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Kaye v. Funding Systems Corp.


June 20, 1977


Appeals from orders of the United States District Court for the Southern District of New York, Robert L. Carter, Judge, dismissing complaint on grounds of mootness. Affirmed in part; reversed in part and remanded.

Author: Knapp

Before: LUMBARD and TIMBERS, Circuit Judges, and KNAPP, District Judge.*fn*

KNAPP, District Judge:

Plaintiff Richard S. Kaye appeals from an order of the Southern District dismissing as moot his claim for injunctive relief under the securities laws. Because we conclude that the district court should not have dismissed while there remained a substantial issue of fact whether the case was moot, we are constrained to reverse in part and remand for further proceedings.


Plaintiff Kaye is the owner of 5000 shares of stock in defendant Funding Systems Corporation ("FSC"). In 1971 defendant Equimark Corporation acquired stock of FSC which, added to Equimark's existing holdings, allowed the latter to control FSC. Kaye brought suit against defendants on December 20, 1974, claiming that Equimark's control of FSC had been acquired in violation of federal law and exercised to the detriment of FSC and its minority shareholders.

Kaye sought no money damages against either defendant. His complaint*fn1 alleged that Equimark, a bank holding company registered under section 5 of the Bank Holding Company Act, 12 U.S.C. § 1844, had, in violation of section 4(a) of the Act, 12 U.S.C. § 1843(a) and Regulation Y promulgated thereunder, 12 C.F.R. § 225, acquired its fifty-four percent control of FSC without the prior approval of the Board of Governors of the Federal Reserve System.*fn2 An injunction was sought restraining Equimark from voting its FSC stock or "[exercising] any control over the affairs of FSC".

Against FSC, the complaint alleged that it had violated section 14 of the Securities Exchange Act of 1934, 15 U.S.C. § 78n, by failing, in a proxy statement distributed to its shareholders prior to the annual meeting of shareholders held on December 27, 1974, to make disclosure of pertinent facts concerning Equimark's allegedly illegal control of FSC. According to the complaint, the necessary disclosure has still not been made. Prior to amendment, the complaint sought an injunction against the holding of the December 1974 meeting; the district court granted the injunction, but this court reversed on appeal, and the meeting was held. Accordingly, the amended complaint requested not a prohibitory injunction against the December 1974 meeting but a mandatory injunction requiring the holding of a new meeting to reconsider the actions then taken under the controlling hand of Equimark.

FSC answered the complaint on January 15, 1975. Equimark filed its answer on January 22, 1975. On February 14, Equimark moved for summary judgment dismissing the complaint on the merits. As originally filed, the motion was returnable on February 28, but by a series of stipulations the motion was adjourned until March 18, 1975.*fn3 Although the motion was not formally withdrawn, it has never been decided, for on April 23, 1975, Equimark's counsel directed a letter to the court asserting that Equimark had sold its entire holdings of FSC stock to G. Gray Garland, Jr., and Floyd R. Ganassi, and suggesting that as a consequence the litigation had become moot.

In the interim, by a notice dated February 28, 1975, and filed on March 5, 1975, Kaye had announced his intention to take depositions of representatives of Equimark and FSC and requested production of documents relating to the litigation. By a series of five stipulations and orders signed by the district court,*fn4 discovery was adjourned until September 1975. On the appointed dates for discovery, however, none took place.*fn5 In an attempt to resolve their dispute concerning the proper scope of discovery, the parties met with the district judge on November 5, 1975. Defendant Equimark apparently claimed that further discovery was inappropriate because the action had become moot; plaintiff rejoined that the sale by Equimark of its FSC stock, which gave rise to the mootness claim, had been a sham because the circumstances of the sale were such as would allow Equimark to retain its control of FSC. Equimark offered Kaye an opportunity to depose Robert F. Kastelic, its Executive Vice President, which offer was renewed by letter dated November 10, 1975. Kaye rejected the offer and insisted instead on being allowed to depose M. A. Cancelliere, Chairman and Chief Executive Officer of Equimark. Although Equimark represented that Kastelic was the officer most knowledgeable concerning the circumstances of the sale of the FSC stock, Kaye believed that Cancelliere had participated directly in that sale and in others which might have borne on the continued existence of control by Equimark over the affairs of FSC.*fn6 When the parties were unable to resolve this dispute, Kaye, on January 12, 1976, moved pursuant to Rule 37 for an order compelling Equimark to make Cancelliere available for a deposition and to produce documents which related to the question of continued control over FSC by Equimark, including copies of certain loan agreements between the companies.

