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Matched Legal Cases: ['§ 10', '§ 78', '§ 1766', '§ 8', '§ 9', '§ 29', '§ 78', '§ 29', '§ 4']

| Thomas v. Duralite Co.
Thomas v. Duralite Co.
filed: October 8, 1975.
MORTON I. THOMAS, EDCO SURGICAL SUPPLY CO., INC., A NEW YORK CORPORATION, AND TEMCO PRODUCTS, INC., A NEW JERSEY CORPORATION,v.DURALITE COMPANY, INC., A NEW YORK CORPORATION, BERTRAM R. LESSER AND IRVING ZAKIN, BERTRAM R. LESSER AND IRVING H. ZAKIN, APPELLANTS IN NO. 75-1044 DURALITE COMPANY, INC., APPELLANT IN NO. 75-1045 MORTON I. THOMAS, APPELLANT IN NO. 75-1046
APPEAL FROM THE UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY (D.C. Civil No. 623-69).
At that point Thomas and Lesser each owned 45 1/2 percent of the Duralite stock and each owned 45 percent of the Randolph shares. Lesser offered to buy out Thomas' stock in both Duralite and Randolph in 1965 but the proposal was not accepted.
In late 1967, Thomas agreed to accept $112,500.00*fn1 for his Duralite stock. The proposed contract between Thomas and Duralite made the sale contingent upon the consent of certain creditors of Duralite who held various security interests. Because of Duralite's weak financial condition, however, the creditors refused to approve the purchase of Thomas' stock.
At the closing transaction on March 31, 1969, Lesser and Zakin delivered all of their Duralite stock.*fn2 Giffen was not required to produce its shares then since the agreement provided that the company was to use its best efforts to register the stock before December 31, 1969 and then turn over the certificates to Lesser and Zakin. In the interim, they continued to work for Duralite which had become a wholly-owned Giffen subsidiary.
The suit in the district court alleged violations of §§ 10(b), 20 and 29(b) of the Securities Exchange Act of 1934, 15 U.S.C.§§ 78j, 78t, and 78cc(b), and Rule 10b-5. A pendent claim asserting fraud under New Jersey law was included in the complaint. Defendant Duralite filed counterclaims against Edco and Temco for the value of products delivered to them and for certain inventory items which they had ordered but later refused to accept.
Lesser was held accountable for affirmative misstatement rather than simply a failure to disclose. As the court phrased it, "when Lesser spoke of a 'loss situation' in April, and the worthlessness of Duralite's stock, he spoke falsely and with intent to deceive Thomas by wielding Thomas' misplaced fear of bankruptcy as a weapon to aid Lesser in obtaining Thomas' stock."
As in Rochez Bros, Inc. v. Rhoades, 491 F.2d 402 (3d Cir. 1974), we need not grapple at any length with the division of authority on whether an actual intent to defraud must be proved. See Kohn v. American Metal Climax, Inc., 458 F.2d 255 (3d Cir.) (Adams, J. concurring), cert. denied, 409 U.S. 874, 93 S. Ct. 120, 34 L. Ed. 2d 126 (1972); 3 LOSS, SECURITIES REGULATIONS § 1766 (1961). Knowledge and failure of disclosure were found by the district court and we are unable to say that these findings are clearly erroneous. They provide adequate basis for culpability on the part of Lesser and Zakin.
Generally speaking, the test of materiality is an objective one - that is, whether a reasonable man would attach importance to the particular facts in controversy. See Rochez Bros., Inc. v. Rhoades, supra; Landy v. Federal Deposit Insurance Corporation, 486 F.2d 139 (3d Cir. 1973), cert. denied, 416 U.S. 960, 40 L. Ed. 2d 312, 94 S. Ct. 1979 (1974); List v. Fashion Park, Inc., 340 F.2d 457 (2d Cir.), cert. denied, 382 U.S. 811, 86 S. Ct. 23, 15 L. Ed. 2d 60 (1965). But there is an interplay between materiality and reliance which tends to blur the distinction between them when the factual backdrop changes. Thus, it is not difficult to accept the necessity for a clearly enunciated objective standard when the 10b-5 suit affects a large number of shareholders who may have had no direct or continuing contact with the corporation. But when the scene shifts to a situation where a single purchaser who is well known to the seller actively conceals facts, the distinction between objective materiality and subjective reliance becomes obscured. See Harnett v. Ryan Homes, Inc., 496 F.2d 832, 838 n.20 (3d Cir. 1974). As one authority in this field of the law has observed:
" Materiality needs to be more pronounced and more carefully measured in open-market transactions because of potential massive liability to hordes of investors who are in fact trading on a variety of data, appraisals, and intuitions. Some sort of reasonable-man, objective test of investment judgment, intrinsic value, or (in the case of a publicly traded security) significant market effect is appropriate . . . A looser or more subjective one may . . . be proper in direct-personal transaction because of the greater ability of one party to appreciate the position of the other." 2 A. BROMBERG, SECURITIES LAW: FRAUD § 8.3 at 199 (1971).
