons" is
persuasive or adequately supported by the record.
The claimed possibility that Federated could extend the 1987 Loan
Agreements for another three years is improbable and speculative. The 1987 Loan
Agreements allowed the Loans to be extended for another three years, but only if
MAXXAM consented. Federated had no right to compel an extension unless it could
------
convince a court that MAXXAM was withholding its consent unreasonably. (PX 1 at
Section 1.6(b)). Given the defendants' admission that Federated's efforts at
managing the property had proven unsuccessful, that scenario was improbable. See
---
Def. Answering Post-Trial Br. at 47. MAXXAM's refusal to allow Federated to
continue on a demonstrably unsuccessful course would hardly have been
unreasonable. The Court is, therefore, unpersuaded that a three year
"compelled" extension of the loans was a truly realistic possibility.
The defendants also rely upon the Committee's supposed belief that
foreclosure would have significantly damaged the image (and hence the value) of
the Mirada. For support, the defendants cite trial testimony of two Committee
members that the foreclosure process was cumbersome and would damage the
reputation of the property. (Tr. 1408, 1617-1618). That testimony is not
corroborated by the minutes of the Committee's deliberations or in any other
contemporaneous document of record.[30]
Finally, the defendants argue that the foreclosure option was rejected
because MAXXAM wanted to take over the property to increase its profit
participation from 25% to 100% for very little additional consideration.
Defendants say that the Committee perceived additional value in acquiring the
property because MAXXAM could manage the Mirada better than Federated.
The problem with that argument is that while it may explain MAXXAM's desire
to acquire the Mirada, it does not explain why it was fair for the Committee to
pay the full $42.9 million appraisal value, as opposed to paying $9 million less
under the foreclosure option. Had MAXXAM simply chosen to wait one and a half
years, it could have bid in the property and achieved 100% ownership and control
for the approximately $34 million of outstanding accumulated debt. If a
competing bidder came along (and there is no evidence that any other interested
purchaser was waiting in the wings), MAXXAM could have engaged in competitive
bidding, secure in the knowledge that if it lost its loans would be repaid, and
that if it won the purchase price (and, thus, the property's value) would have
been established in the marketplace.
Alternatively, even if MAXXAM's objective was to take immediate control of
the property, it is reasonable to assume that a truly independent mortgage
holder would have negotiated for a discount below the property's full appraisal
value, as the quid pro quo for relieving Federated of the burden of finding
---- --- ---
another purchaser. In other words, MAXXAM might reasonably have agreed to pay
some premium above the accumulated loan balance for an immediate transfer of the
property that would avoid litigation. What the defendants have failed to
explain is why MAXXAM, if it were a truly independent reasonable arm's length
purchaser holding a $34 million lien, would agree to pay $9 million more
(Cushman's appraisal value) and thereby relinquish all of its leverage as the
mortgage holder.
2. The Flawed Cushman & Wakefield Appraisal
----------------------------------------
In any event, the Special Committee decided that MAXXAM would acquire the
Mirada without foreclosure, and pay the full appraisal value as determined by
Cushman & Wakefield. The difficulty, however, is that the defendants have not
shown that Cushman's appraisal was one upon which the Committee could reasonably
rely to justify paying almost $43 million. Key assumptions of that appraisal
were based on materially misleading omissions and/or information supplied by
Federated, and the appraisal itself was internally inconsistent: it contained
highly pessimistic marketing conclusions that Cushman then proceeded to
disregard or contradict to arrive at a highly optimistic valuation of the
property.
a) Federal's Disclosures to Cushman
--------------------------------
As earlier noted, after Cushman was retained to value the Mirada as of
1991, Federated did not disclose to Cushman that (1) its consultants had
recommended that Federated discount the prices of the Phase I lots; and (2)
Federated knew that its asking prices for some of the lots were "absurdly high"
and did not accurately reflect their market value. Yet, in a November 14, 1990
letter, Munitz represented to Cushman that all prior lot sales had been at full
asking price (PX 34F) -- which was incorrect because some lots had been sold at
a discount. (PX 34L).
The defendants respond that none of the omitted or incorrect information
was material, because only three of the lots had been discounted from the asking
price and the discounts were minimal. (DX 94 at 21). But, as of November 14,
1990--the date of Munitz's letter to Cushman--only 13 lots had been sold (PX
34L), and at the time of the Exchange only 15 lots had been sold. (DX 94 at 21).
The price discounts for the three lots were 2.5%, 10% and 13% (DX 94 at 21).
At least two of those discounts were not minimal.
