The opinion of the court was delivered by: COOPER
This action, tried to the Court,
involves fourteen (14) claims for relief asserted by plaintiff, and one counterclaim raised by defendants. Plaintiff's claims involve: (1) securities fraud; (2) common law fraud; (3) breach of contract; (4) breach of oral employment contract; (5) assumption of several promissory notes; and (6) monies and personal belongings owing to plaintiff. Defendants' counterclaim alleges that the plaintiff is liable for misrepresentation.1a
The essence of this action centers around the dealings of two men, plaintiff Lawrence Rosenbloom and Asher Schapiro ("Schapiro"), one of the defendants, over a four year period. Between 1971 and 1974, plaintiff's and Schapiro's respective insurance agencies merged, and a new agency, Adams, Scott & Conway, Inc. ("ASC") was created in the hope that a nationwide network would eventuate. Efforts were undertaken and money raised to achieve this goal. However, plaintiff's and Schapiro's business dealings came to an abrupt end when plaintiff's employment with ASC was terminated in October, 1974.
a. Negotiations between the parties
In 1969 plaintiff was the owner of two-thirds of the capital stock of Lawson, Stewart & McCory ("LSM"), an insurance agency headquartered in Los Angeles, California, with affiliated branch offices in other cities. LSM dealt primarily in various forms of commercial insurance, workmen's compensation and group insurance plans; life insurance was not a major feature of the business.
Plaintiff was primarily involved in the marketing aspects of the business, while Warwick Feldman, owner of the remainder of LSM's stock, dealt with the day to day operations of the agency.
Plaintiff testified that LSM was in need of cash in 1970 because of an overly rapid expansion of its business.
One of the contemplated plans was to raise the needed capital through a merger with another company. In 1970 and 1971 plaintiff spoke to several persons including Schapiro and company representatives regarding potential investments or mergers.
Schapiro was then the principal shareholder of Scott Brokerage Limited ("SBC") which dealt primarily in life insurance and did business almost exclusively in the greater New York City region.
During 1970 and 1971 Schapiro considered and gradually concluded that it would be beneficial to the company and himself if the operational and geographical scope of his company was expanded.
In those two years, Schapiro, with the help of Sidney Staunton, Chairman of the Board of Laird, Incorporated, a New York investment banking firm, examined several alternatives for expansion.
One of the alternatives Schapiro considered was a merger with LSM.
It is unclear from the record when plaintiff and Schapiro first met to discuss a potential merger of their respective companies. However, in the early part of 1971 several discussions were held between plaintiff, Schapiro and Feldman. By the summer of 1971, discussions concerning a merger became frequent.
Beginning in June or July of 1971, Schapiro was provided with information concerning LSM's financial condition and became familiar with the general financial and working operations of that agency. He received, among other documents, a consolidated profit and loss statement and an evaluation of LSM by an independent concern.
Schapiro testified that during this period he spent a "fair amount" of time at the offices of LSM in California and was never refused a document.
Both plaintiff and Feldman testified that they told Schapiro about the financial difficulties LSM was encountering, including its "out-of-trust position."
Plaintiff testified LSM had used premiums collected from its customers, and due insurance companies, to cover the company's operating expenses; that Schapiro knew the difficulties LSM was having and knew it was "out-of-trust."
It is unclear from the trial record what the actual extent was of Schapiro's involvement with LSM during the summer and fall of 1971. Plaintiff testified that as of August, 1971 Schapiro was continually involved in the day to day operations of LSM; that no LSM check for payment would be issued without Schapiro's approval. Schapiro, to the contrary, testified that during this period he was not involved in the daily operations of LSM.
It is clear, however, that Schapiro did raise capital for LSM in that period; that in September, 1971 he arranged for a loan of $ 100,000 to be made to LSM from one of his friends, Adolph Biefeld.
