Opinion ID: 500420
Heading Depth: 2
Heading Rank: 1

Heading: Fraud As To The Feasibility Of Mount Royal Towers

Text: 56 The heart of plaintiffs' claim is that the defendants marketed the Mount Royal bonds even though they knew or recklessly disregarded the fact that the project could not generate sufficient income to repay the debt. Specifically, it is alleged defendants were aware that the long delays in construction burned the sales territory so that consumer interest in the Mount Royal units was irreparably damaged. Second, the defendants' failed to heed the warnings of the original underwriter and feasibility consultant that the project could not generate sufficient income to repay the bonds at the going interest rates. Instead, defendants hired new experts who allegedly agreed to modify the project (by increasing the price of apartments and by increasing the bond interest rates) to make it appear feasible, although they knew that the changes would render the apartments too expensive to be sold in the relevant market. Third, the other defendants allegedly were on notice of Rice's sham presale agreements which made the project appear feasible. Finally, defendants were able to market the bonds only because they failed to disclose facts which seriously undermined the conclusion warranted in the offering circular that the project was feasible. The district court reviewed the evidence presented by the parties and concluded that there was no evidence from which a jury could reasonably infer a scheme to bring securities on to the market which were not entitled to be marketed. 57 Before discussing the avalanche of evidence adduced by the parties, we must clarify the scope of our inquiry. First, our review of the district court order granting summary judgment is plenary. See Carlin Communications v. Southern Bell, 802 F.2d 1352, 1356 (11th Cir.1986). 58 Second, our review is affected by the fact that substantial discovery has taken place and that the nonmoving party (plaintiffs) would bear the burden of proving the relevant issues at trial. In such a case, summary judgment should be granted if plaintiffs fail to make a showing sufficient to establish the existence of an element essential to [their] case. See Celotex, 106 S.Ct. at 2552-53. This showing need not be in the form of admissible evidence--it can be made by reference to affidavits, depositions, answers to interrogatories, and the like. Id. at 2553-54. Summary judgment is not, however, designed to be a trial on affidavits. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 106 S.Ct. 2505, 2513, 91 L.Ed.2d 202 (1986). The evidence of the nonmovant is to be believed, and all justifiable inferences are to be drawn in his favor. Id. Essentially, the standard for granting summary judgment mirrors the standard for granting directed verdict--it will be granted if, under the governing law, there can be but one reasonable conclusion as to the verdict. Id., 106 S.Ct. at 2511. 59 Third, our inquiry is affected by the nature of the questions at issue. Plaintiffs must prove that (1) each defendant to be held liable acted with scienter; (2) in participating in a scheme to defraud the investing public; and (3) that but for the fraud the bonds could not have been marketed. Courts have long held that summary judgment generally is inappropriate to decide questions of scienter, knowledge, and intent. See, e.g., Poller v. Columbia Broadcasting System, 368 U.S. 464, 473, 82 S.Ct. 486, 491, 7 L.Ed.2d 458 (1962) (summary procedures should be used sparingly in complex antitrust litigation where motive and intent play leading roles, the proof is largely in the hands of the alleged conspirators, and hostile witnesses thicken the plot); Levinson v. Basic, Inc., 786 F.2d 741, 749 (6th Cir.1986), cert. granted, --- U.S. ----, 107 S.Ct. 1284, 94 L.Ed.2d 142 (1987); Amey, Inc. v. Gulf Abstract & Title, Inc., 758 F.2d 1486, 1502 (11th Cir.1985), cert. denied, 475 U.S. 1107, 106 S.Ct. 1513, 89 L.Ed.2d 912 (1986). Moreover, factual questions regarding the marketability of bonds absent the fraud generally are not susceptible to determination as a matter of law. See Shores, 647 F.2d at 486 (Randall, J., dissenting) ([t]he question whether ... the security, absent the fraud, could have been marketed at some price, and the question whether the scale of the fraud was broad enough are both presumably questions of fact, not readily disposed of by summary judgment).