This Court is not persuaded that a reasonable appraiser would have found
trivial the facts Federated misrepresented and/or omitted to disclose to
Cushman. That information, in my view, was material, because (i) based on the
faulty assumption that all previous lot sales had been at full price, Cushman
assumed that all future lots would be sold at the current asking price and that
there would be no price reductions (PX 25 at 52), and (ii) the Committee
ultimately relied on the Cushman appraisal in authorizing the $43 million
purchase price.
b) The Cushman Appraisal's
Internal Inconsistencies
--------------------------
In addition to its flawed lot price assumption, the Cushman appraisal was
on its face internally inconsistent, because Cushman's high valuation of the
Mirada cannot be reconciled with its description of the project and of its
prospects. In the general market analysis section of Cushman's report, Cushman
was pessimistic about the Mirada's prospects, yet in the section devoted to the
actual valuation, Cushman became extremely optimistic.
Specifically, Cushman reported that the responses to its market survey
indicated that "[t]he historically stable adult housing market has been
devastated" (PX 25 at 32), and that as a result of an oversupply of lots in the
Rancho Mirage area, "reductions of as much as 20% to 25% are commonplace in all
types of lots." Id., at 35. In drawing its own conclusion to the market
---
analysis portion, Cushman stated:
The combination of an oversupplied market and a restricted lending
market have combined to create a down market. The adult housing
market has followed the primary new and used market trend of lower
values for all types of land. The number of capable buyers for
parcels such as the subject is limited and values have dropped.
The upper end product in all sectors is now the least successful
sector. This is true in the adult market as well with most sales
occurring in a range far below the planned asking prices for the
subject. The price for the first phase of the estate lots product
will not increase due to market conditions and competition. There are
other planned developments in Coachella Valley and other communities
have demonstrated a willingness to allow this type of use with
considerable less resistance than the city of Rancho Mirage.
Accordingly, the threat of competition could exist when the market
recovers.
The short term outlook for all subdivision land is not good. The
long term outlook is for eventual improvement; this should occur
within a twelve to eighteen month period.
(PX 25 at 35-36).
In discussing the Phase I lots and the villa properties, Cushman also found
the absence of a golf course was a "severe marketing constraint" (PX 25 at 17),
and that the "vast majority of homeowners, developers and real estate brokers"
disagreed with the proposition that the absence of a golf course would be offset
by locating the Ritz Carlton Hotel near the development. That is because the
Palm Springs market was known as a golf course community, and homeowners there
did not generally wish to live near a commercial operation such as a hotel. (PX
25 at 20).
Oddly, none of those concerns found their way into Cushman's actual
valuation. Despite its earlier conclusion that developers and homeowners
believed otherwise, Cushman cited the prestige of being near the Ritz-Carlton as
support for its valuations of the villa and townhouse sites. Similarly
schizophrenic was Cushman's valuation of the estate lots. Without any reference
to its earlier finding that proximity to the Ritz-Carlton was not an adequate
substitute for a golf course affiliation, Cushman concluded that "the subject's
identification with the Ritz Carlton Hotel" was a factor that justified its
projecting a significant demand for the estate lots. (PX 25 at 55).
Finally, without making any reference to its earlier discussion of its
survey results showing that the values for all types of property had dropped,
Cushman projected no discounts of lot prices, and concluded that all the
remaining lots would be sold at list price. That conclusion was suspect on its
face, and (to repeat) it was based on the incorrect assumption that the
previously sold lots were sold at full list price, and Cushman's unawareness of
the fact that Federated had deliberately overpriced certain lots. (PX 25 at 53).
For these reasons, the defendants have failed to persuade the Court that
Cushman's valuation, upon which the Committee relied in deciding to pay the full
appraisal value, was reliable evidence that $42.9 million was a fair price for
the Mirada.
3. The 1991 Buss Appraisal
-----------------------
Finally, the defendants rely upon an appraisal of the Mirada performed by
Buss-Shelger Associates (the "1991 Buss appraisal"), as evidence that the 1991
Exchange price was fair. That argument is puzzling, because the 1991 Buss
appraisal valued the Mirada as of June 1, 1991 at $39.3 million--$3.6 million
less than the purchase price. Even if that appraisal were accepted at face
value, it shows that MAXXAM overpaid for the Mirada by at least $3.6
million.[31]
* * *
The Court concludes, for the above reasons, that the defendants have
failed to prove that the purchase price MAXXAM was caused to pay for the Mirada
in the 1991 Exchange transaction was entirely fair.
B. THE FAIRNESS OF THE 1991 EXCHANGE: FAIR DEALING
------------------------------------------------
Having addressed the fairness of the purchase price, the Court next
considers the adequacy of the process by which that price was determined. In
this case, the infirmities in the process employed by the Special Committee shed
light on how MAXXAM came to purchase the Mirada at an excessive price.
1) The Initiation and Timing of the Exchange
-----------------------------------------
Federated wanted to sell the Mirada because it had concluded that the
project was a failure and that Federated would not receive a significant return
if it made any further investment in that property. It is undisputed that in
late 1990, Federated approached MAXXAM and proposed (among other possibilities)
a purchase of the Mirada. (Stip. Fact 21). It is also undisputed that Munitz
had already approached several appraisal firms during the fall of 1990, before
the MAXXAM Board meeting called specifically to consider the Federated purchase
proposal.
