First International Bank, f/k/a, First National Bank of New England, No. 4366 (July 9, 1999), Docket No. SIZ-99-04-20-22 UNITED STATES OF AMERICA SMALL BUSINESS ADMINISTRATION OFFICE OF HEARINGS AND APPEALS WASHINGTON, D.C. ______________________________ ) SIZE APPEAL OF: ) ) First International Bank, ) Docket No. SIZ-99-04-20-22 f/k/a, First National ) Bank of New England ) Decided: July 9, 1999 ) Appellant ) ) RE: Elwell Iron Works, Inc. ) ) Loan No. 933,804-3009 ) ______________________________) APPEARANCES for Appellant Edward J. Pontacoloni, Esq. Updike, Kelly & Spellacy, P.C. for the Small Business Administration Audrey H. Liebross, Esq. Office of General Counsel DIGEST Concerns are affiliated if one owns or controls, or has the power to control, 50% or more of the other's voting stock. In determining whether concerns are affiliated, SBA gives present effect to convertible debentures, treating them as though the holder already had exercised them. Parol, or extrinsic, evidence of written or oral agreements made prior to or contemporaneous with a written agreement, which written agreement is intended as a final integration of the entire agreement, may not be used to modify or contradict the terms of the written contract. Parol evidence may be used to explain the facts and circumstances of the transaction in order to interpret the terms of the written contract, and to remove or explain any uncertainty or ambiguity, but it may not be used to create ambiguity where none otherwise exists. Hearsay statements made by counsel as to what parties to a transaction have said, without substantiation by the parties themselves, do not constitute reliable probative evidence. A Standby Agreement, executed after a Small Business Administration Preferred Lender has approved a loan to a challenged concern, is irrelevant in determining that concern's size, because SBA determines size as of the loan approval date. DECISION HOLLEMAN, Administrative Judge: Jurisdiction This appeal is decided under the Small Business Act of 1958, 15 U.S.C. Sections 631 et seq., and 13 C.F.R. Parts 121 and 134 (1999). Issues Whether concerns are affiliated if one owns or controls, or has the power to control, 50% or more of the other's voting stock. Whether SBA gives present effect to convertible debentures when determining whether concerns are affiliated. Whether parol, or extrinsic, evidence of written or oral agreements made prior to or contemporaneous with a written agreement, which written agreement is intended as a final integration of the entire agreement, may be used to modify or contradict the terms of the written contract. Whether parol evidence may be used where it does not explain the facts and circumstances of the transaction in order to interpret the terms of the written contract, or remove or explain uncertainty or ambiguity but, instead, creates ambiguity where none otherwise exists. Whether hearsay statements made by counsel as to what parties to a transaction have said, without substantiation by the parties, constitute reliable probative evidence. Whether a Standby Agreement, executed after a Small Business Administration Preferred Lender has approved a loan to a challenged concern, is relevant in determining that concern's size. I. BACKGROUND A. The Debenture Agreement Elwell Iron Works, Inc. (Elwell) was a Massachusetts corporation with a place of business in Springfield, Massachusetts. Edwin S. Dane was Elwell's majority shareholder and chief executive officer. Elwell was primarily engaged in the business of steel fabrication, which is included in Standard Industrial Classification code 3441, Fabricated Structural Metal, with a corresponding 500- employee size standard. On September 1, 1993, Elwell amended its Articles of Organization to provide that the authorized capital stock of the corporation would consist of 3,750 shares of Class A stock and 3,750 shares of Class B stock. The rights and privileges of each class of stock were identical, share for share, but only Class A had voting power. On June 18, 1994, Elwell entered into a Debenture Agreement (Debenture) with Canam Steel Corporation (Canam), a wholly-owned affiliate of The Canam Manac Group, Inc. (Canam Manac), an admittedly large Canadian firm. The Debenture provided that Canam would loan Elwell $600,000, with an interest rate of 1.5% over prime. Section 4 provided for conversion of the Debenture into Elwell's stock: 4.1 Canam may, at any time, as of and from the date of issuance of this Debenture but no later than May 15, 1999, covert this Debenture in whole but not in part into sufficient shares of any class of the Corporation [Elwell] sufficient to provide it with an equity share and a right to share in distributions equal to 50% of the outstanding share capital of the Corporation on a fully diluted basis. 