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COHEN v. BLOCH

December 18, 1981

RUTH COHEN, Plaintiff, and HARRY LEWIS, Plaintiff-Intervenor, against EPHRIAM BLOCH, JOSEPH VITALE, ALVIN L. LEVINE, ALBERT BLOCH, HARRY FISHLOW, FRED A. LITTLE and PRF CORPORATION, Defendants.


The opinion of the court was delivered by: SWEET

SWEET, D.J.

The defendant officers and directors of the PRF Corporation ("PRF") ("the defendants") have moved under Fed.R.Civ.P. 12(b) for judgment dismissing the complaint in the stockholder derivative action now prosecuted by the intervening plaintiff Harry Lewis ("Lewis") on the ground that the action is now moot. An affidavit has been submitted in support of the motion setting forth certain facts which are set forth below and are not contester. For the reasons stated below the motion will be denied as to the first cause of action and granted as to the second cause of action.

 This 1978 action has had a difficult and tortuous procedural past, a number of motions having been disposed of relating to the capacity of the plaintiff, discovery, and intervention without reaching the merits of the controversy. Familiarity with the prior decisions of the court dealing with this procedural history is assumed. What has remained before the court is an intervenor's complaint which, briefly stated, alleges violation of fiduciary duties by the defendants as well as Securities Act violations arising out of a termination of the purchase agreement entered into between Bloch and PRF, a subsequent plan of recapitalization and improprieties in the proxy solicitation relating to the termination and recapitalization. During this period, PRF terminated the stock purchase agreement which was the subject of the first cause of action and proceeded with its recapitalization plan which was the subject of the second cause of action.

 As a result of a prior action brought against PRF by the Securities & Exchange Commission, and a consequent consent decree entered in the United States District Court for the District of Columbia, a special agent was appointed in connection with a proposed plan of reorganization. Proxy materials were sent the shareholders of PRF in December of 1978, describing the plan to be submitted to a meeting of the shareholders on January 26, 1979. Accompanying these materials was the report of the special agent based on an independent evaluation. The meeting was held, the plan approved, and the recapitalization took place. As a consequence, the Articles of Incorporation were amended to increase the authorized number of common shares, and Class A shares were eliminated altogether by substituting nineteen shares of common stock for each share of Class A stock. Prior to the recapitalization, Class A shares were equivalent to twenty common shares for voting and liquidation purposes, however participated equally with common shares for dividend purposes.

 Thereafter on April 27, 1980 at a special meeting called for the purpose, the shareholders of PRF approved the sale of substantially all of the assets of PRF and the subsequent liquidation and dissolution of the company including the change of its name to the XYZ Liquidating Corporation. On December 31, 1980 a definitive agreement of sale was executed which was subsequently submitted to the shareholders at a meeting of April 27, 1981 where the agreement, the liquidation and the dissolution were approved. On May 14, 1981, the sale of assets closed, and the surrender of stock in liquidation commenced.

 Pursuant to an agreement reached in late 1968, PRF acquired the right to purchase 80% of the class A shares held in the estate of Ephraim Bloch ("Bloch"), then chairman of PRF at a price to be fixed by the application of certain formulae (the "stock purchase agreement"). A stated purpose of the agreement was to prevent any disruption of PRF's management that might result from a sudden shift in ownership of a large block of stock caused by Bloch's death. However, the agreement in no way limited or prevented Bloch from selling any or all of his Class A holdings during his lifetime in which case the shares would not be subject to the agreement. In June of 1977 the PRF board terminated this agreement, a termination which is the subject of Lewis' first cause of action. On June 11, 1981 after the liquidation plan had been adopted as just described, Bloch sold his shares to his brother.

 Lewis claims PRF's termination of the purchase agreement is null and void. Since such a declaration by the court would have no effect on the parties, their rights and obligations, that relief requested has been rendered moot by subsequent events. "[F]ederal courts are without power to decide questions that cannot affect the rights of litigants in the case before them." North Carolina v. Rice, 404 U.S. 244, 246 (1971). "Simply stated, a case is moot when the issues presented are no longer 'live' or the parties lack a legally cognizable interest in the outcome." Powell v. McCormack, 395 U.S. 486, 496 (1969). The requested declaration of invalidity of the termination would have the effect of determining the agreement to be binding and in effect. The agreement provided, however, that Bloch had the unfettered right to sell all or part of his holdings prior to his death in which case the shares would not be covered by the agreement. Since he has exercised this right, PRF would have no rights remaining under the agreement even if it were in effect, and therefore a declaration of invalidity of termination would not benefit Lewis as the representative of the corporation, and is therefore moot.