During this period the Mirada had been foundering. No lots had sold after
August 1990, no lots were being held in escrow, and no prospective purchasers
for the villa and townhome sites were on the horizon. The 1987 Loans had been
drawn down almost to their limit and would fall due in a year and a half. As
Dr. Munitz testified, one reason why Federated was unwilling to invest
additional money was Hurwitz's judgment "as to whether there was a likely
payoff." (Munitz Tr. 155). Given this record, Federated's considerable self
interest in unloading the Mirada project is undeniable.
2) Federated's Misdisclosures to Cushman
-------------------------------------
As discussed earlier, Federated failed to disclose certain material
information to Cushman, and disclosed to Cushman other information that was
misleading or inaccurate. Those misdisclosures impacted Cushman's valuation of
the Mirada, upon which the Special Committee relied in formulating its
negotiation strategy and deciding what price MAXXAM would pay. As a result of
Federated's misdisclosures and omissions to Cushman, the Cushman appraisal of
the Mirada was inflated and, consequently, so was the price MAXXAM ultimately
paid. The result was to advantage Federated unfairly at the expense of MAXXAM's
minority shareholders.
3) The Special Committee Decision
to Purchase the Mirada
---------------------------------
Critical to any analysis of fair dealing is the quality of the Special
Committee's decisionmaking process. The defendants contend that that process
was deliberate and fair. The plaintiffs respond that the Special Committee
never seriously deliberated Federated's proposal, and that its process was
"window dressing" for a decision that from the outset had been a foregone
conclusion.
The decision to begin discussions with Hurwitz was made at the March 15,
1991 Committee meeting, the minutes of which reflect that Governor Connally
viewed the Peat Marwick study as support for his position that MAXXAM should
take over the Mirada. (PX 32F). Mr. Seidl appears to have agreed.[32]
Although some Committee members expressed reservations that it would be
premature to negotiate price at this point, Connally persuaded the Committee to
authorize him to begin negotiations with Hurwitz over a "range of possible
values." Importantly, the minutes reflect no discussion of MAXXAM's other
option: to do nothing and foreclose when the loans fell due in 1992. Although
Dr. Seidl testified at the trial that the Committee considered the option of
foreclosure (Tr. 1617-18), the absence of any contemporaneous documentation of
this crucial point creates doubt whether, or to what extent, that option was in
fact considered. In any event, by March 15, 1991, before it had received
Cushman's final appraisal, the Committee had already decided to purchase the
property.
4. The Special Committee's Use of Experts
--------------------------------------
Having decided that MAXXAM should acquire the Mirada, the Special Committee
then engaged its experts to assist it in determining what the purchase price
should be. As discussed earlier, the Committee first engaged Cushman, which
furnished a generous--but facially inconsistent--$42.9 million valuation. The
Committee then deployed other experts to critique Cushman's appraisal. After
hearing the criticisms of its other experts, the Committee then, it appears,
credited those expert conclusions that supported Cushman's appraisal and
disregarded or discounted those which did not. Those experts' conclusions, and
how the Committee treated them, are next discussed.
a) Peat Marwick
------------
Peat Marwick's marketing study denigrated the Mirada's prospects more
harshly than did Cushman. Peat Marwick reported that (i) even with improved
management the Mirada had only a 25% probability of achieving the absorption
rates Cushman had assumed, and (ii) even under improved management, the most
likely scenario was an absorption rate of 5-6 lots per year, as contrasted with
Cushman's projection of 9-11 lots per year. Peat Marwick repeated its
conclusions in its presentation at the April 17, 1991 Special Committee meeting.
The defendants insist that they justifiably dismissed Peat Marwick's
analysis as an effort at self-promotion, to garner the more lucrative engagement
of marketing the project. The defendants also point to "obvious" mistakes in
Peat Marwick's report, as well as language in the Peat Marwick engagement
letters claimed to evidence Peat Marwick's ulterior interest in offering
additional services. (See DX 84, DX 81).[33]
---
The defendants' present litigating position--that the Peat Marwick study
lacked credibility--is nowhere reflected in the Special Committee minutes. To
the contrary, those minutes repeatedly cite the Peat Marwick study as
justification for MAXXAM assuming control of the Mirada. Thus, the defendants'
present criticism that the Peat Marwick study lacked integrity is without
contemporaneous documentary support. What the documentary evidence does show is
that the Special Committee accepted Peat Marwick's view that stronger marketing
programs were needed to justify MAXXAM acquiring the property, but disregarded
Peat Marwick's pessimistic absorption rate conclusions.
b) First Boston
------------
First Boston submitted a separate critique of the Cushman appraisal,
finding that it was "more towards the higher end of the current range of
reasonable values." (PX 32J). First Boston did not conduct an independent
appraisal, but instead relied on the information set forth in Cushman's
appraisal. Based on that information, First Boston concluded that the range of
values should be $35,639,000 to $45,884,000, as contrasted with Cushman's
valuation range of $39,985,000 to $46,890,000. (DX 53 at FBC002498).
