The opinion of the court was delivered by: WEINFELD
WEINFELD, District Judge:
This is a motion by plaintiff, Applied Digital Data Systems Inc. ("ADDS") for a preliminary injunction to restrain Milgo Electronic Corporation ("Milgo") from consummating a sale of 312,000 shares of its authorized and unissued common stock to Racal Electronics Limited ("Racal") pending a trial upon the merits of plaintiff's claims that Milgo, Racal and the individual defendants (directors of Milgo) committed various violations of the Securities Exchange Act of 1934
in connection with ADDS' proposed exchange offer for Milgo stock, referred to hereafter. Essentially, the claims are that the alleged illegal conduct will deprive ADDS of its right to solicit the shares of Milgo through its exchange offer, and also will deprive Milgo's shareholders of the opportunity to consider that exchange offer. The hard core of ADDS' contention is that the sale, which would make Racal Milgo's single largest shareholder, has no proper corporate purpose but was designed solely to defeat ADDS' exchange offer.
On December 8, 1976, the day the sale was to have been consummated, a temporary restraining order was granted by Judge Motley, sitting as the emergency judge, following which the matter was assigned to this court. Since then extensive discovery has been conducted and all parties have had extensive documentary production.
ADDS, a Delaware corporation organized in 1969, is engaged principally in the production of "dumb" computer terminals, i.e., terminals which have within themselves little or no capacity to perform calculations or other operations associated with the function of a computer. These terminals are sold largely to manufacturers of computer systems for incorporation into those systems.
Milgo, a Florida corporation, was organized in 1955 and manufactures devices to convert computer signals into signals which can be transmitted telephonically, and vice versa. Milgo also manufactures computer terminals.
Racal is a United Kingdom corporation with its principal place of business in Bracknell, England, which manufactures certain electronic equipment. Milgo and Racal each own a fifty per cent interest in Racal-Milgo Limited, a United Kingdom corporation which is the exclusive distributor of certain Milgo products in foreign markets. Racal-Milgo is Milgo's largest single customer, accounting in 1975 for approximately twenty-three per cent of Milgo's total worldwide revenues.
Since early 1974, ADDS has viewed Milgo as a desirable takeover target. However, before November 1976 ADDS made no definitive proposal, principally because the time was not propitious or because ADDS did not have the necessary funds. On November 5, 1976 ADDS, in a letter addressed to Milgo's Board of Directors, proposed a merger designed as a tax free reorganization under federal income tax laws. Under the proposal each common share of Milgo would have been converted on a tax-free basis into one and one-half common shares of ADDS at a substantial premium to Milgo shareholders over the then market price of Milgo.
The letter requested that the proposal be submitted to Milgo's shareholders for their approval. Milgo's Board did not respond directly to ADDS communication. Instead, on November 9, 1976, following a meeting of the Milgo Board at which the proposal was considered and unanimously rejected, Milgo issued a press release ("first press release") which was carried over the Dow Jones "broad tape" and otherwise disseminated to the news media. The release announced that Milgo's directors had rejected the ADDS merger proposal "because it is not in the best interest of the shareholders and does not reflect the long-term prospects of the Company."
Undeterred by the rejection of its merger proposal, ADDS, on November 15, 1976, issued a public announcement that after the appropriate steps had been taken to comply with the federal securities laws and after securing authorization from ADDS' stockholders,
it would make an exchange offer directly to Milgo shareholders. ADDS announced it would offer to exchange one share of a new issue of ADDS convertible preferred stock, $1 par value, for any and all shares of Milgo common stock. Each share of this preferred stock would be (a) convertible after one year into 1 1/2 shares of ADDS common stock; (b) entitled to annual cumulative dividends of $1.00; (c) entitled to one and one-half votes; (d) entitled to a liquidation preference of $25; (e) redeemable after one year at the option of ADDS' Board of Directors at a price of $25.
The next day, November 16, Milgo issued another press release ("second press release") which was disseminated generally to the news media and which the Wall Street Journal reported on November 17, 1976 as follows:
Miami, Fla. Monroe A. Miller, Chairman of Milgo Electronic Corp., said the latest proposed offer by Applied Digital Data Systems Inc. to acquire Milgo isn't as good as the one that Milgo's directors rejected last week.
Management's opinion, Milgo said in a short statement, is that "the revised proposal appears to be even less favorable to our shareholders than the exchange offer that was turned down last week by the unanimous decision of the Milgo board."
