The opinion of the court was delivered by: SWEET
This action was filed by plaintiffs Reprosystem, B. V. ("Reprosystem") a Netherlands corporation, and N. Norman Muller ("Muller"), a New York resident, against the defendant SCM Corporation ("SCM"), a New York corporation. The complaint alleged damages for breach of contract, promissory estoppel, failure to perform and to negotiate in good faith, unjust enrichment, and fraud under the federal securities law and the common law. After extensive discovery, a four week trial before the court was held in the course of which 17 witnesses testified and well over 1,000 documents were introduced into evidence. At issue are the rights and liabilities of the parties arising from an unsuccessful effort in 1976 by Muller and Reprosystem to purchase the European photocopier business of SCM. Both sides were represented by extremely able counsel, not only during the events giving rise to the litigation but particularly during its trial. The issues presented, both factual and legal, constitute an almost exhaustive pathology of an important corporate transaction. For reasons more fully set forth below, Reprosystem and Muller are entitled to recover certain of their damages resulting from SCM's breach of contract and failure to bargain in good faith.
SCM is a multinational conglomerate manufacturing and distributing a number of industrial, commercial and consumer products. Its shares are listed on the New York Stock Exchange. Prior to 1975 and during 1976 and the first half of 1977 it engaged in the business of marketing, leasing and servicing office copiers, paper and toner throughout Western Europe, the Middle East and Africa. This business was conducted by its International Business Equipment Division through six wholly owned subsidiaries: Smith-Corona Marchant, S.A., a French corporation; SCM International S.A., a Belgian corporation; SCM (Switzerland) S.A., a Swiss corporation; SCM (Deutschland) GmbH, a German corporation; Smith-Corona Marchant International S.A., a Swiss (Chur) corporation; and SCM (United Kingdom) Ltd., a United Kingdom corporation. (These six subsidiaries are collectively referred to as the "copier subsidiaries" or "subsidiaries.") During the 1976 fiscal year (ending June 30, 1976) the copier subsidiaries had assets of about $ 17,000,000, total sales exceeding $ 40,000,000, operating profits exceeding $ 4,000,000, and approximately 1000 employees.
Reprosystem was organized in the fall of 1976 to hold the shares and assets of the subsidiaries. Its shares were owned by Reprographex Antilles, N.V., a Dutch Antilles corporation which in turn is a wholly owned subsidiary of Reprographex International, Inc., a Delaware subsidiary of MacMuller Industries, Inc., another Delaware corporation. At the time of the transaction, a majority interest of Reprographex International, Inc. was owned by Muller individually. Muller also owned a controlling interest in MacMuller Industries, Inc. which during most of the period in question owned and operated Eagle Shirts, Inc. and Petrocelli Clothes, Inc. Muller was responsible not only for his own conduct as an individual but for that of the corporations which he controlled. He was an experienced businessman with "ability to raise cash."
Late in 1975 at a corporate planning meeting in Bermuda, Paul Elicker, the President and Chief Executive and Chairman of the Board of SCM ("Elicker") and Herbert Egli, the Vice President Finance and Controller of SCM, ("Egli") and presumably others concluded it was in SCM's best interest to divest itself of its European copier business. This decision was communicated to Frank DeMaio, Vice President and General Manager of the International Group ("DeMaio").
The business of the subsidiaries consisted principally of the distribution of zinc oxide coated paper photocopiers, generally through lease of copier equipment, and sometimes through sale. Under the lease method, the subsidiaries would lease and service equipment, and this equipment was identified as Equipment Held for Lease. The subsidiaries also marketed paper supplies and toner to equipment users, and serviced the equipment. Between 1972 and 1974 annual operating profits of the copier subsidiaries ranged from about $ 4 million to about $ 5 million. DeMaio and Elicker sought out potential purchasers of this business, principally among its suppliers, without success. Through DeMaio a firm specializing in bringing together those interested in buying and selling corporate interests learned of the SCM purpose and advised Muller, who met first with DeMaio and then with Elicker and DeMaio in April, 1976. At the outset Muller and DeMaio had an understanding that if the proposed sale was accomplished DeMaio would receive an equity interest in the acquiring company. In May a meeting was attended by Muller, Elicker and William Rodich ("Rodich"), President of the Business Equipment Division of SCM of which the International Group and the copier subsidiaries were a part. The business of the subsidiaries was described. Muller was provided with a statement of the asset value of the subsidiaries as of March 31, 1976, showing an aggregate book value of $ 16.8 million on an unaudited basis. The current profit and loss statement, also provided to Muller, showed a nine month profit of about $ 3.0 million.
