The opinion of the court was delivered by: SAND
Richard Fuchs, a shareholder in M.P.C., Inc. ("MPC") brings a class action, and a derivative action on behalf of MPC, against Swanton Corporation ("Swanton"), MPC, A. Fred March ("March"), Norman F. Swanton, F. Eberstadt & Co., Inc. and the officers and directors of Swanton.
Plaintiff, who seeks both injunctive and monetary relief, invokes this Court's jurisdiction under Section 22(a) of the Securities Act of 1933, 15 U.S.C. § 77v(a) ("Securities Act"), Section 27 of the Securities Exchange Act of 1934 as amended, 15 U.S.C. Section 78aa ("Exchange Act"), and the principles of pendent jurisdiction. Defendants move to dismiss under F.R.Civ.P. 12(b)(1) and 12(b)(6). Defendant's motion is granted for the reasons stated herein, and plaintiff is granted leave to replead the derivative action for damages and his injunctive and state law claims.
I. The Factual Background
In his amended complaint, plaintiff alleges
that by agreement between Swanton and March, dated March 15, 1978, Swanton on March 28, 1978 purchased 310,500 shares or 51% Of the common stock of MPC from March and members of his family (the "March Holding").
The March Holding constituted a controlling interest in MPC. At the time of the stock purchase, Swanton, according to plaintiff, was primarily engaged in the business of selling coal tax shelters, and was in poor financial condition due to recent changes in the federal tax laws. Plaintiff contends that unless Swanton could effect a major acquisition at highly advantageous terms, Swanton knew it would have to terminate its business. Plaintiff further contends that Swanton, a poor merger partner, was able to achieve this goal through the acquisition of MPC only with the fraudulent support of March, who agreed to sell the March Holding at a premium price which Swanton could not afford to pay to MPC's other shareholders. The sale made available to Swanton the significant liquid assets that plaintiff claims MPC had on hand at the time of the transaction.
Upon the sale, March and his family members resigned as officers and directors of MPC and its subsidiaries. Swanton immediately placed three of its own officers and directors on MPC's five man board, thereby gaining complete control of MPC and its subsidiaries. With Swanton's minimal working capital and its poor business prospects, Swanton needed MPC's assets to replenish the capital it had expended for the purchase. Thus, immediately after gaining control, Swanton engaged in a series of transactions with MPC whereby Swanton, to the detriment of MPC's minority shareholders, appropriated the assets of MPC to its own use. Plaintiff cites the following specific transactions:
1. The transfer of substantial sums to Swanton in the guise of loans at favorable interest rates. Loans bearing interest rates of 81/4% Were made on May 23, 1978 ($ 50,000); on June 10, 1978 ($ 100,000); on August 10, 1978 ($ 75,000); and on September 11, 1978 ($ 200,000).
2. Through its subsidiaries, NFS Services Inc. and Kenerco, Swanton borrowed $ 250,000 from MPC at an interest rate of only 81/4% At a time when Swanton had no working capital other than that appropriated from MPC.
3. Swanton caused MPC's subsidiaries to pledge their assets to secure Swanton's debts: On June 1, 1978, an MPC subsidiary executed a hypothecation agreement with Citibank, N.A. of a certificate of deposit owned by the subsidiary in the amount of $ 425,956.77 to secure Swanton's indebtedness to Citibank; on June 14, 1978, another certificate of deposit owned by an MPC subsidiary, this in the amount of $ 600,000, was also used to secure Swanton's indebtedness to Citibank. In sum, Swanton used over $ 1 million of MPC's current assets to secure Swanton's own debts.
4. Swanton pledged the foregoing assets to secure loans at interest rates higher than the rate which Swanton was simultaneously paying MPC for the monies Swanton "borrowed" from it.
As a result of these transactions, Swanton, according to plaintiff, was able promptly to replenish the working capital it expended to purchase MPC from March. Plaintiff claims that the net effect of the entire transaction was that MPC's working capital was used by Swanton to acquire the March Holding. Moreover, in October, 1978, allegedly in furtherance of Swanton's scheme to loot the assets of MPC, Swanton filed a registration statement with the Securities and Exchange Commission, pursuant to which Swanton proposed to exchange shares in a newly formed, wholly owned subsidiary of Swanton for MPC stock, thereby effecting a merger of Swanton and MPC. Plaintiff alleges that the registration statement is materially false and misleading.
"Count I" of plaintiff's complaint is asserted derivatively on behalf of MPC against all defendants and is based on March's sale of his controlling block of MPC common stock to Swanton. Plaintiff claims that the sale violated Section 17 of the Securities Act,
Section 10(b) of the Securities Exchange Act,
and Rule 10b-5,
promulgated thereunder, in that the defendants fraudulently concealed from MPC and its minority shareholders their intent to enter into the stock-purchase agreement, and further concealed Swanton's intention at the time of the agreement to appropriate MPC's assets in order to finance the purchase of MPC shares. Plaintiff contends that by virtue of such concealment, MPC's minority shareholders were precluded from seeking to enjoin the stock purchase agreement or from otherwise seeking to protect MPC's interest. Plaintiff seeks recovery on behalf of MPC for all damages sustained as a result of this transaction.
Count II, alleged individually and on behalf of the class of shareholders other than defendants who would receive Swanton shares upon the merger of MPC into Swanton, is based on the proposed merger. Plaintiff seeks injunctive relief and damages under Section 10(b) of the Exchange Act and Rule 10b-5, claiming that the merger is part of the same scheme to loot the assets of MPC and will force the minority shareholders to redeem their shares at an inequitable rate of exchange. The amended complaint contains the further claim that the allegedly false and misleading registration statement which defendants filed with the Securities and Exchange Commission pursuant to the plan of merger gives rise to a claim for relief under Section 17(a) of the Securities Act and under Section 10(b) of the Exchange Act.
Plaintiff's fourth count
is a state law claim for breach of fiduciary duty in the corporate waste of MPC's assets. Similarly, Count V, alleging common law fraud, Count VI, asserted by plaintiff and the class as third party beneficiaries of the Swanton-March contract provision that minority shareholders would be offered a price per share equivalent to that received by March, and Count VII, a corporate opportunity claim asserted against March, are all claims arising under state law.
Defendants' motion to dismiss this action under F.R.C.P. 12(b)(1) and 12(b)(6) is based on their assertion that federal jurisdiction cannot be sustained over either Count I or Count II because plaintiff fails to satisfy the purchaser-seller requirement imposed under the anti-fraud provisions of the federal securities laws. Without federal claims, defendant continues, the pendent state claims must also be dismissed. Finally, defendants allege that the derivative counts against March ...