Again the Special Committee appears to have treated this critique
selectively. Rather than focus on First Boston's conclusion that Cushman's
appraisal was at the high end of a reasonable range (which implied that MAXXAM
should pay less than the Cushman valuation), the Special Committee chose to
credit First Boston's conclusion that Cushman's appraisal was somewhere within
the range of reasonableness.
c) Lewis & Howard
--------------
Despite having had the benefit of the documented critiques of Peat Marwick
and First Boston, the Committee relied upon an oral critique by Lewis & Howard,
which was the only expert that unconditionally endorsed the Cushman
appraisal.[34] Lewis & Howard found that the market study portion of the
Cushman appraisal was unduly negative, because it failed to account for the
positive effect of the ending of the Gulf War and attributed too much
competitive impact to a nearby development, Big Horn. (PX 32J at 6).
Nonetheless, Lewis & Howard concluded that Cushman's valuation was reasonable.
Lewis & Howard also criticized the Peat Marwick study for its excessive focus on
MAXXAM's historical absorption rate and for not giving sufficient valuation
credit to a stronger marketing program. (PX 32J at 7).
5. The Negotiations Between the
Special Committee and Hurwitz.
------------------------------
After hearing from the experts, the Committee authorized Messrs. Connally
and Seidl to negotiate a purchase of the Mirada at a price not to exceed
Cushman's $42.9 million appraisal value. How the price was negotiated with
Hurwitz creates cause for concern. The defendants claim that the negotiation
process was fair and active. As evidence, they point the Committee's rejection
of the proposal to purchase all of Federated's assets, and of Hurwitz's first
offer to sell the Mirada at a price above Cushman's appraisal value. To be
sure, that is some evidence of a true arm's-length negotiation. It is not
sufficient, however, to persuade this Court that the balance of the negotiations
were consistent with what truly independent negotiators trying to protect the
interest of the MAXXAM minority would have sought or achieved.
The defendants offered little evidence of what specifically took place
during the bargaining between Connally, Seidl and Hurwitz over the purchase
price. All Seidl could specifically remember was that he made a "take-it-or-
leave-it" offer at the full appraisal value and that Mr. Hurwitz took it. Tr.
1548, 1636-37.[35] That, without more, is simply inadequate to demonstrate that
Seidl and Connally made reasonable efforts to use MAXXAM's considerable leverage
as lienholder to negotiate the lowest available purchase price.
* * *
For these reasons, the Court is unable to conclude that the Committee's
conduct and process replicated what an independent third-party would have done
in deciding whether or not to purchase the Mirada and in negotiating the lowest
available price. Accordingly, the defendants have not shown that the purchase
price of the Mirada was the product of fair dealing, or that the 1991 Exchange
was entirely fair to MAXXAM.
IV. REMEDY
------
Finally, the Court next turns to the matter of remedy. The plaintiffs seek
the remedy of rescissory or, alternatively, out of pocket, damages. The
defendants argue that if damages are to be awarded, only out-of-pocket damages
are appropriate. The computation of damages under each measure is hotly
disputed. I summarize the parties' positions on these subjects, but only as a
predicate for concluding that a determination of remedy must await further
proceedings.
A. The Plaintiffs' Damages Contentions
-----------------------------------
The plaintiffs seek rescissory damages, measured by the value of what
MAXXAM gave to Federated, less the value of what MAXXAM received from Federated
in return, plus interest to the date of trial. To calculate the value of what
MAXXAM gave to Federated, plaintiffs include (i) the monies MAXXAM paid out plus
accrued interest in connection with the 1987 Loans, plus (ii) the consideration
paid above and beyond the outstanding debt MAXXAM forgave in the 1991 Exchange,
but exclude (iii) the credit MAXXAM received in 1991 for its 25% profit
participation. From that resulting figure, plaintiffs then subtract the
payments MAXXAM received from the post-1991 Mirada lot sales. Finally, from the
total of these sums (and in an effort to replicate a "true" rescission wherein
Federated would actually take back the Mirada), plaintiffs deduct their
contended-for value of the Mirada as of the date of trial. By this process,
plaintiffs calculate their claim for rescissory damages at $64,728,377
(representing what MAXXAM paid), less $15,314,453 (representing what it
received), for a total of $49,413,924.
In the alternative, the plaintiffs claim "out-of-pocket" damages, which
they calculate as follows:[36] The 1987 Loans required $34 million of
collateral to secure a $20 million loan, yielding a collateral-to-loan ratio of
1.7 to 1. Applying that ratio to the entire 1987 Loan package (including the
additional $5 million golf course loan) the plaintiffs contend that the 1987
Loans should have been collateralized by property valued at $42.5 million.
After making certain adjustments to the Blee & Stark appraisal value, and adding
to it the collateral value of the golf course property, the plaintiffs calculate
an actual collateral value of $22 million. Thus, plaintiffs contend, the 1987
Loans were under-collateralized by approximately $20 million, which they claim
is the proper measure of their out-of-pocket damages. To that figure, the
plaintiffs then add the $7 million of additional consideration MAXXAM paid in
1991, for a total out-of-pocket damages claim of $27 million, plus interest.
