The opinion of the court was delivered by: CONNER
Defendants Butler Aviation International, Inc. ("Butler"), and G. Norman Widmark ("Widmark"), and Reginald F. Woods ("Woods"), officers and directors of Butler, have moved for an order pursuant to Rules 12 and 56, F.R. Civ. P., dismissing the complaint against them on the grounds that it states no claim on which relief can be granted; that plaintiff lacks standing to maintain an action to recover damages against these defendants for alleged violations of Section 17(a) of the Securities Act of 1933, Section 10b of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder; and that since there is accordingly neither diversity jurisdiction nor a federal question, the complaint must be dismissed.
Initially, this action was commenced in 1971 in an effort by plaintiff Dopp, a former President and Chairman of Butler, who was engaged in a proxy fight for control of the Company, to block the sale of a number of shares of Butler's common stock which Dopp had pledged to Franklin National Bank ("Franklin") as collateral for a loan on which he had defaulted. At Widmark's suggestion, Franklin gave an option to the brothers John and Michael Galesi to purchase the shares at a private foreclosure sale, as part of an admitted effort by Widmark and the other defendants to reduce plaintiff's voting power and prevent his regaining control in view of Butler's financial misfortunes during his tenure, which they attributed to his mismanagement and possibly even misapplication of funds. Dopp sought, initially, a preliminary injunction prohibiting consummation of the option agreement and, ultimately, rescission of the agreement. The District Court granted the preliminary injunction, 346 F. Supp. 424 (S.D.N.Y. 1971), and defendants appealed. The Court of Appeals for the Second Circuit reversed, 461 F.2d 873 (2d Cir. 1972), finding the following "virtually undisputed" facts:
In July, 1969, while President and Chairman of Butler, Dopp pledged 51,500 shares of Butler common stock to Franklin for a loan of $380,000
secured by a demand note. The promissory note, which incorporated the pledge agreement, provided that "whether or not default exists, the [securities] may be registered and held in the name of the Bank or its nominee, without disclosing that the Bank is a pledgee thereof, and the Bank or said nominee may exercise all voting . . . rights as if the absolute owner thereof . . ."; and that upon default the bank could "sell, assign, give option or options to purchase, and deliver any and all securities pledged as collateral." It was further provided that "no waiver [of the Bank's rights] would be valid unless in writing, signed by the Bank, and then only to the extent therein set forth."
In July, 1970, Dopp still owed $351,000 in unpaid principal, and Franklin was pressing him for repayment. In expectation of an advance from a Swiss company, Dopp assured Franklin he would repay the loan by August 15th. He failed to so do, and on December 16, 1970, Franklin entered a default judgment against him in the amount of $369,447.61.
On January 20, 1971, after negotiation, Dopp and Franklin entered into a new agreement providing that Dopp would have until February 26, 1971 to pay the reduced sum of $325,045.25 plus 7 1/2% interest from the date of judgment, failing which the judgment would be enforceable immediately. As additional collateral, Dopp executed second mortgages on two Pepsi Cola bottling plants he owned in Michigan. However, he defaulted again and by May 17, 1971 had paid only $20,000 on the new obligation.
In late May, 1971, Widmark, the new Chairman of Butler, informed Franklin that Dopp's shares were no longer control shares, and Franklin began negotiating through Widmark for the sale of the shares to the Galesis. On June 15, 1971, Franklin gave Dopp formal written notice that it intended to sell the shares at a private sale on or after June 25. On June 28, Dopp again sought time from Franklin to meet his obligation and entered into an oral agreement with the bank that the shares would not be sold if Dopp made a $20,000 payment by July 2, delivered an additional 10,000 shares as collateral, and arranged for the sale of all the pledged shares by July 21.
On July 26 the $20,000 payment was made, although the additional shares were not delivered and no arrangement for the sale of the 51,500 shares was made by Dopp.
Dopp alleges that, in a telephone conversation on August 21, Franklin told him that he would have the right of first refusal either to arrange for a third party of his choosing to purchase the shares, or to redeem the shares himself, without any specified time limitation. On September 21, Franklin and the Galesis entered into an option agreement for the sale of the stock. Franklin informed Dopp of the option one week later, although it did not tell him that the prospective purchasers were the Galesis, having been requested by them not to divulge their identity.