Initially, the discussions among the three parties (plaintiff, Schapiro and Feldman) centered on a possible three way merger between LSM, SBC, and the CFC Financial Corp. ("CFC") (Schapiro was president of the company last named). CFC among other enterprises had a subsidiary in the casualty and property phase of insurance. In furtherance of these discussions a memorandum of intent was prepared.13a No merger ensued because CFC's board of directors considered LSM's financial position weak and were concerned about the alleged questionable reputation plaintiff and Feldman had in the industry.
Schapiro took the contrary position and felt a merger with LSM was a good opportunity. He, plaintiff and Feldman then considered a two way merger between SBC and LSM. Schapiro testified that in the discussions which ensued he made his conditions for approval known: (1) he would be chief executive officer of the new company; (2) he would receive 50% of the stock; and (3) each of the three parties would be treated equally as to benefits, salaries and respective shareholdings.
Likewise, plaintiff made his intentions and goals clear: (1) improve the financial condition of LSM; (2) be relieved of certain personal liabilities he had on loans he had undertaken for LSM; (3) stay in financial control; and (4) be a partner in the new entity.
At the time of the merger discussions between SBC and LSM in 1970 and 1971, plaintiff was indebted to the extent of $ 25,000 to Ruta Lee, a long time family friend. Even though the note was cast in the form of a personal loan to plaintiff and his wife, plaintiff testified all concerned understood the note was for LSM's use;
that Schapiro represented to him that the new company would pay this obligation.
Lee testified that in 1971 Schapiro said "... he was taking care of everything and that he would personally see to it that this loan was repaid."
Schapiro admitted that he had spoken to Lee in regard to the note, but that he only said that "somehow" the note would be repaid if the new company became financially stable.
At about the same time, plaintiff was also personally indebted to his in-laws, Irving and Beatrice Citron, for approximately $ 26,500. That loan also on its face was a personal one to plaintiff and his wife, but plaintiff testified that this note too was to be used by LSM;
that Schapiro and Mrs. Citron met in 1971 and Schapiro told her that plaintiff's debt to her would be paid off from the new financings of the company.
Schapiro, on the other hand, testified that he met Mrs. Citron, but denied discussing the note with her.
At her deposition Mrs. Citron testified: "Q. You mentioned Asher Schapiro in your testimony. Do you know Mr. Schapiro? A. Yes. Q. When did you first meet him; do you recall? A. At a restaurant. I was with Stephanie and Larry and we all had dinner together.... Q. Do you recall whether that was before or after Mr. Rosenbloom and Mr. Schapiro began working their businesses together? A. Before. Q. Did you ever discuss with Mr. Schapiro the obligation or the loans you had made to Mr. Rosenbloom? A. Did I ever speak with Asher? No. Q. At any time? A. No."
This sharp conflict in sworn testimony on the Lee and Citron notes is but one of the many examples, throughout the trial record, which dealt with key factual issues confronting us; clear contradictions, uncertainty, unpersuasiveness characterized each. We feel duty bound to delve quite considerably (throughout this opinion) into such instances; in the main, they account for our estimate of the proof adduced.
At the time of the merger of LSM and SBC, LSM was also indebted to City National Bank of Beverly Hills, California for $ 150,000. Plaintiff had secured this note with personal assets, and it was repaid in 1972.24a LSM again borrowed $ 150,000 from City National Bank in September, 1972. Both plaintiff and Schapiro gave personal guarantees on this note, guarantees which could be revoked once the note was repaid. It was repaid in October, 1972.24b
In the fall of 1971, steps were undertaken towards a contemplated public financing the vehicle which plaintiff, Schapiro and Feldman considered essential to raise the capital to meet LSM's financial needs and provide the necessary funds for nationwide expansion. To this end, Schapiro retained the services of Richard A. Eisner & Co., certified public accountants, to review LSM's books. They reported the books were not certifiable. Counsel retained for the public offering advised Schapiro that because LSM's financial records were inadequate the Securities Exchange Commission would not approve an underwriting for it.
To overcome this problem, a plan was devised to create a new and separate corporation, one which would eventually take over the business of LSM and SBC.