60 With these standards in mind, we turn now to the evidence presented to the district court. There is no doubt that the fraud alleged in this case is of a different character than the fraud alleged in Shores and is not as pervasive. In Shores, the entire transaction was a sham, and an apparently safe investment was merely a hollow shell. In this case, on the other hand, the defendants disclosed that the project entailed substantial risk. Nevertheless, the essence of a Shores action is that but for the fraud the bond issue would not have been marketed. Thus, when a fraud passes an unmarketable security off as a risky project, it is actionable to the same extent as a fraud which attempts to pass a worthless project off as a safe investment. In either case, the defendants have defrauded the market by knowingly or recklessly issuing bonds which are destined to end in default. Thus, while Shores stresses the requirement of fraud on a broader scale, we note that the breadth of the fraud is measured by its effect on the marketability of the bond, and not by the extent of deception. 61 Plaintiffs offered the following circumstantial evidence of a fraudulent scheme. The 1978-79 presale marketing of Mount Royal units initially was quite successful, and Rice was able to obtain a substantial number of commitments secured by deposits. Rice was unable, however, to obtain financing for the project. In a December 23, 1980 meeting, the Mount Royal Board of Trustees adopted a resolution abandoning the project and noting that one-half of the presale agreements had been cancelled due to long delays in construction. The resolution indicated that the delays had a negative impact upon the success of the project. Despite this finding, Rice began organizing financing for another try at developing Mount Royal. According to plaintiffs, the relentless pursuit of the project was motivated primarily by Rice's desire to recoup his investment in the project. The new deal was structured so that Rice could obtain payment upon the closing of the bond issue, thus diminishing his incentive to market the units aggressively after construction was completed. 62 Plaintiffs also offered some evidence that defendants ignored the advice of Henderson, Few and Peat, Marwick when they restructured the bond project in early 1981. Thomas Kelly, executive vice-president of Henderson, wrote a letter to Rice in December, 1980 indicating that the Mount Royal bond issue could not be marketed given investor reluctance to purchase risky bonds. In the letter, Kelly suggested cutting construction costs to maintain the feasibility of the project: 63 Undoubtedly the project will be faced with costs increases as a result of the delay. I do not think we can add significant additional costs to the bond issue budget and still have a feasible financing package. Therefore, you should discuss with the architect and contractor the possibility of reducing the scope of the project by an amount at least equal to the construction increases they anticipate. Hopefully they will be able to reduce the project's scope without effecting [sic] the revenue-producing ability of the facility. 64 Exhibit 109. In his deposition, Kelly testified that during 1980 the parties anticipated issuing approximately $20,000,000 of bonds at 11 1/2% interest. When market interest rates went up, they were unable to raise the interest rates of the bonds because there would not have been sufficient cash flow from the project to cover the increased debt. One way of increasing cash flow would have been simply to raise the price of the apartments. Kelly testified that, as far as he knew, such increases would have rendered the project infeasible: 65 My recollection is that it was the opinion of the financial feasibility consultant that the rates and charges that were originally proposed were appropriate to the market conditions in Birmingham, Alabama, and that any significant increases in those rates and charges could have had an effect on the marketability or the acceptability of the project in the marketplace. That is my recollection of the opinion of the financial feasibility consultant. 66 Kelly Deposition at 151. While this evidence is not conclusive, a reasonable jury could infer that Rice had been warned not to raise the prices of Mount Royal apartments and that he knew raising the prices would jeopardize the project's feasibility. 67 Soon after Henderson, Few withdrew its support and after the board of trustees officially abandoned the project, Rice engaged defendants Herreth, Orr & Jones, Laventhol & Horwath, and Jones, Bird & Howell to assist in restructuring the project so that financing could be obtained. The new project differed from the abandoned project in several significant ways. The bond issue was increased from $19,950,000 to $29,950,000. To cover the increased debt, the price of apartments was raised dramatically. The increased prices were justified by including in the purchase agreements a provision giving purchasers a right to a refund if they were dissatisfied. This right to a refund was subject, however, to the prior rights of bondholders in the event of a default. The district court found, as a matter of law, that the new project was so dissimilar from the original project that the warnings issued in regard to the feasibility of the original project had little or no bearing on the feasibility of the new project. We disagree. A reasonable jury could find from the evidence that the prices of units were raised to an unmarketable level, that the addition of a limited refund did not render the units marketable at a higher price, that the defendants knew that the new project could not be successfully marketed in the Birmingham area at the higher price, and that the deal was restructured with the intent to make the bonds appear to be genuine while they were in fact doomed to end in an early default. Since these failures followed this exact pattern, it is a jury question as to whether this default was as predictable as the night following the day or whether there were other causes for these failures. 68 Plaintiffs offered evidence that Rice obtained purchase agreements without deposits from friends and relatives in order to give investors the false impression that 50% of the Mount Royal units were presold. Defendant Laventhol & Horwath's feasibility opinion was premised on the fact that these presale agreements were not sham agreements. Plaintiffs offered additional evidence that without some form of commitment as to 50% of the units, the bonds would not have been marketable. The district court determined that the developer's failure to obtain valid presale agreements did not jeopardize the marketability of the bonds, because the disclosure statement fairly disclosed that many of the presale agreements were not secured by deposits. As we have noted, the marketability of bonds normally will be a fact question for the trier of fact, and this case is no exception. A reasonable jury could find that as to this type of project, the bonds were not marketable unless the developer obtained (without using sham sales) some commitment from potential purchasers as to 50% of the units. 