After the Court of Appeals reversed the order of the District Court granting the preliminary injunction, the option agreement was consummated, with the Galesis buying the stock at a price above that at which it was then selling on the American Stock Exchange. Franklin credited Dopp's account with the full amount of the $281,000 purchase price, thus reducing the amount owed on the still unsatisfied default judgment. In October, 1972, after Dopp's petition for reargument and petition for certiorari had been denied, Dopp and Franklin entered into a stipulation of settlement and discontinuance, exchanging mutual general releases, a discharge of the two collateral mortgages and satisfactions of the $369,447 judgment and of an additional judgment for $4,436 in costs. The release given by Dopp specifically reserved any cause of action he had against the other defendants.
The only claim asserted by Dopp against the moving defendants Butler, Widmark and Woods, is that, for the purpose of shifting the balance of voting strength in the proxy fight for control of Butler,
defendants conspired with Franklin to breach Franklin's alleged oral agreement giving Dopp the right of first refusal, and to conceal from Dopp the fact that it was the Galesis who had acquired the option to purchase the pledged stock. Dopp seeks only money damages against these defendants for their part in the alleged conspiracy.
I. STANDING under Section 10b and Rule 10b-5
Defendants argue that plaintiff was neither a "buyer" nor "seller" of the securities in question and that he therefore lacks standing to sue under Rule 10b-5.
Plaintiff contends that as owner and pledgor of the securities which were sold, he has standing to maintain this action as a "seller". Defendant relies primarily on Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 72 S. Ct. 1051, 96 L. Ed. 1356 (1952), and its progeny, see Iroquois Industries, Inc. v. Syracuse China Corp., 417 F.2d 963 (2d Cir. 1969), cert. denied, 399 U.S. 909, 26 L. Ed. 2d 561, 90 S. Ct. 2199 (1970), which limited standing to sue under Rule 10b-5 to purchasers and sellers of securities who were parties to the transactions at issue. However, in subsequent decisions, the "Birnbaum rule" has been relaxed by giving the terms "purchaser" and "seller" broadened interpretations, thereby extending the protection of Rule 10b-5 to an increasing variety of interested parties.
There have been several cases in which a pledgor of shares later sold on foreclosure has been ruled a "seller" with standings to sue under the securities acts. In Alloys Unlimited, Inc. v. Gilbert, 319 F. Supp. 617 (S.D.N.Y. 1970), an action was initiated under the 1934 Act, § 10b, 15 U.S.C. § 78p(b), to entitle the corporation to recover short-swing profits made by a corporate officer who had pledged registered securities as collateral for a loan under a pledge agreement authorizing the bank to sell the collateral "whenever in its discretion [it] considers such sale necessary for its protection." Within six months after the officer had purchased additional, unregistered shares of stock in the corporation, the bank sold some of the pledged shares to reduce the concentration of the officer's stock held as collateral. The Court held that the officer's purchase of the unregistered shares, followed within six months by the bank's sale of the pledged shares, with the proceeds being credited against the officer's indebtedness, was a "sale" by him in violation of § 16b, so that the corporation was entitled to recover the profits realized by him thereon. Thus, for the purposes of § 16b, a sale of pledged stock by the pledgee bank was held to constitute a "sale" by the pledgor, the beneficial owner of the shares.
In Cambridge Capital Corp. v. Northwestern National Bank of Minneapolis, 350 F. Supp. 829 (D.C. Minn. 1972), Cambridge Capital Corp. ("Cambridge") sold shares of stock in the Savage State Bank to Charter Management, Inc. ("Charter"). On the same day, Charter obtained a loan from Northwestern National Bank ("Northwestern"), pledging the shares as security. In part payment for the shares, Charter gave Cambridge a promissory note, secured by a subordinated security interest in the same shares. Charter defaulted on both loans, and the stock was sold at a foreclosure sale, for a price sufficient to satisfy the indebtedness to Northwestern, but leaving only a small amount to apply against the indebtedness to Cambridge. Cambridge brought an action under Section 10(b) and Rule 10(b)5, charging that significant information had been withheld from the purchasers, thereby reducing the amount ...