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WELLINGTON COMPUTER GRAPHICS, INC. v. MODELL

June 30, 1970

WELLINGTON COMPUTER GRAPHICS, INC., Plaintiff,
v.
Milton MODELL, Stanley Modell, Eugene Modell, Milton Siegel and Philip Cohen, Defendants


MacMahon, District Judge.


The opinion of the court was delivered by: MACMAHON

MacMAHON, District Judge.

Defendants move for a stay of this action or, in the alternative, to transfer this action to the United States District Court for the District of New Jersey, pursuant to 28 U.S.C. ┬ž 1404(a).

 The action is based on defendants' alleged violations of Section 10(b) of the Securities Exchange Act of 1934, Rule 10b-5 of the Securities and Exchange Commission, and Section 12(2) of the Securities Act of 1933.

 Defendants, here, previously commenced an action against plaintiff in the New Jersey state courts charging fraud, breach of warranty, breach of contract, and conversion. Both actions arise out of the merger of plaintiff with Cosmo Book Distributing Co., Inc. (Cosmo).

 Defendants are shareholders of Cosmo and in the state action claim that plaintiff and its president, Cary Wellington, refused to pay defendants for Cosmo shares purchased from defendants, refused to supply defendants with agreed upon employment contracts, and refused to return Cosmo shares which plaintiff had agreed to return if not sold. There, plaintiff counterclaimed and charged, among other things, that defendants induced plaintiff to purchase the Cosmo shares by fraudulent misrepresentations concerning Cosmo's financial condition. Here, that claim is transformed to an allegation that defendants violated the federal securities laws by supplying plaintiff with misleading information concerning Cosmo's financial condition.

 Defendants contend that determination of plaintiff's counterclaim in the New Jersey action will fully dispose of plaintiff's claim for relief here.

 Defendants rely on two cases where a federal court stayed a shareholder's derivative action pending determination of a derivative action brought by other shareholders against the same defendant and involving the same factual issues. *fn1" Those cases involved claims for relief based on alleged violation of the same state-created right which different sets of plaintiffs were seeking to adjudicate by use of the exact same remedy; a shareholder's derivative action. *fn2"

 Here, however, although both the state and federal actions concern essentially the same transactions, the legal rights are different.

 The counterclaim for common law fraud is founded on state law, while the claim of violation of the federal securities law is created by federal statutes. These two claims, unlike derivative actions where diversity of citizenship is present, are not cognizable either in a state or federal court. Plaintiff's claim for violation of Section 10(b) and Rule 10(b)-5 is cognizable solely in a federal court. *fn3"

 Moreover, the elements necessary to establish common law fraud differ from those essential to prove a violation of the federal securities law. *fn4" Proof of a specific intent to defraud or scienter is an essential element of common law fraud, but scienter is not essential to establish a violation of Section 10(b) and Rule 10b-5 where it is sufficient merely to show "lack of diligence, constructive fraud, or unreasonable or negligent conduct." *fn5"

 Defendants, in support of their argument that the determination of the New Jersey action will dispose of all the issues raised here, rely on cases where the state action had reached the judgment stage and which, therefore, served as a basis for barring the federal action on familiar principles of res judicata or collateral estoppel. *fn6"

 Since the New Jersey court lacks subject matter jurisdiction over plaintiff's claim under Section 10(b) and Rule 10b-5, a final judgment there could not have res judicata effect here. *fn7" At most, final judgment there would collaterally estop relitigation here of issues common to both actions. *fn8"

 Collateral estoppel, however, only bars relitigation of common issues which are actually adjudicated in the first action. It does not bar relitigation of issues which could have been raised but were not. *fn9" Obviously, we cannot, at this stage of the New Jersey action, determine which of the common issues will actually be litigated there. The estoppel effect of the New Jersey action on this federal action is thus presently unknown and unknowable. The cases involving collateral estoppel are therefore inapplicable.

 Defendants also contend that a New Jersey statute protects the same rights as Section 10(b) of the federal securities law and that plaintiff, by counterclaiming under that statute, could fully adjudicate its federal claim in the state court. ...


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