4.2 Canam's conversion right shall be exercised by way of a notice by Canam to the Corporation stating its intention to convert as well as the estimated number of shares to which such conversion shall entitle it and a date, no later than five working days from the date of sending of the notice on which Canam shall tender its Debenture duly endorsed for purposes of conversion in exchange for certificates representing the number and class of shares stated in the notice. . 4.3 Should the Corporation disagree with the contents of the notice, it shall forthwith notify Canam and the parties shall in good faith attempt to resolve any difference with respect to the contents of such notice. Should the parties fail to agree within the prescribed time, the parties shall defer decision to the CPA firm of Price Waterhouse at its office in Baltimore, Maryland, for final determination, which determination shall be made within five (5) working days of a request by either party to so determine the amount. . The Debenture also provided it would be interpreted and governed according to Massachusetts and federal law. Debenture Section 11. B. The Loan On June 5, 1996, the First International Bank, formerly known as the First National Bank of New England (Appellant), a participant in the Small Business Administration's (SBA) Preferred Lender Program (PLP), made a guaranteed loan under SBA's 7(a) loan program to Elwell. [1] That same day, Appellant submitted an eligibility form on Elwell to SBA's PLP Loan Processing Center. Appellant did not check the box which would have shown Elwell had possible affiliates. On June 21, 1996, Elwell and Canam executed a Standby Agreement on SBA Form 155, under which -- in order to induce Appellant to make the loan to Elwell -- Canam agreed that it would take no action to "assert, collect, or enforce" the debt or to realize upon collateral without Appellant's prior consent. Although the Standby Agreement printed form included some additional typewritten provisions, it did not include Canam's explicit agreement to forgo converting the Debenture into equity. Subsequently, Elwell defaulted on its loan and went out of business. On March 20, 1998, SBA's Massachusetts District Office (District Office) informed Appellant that, at the time Appellant approved the loan, Elwell was not eligible for financial assistance because it was affiliated with Canam. The District Office directed Appellant to reimburse SBA the amount the Agency had paid the secondary market holders of the SBA-guaranteed portion of the loan. On May 8, 1998, Appellant -- through counsel -- protested the District Office's denial of eligibility, and requested a formal size determination. Appellant asserted the Debenture did not grant Canam an interest in Elwell's voting stock. Further, even if the Debenture did so, it did not create affiliation with a large business, because Canam had only 30 employees, and the Standby Agreement prevented Canam from exercising the conversion option. On May 21, 1998, SBA's District Counsel requested additional information from Appellant's counsel. On May 26th, Appellant's counsel provided it. On May 29th, Appellant asserted for the first time it had approved the loan in reliance upon Mr. Dane's representations that Elwell did not intend the Debenture to grant Canam a controlling interest. Appellant reiterated its arguments that the Debenture did not grant Canam the right to convert the Debenture into voting stock, and that the Standby Agreement prevented Appellant from converting the Debenture. Appellant also conceded the Debenture ran to Canam's parent, Canam Manac. On June 19, 1998, the District Counsel informed Appellant he had concluded Elwell was affiliated with Canam Manac, and renewed SBA's demand for reimbursement. On December 9, 1998, the District Office referred the matter to SBA's Area I Office of Government Contracting (Area Office) for a formal size determination on Elwell. C. The Area Office Size Determination On March 12, 1999, the Area Office issued its size determination. The Area Office first found Canam and Canam Manac were affiliated. Second, after reviewing the Debenture, the Area Office found it gave Canam the option of converting the Debenture into sufficient shares of any class of corporate stock, thereby constituting a 50% equity share in Elwell. Third, the Area Office found the Debenture's language was clear and, therefore, it was inappropriate to look beyond it to statements by the parties which might vary its terms. Fourth, the Area Office found that, even if it were to look beyond the Debenture's terms, the statements Appellant offered in support