In Affiliated Ute Citizens v. United States, 406 U.S. 128, 153, 31 L. Ed. 2d 741, 92 S. Ct. 1456 (1972), a nondisclosure case, the Supreme Court indicated that positive proof of reliance was not necessary. The difficulty of establishing reliance on a negative is obvious*fn3 and the burden of proving nonreliance rests upon the defendants, Rochez Bros., Inc. v. Rhoades, supra. They failed to meet that burden here.
The plaintiff, as an "insider," had the duty of using due care to ascertain the relevant facts, Rochez Bros., Inc. v. Rhoades, supra. He met the test because the trial judge was satisfied that Thomas did not have access to all the records of Duralite - particularly the monthly financial report - and other information which would have alerted him to the deception.
Any judgment payable by Duralite would be at the expense of the members of the public who held Giffen's shares. The court noted that the rationale of allowing recovery for windfall profits was not applicable to the passive corporation and, accordingly, entered a judgment against Duralite for compensatory damages only. This conclusion was reached because ". . . Duralite's liability attach[ed] only through operation of law; it was not itself in pari delicto. . . ."
The court was obviously reluctant to enter any judgment against Duralite but, apparently, believed it was required to do so by virtue of the doctrine of respondeat superior. We do not believe that that concept is applicable here. This court, in Rochez Bros., Inc. v. Rhoades, II, 527 F.2d 880 (3rd Cir. 1975), held that the corporation was not liable for the fraud of its principal shareholder since no showing had been made of participation, aiding and abetting, conspiracy or conduct falling within the ambit of Section 20. We believe that decision controls and, accordingly, the judgment against Duralite will be vacated.*fn4
In a 10b-5 case, the measure of damages is the difference between what the seller received for his stock and what he would have received had there been no fraudulent conduct. If the defendant, however, on resale received more than the latter amount, then the award is the amount of the defendant's profit over and above what he had paid to the plaintiff. In that situation, the profit is considered a proximate consequence but must be limited to the amount not due to the defendant's own special efforts after the fraud occurred. Affiliated Ute Citizens v. United States, supra; Rochez Bros., Inc. v. Rhoades, supra at 411-17; Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. denied, 382 U.S. 879, 15 L. Ed. 2d 120, 86 S. Ct. 163 (1965). See 3 A. BROMBERG, supra, § 9.1.
1. Lesser and Zakin would assign 16,000 shares of Giffen stock to Duralite; Duralite in turn would transfer the Randolph premises to Lesser and Zakin, or their nominee;*fn5 Duralite would enter into a long term lease for the Randolph property.
3. Giffen was to deliver 54,000 shares of its stock by November, 1970 and if it was unable to do so, would instead give Lesser and Zakin cash and notes totalling $600,000.00. At the time set for delivery, Giffen did in fact deliver the cash and notes.*fn6
"Whereas, the Corporation is desirous of obtaining the services of the employee in a broader capacity than heretofore . . . as full compensation for his services the corporation shall pay . . . ."
The court found that on February 28, 1969 Duralite and Randolph combined had a value of $530,000.00 and that it was impracticable to make a separate allocation for Randolph. As of a little more than a year later, the total value was determined to be $1,677,150.00, of which $1,077,150.00 was attributed to the Randolph property*fn7 alone and the remaining $600,000.00 to the Duralite stock. Considering that Randolph's sole asset, both in 1969 and 1970, was the same real estate and that apparently no substantial improvements had been made in the interim, the disparity in valuations is striking. It is difficult to conclude other than Lesser and Zakin's personal worth to Giffen was a very substantial factor in the re-negotiation bargaining. We rejected defendant's claim to an allowance for his special efforts in Rochez Bros., Inc. v. Rhoades, supra at 412-13, because they did not take place after the purchase of plaintiff's stock. That circumstance is not present here.