The new plan was adopted and consummated during the latter part of 1971 and early part of 1972. First, in December, 1971 there was a merger between SBC and LSM, with the latter the surviving entity. As a result of this merger Schapiro owned 50% of LSM's stock, plaintiff 331/3% and Feldman 162/3%.
As plaintiff testified, this division of stock was agreed upon because it reflected the past contribution of the parties to their respective companies as well as their respective efforts towards future similar contributions to the new company.
Next, LSM distributed all of its stock in its wholly owned subsidiary, Professional Insurance Administrators ("Professional") to the parties in the same proportion as their holdings in LSM. Simultaneously, the three parties contributed their stock in Professional to a newly formed Delaware corporation, PIA, Inc. in exchange for PIA stock.
The net result of this final transaction was that each participant held stock in PIA as follows: Schapiro 45%; plaintiff 30%; Feldman 15%; and Staunton 10%.
After a series of name changes, PIA, Inc. became known as Adams, Scott & Conway.
Despite plaintiff's desire to remain a partner in ASC, he was discharged in October, 1974. The proof adduced at trial concerning the termination of plaintiff's position is likewise unclear and confusing. Defendants assert that his post was terminated for cause. To this end, defendants introduced evidence of several of plaintiff's business practices and difficulties to which defendants objected. For example, Hjelm, a vice-president of ASC who worked with plaintiff in California between April, 1972 and April, 1973, testified that he observed plaintiff's performance and objected to several of his practices in that: (1) plaintiff charged the company for personal expenses; (2) plaintiff failed to secure needed information in connection with insurance applications; (3) plaintiff was not a good collector of accounts; (4) company funds were used to cover overdrafts in plaintiff's personal accounts; and (5) plaintiff wrote off substantial numbers of credit balances money owing to customers.
Hjelm further testified that ASC was concerned with legal proceedings brought by John Hancock Mutual Life Ins. Co. in 1972; that LSM had never forwarded funds owing to Hancock with the result that Hancock commenced legal proceedings and the action was eventually settled. Hjelm's testimony included the assertion that the California insurance commissioner in 1973 investigated plaintiff's business practices and that Hjelm in support of plaintiff met with the commissioner in an effort to persuade him not to revoke plaintiff's license.
Hjelm concluded his testimony with the assertion that the main factor ultimately crucial to the discharge of plaintiff was his lack of productivity;
that theretofore he had spoken to Schapiro of it; that Schapiro recognized it and wanted to try to motivate plaintiff by giving him a title; that in late 1973 a meeting was held between Schapiro, plaintiff and several other employees of ASC at which plaintiff was made senior vice-president of marketing for ASC.
Addressing himself to what he considered other bad business practices by plaintiff and warranting his discharge, Schapiro testified that: (1) plaintiff failed to execute guarantees in connection with financing efforts; (2) disregarded the company's expense policies; and (3) failed to disclose the true extent of LSM's financial difficulties.
Plaintiff's sole response was a denial that he was fired for cause and included a naked refutation of the points defendants raised; he asserted that the real reason for his discharge was the fact he was no longer needed for refinancing arrangements.
Plaintiff spends many pages in his memorandum (post-trial) comparing his practices and use of company funds with Schapiro's and asserts that he, plaintiff, was singled out for unfavorable treatment.
It is clear that from at least 1972 plaintiff understood that Schapiro was to be the chief executive officer of the company whose efforts would be primarily devoted to raising capital for the company. Comparing the expenses which plaintiff spent bringing business to ASC with those which Schapiro incurred raising funds (necessitating several overseas trips), is simply not realistic. Their individual functions were different and of necessity the expenses related thereto are not comparable.
The actual circumstances which led to the firing of plaintiff are unclear. In late October, 1974 a meeting was held in the California offices of ASC attended by plaintiff, Schapiro, P. Hjelm and Men Levi, the manager of the Los Angeles office. What exactly was said at this meeting is ambiguous. Plaintiff testified that he stated his discontent and that perhaps the merger was not a good venture because the company was in no better financial position than before the merger.