B. The Defendants' Damages Contentions
-----------------------------------
In response, the defendants first contend that an award of rescissory
damages would not be justified. The reason, they urge, is that (1) there is no
evidence that any defendant was motivated in either transaction other than to
further the best interests of MAXXAM and its stockholders; and (2) to award
rescissory damages would produce an inappropriately harsh result in this case.
The defendants also argue that rescissory damages cannot be computed with
respect to the 1987 Loans, because (i) no harm could have occurred until the
1991 Exchange, since at that time the 1987 Loans were not due, and (ii) the 1987
Loans were fully discharged in 1991 and, hence, no damages were sustained up to
that point.[37]
Finally, the defendants contend that the Court should award only the out-
of-pocket damages, if any, MAXXAM incurred in the 1991 Exchange. In that
connection, defendants urge that even if the Court rejects the Cushman appraisal
and First Boston's conclusions, the Court should accept the 1991 Buss appraisal
and on that basis award out-of-pocket damages of approximately $3 million, plus
interest.
C. The Biurcated Approach to Damages
---------------------------------
Having considered the parties' multitudinous and complex damages arguments,
the Court concludes that the most prudent course is to bifurcate this
proceeding, i.e., determine liability in this Opinion[38] and the appropriate
----
remedy at a later stage. I so conclude for two reasons. First, in its earlier
Pre-Trial Order granting a motion in limine, the Court precluded the plaintiffs
-- ------
from seeking rescission. That motion, the Court now believes, may have been
improvidently granted. Second, the computation of damages could differ
depending on whether or not the Court's determination of the validity of the
1987 Loan claims is upheld on appeal. As explained more fully below, it may not
be efficient to resolve the damage issues before the parties (should they so
decide) obtain an appellate review of the various pretrial procedural and
substantive determinations reached in the Court's earlier Opinions.
1. The Alternative of "True" Rescission
------------------------------------
Any calculation of damages will necessarily require the Court to determine
the value of the Mirada, potentially as of two different points in time. That
task will be difficult because the competing appraisals are far apart and
because many key assumptions underlying each are hotly contested.
Understandably, any court would be hesitant to perform such a complex valuation
exercise if it could be avoided.
With that in mind, the Court is reassessing whether it should have
foreclosed the remedy of "true" rescission, in which MAXXAM would actually give
back the Mirada to Federated, rather than Federated receiving credit for the
Mirada's judicially determined value. One virtue of rescission is that it would
eliminate the need for the Court to determine the value of the Mirada, with its
many pitfalls and attendant uncertainty risks. That approach would also obviate
defendants' argument that a rescissory damages award would be unfair, because
under that scenario MAXXAM would own the property and receive the benefit of any
upswing in its value if and when the real estate market recovers. If "true"
rescission were granted, Federated would receive that benefit.
The Court is mindful that its Pre-Trial Order dated December 22, 1995,
precluded the plaintiffs from seeking rescission. That Order was entered
because the plaintiffs had represented, in their initial answers to
interrogatories, that they would not be seeking rescission. The defendants
claimed that they would be prejudiced if the plaintiffs were permitted to change
their position and seek rescission at a date so close to trial.[39] At that
point, the Court was not aware of the complexities of the valuation issues and
how they might be avoided if rescission were available as a potential remedy.
Having now a firmer grasp of these issues, the Court is inclined not to delve
into the complex valuation disputes that the parties' hypothetical rescissory
and other damage calculations would entail, without first having the benefit of
the parties' views as to (i) whether true rescission is feasible, and (ii) if
so, the merits and demerits of that remedy.
2. The Calculation of Damages
--------------------------
There is a second reason why the damage issues should not be decided now.
This litigation has been lengthy and procedurally complex, generating multiple
Opinions by this Court. The 1987 Loan claims have survived motions to dismiss
based on complex statute of limitations and standing defenses.[40] Given the
parties' considerable investment in this litigation and what is at stake, it is
not illogical to surmise that one side or the other (or perhaps both) would
appeal any judgment. Although this Court believes that its prior rulings are
correct, it recognizes, as any trial court must, that those rulings are subject
to appeal and that any appeal carries with it the possibility of reversal.
In this case, a reversal either in whole or in part could render any
determination of damages superfluous. Obviously, a reversal of the liability
determination on both the 1987 and 1991 claims would end the matter. But even
if there were a partial reversal, an assessment of damages for the 1987 and 1991
claims taken together as a package could differ from a damages award based upon
the 1991 claims alone. If the 1987 Loan claims were eliminated by a reversal on
appeal, that also might affect the feasibility of "true" rescission. Finally,
any assessment of damages for the 1987 and 1991 claims together may require a
complex apportionment among the various defendants that otherwise might not be
required if damages were determined for the 1991 claims alone.
