Mainstreet Bank v. Nat'l Excavating Corp..

791 F.Supp.2d 520

MAINSTREET BANK, Plaintiff,

v.NATIONAL EXCAVATING CORPORATION, et. al., Defendants.

Case No. 1:10cv1230.

United States District Court, E.D. Virginia,Alexandria Division.

June 8, 2011.

Heather Hays Lockerman, Joshua David Heslinga, Troutman Sanders LLP, Richmond, VA, Richard Eugene Hagerty, Troutman Sanders LLP, McLean, VA, for Plaintiff.Stephen M. Seeger, James Faughnan, Seeger Faughnan Mendicino PC, Washington, DC, for Defendants.

MEMORANDUM OPINION

T.S. ELLIS, III, District Judge.

At issue in this transferred ¹ diversity action alleging fraud and fraudulent conveyances arising out of a leveraged employee buyout is whether plaintiff's claims survive summary judgment. Defendants essentially argue that plaintiff's claims fail for two reasons. First, defendants argue that Virginia law governs plaintiff's claims, and hence plaintiff's statutory fraudulent conveyance claims under Maryland law must be dismissed. Second, defendants argue that the common law actual and constructive fraud claims fail because the undisputed facts on summary judgment demonstrate that no fraud occurred.

For the reasons that follow, because Virginia law governs, summary judgment must be granted in favor of defendants on the Maryland statutory fraudulent conveyance claims but denied as to the common law actual and constructive fraud claims.

I.²

Plaintiff MainStreet Bank (“MainStreet”), a community bank chartered in Virginia, brought this action against five defendants: (i) National Wrecking Corp. (“NWC”), (ii) National Excavating Corp. (“NEC”), (iii) National Excavating Corp. Employee Stock Ownership Trust (“NEC ESOT”), (iv) William Finagin, Jr., and (v) G. Rogers Smith in his capacity as trustee of NEC ESOT. ³ NWC and NEC are corporations primarily engaged in the excavating business, and both corporations were at one time majority-owned by Finagin.

Finagin founded NEC in November 2007 with the intent to make NEC a successor to NWC. After NEC came into existence, NWC continued work on various projects but did not bid on new projects. NWC transferred several projects to NEC and also leased some, but not all of its equipment to NEC. In or around October 2008, Dynasty Capital Advisors (“Dynasty”) represented to Finagin that Dynasty could sell Finagin's interest in NEC to the employees of NEC in a leveraged employee buyout through an employee stock ownership plan.

A leveraged employee buyout generally proceeds in three stages. First, the company establishes an employee stock ownership trust. Next, the trust borrows money from a lender to purchase the existing owner's shares of the company, thus transferring ownership of the company to the trust. This allows the existing owner to “cash out” of the company. The company then uses cash from its operating income to purchase the shares from the trust. As the company acquires its shares, it redistributes them to the company's employees. The cash paid to the trust to acquire the shares can be used by the trust to make loan payments. Over time, all of the company's stock is transferred from the trust to the company's employees, and the lender is fully paid on the loan. When this process is complete, the trust is terminated.

After conducting a study of NEC, Dynasty concluded that (i) an employee stock ownership plan would be a feasible means of buying out Finagin, and (ii) that the value of a 100% interest in NEC was approximately $11.42 million. Value Driven LLC, a business valuation firm hired to conduct an independent valuation of NEC, calculated the value of NEC's stock to be approximately $10.2 million. Accordingly, under the terms of the buyout, NEC ESOT was created to purchase all of Finagin's shares in the company for approximately $10 million, with $3 million to be provided to Finagin in cash and the remaining $7 million in the form of a note to be paid to Finagin over seven years out of NEC's operating profit. NEC ESOT would obtain the $3 million in cash from NEC, which in turn would borrow the money from MainStreet on a promissory note. NEC's $3 million promissory note from MainStreet was to be secured by a portion of Finagin's real property and by all of NEC's assets.

