Opinion ID: 353796
Heading Depth: 1
Heading Rank: 1

Heading: the foundations:

Text: INCORPORATION AND GOING PUBLIC 5 Homex was incorporated as a close corporation in Delaware in 1968; its principal offices and factory were located in Avon, New York, a suburb outside Rochester. The Stirling brothers were its founders, officers and principal owners. Shortly after incorporation, Homex made a private offering, selling 1.6 million shares at $1 each. It thus began as a relatively small concern, doing business primarily with private residential projects developed by the Stirlings. It soon became clear, however, that it would be in the best business interests of Homex to exploit the then-budding public housing market. Accordingly, Homex focused its efforts on sales to public housing authorities in federally-financed housing programs. 6 In late 1968, the Stirlings decided to explore the possibility of going public and approached R. W. Pressprich & Co. as a prospective underwriter. Pressprich agreed to underwrite the public sale of Homex common stock on the condition that Homex's annual net earnings totaled $1 million, as projected by the Stirlings. In January of 1969, when the agreement with Pressprich was reached, Homex was reporting profits at the end of the second quarter of approximately.$390,000 from the sale of modules and gross land sales totaling $4.7 million. 7 By April 30, 1969, however, the end of the third quarter, it became obvious that year-end profits would fall far short of the $1 million required for the underwriting, third quarter gross sales totaling only $900,000. At this point Homex arranged two sales of land holdings in order to boost total sales and profits to the amount required for the Pressprich underwriting. 8 The Kece Land Sale. 9 Peter Thun was the general partner of a limited partnership called Hollyrood Park Associates, located in Clay, New York; the Stirlings were limited partners. In May, 1969, David Stirling offered Thun two parcels of land owned by a Homex landholding subsidiary, Hollyrood Park II, Inc. Thun had a right of first refusal on both parcels. He indicated that he was interested in only one of the parcels the one adjacent to his Hollyrood Park project but only if it were part of an economically reasonable package consisting of both the purchase of the land for $325,000 and the development by Homex of a plan to build a 330-unit modular apartment building. In other words, he was interested in the land only if apartment units could profitably be built on it. Because Stirling was unable to quote a price for the development of such an apartment complex, Thun arranged to have the land purchased by Kece Associates, Ltd., a newly-formed shell corporation, in such a way as to maintain control over the land and at the same time incur minimal risk. Kece Associates made a 10 percent down payment, assumed existing mortgages on the property and gave a purchase-money mortgage that required interest payments and an annual principal reduction of $10,000 for the first five years. 10 In practical effect, as the government suggests, this $325,000 sale was a purchase by Thun of an option on the land. Indeed, Thun himself so characterized the practical effect of the arrangement. He stated that if it had been otherwise he would not have considered entering into it at all. Under the agreement, if Thun were to decide that the construction of a 330-unit apartment project would not or could not be financially advantageous, he could merely order the termination of mortgage payments and, while relinquishing all rights to the land, shed all mortgage responsibilities. The mortgage itself included exculpatory language of the sort commonly found in non-recourse loan agreements. It provided that, upon default by Kece, the Homex subsidiary could foreclose only on the property and could not pursue Kece's or Thun's assets to satisfy the mortgage. Thun viewed the arrangement as one in which he paid money to control the land and, if the arrangement proved ill-fated, one in which his liability was limited. 11 The transaction was closed on June 3, 1969. Subsequently, appellant Yanowitch wrote a letter on behalf of Kabeth Properties, Inc., another wholly-owned subsidiary of Homex, to Riverbend Estates, Inc., formed by Thun to hold title to the land, confirming the understanding between Kabeth and Riverbend that the Homex units would be designed and manufactured at published prices and that the cost of installing them would be one that the parties agreed upon in the future as reasonable. Thun, meanwhile, told the other Hollyrood Park partners that he had purchased the land at his own personal risk and that, if the apartment complex materialized, he would sell the developed land to the partnership at cost. 12 The Reseac Land Sale. 13 Also in June, 1969, appellant Yanowitch spoke to Cesare Falcone, Donald Barbato and Dr. Morris Shapiro about purchasing the parcel of Hollyrood Park II land that Peter Thun did not want. Homex sought $435,000 for the parcel and was willing to accept an $80,000 down payment and a purchase-money mortgage. Yanowitch made assurances that the land could be zoned so as to allow for the construction of a financially productive shopping center. Added to these generally favorable investment conditions was the fact that Gulf Oil Corporation owned an option on 3/5 of an acre of the parcel, the exercise price of which was $100,000. Still, the prospective purchasers expressed reluctance. Yanowitch, and eventually David Stirling, then assured them that, if anything went awry, Homex would either repurchase the land or find another purchaser. In effect, the purchasers were assured that they would not lose money on their investment. This assurance was repeated prior to closing when complications developed regarding a zoning ordinance that prohibited the type of shopping center facilities the purchasers were interested in constructing. Yanowitch assured them that a variance would be obtained. Yanowitch also told them that they would be getting some stock in Stirling when it went public. Homex declined to enter into a written indemnification agreement, but it is clear that Falcone, Barbato and Shapiro believed that, if they agreed to enter into the purchase agreement, Homex would protect them from losses. 14 The deal was closed on August 18, 1969, after the end of the fiscal year; the deeds were back dated to June 30, 1969. Falcone, Barbato and Shapiro had created Reseac Realty, Inc. (Reseac), to purchase the land, which it did by transferring $80,000 as down payment, assuming $30,000 and $13,000 mortgages on the property and granting a $302,000 purchase-money mortgage. No principal payments were required for the first three years. 15 HKF Audits the 1968-1969 Fiscal Year. 16 On August 27, 1969, the accounting firm of Harris, Kerr, Foster & Company (HKF) certified the Homex financial records for the 1968-1969 fiscal year. HKF certified for inclusion as income the $325,000 receivable from the Kece transaction and the $425,000 receivable from the Reseac transaction. The inclusion of these two sales boosted Homex's net income after taxes slightly above the $1 million required for the Pressprich underwriting. 17 During the audit, Yanowitch told HKF that he had personal knowledge of Reseac's ability to honor its mortgage commitment and that, in the event of a default by either Kece or Reseac, the land could easily be sold to satisfy the mortgages. Yanowitch told HKF that the agreed-upon design and manufacture of modules for the Kece property would be at published prices; he failed to tell HKF that the parties had not agreed upon the cost of installing the modules other than to say it would be reasonable. In other words, he did not tell HKF that the completion of the sale depended upon certain conditions being met by Homex in the future. Yanowitch also neglected to tell HKF of the assurances made to Reseac regarding the zoning restriction and of the commitment by Homex to repurchase the land or arrange for a purchaser if anything went wrong. Finally, although he told HKF that Homex and Reseac had no stockholders in common, he did not tell HKF that promises had been made to Falcone, Barbato and Shapiro that arrangements would be made for them to purchase Homex stock at the anticipated public offering for the issue price. 18 The 1970 Registration Statement. 19 On October 1, 1969, Homex filed a registration statement with the SEC in connection with the issuance of Homex common stock. It made scant mention of the Kece and Reseac land transactions: 20 Two sales of undeveloped land acquired at the time of organization of the Company accounted for approximately 18% Of the Company's net income during its first fiscal year. The larger parcel was purchased by a developer who subsequently entered into an agreement with the company to purchase modular housing for installation on such land. 21 The registration statement became effective on February 19, 1970, for a total sale of 1,175,000 shares of Homex common stock at $16.50 per share, netting Homex approximately $20 million. 22