of varying its terms were unpersuasive. Fifth, the Area Office found the Standby Agreement was irrelevant, because it was executed after Appellant approved the loan, the date on which SBA determines size. Applying the present effect rule (13 C.F.R. Section 121.103(d)), the Area Office found Elwell was affiliated with Canam and Canam Manac and, thus, concluded it was other than small. On March 22, 1999, Appellant's counsel received the size determination. D. The Arguments of the Parties On April 20, 1999, Appellant filed the instant appeal. Appellant asserts the Area Office erred in refusing to consider external evidence to clarify the ambiguities in the Debenture. Because the Debenture gives Canam the right to convert it into "any class" of stock, Appellant asserts this ambiguous Debenture can be construed only with extrinsic evidence. Appellant asserts it questioned Mr. Dane about the Debenture when it approved the loan, and relied upon his assurance the Debenture was not intended to enable Canam to obtain a controlling interest in Elwell. According to Appellant, Mr. Dane viewed the Debenture as continuing his and Elwell's minority shareholder's control of Elwell. The parties intended that, if Canam exercised the conversion provision, it would acquire only Class B non-voting stock. To ensure this result, Appellant obtained the Standby Agreement from Canam. Appellant asserts that Debenture Section 4.3 on dispute resolution creates further ambiguity. If the Debenture clearly authorized Canam to convert it into Class A voting stock, this provision would be unnecessary; Elwell would have no reason to disagree with Canam. Appellant asserts that, because Canam's option to acquire voting stock under the Debenture was either conditional or simply not contemplated by the parties, the Area Office erred in applying the present effect rule. Thus, it should not have found affiliation between Elwell and Canam. On May 14, 1999, SBA responded to the appeal. [2] SBA asserts the Debenture gave Canam the immediate right to acquire voting stock. Therefore SBA properly applied the present effect rule, treating the Debenture's conversion option as though Canam had exercised it. SBA further asserts Section 4.3 merely is designed to settle disputes over the number of shares to be converted. In addition, SBA asserts Appellant's attempt to introduce Mr. Dane's statements, in order to vary the terms of the Debenture, violates the parol evidence rule. Finally, SBA asserts the Standby Agreement is irrelevant, because it was executed after Appellant approved the loan. Even if the Standby Agreement were applicable, it merely would make the stock conversion conditional. SBA asserts the present effect rule applies to conditional transactions. II. DISCUSSION Appellant filed the instant appeal within 30 days of receiving the size determination, and it is thus timely. 13 C.F.R. Section 134.304(a)(2). Appellant also has standing to appeal because it is adversely affected by the size determination: SBA seeks reimbursement from it. 13 C.F.R. Section 134.302(a). Appellant has the burden of proving, by a preponderance of the evidence, all the elements of its appeal. Specifically, it must prove the Area Office size determination is based on a clear error of fact or law. 13 C.F.R. Section 134.314; Size Appeal of Rebmar, Inc., No. 4173 (1996). Here, it is undisputed that Canam and Canam Manac are affiliated, and that Canam Manac is a large firm. Therefore, if affiliation exists between Canam and Elwell, Elwell is not an eligible small business. 13 C.F.R. Section 121.301(a)(1). Affiliation exists if one concern controls, or has the power to control, another. 13 C.F.R. Section 121.103(a)(1). More specifically, affiliation exists if one concern owns or controls, or has the power to control, 50% or more of another concern's voting stock. 13 C.F.R. Section 121.103(c)(1). In determining whether affiliation exists, SBA gives present effect to convertible debentures (and similar instruments such as stock options and merger agreements). That is, it treats these instruments, even where they are conditional, as though the holder had already exercised them. 13 C.F.R. Section 121.103(d); Size Appeal of Consolidated Industries, Inc., No. 4235 at 6 (1997). Thus, the issue here is whether the Area Office erred in interpreting the Debenture, and in giving it present effect. First, the Administrative Judge must determine whether Appellant's reliance on Mr. Dane's statements to interpret the Debenture violates the parol evidence rule. This rule requires that parol or extrinsic evidence of written or oral agreements made prior to or contemporaneous with a written agreement, which written agreement is intended as a final