On November 19 Milgo's Board of Directors met and discussed ADDS' exchange offer. According to the minutes of that meeting, the Board agreed that information as to the exchange offer was "insufficient to make a fully informed judgment" but that based upon available information the "current proposed offer is less favorable to shareholders than the offer of merger previously submitted by ADDS to the Company directly." Notwithstanding these events, ADDS undertook preparation of a registration statement, a Schedule 13D and proxy materials, all of which were required under the federal securities laws in connection with the proposed exchange offer, and filed them with the Securities and Exchange Commission ("SEC") on December 13, 1976.
However, subsequent to the first press release, Milgo and Racal engaged in certain actions, the results of which came to light on November 29, 1976, when Milgo made a public announcement that it had agreed to sell Racal 312,000 of its authorized but unissued shares. The events that led to this agreement, according to deposition testimony, were as follows. On November 11th, two days after the Milgo Board of Directors had rejected ADDS' merger proposal, Monroe A. Miller, Milgo's President and Chairman of the Board, made an overseas telephone call to Ernest T. Harrison, the managing director of Racal, to advise him of the merger proposal and its rejection. Harrison testified that he then inquired whether Milgo was short of cash. When Miller responded that Milgo had been unable to raise equity capital, Harrison volunteered that Racal was in a strong liquid position. Thereupon they renewed proposals for Racal to purchase Milgo stock, which had been considered in 1974 and 1975 but abandoned.
On November 17, Derek Berry, Racal's corporate secretary, wrote to the Bank of England requesting approval for the purchase by Racal of enough new shares of Milgo common stock so that Racal would hold twenty per cent of the outstanding shares, at a cost of approximately 7,000,000 pounds. Racal desired a twenty per cent equity share so that under English law Milgo would be considered Racal's associate company and Racal would be able to incorporate a portion of Milgo's profits in its financial statements, even though no portion of that profit was remitted to the United Kingdom. The letter expressed anxiety about the proposed takeover of Milgo and also noted that the "Board of Milgo Electronic Corporation are concerned that the interest created by these two offers could well generate counter offers from other competitors." Two days later, November 19, the Bank of England authorized the transaction and noted "[the] authority is valid for twelve months from the date of this letter."
At the meeting of Milgo's Board of Directors on November 19, immediately after ADDS' exchange offer was considered, reference to which has already been made, Miller advised the Board of Racal's offer and that representatives of both companies would confer about the matter the following week. The Board then authorized the transaction and an application to the New York Stock Exchange (the "Exchange") for the listing of 382,300 new shares of common stock. On November 22, 1976, Milgo's attorneys applied to the Exchange for a listing of the 382,300 shares of common stock. The attorneys expressly requested that the Exchange confirm that under its rules the sale would not require stockholder approval.
The letter to the Exchange stated, among other matters, that while there was no written agreement with respect to placing designees of Racal on the Board of Directors of Milgo, it was "anticipated . . . that Racal [would] request that Milgo use its best efforts to cause two designees of Racal to be placed on Milgo's Board of Directors and that Milgo [would] do so."
However, even though an issue of 382,300 shares, constituting 18.4% of Milgo's contemplated outstanding shares, on its face qualified under the Exchange Rules for listing without stockholder approval, the Exchange did require such approval in this case. Thereupon Milgo and Racal reduced the amount of the sale to 312,000 shares (15.5%) and the Exchange agreed to list the shares without stockholder approval. However, the Exchange was made aware that Racal desired ultimately to purchase a twenty per cent interest in Milgo and that if Racal could not purchase the necessary additional shares in the market at reasonable cost, the shareholders of Milgo would be asked at their next annual meeting to authorize issuance of the amount required for Racal to obtain the twenty per cent.
Racal and Milgo concluded their negotiations and on November 29th Milgo issued a press release announcing that Racal had agreed to purchase 312,000 shares of Milgo common stock at $21.50 a share for a total of $6,708,000, that the proceeds of the sale would be used by Milgo to reduce its bank borrowing, and that the sale would be consummated as soon as the additional shares had been approved for listing by the Exchange. A written agreement covering the terms of the sale was executed by Milgo and Racal as of November 30, 1976; the agreement provided for closing to take place not later than March 31, 1977.
On November 30 Racal's Board of Directors met to discuss the transaction. A report prepared by Berry for the meeting stated:
Milgo Electronic Corporation has been the subject of a takeover bid by Applied Digital Data Systems Inc. It is considered that should this bid be successful, it could be detrimental to the future prospects of our jointly owned company Racal-Milgo Limited.
The Directors of Milgo Electronic Corporation have stated that in their opinion, the acceptance of the bid is not in the best interest of their shareholders.
Following discussions with us on methods by which the bid could be defeated, it was decided that the most effective method would be for Racal Electronics Limited to acquire a proportion of the ...