 Declaratory relief, however, is not the only relief sought in the complaint which also prays for "such other and further relief as the court may deem proper." Courts are granted considerable leeway in fashioning a remedy, United States for use of Bergen Point Iron Works v. Maryland Cas. Co., 384 F.2d 303, 304 (2d Cir. 1967); J.I. Case Co. v. Borak, 377 U.S. 426, 433-34 (1964), Bell v. Hood, 327 U.S. 678, 684 (1946); Columbia Nastri & Carta Carbone v. Columbia Ribbon & Carbon Mfg. Co., 367 F.2d 308, (2d Cir. 1966), and monetary relief can clearly fall within the prayer for relief quoted above. Truth Seeker Co. v. Dunning, 147 F.2d 54, 57 (2d Cir. 1945). Lewis, therefore, appears to claim that the corporation should be awarded monetary damages for the termination of the purchase agreement in violation of Section 10(b) and Rule 10b-5.

 A shareholder derivative action on behalf of the corporation can be brought as an implied private action under Rule 10b-5 for damages resulting to the corporation. Shell v. Hensley, 430 F.2d 819, 824 (5th Cir. 1970); Herpech v. Wallace, 430 F.2d 792, 803 (5th Cir. 1970); Schoenbaum v. Firstbrook, 405 F.2d 215, 219 (2d Cir. 1968) (en banc), cert.denied, 395 U.S. 906 (1969); Ruckle v. Roto American Corp., 339 F.2d 24, 28 (2d Cir. 1964). In dealing with a derivative suit on behalf of corporate purchasers and sellers the problem arises "in the degree to which the knowledge of officers and directors can be attributed to the corporation, thereby negating the element of deception." Goldberg v. Meridor, 567 F.2d 209, 215 (2d Cir. 1977), cert.denied, 434 U.S. 1069 (1978). As stated by Judge Friendly:

 There is deception of the corporation (in effect, of its minority shareholders) when the corporation is influenced by its controlling shareholder to engage in a transaction adverse to the corporation's interests (in effect, the minority shareholders' interests), and there is non-disclosure or misleading disclosures as to the material facts of the transaction.

 Goldberg. v. Meridor, 567 F.2d at 217. See also Schoenbaum v. Firstbrook, 405 F.2d at 217; Pappas v. Moss, 393 F.2d 865 (3d Cir. 1968).

 The complaint alleges a failure to disclose substantial back orders that would have resulted in higher anticipated future earnings at the time the option agreement was terminated and one can construe the complaint to allege that had such knowledge been available to a disinterested director or the shareholders, the cancellation of the option agreement would not have taken place. Although these omissions might conceivably appear material as facts that might "'have assumed actual significance in the deliberations' of reasonable and disinterested directors or created 'a substantial likelihood' that such directors would have considered the 'total mix' of information available to have been 'significantly altered,'" Goldberg v. Meridor, 567 F.2d at 219, see also Shell v. Hensley, 430 F.2d at 827, cf., TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 (1976), whether this omission now meets the burden of materiality may be questionable in view of the uncertain value of the option. However, for these reasons the first cause of action is not moot although the nature of the damages will be discussed shortly in connection with the state claim.

 It is also well established that a private action for damages under Section 10(b) and Rule 10b-5 can only be brought by a purchaser or seller of the security. Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731-49 (1975); Birnbaum v. Newport Steel Corp., 193 F.2d 461 (1952), cert.denied, 343 U.S. 956 (1952). Although perhaps a restrictive application of the implied private right, this rule limits recovery and hence enforcement of the statutory scheme to:

 those persons whose active participation in the marketing transaction promises enforcement of the statute without undue risk of abuse of the litigation process and ...


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