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NATOWITZ v. MEHLMAN

June 28, 1983

ELSA NATOWITZ, individually and on behalf of all Limited Partners of LEXINGTON/56th ASSOCIATES, and LEXINGTON/56th ASSOCIATES, a New York Limited Partnership by ELSA NATOWITZ, a Limited Partner, Plaintiffs, against GEORGE MEHLMAN, PHILIP WOLITZER and MILTON KESTENBERG, all individually and as General Partners of LEXINGTON/56th ASSOCIATES, MEHLMAN MANAGEMENT CORP., MIDLEX ASSOCIATES, STEPHEN FRANK, MATTHEW BERGER, HERBERT GLABMAN, THE MASTAN COMPANY INCORPORATED, WALTER J. SCHNEIDER, PAUL GREEN, BARRY TRAUB, HELMSLEY-SPEAR, INC., 56th/LEXINGTON ASSOCIATES, and CHEMICAL BANK, Defendants.


The opinion of the court was delivered by: DUFFY

MEMORANDUM & ORDER

KEVIN THOMAS DUFFY, D.J.:

 The plaintiff in the present action, Elsa Natowitz, a limited partner in Lexington/56th Associates ("Lex/56"), a New York limited partnership, alleges on behalf of herself and all other Lex/56 limited partners that Lex/56's general partners, George Mehlman, Philip Wolitzer, and Milton Kestenberg, and other persons named as defendants defrauded the partnership and rendered it worthless by either directing or participating in the assignments of a mortgage, the partnership's sole asset, without the knowledge or consent of the limited partners and without providing the partnership with any consideration for the transfers. Natowitz's original complaint charged one or all of the defendants with violations of section 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78j(b) (1976), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1982); violations of the New York securities anti-fraud act, N.Y. Gen. Bus. Law § 352-c (McKinney 1968 & Supp. 1982-83); common law fraud; violations of section 98 of New York's partnership law, N.Y. Partnership Law § 98 (McKinney 1948); and breach of fiduciary duty. On June 22, 1982, on the motion of certain defendants, I dismissed the complaint in its entirety on the ground that Natowitz had failed to plead her allegations of fraud under the 1934 Act with the particularity required by Fed. R. Civ. P. 9(b). 542 F. Supp. 674. Dismissal of her federal securities law claim, which served as the sole predicate for federal jurisdiction, rendered inappropriate the exercise of pendent jurisdiction over her various state law claims. Id. at 676. However, I granted Natowitz leave to amend her complaint within twenty days of the filing of the June 22 Memorandum and Order, and on July 12, she served and filed an amended complaint which differs from the original complaint only in that it attempts to plead its allegations of fraud with more particularity. Defendants 56th/Lexington Associates ("56th/Lex Assoc."), a New York partnership, Helmsley-Spear, Inc., a New York corporation, Wolitzer, Stephen Frank, Matthew Berger, Herbert Glabman, Paul Green, the estate of Walter J. Schneider, and Chemical Bank, a New York banking corporation, have now moved for dismissal of the amended complaint for the following reasons: (1) failure to state a federal claim upon which relief can be granted; (2) lack of subject matter jurisdiction over pendent New York state law claims; (3) incapacity of the plaintiffs to sue derivatively; and (4) failure, again, to plead fraud with particularity. Because I conclude that Natowitz's amended complaint fails to state a federal securities law claim under section 10(b) and Rule 10b-5, and because such a failure leaves this court without power to exercise pendent jurisdiction over her state law claims, defendants' motions for dismissal of Natowitz's amended complaint are granted.

 BACKGROUND

 The facts alleged in Natowitz's amended complaint, which must be deemed true for the purposes of these motions to dismiss, Cruz v. Beto, 405 U.S. 319, 322, 31 L. Ed. 2d 263, 92 S. Ct. 1079 (1972), are detailed in my Memorandum and Order of June 22, 1982, and need only be summarized here. 542 F. Supp. at 675. Originally, Lex/56 had owned as its sole asset a two-thirds interest in a building located at 140-150 East 56th Street, New York, New York. Lex/56 subsequently sold its share in the building to 56th/Lex Assoc. and received in return a mortgage which then became Lex/56's sole asset.

 Natowitz alleges that she purchased, at a time unstated, an interest in the Lex/56 limited partnership,

 in reliance on the representations that the sole partnership asset (either the Building or, subsequently, the Mortgage) would not be sold or transferred without [the limited partners"] knowledge and written consent (as required by section 98 of the New York partnership Law), but in any event, if such property were sold and transferred, it would not be for less than full and fair consideration to the Partnership.