On October 22 or 23, 1974 plaintiff met with Levi in the latter's office. Levi asked for plaintiff's resignation. Plaintiff testified that he was absolutely shocked at this occurrence and told Levi he would not resign. Levi then told him he was fired as of "right now."
Schapiro testified that he had given Levi the authorization to discharge plaintiff, but left the details to Levi's discretion.
Plaintiff's first three claims for relief arise out of the same factual allegations of fraud by the defendants. Plaintiff claims that Schapiro, in his individual capacity and as agent for ASC, knowingly made certain untrue representations to plaintiff as hereinabove outlined in connection with the transfer of his Professional stock for ASC shares, to wit: (1) plaintiff would be employed on equivalent terms with Schapiro; (2) Schapiro would fulfill his obligations as represented in a letter of intent signed by both plaintiff and Schapiro (exhibit 18); and (3) plaintiff would be relieved of personal liability on the City National Bank, Lee and Citron promissory notes. Claim 1 is based on Rule 10b-5, 17 C.F.R. § 240.10b-5; claim 2 on Cal.Corp.Code § 25401 (West), an antifraud provision; claim 3 on California common law fraud.
Our analysis of the issues raised by these three claims necessitates an examination of the entire course of dealings between plaintiff and Schapiro from the time they first met to after the date plaintiff was discharged from ASC in October, 1974. Many of the issues raised here relate to all the other separate but interrelated claims asserted in this action by plaintiff. Accordingly, our disposition of those other claims, discussed hereinafter, is pertinent to these three claims as well.
To sustain a private action for damages under Rule 10b-5, the plaintiff must establish the following essential elements: (1) defendants used the mails, or an instrumentality of interstate commerce, in connection with the purchase or sale of a security; (2) that in connection with the purchase or sale, defendants employed a device, scheme, or artifice to defraud, or made an untrue statement of a material fact, or omitted to state a material fact necessary in order to make the statements in light of the circumstances under which they were made not misleading, or engaged in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person; (3) that the defendants had the requisite "scienter"; (4) that the plaintiff relied on the statements of defendant; and (5) that plaintiff suffered damage as a result. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S. Ct. 1375, 47 L. Ed. 2d 668 (1976); SEC v. Texas Gulf Sulphur Co., 401 F.2d 833 (2d Cir. 1968) (en banc), cert. denied, 394 U.S. 976, 89 S. Ct. 1454, 22 L. Ed. 2d 756 (1969); 15 U.S.C. § 78j(b); 17 C.F.R. § 240.10b-5.
The elements of fraud under California common law are very similar:
A cause of action for fraud is proven where the evidence discloses (1) the making of a false representation of a material fact; (2) that defendant either knew the statement was false, or lacked an honest belief in its truth, or that the statement was carelessly made, in a manner not warranted by the information possessed by defendant; (3) that it was made with intent to induce reliance by plaintiff; (4) that it was justifiably relied on by plaintiff, and (5) plaintiff suffered damage thereby.
Gagne v. Bertran, Cal.App., 264 P.2d 641, 645 (Cal.Dist.Ct.App.1953) (citations omitted), rev'd on other grounds, 43 Cal.2d 481, 275 P.2d 15 (Cal.Sup.Ct.1954).
Under both Rule 10b-5 and common law fraud, plaintiff must prove that the defendants made an untrue or false statement of material fact. As to the alleged representation by Schapiro that plaintiff would be relieved of personal liability on the Lee and Citron notes, we can not conclude from the total trial record that this representation was made. The evidence adduced was conflicting and unconvincing. As to the Lee note, she and plaintiff testified that the Schapiro promise was made. Schapiro denied this. As to the Citron note, plaintiff's mother-in-law completely contradicted plaintiff's own testimony. Considering the confusion in the record and the contradictions in plaintiff's testimony, we are not convinced and find that Schapiro did not represent to plaintiff that he would be relieved of personal liability on these notes.