We recognize that the theory of damages which allows windfall profits does not depend solely on the premise that, but for the fraud, the injured party would have realized these gains. Additionally, there is the philosophy that if the defendant made profits through the use of assets which he had fraudulently acquired, he should not be permitted to keep them. See Zeller v. Bogue Electric Manufacturing Corp., 476 F.2d 795 (2d Cir.), cert. denied, 414 U.S. 908, 38 L. Ed. 2d 146, 94 S. Ct. 217 (1973); Janigan v. Taylor, supra. However, this approach has not been utilized to assess damages for an indefinite time in the future. As the Janigan case indicates, there are limitations to the doctrine,*fn8 and we remand to the district court to determine if they are applicable here.
Assessment of prejudgment interest in addition to a windfall damage award is not logically inconsistent, but a district court should be cautious in exercising its discretion in such circumstances. Interest is not to be recovered merely as compensation for money withheld but, rather, in response to considerations of fairness. It should not be imposed when its exaction would be inequitable, Blau v. Lehman, 368 U.S. 403, 414, 7 L. Ed. 2d 403, 82 S. Ct. 451 (1962).
As co-plaintiffs, Edco and Temco requested a declaratory judgment that the portion of the June 18, 1968 agreement requiring them to purchase inventory from Duralite was void under § 29(b) of the 1934 Act, 15 U.S.C. § 78cc(b). In response, Duralite filed two counterclaims against Edco and Temco arising from the same transaction. The first claimed reimbursement for goods Duralite had already delivered to them,*fn9 the second sought payment for raw materials purchased for conversion into finished products and some other items which had not yet been delivered to Edco and Temco. The parties stipulated the amount of the second claim to be $20,000.00, and the court was asked to decide whether Edco and Temco were entitled to invoke § 29(b).
" In recognition of the intimate relationship between Thomas and the Edco and Temco corporations existing at the execution of the June 18, 1968 agreement, Edco and Temco, as unwilling innocent parties to the defendants' fraudulent conduct in violation of Rule 10b-5 are entitled to rescind any and all of their obligations incurred under the aforementioned agreement."
Several difficulties present themselves. First, the contract which Edco and Temco seek to avoid is for the purchase, not of securities, but for an inventory of supplies - a routine commercial agreement. Second, neither Temco, Edco nor Duralite are purchasers or sellers of securities. Finally, Duralite is not vicariously liable under 10b-5 for the fraudulent misrepresentations.
Several months after this case was decided by the district court, the Supreme Court handed down an opinion in Blue Chip Stamps v. Manor Drug Stores, Inc., 421 U.S. 723, 95 S. Ct. 1917, 44 L. Ed. 2d 539 (1975), limiting the class of plaintiffs who can maintain private actions for damages under Rule 10b-5. In that case, the plaintiff allegedly had decided not to purchase stock on the strength of defendants' misleading prospectus. In approving the Birnbaum*fn10 rule, the Court stated that plaintiffs who are neither purchasers nor sellers of securities have no standing to claim damages for violations of 10b-5. Soon thereafter, this court followed the Blue Chip decision in Thomas v. Roblin Industries, Inc., 520 F.2d 1393 (3d Cir. 1975). We held that the trustee in bankruptcy of a corporation had no standing to sue under 10b-5 when the alleged violation involved the sale of stock in the company by a large shareholder to third persons.
The fact that Edco and Temco sought a declaratory judgment, rather than damages, is not sufficient in the circumstances of this case to grant standing. The violations had been completed some time before the suit was filed and so the preventative aspects of an action to enjoin continuing violations which we found sufficient to relax the Birnbaum rule in Kahan v. Rosenstiel, 424 F.2d 161, 173 (3d Cir.), cert. denied, 398 U.S. 950, 90 S. Ct. 1870, 26 L. Ed. 2d 290 (1970), are not present here. See 1 A. Bromberg, supra, § 4.7 at 564.
Being neither purchasers nor sellers of securities, Edco and Temco have no standing under Rule 10b-5 and, accordingly, the judgment of the district court will be vacated insofar as it held that Duralite's claim against Edco was not enforceable. The dismissal of Duralite's second counterclaim will also be vacated so that the district court may determine whether it should consider a defense based upon state law.*fn11