The district court denied plaintiff Kaye's motion but provided that "[plaintiff] will be afforded the opportunity to depose Mr. Kastelic but that deposition must be taken within thirty (30) days [of publication of the court's order]; and, within that period, plaintiff is ordered (1) to conclude discovery in respect of the issue before the court, which is the validity of the FSC sale of stock...".*fn7 Within the stated time limitations, Kaye took Kastelic's deposition but conducted no other discovery. Kaye sought additional time to conduct further discovery but the request was denied by the court. Defendants thereupon moved to dismiss on mootness grounds; the motions were granted and plaintiff has appealed.


Clearly, the litigation is not moot against Equimark if, as Kaye contends, the circumstances surrounding the sale of Equimark's FSC stock to Garland and Ganassi were such that Equimark retained actual, if not nominal, control of Funding Systems. Against Equimark, the complaint requests an injunction prohibiting the "exercise of any control over the affairs of FSC." In determining whether plaintiff's claim has been mooted, it matters not whether Equimark votes stock registered in its own name or exercises control through "nominees" who may be independent in appearance but who in reality are subservient to the commands and interests of Equimark. If indeed Equimark has surrendered only the outward incidents of ownership, nothing has transpired which would prevent the district court from awarding substantially the relief demanded in the complaint. As this court has stated it, the test of mootness where a plaintiff seeks equitable relief without a claim for monetary damages is whether the suit, "if successful, would... change anyone's behavior." Browning Debenture Holders' Committee v. DASA Corp. (2d Cir. 1975) 524 F.2d 811, 816. So long as Equimark actually controlled FSC, an injunction compelling the former to relinquish control would, by hypothesis, force it to mend its ways, and thus "change" its "behavior".

Proceeding for the moment on the same assumption that Equimark retains control of FSC through "nominees", we confront the question whether plaintiff's suit is also not moot as against FSC. Although the question is a closer one, we hold that, on the stated assumption, the claims against FSC are not entirely moot.

We do not hesitate to affirm the dismissal of the complaint against FSC insofar as it sought a judgment "declaring the annual meeting of the shareholders of FSC held on December 27, 1974, to have been null and void" and ordering the rescheduling of the 1974 meeting or the holding of a new one. The agenda for the 1974 meeting consisted of essentially three items of business - election of auditors, election of directors, and consideration of several shareholder resolutions submitted by Kaye. At the meeting, the slate of auditors and directors proposed by management was elected; also as management recommended, Kaye's proposals were defeated. The auditors then selected have completed their audit, the directors have completed their terms, and a subsequent meeting has been held at which the shareholder resolutions presented by Kaye were again rejected. With respect to the 1974 election of directors and auditors, what was done cannot now be undone; if a new meeting were rescheduled it could only go through the "empty exercise" of electing auditors and directors whose terms had already expired. Certainly the litigation is moot insofar as it seeks such relief. Browning Debenture Holders' Committee v. DASA Corp., supra, 524 F.2d at 814. Nor is there any point to rescheduling the 1974 meeting or holding a new 1974 meeting to reconsider the resolutions which were originally defeated: the resolutions, which in the main would have required the appointment of "outside" directors and auditors, could not change what has transpired from 1974 to the present. They would have no more effect if adopted at a new or rescheduled annual meeting for the calendar year 1974 than if they were to be adopted at some forthcoming annual meeting which would be held in the ordinary course of events.*fn8 Accordingly the claim against FSC is moot insofar as it seeks a new annual meeting for 1974.