As to the representation by Schapiro that plaintiff would be relieved of liability on the City National Bank note: That note was in fact paid by LSM. Plaintiff admitted that the City National Bank indebtedness which existed when LSM and SBC were merged was paid in October, 1972. It is true that plaintiff had signed a continuing guarantee with the bank, but once the note was paid, plaintiff was free to revoke the guarantee it was plaintiff's own decision to remain personally liable on the other notes issued by LSM in 1973. Here again we find the proof offered to sustain the contention unconvincing.
The remaining representations which plaintiff claims were made involved his relationship with Schapiro and his continued role with the new company. Specifically, plaintiff alleges that Schapiro promised he would fulfill his obligations as evidenced by the letter of intent (exhibit 18) that plaintiff and Schapiro would be employed on equivalent terms.
To support his contention that Schapiro made these representations with no intent to fulfill them, plaintiff argues that several occurrences are probative: (1) defendants did not offer plaintiff an employment contract in 1972 even though Schapiro had one; (2) defendants' bad faith dealing with plaintiff in 1973 concerning employment and equalization agreements; (3) Schapiro's execution of LSM notes to Lee and the Citrons in 1974 when he knew LSM was unable to repay them; and (4) defendants reneged on these notes once Rosenbloom was discharged in 1974.
Plaintiff rightfully points out that it is impossible for us to probe Schapiro's mind for any direct evidence of intent or state of mind at the time when these representations were made. We can only view what transpired from hindsight and where possible draw our own inferences from the credible proof adduced.
We find that plaintiff has failed to convince us by a fair preponderance of the credible evidence that Schapiro made these representations with knowledge of their falsity or made carelessly or recklessly. The trial record contains evidence that Schapiro intended to carry out his promise. For instance, plaintiff was offered employment contracts by Schapiro in 1973 and 1974 and had several discussions with Schapiro concerning the same as early as 1972. Plaintiff was also offered by Schapiro an equalization agreement in 1973, but refused to sign it because he would not accept equal burdens with Schapiro. Further, plaintiff admitted that while he was employed by ASC he received the same salary, benefits and terms of employment as Schapiro. He was also a member of the board of directors and a senior vice-president of ASC.
Plaintiff asserts that his eventual discharge from employment is strongly probative of Schapiro's bad intent. We are not prepared to so conclude. Plaintiff's termination occurred approximately three years after the date that the alleged representations were made. The record is replete with evidence of circumstances (not present in 1970 and 1971) which tend to prove that defendants became displeased with plaintiff's performance only after the passage of a number of years.
As one California court has stated:
A declaration of intention, although in the nature of a promise, made in good faith, without intention to deceive, and in honest expectation that it will be fulfilled, even though it is not carried out, does not constitute a fraud.
Church of the Merciful Saviour v. Volunteers of America, Inc., 184 Cal.App.2d 851, 8 Cal.Rptr. 48, 53 (Dist.Ct.App.1960) (citations omitted).
See Ernst & Ernst v. Hochfelder, supra; Gagne v. Bertran, supra; Cal.Civ.Code § 1572 (West). See also W. Prosser, Law of Torts 700-03, 714-15 (4th ed. 1971).
In January, 1972, plaintiff, Schapiro and Feldman met in New York to discuss the proposed public financing for ASC, the new company. Plaintiff testified that at one of these meetings he stated that he wanted to memorialize his understanding as to the relationship and relative standings of the three parties.
To this end, at a meeting held on January 21, 1972, discussions were held concerning these matters; counsel to ASC was directed to draw up a document reflecting the understanding of the parties. At that same meeting the document was prepared and denominated a letter of intent.
It detailed, among other matters, the relative position and salary the three parties would have in the new company. The remaining provisions of the document provided: (1) plaintiff, Schapiro and Feldman would at all times vote their shares to elect the others as members of the board of directors; (2) all decisions relating to LSM and ASC would be made upon agreement of the three parties, but in the event no agreement resulted Schapiro would have final say; (3) as ...