69 Finally, plaintiffs have offered evidence that it was fraudulent to market these bonds as tax exempt bonds. There is some dispute as to whether Mount Royal was formed for charitable purposes and whether its activities are essentially public in nature. See Rev.Rul. 63-20, 1963-1 C.B. 24. Although the taxability of these bonds is not directly relevant to this case, 15 defendants' alleged knowledge that the bonds were not properly tax-exempt is relevant to the existence of a fraudulent scheme to issue unmarketable securities and to the issues of scienter and unmarketability. 70 In response to plaintiffs' evidence, defendants offered evidence which they contend negates any inference of pervasive fraud raised by plaintiffs' evidence. First, defendants rely heavily on the fact that each bondholder has received his investment plus some positive return. Indeed, the bondholders paid $29,950,000 in to the project and received total payments of approximately $34,000,000 by 1985. Defendants urge that because plaintiffs obtained a positive return on their investment after default, they cannot contend that but for the fraud the bonds would not have been marketed. The defendants argue that because the bonds resulted in some positive return, they had some value and could have been marketed even without the alleged fraud. Alternatively, defendants argue that any project which produces enough revenue after default to pay off the face value of the bonds could not have been the subject of a pervasive scheme to defraud the market. We reject these attempts to establish bright-line rules of marketability. Certainly, the jury may consider the fact that the bond proceeds of $29,500,000 were used to construct an $18,000,000 project and that the investors have recouped some of their investment (although without significant interest). These facts should not, however, bind the jury to a verdict for defendants. It is conceivable that a bond issue to build valuable property can be the result of a scheme to defraud investors. Plaintiffs allege that defendants knew or recklessly disregarded the fact that this bond issue would end in default. A jury could reasonably find that such a bond issue is unmarketable even though the investors would receive their initial investment plus some minimal interest after the inevitable default. The inevitability of the default, and not the consequences of the default, could lead the jury to conclude that the Mount Royal bond issue would have been unmarketable but for the defendants fraud. 71 Whether or not the bonds would have been marketable absent the fraud is a complex factual inquiry. It involves an analysis of purchasers and potential sellers of bonds in the relevant market at the time these bonds were issued. Defendants do not prevail merely because they can show that the public would have purchased these bonds at some price absent the fraud. This focus solely on bond purchasers is not helpful. The lower price or higher rate which buyers would accept is only relevant if the bonds would be offered at that price or rate by nonfraudulent sellers of securities. The issue is whether bond sellers (i.e., underwriters, developers, etc.) would have been able to price these bonds without fraud at a price and rate which would attract informed buyers. Under Shores, plaintiff has the burden of proving that the bonds would have been unmarketable absent the fraud. Although this is a difficult fact to prove, plaintiffs' case is not fatally injured by the fact that they have received some return on their investment. They should be permitted to prove (perhaps through expert testimony) that the Mount Royal bond issue could not have been marketed in September, 1981 without the benefit of a fraudulent scheme to deceive investors. 72 Second, defendants contend that this case does not involve a pervasive scheme to defraud because the offering circular fully disclosed the significant risk that the bond issue would end in default. Indeed, the offering circular is replete with warnings that the bonds were not backed by the assets of Vestavia Hills, and that the bonds would be paid (if at all) from the sale of the units after the closing of the bond issue. There is, however, a genuine disputed issue of fact as to whether the offering circular disclosed the full extent of the risks involved in the Mount Royal project. The circular does not explain the negative impact which the construction delay allegedly had upon purchaser interest in the units. It does not, according to plaintiffs, fully explain the failure to bring the original $20,000,000 bond issue to market and does not disclose the fact that the project was resurrected only after doubling the price of apartments. Furthermore, the circular stated that the pre-marketing program has convinced the Company that its unique fee structure can be successfully marketed. Although the circular gives no assurance of successful marketing, plaintiffs claim it is misleading because defendants knew or recklessly disregarded the fact that the pre-marketing program was a failure and that the sales figures were artificially inflated by Rice's sham sales to friends and relatives. In short, plaintiffs claim the offering circular explained the existence of extensive risks but did not (and could not) disclose the full extent of the risk of default because such disclosure would have rendered the bonds unmarketable. 73 Disclosure of some risks is not a bar to a claim of fraud for failing to disclose the full extent of the risk. To warn that the untoward may occur when the event is contingent is prudent; to caution that it is only possible for the unfavorable events to happen when they have already occurred is deceit. Huddleston, 640 F.2d at 543-44. Plaintiffs have adduced enough evidence from which a reasonable jury could find that the Mount Royal project was destined to default, that some of the defendants knew this, and that these defendants fraudulently placed these bonds on the market. If the jury finds these facts, the disclosure of risks in the offering circular is immaterial. Plaintiffs could prove that the risks actually known to defendants but not disclosed in the offering circular would have made the project unmarketable on the bond market. This is a question of fact, and should be decided by the jury and not by the court. Of course, the jury can and should consider the extent of disclosure in determining the existence and extent of the fraud. The jury might find that the disclosure proves the defendants did not intend to defraud the investing public. Alternatively, the jury might find that there was some undisclosed risk of default but that this risk was not so high as to prevent the bonds from being marketed at a lower price or at a higher rate. Shores, 647 F.2d at 470. In either event, plaintiffs could not recover. Because a reasonable jury could find that the bonds may have been unmarketable absent the fraud, however, summary judgment as to the existence of a fraud on the market was inappropriate.