However, the complaint against FSC is not moot insofar as it seeks to require disclosure of the true nature of the relationship between the defendants. The complaint alleges that in several respects Equimark wrongfully exploited and continues so to exploit its position as FSC's majority shareholder.*fn9 Kaye contends that, if the FSC shareholders knew the truth, they would be more likely to enact the resolutions he has proposed and continues to propose; in addition, they might cause FSC to pursue its own legal rights against Equimark. As we read the complaint, plaintiff complains not merely of an isolated failure to make proper disclosure in connection with the 1974 meeting but of a failure to disclose which continues to the present.

Such a claim is clearly not moot. In GAF Corp. v. Milstein (2d Cir. 1971) 453 F.2d 709, cert. denied (1973) 406 U.S. 910, the plaintiff corporation, the target of an unsuccessful tender offer by the defendants, brought suit to enjoin violations of sections 10(b) and 13(d) of the Securities Exchange Act alleged to have been made in connection with the tender offer. Although management had been victorious in defending the proxy battle which gave rise to the litigation, this court declined to declare the case moot, since the complaint "[alleged] that past violations of section 13(d) are continuing and that the conspiracy to take over GAF 'continues unabated.'" 453 F.2d at 714 n.11. Here, as in Milstein, the litigation is not moot since the conduct complained of - violation of section 14(a) by failure to disclose material information concerning Equimark's relationship with FSC - is alleged to be continuing, and no conclusive proof to the contrary has been advanced.*fn10 The complaint therefore alleges "more than an abstract or nebulous plan to possibly commit a wrong sometime in the future." General Fireproofing Co. v. Wyman (2d Cir. 1971) 444 F.2d 391, 393.

Isaacs Brothers Co. v. Hibernia Bank (9th Cir. 1973) 481 F.2d 1168, upon which defendant FSC relies, is not apposite. There, the alleged violation of section 14(a) was the defendants' false statement that they knew of no proxy proposals for a particular meeting other than those included in proxy material mailed to shareholders. However, by the time Isaacs was decided, the defendants had included the plaintiff's proposals in a statement for a subsequent meeting, at which the proposals were rejected. The Ninth Circuit held the alleged failure to disclose was moot in light of the subsequent disclosure of the plaintiff's proposals. See 481 F.2d at 1170. Here, however, there has been no subsequent disclosure; and there is the distinct possibility that the FSC stockholders might take action favorable to Kaye's position if they had the benefit of the sought-for disclosures.*fn11

Since Kaye's claims are not moot if in fact Equimark continues to control FSC, we must reverse unless a finding of no control is warranted. We conclude that such a finding cannot be sustained on the present record.

Since April 23, 1975, Equimark has maintained that the litigation is moot because Equimark has sold its FSC stock to Garland and Ganassi. Equimark and FSC contend that plaintiff's allegations that Equimark retains control of FSC through Garland and Ganassi are merely conclusory and unsupported by the record, despite the opportunities for discovery. The district court accepted the defendants' views of the matter, and accordingly it granted motions to dismiss on mootness grounds. However, the district court was never asked to address itself to the standard of proof required where matters outside the pleadings form the basis for a pre-trial dismissal on grounds of mootness. Indeed, the parties have not expressly argued the question in their briefs on appeal. Nonetheless, we are required to consider it.

We start with the proposition that when a case becomes moot there ceases to exist a "case" or "controversy" between the parties as these terms are used in Article III of the Constitution, and the federal courts are accordingly without jurisdiction over the subject matter of the litigation. SEC v. Medical Committee for Human Rights (1972) 404 U.S. 403, 405-7; North Carolina v. Rice (1971) 404 U.S. 244; Browning Debenture Holders' Committee v. DASA Corp., supra, 524 F.2d at 817; Isaacs Brothers Co. v. Hibernia Bank, supra, 481 F.2d at 1170. Where it appears that a federal court lacks subject matter jurisdiction, it must dismiss the cause no matter what the stage of the litigation, Capron v. van Noorden, (1804) 6 U.S. (2 Cranch) 125, and whether or not the parties have addressed the issue, North Carolina v. Rice, supra, 404 U.S. at 246. Fed. R.Civ. Pro. 12(h)(3).