integration of the entire agreement, may not be used to modify or contradict the terms of the written contract. Edward M. Swartz, Trial Handbook for Massachusetts Lawyers Section 23:1 (2d ed. 1990); See also 4 Samuel Williston and Walter Jaeger, A Treatise on the Law of Contracts Section 631 (3d ed. 1961); 3 Arthur Corbin, Corbin on Contracts Section 573 (1960). The first step in applying the rule is to determine whether the contract at issue is an integrated agreement, that is, whether the parties intended the contract to be a statement of their complete agreement. Ryder v. Williams, 29 Mass. App. Ct. 146, 149; 558 N.E.2d 1134, 1136 (1990). While the Debenture does not expressly state it is an integrated agreement, the Administrative Judge's review shows it is a comprehensive written agreement between sophisticated corporate entities, and comprises all the necessary elements of a contract. It therefore meets the Massachusetts criteria for determining whether a contract is an integrated agreement. Wang Laboratories, Inc. v. Docktor Pet Centers, Inc., 12 Mass. App. Ct. 213, 218-19; 422 N.E.2d 805, 808 (1981); Kilroy v. Schimmel, 243 Mass. 262, 267; 137 N.E. 366, 368 (1922). [3] Because the Administrative Judge has found the Debenture is an integrated agreement, parol evidence is not admissible to contradict its terms. Bettencourt v. Bettencourt, 362 Mass. 1, 8-9; 284 N.E.2d 238, 243 (1972). However, parol evidence still may be used to explain the facts and circumstances of the transaction, in order to interpret the terms of the written contract and to remove or explain any uncertainty or ambiguity. Robert Industries, Inc. v. Spence, 362 Mass. 751, 753-54; 291 N.E.2d 407, 409 (1973). Contract language usually is considered ambiguous where the terms are facially inconsistent, or where the language can support reasonable differences of opinion as to the meanings of the words employed and obligations undertaken. Rey v. Lafferty, 990 F.2d 1379, 1384-85 (1st Cir. 1993) (applying Massachusetts law). However, parol evidence may not be used to create ambiguity where none otherwise exists. Boston Car Company, Inc. v. Acura Auto Div., American Honda Motor Co., Inc., 971 F.2d 811, 815 (1st Cir. 1992); cert. denied, 510 U.S. 828 (1993) (applying Massachusetts law). In this case, the Debenture is clear on its face, and the language is unequivocal. Canam may convert it at any time into "sufficient shares of any class" to provide it with 50% of Elwell's outstanding stock. Debenture Section 4.1 (emphasis added). Since Elwell had only two classes of stock, Class A voting and Class B nonvoting, Canam could convert the Debenture into Class A voting stock. Indeed, since the voting stock represented 50% of Elwell's equity, Canam conceivably could have taken all of Elwell's voting stock in exchange for the Debenture. The language of Section 4.2 reinforces this interpretation. It requires Elwell to tender Canam the "number and class" of shares identified in Canam's notice of conversion, which clearly authorizes Canam to convert the Debenture into more than one class of shares. Appellant's reliance on Section 4.3 is misplaced. Notwithstanding the language that Price Waterhouse will arbitrate disputes over any conversion notice and will determine the amount of stock Canam will receive, it says nothing about resolving disputes over which class of stock Canam will receive. Unlike a dispute over the valuation of the stock, an accountant's expertise is not necessary to resolve disputes over the class of stock. The Administrative Judge concludes Section 4.3 does not create an ambiguity in the Debenture, because it explicitly permits Price Waterhouse to settle disputes concerning the amount of stock at issue. Although it does not address disputes over which class of stock Canam will receive, such language is unnecessary; the "any class" language in Section 4.1 resolves that issue. Therefore, Canam retained the discretion to receive 50% or more of the voting stock in exchange for the Debenture. [4] As mentioned above, the parol evidence rule prohibits the Administrative Judge from considering Mr. Dane's statement here. He cannot do so, because Appellant attempts to use the statement to create ambiguity where none otherwise exists, and to contradict the plain meaning of the unambiguous integrated Debenture. Even if the Administrative Judge could consider Mr. Dane's statements, the probative value of the proffered evidence is inadequate to meet Appellant's burden of demonstrating clear error by the Area Office. Appellant merely proffers hearsay, its counsel's assertion in letters and pleadings as to what Mr. Dane told Appellant. Appellant fails to proffer sworn or unsworn statements from its own