A subsequent review by SCM's accounting department indicated that this unaudited statement might have been overstated by $ 1 million. However, there is no evidence that, if the asset value was indeed overstated, the overstatement was deliberate and for a fraudulent purpose. The full disclosure offered to Muller and his accountants by SCM in the fall of 1976 also serves to refute any fraudulent purpose. A projected drop in operating profits in fiscal 1976-1977 for the subsidiaries of less than $ 600,000 was not disclosed.
Although not expressed in writing initially, both parties had certain underlying concerns. SCM desired to divest itself of the business, to protect against any further liabilities either on bank or employee severance guarantees, and to protect its good will and relationships with customers and suppliers since it intended to remain in the typewriter business. Muller sought to purchase an ongoing business and its distribution network with its capacity to introduce new items. Early in the discussions it was recognized that the availability of a plain paper copier as opposed to a zinc oxide coated paper copier was an important, if not vital, aspect of the business. SCM, having decided to get out of the copying business, sought to minimize its commitment to this new product, while Muller believed a plain paper copier essential to the continuation of the business. Rodich and DeMaio had concluded that the availability of plain paper copiers was necessary, regardless of the ownership of the business, and during the spring of 1976 DeMaio travelled to Japan and reached a preliminary understanding with Mita, a Japanese manufacturer, to provide plain paper copiers for SCM's benefit. These underlying concerns of the parties were articulated and understood but not made the subject of any writing at this early state.
By letter of May 7, 1976, Muller offered to pay.$ 9.0 million for the subsidiaries. His letter also contained the following language, which forms a keynote to SCM's position on the law:
This offer is made subject to the following conditions:
1. that a satisfactory audit review will be performed by our accounting firm, S. D. Leidesdorf & Co.
2. that a formal agreement, which is satisfactory to SCM and ourselves be entered into.
Rodich informed Muller that his May 7 letter provided the basis for negotiation, but all further discussions were deferred because of a security offering by SCM and a consequent "quiet period." However, on August 4 discussions were resumed at a luncheon at the Atrium Club attended by Rodich, Egli, Muller and Brier, the latter being a participant in MacMuller Industries, as well as officers of Citibank where Muller and his companies banked. One of the purposes of the meeting was to discuss Muller's financial standing. Wallace of Citibank stated his satisfaction with the bank's relationship with Muller and added that he dealt only with seven figure accounts. No further representations were made or requested. Muller at the time was seeking financing from Citibank, financing which he failed to obtain. Shortly thereafter SCM obtained a Bishop's Service and a Dun & Bradstreet report relating to Muller. Muller's strengths were described in the Bishop's Service report by one source as "putting together financial deals, acquisitions and raising money." No further questions were raised concerning Muller's finances during this phase of the discussions.
The Agreement in Principle
Shortly after the Atrium meeting Rodich gave Muller a list of items which he considered to be essential to SCM in connection with the contemplated transaction. At a later meeting in September this list was supplemented by four additional items. These memoranda are annexed as an Appendix to this decision. These points were viewed as "the Bible" by Rodich according to Muller and were non-negotiable. Whether or not the term was in fact used, these documents constituted the basic agreement which remained in place throughout the discussions, including the formula by which the purchase price was to be calculated. Muller accepted these items, the firm of Hardee, Barovick, Konecky & Braun ("Hardee Barovick") was retained by Muller, meetings were held and at one point in August it was even suggested that consideration be given to a closing at the end of the month, an objective which continued to elude the parties.
In mid-September, principally as a consequence of Rodich's memoranda it had been agreed by Rodich and Muller that Muller would purchase the non-typewriter European business of SCM, that the purchase price would be calculated on the basis of a formula derived from Muller's offer of.$ 9.0 million cash for $ 16.4 million assets as of August 31, 1976, that the typewriter assets would be stripped out by SCM prior to closing, that the business would be operated by SCM for Muller in its ordinary course after August 31, 1976 and that the purchase price would be adjusted to reflect events subsequent to that date. The transfer would be in a form determined by SCM, which initially called for the intended transfer of the stock of the French, German, Belgian and Swiss subsidiaries, and the transfer of the copier assets of the U.K. and Chur subsidiaries. SCM retained its claims against Xerox Corporation for damages in a pending litigation involving, among other things, claims that Xerox unfairly competed with the SCM copier subsidiaries. Muller assumed responsibility for possible employee severance and vacation pay obligations, leases and employees in the U.K. relating to the copier business, and the performance of SCM purchase agreements for equipment and supplies. Muller had the right to license and use the SCM name and logo for three years with appropriate safeguards on its use. SCM made certain warranties with respect to undisclosed liabilities, inventories and accounts receivable. Discussions on these matters correlated the "deep discount" from stated asset value with the assumption by Muller of the employee severance liability and lease obligations of SCM.