On May 27, 2009, MainStreet provided a commitment letter describing the terms of the deal. That letter—signed by MainStreet, Finagin, NWC, and NEC ⁴—states that the “agreements evidenced hereby, and the transactions contemplated hereby, shall be governed in all respects by the laws of the Commonwealth of Virginia.” Commitment Letter at 11 (Pl. Ex. 21). At closing on June 24, 2009, which occurred in Virginia, MainStreet and NEC signed two documents, namely a secured credit agreement and a promissory note, as contemplated by the earlier commitment letter.⁵ Both the secured credit agreement and promissory note contained choice of law provisions selecting Virginia law.⁶

Although Finagin and NWC were not parties to the secured credit agreement or promissory note, their role in the transaction was clearly referenced in those documents. Indeed, the secured credit agreement contained a covenant stating that the $3 million loan from MainStreet to NEC must be used “exclusively to finance the [employee buyout] of employer securities.” Secured Credit Agmt. at 8 (Def. Ex. 16). It is undisputed that the employer securities in issue were Finagin's NEC shares.

The parties do not provide a pellucidly clear picture of how the $3 million was transferred from MainStreet to Finagin. Based on the wire transfers referenced in the parties' memoranda, it appears that MainStreet first wired the $3 million to a closing attorney for the transaction at the attorney's bank account located in the District of Columbia. That attorney was then instructed by NEC and Finagin to wire the money to the District of Columbia bank account of Finagin's attorney, who thereafter transferred the money to Finagin's personal bank account in Maryland.⁷

The first payment to MainStreet on NEC's loan was due July 18, 2009. It was received late, on July 27. That same day, Finagin informed Dynasty,⁸ which in turn notified MainStreet, that NEC's business had declined very significantly. NEC subsequently failed to make the second payment, which was due on August 18. On August 26, Finagin informed MainStreet that NEC lacked the necessary cash flow to make the August payment, but Finagin agreed, at MainStreet's request, to fulfill the loan payment using his personal funds. No further loan payments were made after that point. By November 3, NEC's checking account with MainStreet was virtually depleted.

MainStreet obtained a confessed judgment against NEC in the amount of $2,986,939.81 in Fairfax Circuit Court, Virginia. MainStreet then sold the NEC machinery and equipment in which it had taken a security interest for the loan, resulting in net proceeds of $565,702.66.⁹ After foreclosing on NEC's secured equipment, machinery, and real estate, MainStreet contends that it is still owed approximately $1.5 million by NEC on the promissory note.

MainStreet brought this action for declaratory judgment and damages alleging four statutory fraudulent conveyance claims under Maryland law,¹⁰ common law actual fraud, and common law constructive fraud. Distilled to its essence, MainStreet's amended complaint stems from three alleged wrongs: (i) that defendants committed fraud by falsely representing the financial condition of NEC and NWC; (ii) that defendants committed fraud by falsely representing that all of NWC's assets would be transferred to NEC prior to closing to collateralize MainStreet's loan; and (iii) that NEC's transfer to Finagin of $3 million in cash and a $7 million promissory note in exchange for Finagin's NEC stock amounted to a fraudulent conveyance under Maryland statutory law, inasmuch as defendants were aware that the stock was worth far less than $10 million. MainStreet seeks (i) declaratory judgments that the conveyances from NEC to Finagin and the sale of assets from NWC to NEC were designed to defraud MainStreet, (ii) a personal judgment against Finagin for compensatory and punitive damages, and (iii) reasonable attorneys' fees and costs.

Finagin and NWC deny any wrongdoing and move for summary judgment. The remaining parties—NEC, NEC ESOT, and Smith—are in default but await ruling on the claims against Finagin and NWC before continuing with default judgment proceedings.

Because defendants seek summary judgment as to the fraud claims, a review of the record facts pertaining to the alleged misrepresentations is essential to the summary judgment analysis. According to MainStreet, the summary judgment record demonstrates, inter alia, two misrepresentations by defendants with respect to the buyout. First, MainStreet argues that defendants intentionally misled MainStreet into believing that all the assets of NWC would be transferred to NEC at or before closing.¹¹ In support of this contention, MainStreet cites email exchanges between MainStreet's loan officer and defendants' agents in which the loan officer repeatedly references his understanding that all assets would be transferred from NWC to NEC prior to closing. MainStreet's loan officer also provided a sworn declaration representing that, based on the sum of his communications with defendants, defendants intentionally led him to believe all assets would be transferred from NWC to NEC. Defendants respond that nowhere in the email exchanges do defendants or their agents explicitly state that all NWC assets would be transferred to NEC. To the contrary, defendants claim that they provided MainStreet a bill of sale specifying the assets actually transferred to NEC. Defendants further note that had MainStreet compared this bill of sale to previously submitted documents describing NWC's assets, MainStreet would have been on notice that not all NWC assets were transferred to NEC. In response, MainStreet points out that the bill of sale was not provided until the eve of closing and was...