 Verified Amended Complaint at P22. Natowitz pleads that in violation of this representation, two of Lex/56's general partners, defendants Mehlman and Wolitzer, purportedly with the knowledge and participation of the other defendants, made assignments of Lex/56's mortgage interest without the knowledge or consent of the limited partners.Pursuant to the contracts of assignment, the monthly mortgage payments of 56/Lex Assoc. and Helmsley-Spear, the managing agent of the building, were tendered to defendants Frand and Berger instead of to Lex/56. In consideration for the mortgage assignment, defendants Green, Frank, and Berger cancelled antecedent personal debts owed to them by defendant Mehlman. Since October, 1978, Lex/56 has not received any mortgage payments.

 In support of her federal securities fraud claim, Natowitz alleges that the assignments of the mortgage, which deprived the partnership of its sole asset without consideration and without the knowledge or consent of the limited partners, precipitated a fraudulent "forced sale" of her partnership interest by rendering the partnership worthless, thereby converting each partnership intereest into a mere claim for cash. Further, she alleges that the defendants' purported fraud was "in connection with" the forced sale.

 DISCUSSION

 A claim under sectio 10(b) of the 1934 Act and Rule 10b-5 can only be established if the fraud is "in connection with the purchase or sale" of a security. 15 U.S.C. § 78j(b) (1976); 17 C.F.R. § 240.10b-5 91982); see Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 44 L. Ed. 2d 539, 95 S. Ct. 1917 (1975). Natowitz argues that her amended complaint "plainly states a claim under Rule 10b-5."

 Although acknowledging that the Lex/56 partnership is still intact and that she has not actually sold her securities, cf. Bolger v. Laventhol, Krekstein, Horwath & Horwath, 381 F. Supp. 260, 266 (S.D.N.Y. 1974) (conversion of partnership interests into cash through dissolution of partnership constitutes a sale of securities); Feldberg v. O'Connell, 338 F. Supp. 744, 746 (D. Mass. 1972) (same), Natowitz nonetheless contends that since the purportedly fraudulent assignments of Lex/56's sole asset rendered the partnership worthless, she was a "forced seller" of securities under the rule of Vine v. Beneficial Finance Co., 374 F.2d 627 (2d Cir.), cert. denied, 389 U.S. 970, 19 L. Ed. 2d 460, 88 S. Ct. 463 (1967). Vine held that a minority shareholder, still possessing his shares at the time the suit was commenced, had standing to sue under Rule 10b-5 on the ground that an allegedly fraudulently induced short-form merger placed him in a position where he had, as a pratical matter, no option but to exchange his shares for case, either by accepting the defendant corporation's cash offer or by pursuing his right of appraisal. The court concluded that since the plaintiff necessarily would be forced to become a party to a sale, "requiring him to do so as a condition to suit [would be] a needless formality." Id. at 634; see also Feldberg v. O'Connell, 338 F. Supp. at 746-47 (limited partners were "forced sellers" where, though the partnership was not yet dissolved, dissolution was rendered inevitable). Natowitz also contends that her amended complaint adequately alleges that the purported fraud was "in connection with" this forced sale.

 Defendants, on the other hand, assert (1) that the Vine forced sale doctrine has been effectively negated or cut back by the Supreme Court's ruling in Blue Chip Stamps, supra; (2) that the doctrine is not applicable to the instant facts; and (3) that, in any event, the purported fraud was not "in connection with" the forced sale. Without reaching the forced sale questions, I grant defendants' motions for dismissal on the ground that the amended complaint has failed to set forth facts satisfying the "in connection with" requirement.

 The gist of Natowitz's position is that the "in connection with" requirement is met because the purported fraud was the direct and proximate cause of the forced sale. Specifically, the partnership interests would never have been rendered worthless, thereby precipitating any forced sale, but for the fraudulent assignments of the mortgage. Natowitz, however, does not allege that defendants sought to effectuate or influence a transformation of the limited partnership interests into a claim for cash, that defendants' purpose was to achieve such a sale of the partnership interests through dissolution or otherwise, or that such a sale was necessary or even helpful to the accomplishment of defendants' fraudulent scheme. Indeed, the only conclusion that can be gleaned from the pleaded facts is that although defendants must have realized that the fraudulent assignments would render the partnership worthless, thereby causing a forced sale, they were indifferent ...


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