However, our sensitivity to defects of subject matter jurisdiction does not warrant pre-trial dismissals for mootness on the basis of matters outside the pleadings unless "by the record... it manifestly appeareth" (Capron v. van Noorden, supra, 6 U.S. (2 Cranch) at 126) that jurisdiction is wanting. For the reasons that follow we conclude that where mootness not established by the pleadings is the basis for pre-trial dismissal of an action, the governing standard is akin to that established by Rule 56 of the Federal Rules of Civil Procedure; namely, such dismissal, like summary judgment, is appropriate only where the opposing papers of the parties leave no genuine issue for in-court resolution.

This court hitherto has not had occasion to specify whether a "suggestion" by a party that subject matter jurisdiction is lacking, Fed. R. Civ. Pro. 12(h)(3), must, when made without an evidentiary hearing and on the basis of matters not contained in the pleadings, meet a strict standard like that of Rule 56.*fn12 It has been held, however, that where the defendant asserts through affidavits that no subject matter jurisdiction exists, a plaintiff is entitled to discovery, "for on it turns [plaintiff's] rights to be in court." Investment Properties Int'l, Ltd. v. IOS, Ltd. (2d Cir. 1972) 459 F.2d 705, 707. Accord, Littlejohn v. Shell Oil Co. (5th Cir. 1972) 456 F.2d 225 (opinion assumes that Rule 56 applies to motions to dismiss for lack of subject matter jurisdiction); Urquhart v. American La-France Foamite Corp. (D.C. Cir. 1944) 144 F.2d 542, 544. In the Investment Properties case, this court noted that "affidavits based on mere supposition or only of a conclusory nature might well be held insufficient" to warrant dismissal for lack of subject matter jurisdiction. 459 F.2d at 708 n.4. In addition, it has been held that, to grant dismissal for mootness, the court must be fully satisfied that "the allegedly wrongful behavior" claimed to have been discontinued by the defendant "could not reasonably be expected to recur." SEC v. Medical Committee for Human Rights (1972) 404 U.S. 403, 406, quoting United States v. Phosphate Export Assn. (1968) 393 U.S. 199, 203. On the defendant rests the burden of showing that the challenged conduct will not be repeated. United States v. W. T. Grant Co. (1953) 345 U.S. 629, 632-33; 13 C. Wright, A. Miller & E. Cooper, Federal Practice and Procedure § 3533, at 266-68 (1975). Thus, determinations of facts which give rise to the legal conclusion of mootness must rest on as firm a factual footing as other pretrial conclusions of fact based upon matters outside the pleadings.*fn13

Clearly, such a standard has not been met here. Even with only limited discovery, Kaye has been able to adduce evidence in support of his claim that Equimark continues to exert control over FSC through Garland and Ganassi as nominees. Garland, the Kastelic deposition revealed, is an attorney who has on at least three occasions represented a subsidiary of Equimark in litigation. Prior to the April 1975 sale, when all agree that FSC was under Equimark's thumb, Garland and Ganassi were hired as major officers of FSC. Kastelic did not deny that Garland and Ganassi were shareholders in Equimark. Although Equimark had once been offered three dollars a share for its FSC stock, it sold the stock to Garland and Ganassi for fifty-five cents a share. Mr. Kastelic claimed that other potential purchasers had been approached in Equimark's efforts to dispose of its FSC holdings, but he could not recall the name of any such other person.*fn14

In addition, counsel for Equimark refused to allow Kastelic to respond when plaintiff's counsel asked whether Equimark or its subsidiaries had made any loans to Garland or Ganassi, to the law firm of which Garland was a member, or to various corporations (other than FSC) with which Garland and Ganassi were affiliated. The objection of Equimark's counsel, joined by the attorney for FSC, was that the question did not bear on the issue to which the district court had restricted discovery, namely, the "validity" of the sale to Garland and Ganassi.*fn15 It is obvious, however, that the existence of loans by Equimark to Garland or Ganassi would be relevant in determining whether Equimark retained control of FSC through its ability to influence those men, and thus would be essential to the proper determination of the issue of mootness.