* * *
Counsel are requested to confer with the Court about further proceedings in
this case, and to address the foregoing issues, including the possibility of an
appeal and supplementing the record should the December 22, 1995 in limine Order
-- ------
be vacated.
[1] Although Hurwitz (through Federated) owned only 30% of MAXXAM's (then MCO
Holdings') common stock, he had over 60% voting control of MAXXAM through his
ownership of super-voting preferred stock. (PX 55A at 84, 86). Hurwitz also
served as CEO and Chairman of both Federated and MCO Holdings. (Stip. Fact 10).
[2] The funds were actually loaned by MCO Properties, Inc., a wholly-owned
subsidiary of MCO Holdings, Inc. In 1988, MCO Properties, Inc. assigned all of
its rights under the 1987 Loans to MAXXAM. For ease of reference, MCO
Properties, Inc. is referred to throughout this Opinion as "MAXXAM."
[3] The defendants argue that Federated's proposal to Columbia was more
favorable to Federated than its proposal to MAXXAM. Defendants claim that under
the former proposal, Columbia would loan the funds necessary to develop the golf
course property (PX 18 at 5), whereas the 1987 Loan agreement contemplated that
Federated would enter into joint ventures to finance the development of the
property. There is no evidence, however, that the terms under which Columbia
would loan the funds for the golf course were more advantageous than the terms
Federated could have received on the market or under its proposal to MAXXAM.
[4] Nor do the defendants explain why Mr. Iaco's original concerns were never
communicated to the MAXXAM Board. Mr. Iaco's memorandum criticized Federated's
initial proposed terms, which were more favorable to MAXXAM than those the Board
ultimately accepted. (PX 9). The defendants argue that Mr. Iaco prepared his
report before he participated in a site visit, after which he changed his mind.
By not calling Mr. Iaco to testify, however, the defendants failed to
demonstrate (and precluded the Court from assessing) the basis for Mr. Iaco's
supposed change of heart.
[5] The $15,300,000 value represented the discounted value of the lots
assuming they were sold in bulk with completed improvements; the $14.7 million
figure represented the discounted value of the lots assuming they were sold in
bulk "as is." (PX 5).
[6] By the summer of 1991, 73% of those lots remained unsold. Federated's
consultants had previously advised Federated that its asking prices for the lots
were too high, and recommended that those prices be reduced. (PX 33A at 14650-51
recommending price cuts averaging 13%); (PX 33B at 14654-55 recommending price
cuts averaging 20%); see also PX 33C at 14657 (internal Federated memo rejecting
--- ----
advice to discount the lots but noting that some lots had been priced absurdly
high to insure that they would not sell early in the marketing program). Except
as to the lots it retained for itself, Federated did not follow this advice.
[7] The defendants claim that Federated terminated the negotiations because
Mitsui's offer was too low. However, the Court finds more persuasive the
testimony of Mr. Kibrick and Dr. Munitz, that Mitsui withdrew its offer because
it was concerned about the litigation. (Tr. 1350-52, Munitz Tr. 145-48).
[8] The first page of Cushman's formal engagement letter to Connally is dated
November 7, 1990, but every other page bears the date of November 5, the day
before the meeting. (PX 72). Moreover, although Cushman was preparing the
appraisal for MAXXAM, Munitz wrote Cushman a letter on November 9 on Federated
---------
letterhead stating that "we will look for the first preliminary numbers around
December 1." (PX 71).
[9] There is no written record of what work Lewis & Howard specifically
performed. That firm's sole apparent contribution was to verbally criticize the
reports of Cushman and Peat Marwick at this one Special Committee meeting. (PX
32J).
[10] Seidl agreed that MAXXAM would pay the full Cushman appraised value,
even though the Committee had been told that the ability to structure the
transaction to provide a tax benefit to Federated might serve as leverage that
could induce Federated to accept a lower price. (PX 32C at 12256).
[11] The Special Committee's final report shows that the purchase price
reflected a "Cushman & Wakefield Appraisal Value" of $42,892,000. (PX 4). The
slight difference between this number and the $43,560,000 value in Cushman's
February appraisal is due to the inclusion in Cushman's February appraisal of 31
estate lots, whereas only 29 lots were actually transferred to MAXXAM in the
Exchange. (DX 37; PX 32K at 12301).
[12] Although MAXXAM received a $1.3 million credit for its 25% interest, the
plaintiffs have not included that amount as part of the additional
consideration, because under their rescissory damages calculation MAXXAM would
be treated as never having obtained the 25% interest, and therefore as never
having received a credit for that interest as part of the consideration for the
1991 Exchange.
[13] In one sale, MAXXAM extended 80% financing and bought back the lot by
deed in lieu of foreclosure.
[14] Leone was not a director who was "deemed independent" in the minutes of
the MAXXAM Board meeting in which the 1987 Loans transaction was approved. That
is hardly a surprise. Leone was President of MAXXAM, CEO of Pacific Lumber
Company, and a director of Kaiser Aluminum, all of which were entities
controlled by Hurwitz. (Stip. Facts 10, 17).