officers, from Mr. Dane, or any evidence whatever from Canam. While judges in administrative proceedings may rely on hearsay evidence, that evidence must be probative and contain satisfactory indicia of reliability. Gray v. U.S. Department of Agriculture, 39 F.3d 670, 676 (6th Cir. 1994). The statements here, made by counsel without any substantiation, cannot constitute such evidence. A lawyer may not attest to what his clients do or do not know. See Cooper v. Sedona Group, 1997 U.S. Dist. LEXIS 20015 at *2 (N.D. Ill. 1997); Oceanic Trading Corp. v. Vessel Diana, 423 F.2d 1, 4 (2d Cir. 1970). Even if the Administrative Judge could review Mr. Dane's statement, it would not be highly probative evidence, because it would be a self-serving, after-the-fact recollection of a two-year old transaction. The Administrative Judge notes Appellant did not raise this issue initially when responding to SBA's demand for reimbursement. The Administrative Judge further notes: What a party remembers about what was said at a business conference is easily colored by what that person wished to be resolved by the discussion. The hoped for result metamorphoses into fact. U.S. Trust v. Henley & Warren Management, Inc., 40 Mass. App. Ct. 337, 343; 663 N.E.2d 1238, 1242 (1996). As to Appellant's reliance upon the June 21, 1996 Standby Agreement, although evidence of a subsequent agreement may be used to prove the parties modified an integrated written contract (L.W. Severance & Sons, Inc. v. Angley, 332 Mass. 432, 439; 125 N.E.2d 415, 420 (1955)), Appellant's reliance on it here is misplaced. SBA was required to determine Elwell's eligibility as of the date Appellant approved the loan, no later than June 5, 1996. 13 C.F.R. Section 121.302(b). Even if the Standby Agreement actually modified the Debenture, Canam executed it more than two weeks after loan approval. Accordingly, the Standby Agreement is not relevant, and the Area Office was correct in declining to consider it. [5] The Administrative Judge finds the Debenture's clear, unequivocal language gave Canam the option of converting it into 50% or more of Elwell's voting stock. Thus, under the present effect rule, he finds the two firms were affiliated at the relevant time. 13 C.F.R. Section 121.103(c)(1). He will not admit Appellant's proffered parol evidence to vary the clear terms of the Debenture, or to create an ambiguity where none otherwise exists. Even if the Administrative Judge were to consider Appellant's proffered evidence, it has no probative value, as it consists merely of hearsay statements by counsel. In addition, the Standby Agreement is irrelevant, because Canam executed it after Appellant approved the loan. Accordingly, the Administrative Judge concludes Appellant has failed to meet its burden of demonstrating clear error of fact or law in the Area Office's determination that Elwell was affiliated with Canam and Canam Manac and, thus, was other than small. III. CONCLUSION For the above reasons, the Administrative Judge AFFIRMS the Area Office size determination and DENIES the instant appeal. This is the final decision of the Small Business Administration. See 13 C.F.R. Section 134.316(b). ___________________________ CHRISTOPHER HOLLEMAN Administrative Judge _________________________ [1] On April 15, 1996, the Bank of Western Massachusetts denied Elwell's request for a guaranteed loan under the Small Business Administration's (SBA or Agency) 7(a) loan program, because the Debenture created an affiliation between Elwell and Canam. Appellant asserts it was unaware the Bank of Western Massachusetts had denied Elwell's application. [2] The Administrative Judge, upon a showing of good cause, granted SBA an extension of time to respond. [3] In contrast to the Debenture here, agreements which Massachusetts courts have found unintegrated generally were terse, incomplete, and not professionally drafted. Ryder v. Williams, supra; Antonellis v. Northgate Construction Corp., 362 Mass. 847; 291 N.E.2d 626 (1973). [4] While some prior OHA cases have held SBA will not give present effect to convertible debentures or similar instruments if the conditions for their fulfillment are speculative, conjectural, or beyond control of the option holder, none of these characteristics is present in the Debenture. Therefore, that precedent is not applicable here. See Size Appeal of Horizons Technology, Inc., No. 3591 at 19 (1992); Size Appeal of SRS Technologies, No. 3180 at 10 (1989). [5] Thus, the Administrative Judge need not address SBA's argument that even if the Standby Agreement is relevant, the present effect rule remains applicable here, because the Standby Agreement merely makes Canam's exercise of the Debenture conditional. Posted: July, 1999