Moreover, Kaye was frustrated in his attempts to learn from Kastelic details of any continuing relationship between Equimark and FSC. During Equimark's tenure as majority shareholder of FSC, the latter had become indebted to Equimark to the tune of $20,000,000. Kaye inquired about changes in the loan agreements since Equimark's sale of its FSC stock. The nature of the changes might have given a clue whether Equimark still had control of its former subsidiary, but Mr. Kastelic denied any knowledge on the subject. The relevant documents have never been made available to Kaye, though they were within the scope of his requests for document production.

Shortly after the Kastelic deposition, the time which the district court had allowed for completion of discovery expired. Kaye's requests for further discovery were denied by the district court. Defendants then moved for dismissals on account of mootness. As against a showing, based nearly entirely on the Kastelic deposition which we have described, defendants did no more than establish a technically valid transfer of legal title to Garland and Ganassi; nevertheless, the district court granted the motions.

We think it manifest that there was a sufficient showing to create a genuine issue whether Equimark had retained control of FSC despite the sale of its stock. Schoenbaum v. Firstbrook (2d Cir. 1968) 405 F.2d 215 (en banc), cert. denied sub nom. Manley v. Schoenbaum (1969) 395 U.S. 906, treated an analogous case, 405 F.2d at 218:

"The district court's grant of summary judgment against the plaintiff was accompanied by a refusal of his request for discovery. This court has indicated that summary judgment should rarely be granted against a plaintiff in a stockholder's derivative action especially when the plaintiff has not had an opportunity to resort to discovery procedures. See, for example, Subin v. Goldsmith, 224 F.2d 753 (2d Cir.), cert. denied, 350 U.S. 883, 76 S. Ct. 136, 100 L. Ed. 779 (1955); Colby v. Klune, 178 F.2d 872 (2d Cir. 1949); Fogelson v. American Woolen Co., 170 F.2d 660 (2d Cir. 1948). The plaintiff typically has in his possession only the facts which he alleges in his complaint. Having little or no familiarity with the internal affairs of the corporation, he is faced with affidavits setting forth in great detail management's version of what actions were taken and what motives led the affiants to take these actions. Since the facts in such a case are exclusively in the possession of the defendants, summary judgment should not ordinarily be granted where the facts alleged by the plaintiff provide a ground for recovery, at least not without allowing discovery in order to provide plaintiff the possibility of counteracting the effect of defendants' affidavits."

See also Poller v. Columbia Broadcasting System, Inc. (1962) 368 U.S. 464, 472-73. The instant case closely resembles Schoenbaum in several respects. As was the plaintiff in Schoenbaum, Kaye is a minority shareholder who was not in a position to have personal knowledge concerning the events of which he complains. The information relevant to the lawsuit - and to the defense of mootness - is almost entirely in the defendants' hands.

Beyond all that, the record before us indicates that the instant case is even less suited than was Schoenbaum to resolution by summary procedure. The court here is not presented "with affidavits setting forth in great detail management's version of what actions were taken and what motives led the affiants to take these actions". 405 F.2d at 218. On the contrary, defendants have disclosed virtually nothing, except the sale itself, that would prove or disprove the continued existence of control. While the fact of sale of a majority interest in a corporation might ordinarily give rise to an inference that control was disposed of as well, the inference is hardly irrebuttable. The meager facts before us go a long way toward rebutting - if they do not actually rebut - that inference. Kastelic's deposition revealed that Garland was the attorney of Equimark's subsidiary and thus its fiduciary, and that Garland and Ganassi had been hand-picked by Equimark to manage FSC (and according to Kaye to supervise its plunder) and thus were no doubt in the habit of doing the bidding of their patron. In addition, Kastelic's testimony left open the crucial questions whether Garland and Ganassi were still indebted to Equimark (literally, for clearly they were figuratively) and to what extent - if at all - Equimark had made efforts to sell its FSC holdings at a better price to outsiders.*fn16

We have no doubt that there remains a substantial question whether Equimark continues to control FSC; thus, at this stage of the lawsuit, we are warranted in assuming the existence of control.

We therefore conclude that the judgment of the district court must be reversed, except insofar as it dismisses the claim against FSC for a new shareholders' meeting for the year 1974. We remand to the district court for further proceedings not inconsistent with this opinion. Costs will be taxed to defendants-appellees.

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