[15] Mem. Op. at 6-7, explicating Kahn v. Seaboard Corp., Del. Ch., 625 A.2d
----------------------
269, 276 (1993).
[16] Nor does this Court find merit in the plaintiff's argument that the
statute is tolled if Rosenberg is found to have breached his duty of loyalty and
care by failing adequately to monitor an interested transaction. Even there,
the statute is tolled only if the plaintiffs can demonstrate his participation
in an affirmative act of concealment. See, Citron v. Steego Corporation, Del.
--- ----------------------------
Ch., C.A. No. 10171, Allen, C. (Dec. 23, 1992) (dismissing action against
disinterested directors who allegedly failed to monitor effectively a
transaction between the corporation and its controlling shareholder, where there
were no pleaded facts showing a conspiracy or the fraudulent concealment of a
wrong); Boeing Co. v. Shrontz, supra. As previously found, no such showing is
--------------------- -----
made here.
[17] Defendants argue that Columbia's cessation of negotiations was temporary
and intended only as a bargaining tool, but that argument only demonstrates that
Columbia wanted terms more favorable than what Federated was proposing.
[18] The defendants cite their expert, Mr. Smith's, testimony that this
practice was not unusual. But Mr. Smith testified that in some transactions the
lender might accept the appraiser it had selected as the mortgage broker
representing the borrower. He could not recall any case where the lender had
accepted the borrower's choice of an appraiser. Mr. Smith also testified that
in these instances where the lender accepted the mortgage broker's appraisal,
the lender would reinstruct the appraiser as to what specific issues it wanted
the appraiser to address. (Tr. 849-50).
[19] The Board also had available the Lesser study which, though highly
optimistic about the Mirada's prospects, predicted much lower absorption rates
and average lot prices than did Blee & Stark. There is no evidence that the
MAXXAM Board considered the Lesser study before voting to approve the 1987 Loan
transaction.
[20] Those features were that: 1) Federated was being reimbursed over and
above its actual prior investment, leaving it with no money in the project at
risk plus a developer's "profit"; 2) interest would accrue throughout the entire
term of the loan, leaving MAXXAM unable to declare a default for 5 years; 3) 6
lots would be excluded from the collateral, thereby putting Federated in direct
competition with MAXXAM with respect to those lot sales; 4) there was no
requirement that the proceeds of lots sales be used to pay down the loans; 5)
the nonrecourse nature of the loans; 6) there was no loan budget or construction
loan agreement, resulting in MAXXAM's security interest not having priority over
any mechanic's lien placed on the property; 7) Federated selected the appraiser;
8) the loans were administered by an Approval Committee that included a
representative of Federated; 9) Federated had the ability to increase the $5
million revolving loan subject to the approval of the Approval Committee; and
10) the November golf course loan was approved without any appraisal or
government approval for the golf course.
[21] Those characteristics include: 1) the lender provides substantially all
of the funds to acquire and complete the project, 2) interest is accrued, 3) the
loan is nonrecourse, and 4) first payments are not due until the project is
completed.
[22] Mr. Smith also failed to take into account the fact that Federated was
entitled to 75% of all interest earned on the deposit account. (PX 1 at S
1.5(b)). Thus, if the loans became troubled, Federated's incentive would be to
retain the funds in the deposit account, rather than allow them to be used to
repay the loans.
[23] The defendants argue that Mr. Smith was not required to review those
documents because he was not an appraiser. Insofar as Mr. Smith's testimony was
offered to support the contention that the terms of the 1987 Loans were typical,
that is correct. But, to the extent that his expert opinion was offered to show
that the overall transaction was fair, the argument lacks merit, because the
substantive fairness of the loans depends critically on the value of the
collateral. In that context Mr. Smith's failure to conduct his own analysis of
the value of the underlying collateral diminishes the persuasive force of his
opinion.
[24] That figure is the sum of: (i) $13,400,000 for the 40 Phase I lots;
(ii) $10,250,000 for the villa site; (iii) $7,050,000 for the townhouse site;
and (iv) $3,100,000 for the golf course property.
[25] Defendants explain that in 1987 only non-view Vintage lots were sold,
whereas both view and non-view Mirada lots were sold. Although defendants argue
that it was reasonable for Buss to assume that the combined view and non-view
Mirada lots were, on average, more valuable than the non-view Vintage lots,
even Mr. Buss conceded that the Vintage was a superior property and that the
sales prices of Vintage lots between 1991 and 1995, view and non-view, far
exceeded the average price of the Mirada lots. (Tr. 1166-69).
[26] Only 80 townhouse units had been approved in 1987. Not until late
November 1989, as part of the settlement of the golf course property litigation
with the City of Rancho Mirage, did Federated obtain approval for 10 additional
units. (Tr. 1173). Confronted with the fact that that approval occurred two
years after the 1987 Loans, Mr. Buss testified that an appraiser could
-----
reasonably assume in 1987 that 9 approved residential lots in Phase I that would
not be developed, could ultimately be transferred to the townhouse site. (Tr.