The burden of preparation of more formal documents fell upon Arthur J. Mannion, Jr. ("Mannion"), inside counsel for SCM, his work product then to be reviewed by the Hardee Barovick firm. The latter firm also employed Harvey Dale as outside tax consultant. A closing at the end of September was then anticipated. Both sides dispatched teams of lawyers and accountants to Europe, the latter to conduct "a businessman's review" and the former to obtain facts and delineate issues to be incorporated in the agreements to be signed. The parties resumed discussions in New York in the latter part of September dealing in part with issues resulting from the trip, including the effect of a French transfer tax and the anticipated time to obtain a necessary Bank of England approval.
In connection with its 10-K report for the fiscal year ending June 30, and other matters, Elicker met with the SCM board and after discussion the following resolution was adopted:
We have agreed in principle to sell our European office copier operations to N. Norman Muller, a private investor who owns substantial interests in various businesses. Current personnel and management will continue to operate the sold business.
SCM's 10-K filed with the SEC on September 30, 1976, stated in relevant part:
In late September, 1976, the Company reached an agreement in principle to sell its European copier sales and service operations. These operations account for approximately 40 percent of SCM's copier products net sales, with an operating income of approximately $ 2 million in fiscal 1976 which was expected to decline in fiscal 1977. The Company makes no assurance that this transaction will be completed.
During the same period Muller was anxious to make his presence felt in Europe and to establish a relationship with the general managers of the subsidiaries. A trade exhibition in Paris in late September 1976, the SICOB show, provided an opportunity to satisfy Muller's needs. That, together with SCM's reporting requirements, resulted in a press release which was issued on September 28, 1976, and which stated with respect to the transaction:
SCM Corporation has reached an agreement in principle to sell its office copier service organizations in the United Kingdom, France, Germany, Switzerland and Belgium and its distribution operations covering Europe, the Middle East and Africa to a company controlled by N. Norman Muller, a private investor.
While terms of the agreement in principle were not disclosed, Paul H. Elicker, president of SCM, indicated that SCM would incur a pre-tax loss of approximately.$ 1.4 million on the transaction.
The proposed sale of the European copier business is subject to a definitive agreement expected to be reached soon. SCM said that all parts of the combined 900-man marketing operation would be sold to the new owners intact and the current management will continue to operate the business....
The announcement was reported in The New York Times, The Wall Street Journal, on the Dow Jones ticker tape and elsewhere. These events aroused sufficient interest in Muller to result in an article in Forbes which reported that Muller intended to use his own assets to buy the subsidiaries, a report that was more fictional than factual, given Muller's discussion with Citibank and his later discussions with the Chemical Bank to be considered below.
The "agreement in principle" thus approved by the SCM Board and announced to the public at large consisted largely of the thirteen items set forth in Rodich's August and September memoranda, to which Muller had agreed. These points with some additions and alterations remained central to the negotiations throughout.
After the issuance of the September 28 press release, the principals left for Paris where the SICOB show was in progress. Rodich addressed a luncheon meeting of the general managers of the subsidiaries at the Hotel Crillon, sought their cooperation during the period before the contemplated transfer could take place, offered a substantial bonus in the event that the transaction was completed as contemplated, and introduced Muller as the intended buyer. He then left the meeting and returned to New York. Muller remained and discussed the business of the subsidiaries with the general managers, and attended the SICOB show and a reception given at the Hotel Intercontinental for the general managers and suppliers to the subsidiaries. These events ended up as charges to Muller's bill at the Crillon, as did the charges for the living expenses of Muller's party, all of which were subsequently paid for by the French subsidiary. SCM seeks repayment of approximately $ 14,000 by way of counterclaims, more to establish some of the color surrounding these events than to be made whole financially, and of course Muller is responsible for any expenses not related to his business activities. The evidence presented, however, has been inconclusive as to the amount properly attributable to Muller's personal expense.