1287-88).
[27] The defendants argue that because Seidl's employment contract would not
terminate until three years after the Exchange, that establishes his
independence from Hurwitz's influence. Why that should be so is not explained,
nor is any authority cited to support that proposition.
[28] Although the November 6, 1990 Special Committee meeting minutes reflect
that the Committee members authorized him to engage Cushman if appropriate,
Connally had already engaged Cushman before the November 6 meeting. As earlier
noted (see supra n. 8), while the first page of Cushman's formal engagement
--- -----
letter is dated November 7, 1990, every other page bears the date of November 5,
the day before the meeting. Similarly, the March 15 minutes recite that "[t]he
Committee discussed the possibility of engaging a firm such as Lewis & Howard"
to review the Cushman appraisal (PX 32F at 12284), but the record shows Governor
Connally had unilaterally engaged Lewis & Howard one month before. (DX 30).
[29] Kahn v. Tremont Corporation, Mem. Op. at 16-17; see also Cinerama, Inc.
--------------------------- -------- --------------
v. Technicolor, Inc., Del. Ch., 663 A.2d 1134, 1148 (1994) (discussing policy
- --------------------
behind allowing self-interested transactions in corporate law, as distinguished
from trust law).
[30] The defendants also rely upon testimony by plaintiffs' trial expert, Mr.
Opperman, that all interested parties are harmed whenever a lender forecloses on
a property. What Mr. Opperman actually said, however, is that a lender would
first attempt a "work out," i.e., would cooperate with the borrower to develop a
----
plan to pay the debt, and if that proved unsuccessful, the borrower would then
attempt to obtain a deed in lieu of foreclosure. (Tr. 283-84.) What defendants
do not confront is that that could have been done here as well, with no internal
disruption or adverse publicity.
[31] The defendants claim that the 1991 Buss appraisal value establishes that
the 1991 Exchange price was fair because it fell within the range of the $42.9
million that MAXXAM actually paid, and because there is "no single price that
all persons could agree constitutes a 'fair' price" (citing Kahn v. Tremont
---------------
Corporation, Mem. Op. at 21). That argument fails to confront the fact that had
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the Committee waited until 1992 and foreclosed on the loans, MAXXAM could have
bought the property for near the $34 million accrued debt.
[32] See PX 32F at 12284 ("Chairman Connally said that the Peat Marwick study
---
indicates to him that MAXXAM needs to acquire the property and fully take charge
in order to make sure that its in the best position with respect to its
investment); Id. at 12285 ("Dr. Seidl said ... he agreed with Chairman
---
Connally's view that the primary value of the Peat Marwick study was to advise
MAXXAM how to manage and market the property if it acquires the same"). See also
--------
PX 32G.
[33] For example, Peat Marwick concluded that the absence of a security wall
would be a problem -- a conclusion defendants claim was erroneous because the
Mirada was located at the top of hills that could only be accessed by a single
road with a full-time security gate. (DX 82 at 27).
[34] Lewis & Howard was the appraisal firm Governor Connally had unilaterally
selected. Although the Committee relied upon Lewis & Howard, the defendants
have not introduced any document that evidenced Lewis & Howard's critique or its
basis or what preparatory work that firm actually performed.
[35] The Committee agreed to pay the full Cushman appraised value even though
it had been advised that the potential to structure the transaction in a manner
that would provide a tax benefit to Federated might serve as leverage to
persuade Federated to agree to a lower purchase price.
[36] See Oral Arg. Tr. 96-98.
---
[37] The defendants also argue that the plaintiffs' rescissory damage
calculation contains basic errors, such as including the portion of the borrowed
funds that Federated invested in the Mirada, in the amount that MAXXAM gave up.
In addition, the defendants argue that any rescissory damage calculation should
be based on the defendants' expert's appraisal, and not the plaintiffs' expert's
appraisal, which (defendants claim) was fatally flawed.
[38] Because the Court reaches no conclusion as to damages in this Opinion,
it does not address (and defers to a later time) the defendants' argument that
Leone, Rosenberg and Seidl are exculpated from liability by MAXXAM's Certificate
of Incorporation.
[39] See NL Plaintiffs' Response to Defendants' Second Set of
---
Interrogatories; Plaintiffs' Response to Defendants' First Set of
Interrogatories; Defendant's Motion in Limine to Preclude Rescission as a
Remedy.
[40] See In re MAXXAM, Inc./Federated Dev. Shareholders Litig., Del Ch.,
--- -----------------------------------------------------
C.A. Nos. 12111 & 12353, Jacobs, V.C. (June 21, 1995); In re MAXXAM,
-------------
Inc./Federated Dev. Shareholders Litig., C.A. Nos. 12111 & 12353, Jacobs, V.C.
- ---------------------------------------
(September 10, 1996).
* * *