After returning to New York a first draft of an agreement on the sale of one of the subsidiaries was prepared by Mannion. It was considered to be incomplete by the Hardee Barovick firm, some words were had on the subject, and by early November SCM retained Messrs. Sullivan & Cromwell to assist in the negotiations and preparation of agreements.
On November 8, 1976, SCM's Board of Directors adopted the following resolution:
RESOLVED, that the officers of the Company be and hereby are authorized to negotiate the sale of the Business Equipment Division copier operations in England, France, Germany, Belgium (including distributor operations) and Switzerland to N. Norman Muller or a company(ies) owned by N. Norman Muller at such prices and pursuant to such other terms and conditions, as in its absolute discretion, may be approved by the Executive Committee of the Board of Directors....
It is undisputed that both parties anticipated that a final written agreement would be reached and executed, an anticipation that, of course, was never fulfilled although a closing date of March 31, 1977 was acceptable to Rodich and was subsequently advanced at SCM's request as more fully set forth below. Meetings were held between counsel on November 16, 17, 18 and December 10 and with the participation of the respective clients on December 15 and 16. Drafts were discussed and negotiated. The starting points for these discussions were the thirteen points outlined by Rodich in August and September and accepted by Muller before the SICOB trip. The negotiations produced a number of refinements and changes.
The non-copier assets of the French, German, Swiss and Belgian subsidiaries, the shares of which were to be acquired by Muller, were not to be stripped out prior to closing but rather to be transferred to third parties, affiliates of SCM, for cash. Since the transaction contemplated a purchase price based on the formula described above, this change increased the cash in the subsidiaries at the time of closing and thus increased the cash required to close.
Throughout it was understood that SCM was concerned about its employee severance liability and its good will. Clauses were drafted to prevent dividends, loans and pledges which would transfer funds from the Muller operating companies to Muller or his holding companies.
These clauses were designed to prevent Muller from removing assets from the subsidiaries but did not by their terms prevent any other transfer pledges or loans to third parties.
SCM sought to obtain a personal guarantee from Muller and a commitment to operate the subsidiaries for three years. The request was refused, and no provision appeared in the last drafts on this subject. SCM sought a provision requiring approval by its Board of Directors before signing, a request which was rejected in view of the action already taken and upon the view of SCM's counsel that the signature would not be affixed unless the agreement was approved.
At the negotiations at the Atrium Club in August, SCM had sought reassurance as to Muller's financial competence. The Dun & Bradstreet and Bishop's reports had been reviewed. During the negotiations in the fall SCM sought Muller's personal guarantee and certified financials but these requests were rejected by Muller. The issue was resolved by the limitation on upstream pledges, loans and dividends, the purpose of which was to prevent the transfer of funds to Muller which might jeopardize the viability of the subsidiaries.
During this period from September through December it was understood by all concerned that the companies which were to be the subject of the agreement were being operated by SCM for the benefit of Muller. So-called "Flash Reports," weekly forms reporting the pertinent financial data, were shared with Muller. Rodich had instructed DeMaio to keep Muller apprised of all developments. No significant problems were raised or discussed between the parties during the period concerning the operation of the business in the normal course. However, one significant development, relating to the production and marketing of a plain paper copier, began to cast a shadow over the business picture.
DeMaio, after being instructed in the fall of 1975 that SCM intended to cast his division adrift, loyally assisted in the plans to locate a willing buyer to whom the business could be transferred. However, he was persuaded that the viability of the business even to its new owners required the capacity to compete in the plain paper copier field whether or not SCM had determined to abandon this field. To this end he had obtained Rodich's agreement to travel to Japan in the spring of 1976 to select a manufacturer of a plain paper copier and arrange for its production as recounted above. By early fall he had exchanged correspondence with Mita relating to the production of a plain paper copier, its testing and the purchase of a number of copiers. Muller shared DeMaio's belief that the availability of a plain paper copier was essential to the health of the European subsidiaries. The SICOB show was the public debut of the Mita plain paper copier, and the European managers were encouraged and enthusiastic, shared DeMaio's hope for the success of this product and the consequent commissions on sales, a factor which served to hold the sales organizations together during this period of uncertainty. Orders for sales were taken for production to commence some time around the first of the year, and these orders appeared on the Flash Reports.
It was anticipated that the Mita copier would cost in the neighborhood of $ 3,000 and be sold for approximately $ 4,000 and that approximately 2,000 units would be involved in the first year's production. Thus an initial investment of $ 6 million was in contemplation. Since SCM in its 1976-77 budget had determined to reduce its commitment to the copier business and to liquidate its investment, and since Muller felt that plain paper copiers essential to his ability to carry on the business, the production of the plain paper copier had the potential of presenting a significant divergence in business objective between Muller and SCM. However, only the tip of this issue could be perceived on the horizon in mid-December, and neither of the parties focused upon it. By all that had been discussed between the parties and their counsel, the operation of the business was proceeding to the satisfaction of each.
The Agreement and Final Events of 1976
By mid-December counsel had produced 16 drafts, and pressures were building up for a resolution. Rodich was to be reassigned as of January 1, 1977 to become President of the Chemical and Metallurgical Division of SCM headquartered in Baltimore, and as the principal negotiator for SCM he sought to conclude the discussions. He called a meeting at SCM for December 15 to be attended by all counsel and their clients with the purpose of clearing up all matters then outstanding.
Rodich, Muller, and DeMaio, Robert Kay, and Ronald Konecky, counsel for the buyer, John Merow and Charles Sprague, counsel for the seller, James Conway, the chief auditor of SCM and Ben Evans, the S. D. Leidesdorf partner bearing accounting responsibility for Muller, and two other lawyers all testified as to the conduct of this meeting. Two drafts were discussed, one a "Global" Agreement between buyer and seller and the second, the agreement for the sale of the French company which was intended not only to serve to govern that transfer but also to serve as a prototype of the agreements to be completed with respect to the Belgian, Swiss and German companies. It is undisputed that the drafts were reviewed, page by page, and all open issues were sought to be resolved. Parties caucused in various groups, discussions were held, and agreement was reached wherever possible. It was contemplated that another draft would be generated by Sullivan & Cromwell, and indeed on the evening of December 15 another draft of the Global Agreement was produced.
The meeting continued on December 16, and at its conclusion the assembled group was asked by Rodich whether there were any open terms, and none were advanced. Sullivan & Cromwell was to provide agreements embodying the discussions. The negotiators were released, and adieus, season's greetings and congratulations were exchanged. Rodich escorted Muller to DeMaio's office, and advised the latter that the meetings had been successfully completed. Whether or not Rodich stated, as recalled by Muller and DeMaio, "Frank, shake hands with your new boss, the deal is done," the import of the meeting with DeMaio was to acknowledge in an informal manner the transfer of power. In addition Rodich took Muller to Egli's office and advised Muller that Egli would finish up the transaction. He also informed the finder that his fee could be expected around Christmas or shortly thereafter.
On December 16, the Board of SCM met and the following minute was made with respect to Elicker's report:
He commented on the sale of the European copier business and the assignment of domestic copiers to Allied Paper.
By deposition Elicker expanded on this subject, stating that he had informed the Board that he remained hopeful, that the negotiations were "stuck," that Rodich's transfer would be completed and that Egli would take over for the short and temporary period remaining.
Elicker also testified by deposition that a receivable for the Muller transaction had been booked by the Board in 1976. Both Egli and Conway disputed this fact, and testified that no such entry appears on the SCM books. Egli also indicated that Elicker must have confused the September write-down of the copier assets when he testified about this receivable. Given the clarity of Elicker's pretrial deposition, his absence at trial, the testimony of Conway that such an entry would not have been made for about ten days after year-end, and the findings shortly to be described concerning Egli's year-end memo, the preponderance of the evidence weighs on the side of the existence of the booking.
Just after the meeting, on behalf of Muller the following request was made to the French government for approval of the transaction:
(SCM) has come to an agreement with Mr. Norman Muller, a U.S. citizen, under which the Group of the latter will take over the SCM copier business in some of the European countries, i. e., West Germany, Belgium, the United Kingdom, Switzerland, and France.
As the negotiations were being held DeMaio telexed to Mita seeking to complete the plain paper copier transaction and confirming a Letter of Intent between Reprosystem and Mita for the purchase of about $ 6,000,000 worth of plain paper copiers from Mita. On December 16 DeMaio also notified Mita that
we have agreed, on December 15, 1976, to the final terms and conditions pertaining to the sale of the six European companies and the distribution right in all other countries in all of Europe, the Middle East and Africa.
While the negotiations were in progress, DeMaio had prepared a telex for the managers keeping them advised of the events. Rodich approved the telex and it ...