UNITED STATES DISTRICT COURT SOUTHERN DISTRICT OF NEW YORK
August 19, 1983
MORGAN STANLEY & CO., INCORPORATED Plaintiff, against ARCHER DANIELS MIDLAND COMPANY Defendant.
The opinion of the court was delivered by: SAND
This action, together with 83-5601 and 83-5604, arises out of the planned redemption of $125 million in 16% Sinking Fund Debentures ("the Debentures") by the defendant ADM Midland Company ("ADM") scheduled to take place on Monday, August 1st, 1983. Morgan Stanley & Company, Inc. ("Morgan Stanley") brings this suit under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j, § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77g, §§ 323(a) and 316(b) of the Trust Indenture Act of 1939, 15 U.S.C. §§ 77www(a), 77ppp(b), and other state and federal laws, alleging that the proposed redemption plan is barred by the terms of the Indenture, the language of the Debentures, and the Debenture Prospectus. Plaintiff contends, in addition, that the failure on the part of ADM to reveal its intention to redeem the Debentures, as well as its belief that such redemption would be lawful under the terms of the Indenture Agreement, amounts to an intentional, manipulative scheme to defraud in violation of federal and state securities and business laws. Morgan Stanley seeks a preliminary injunction enjoining ADM from consumating the redemption as planned, and, after full consideration on the merits, permanent injunctive relief barring the proposed transaction and damages. Both parties have pursued an expedited discovery schedule and now cross-move for summary judgment.
In May, 1981, Archer Daniels issued $125,000,000 of 16% Sinking Fund Debentures due May 15, 2011. The managing underwriters of the Debenture offering were Goldman Sachs & Co., Kidder Peabody & Co., and Merrill, Lynch, Pierce, Fenner, & Smith, Inc. The Debentures state in relevant part:
The Debentures are subject to redemption upon not less than 30 nor more than 60 days' notice by mail, at any time, in whole or in part, at the election of the Company, at the following optional Redemption Price (expressed in percentages of the principal amount), together with accrued interest to the Redemption Date..., all as provided in the Indenture:
If redeemed during the twelve-month period beginning May 15 of the years indicated:
1981 115.500 %
199 0 108.525
1991 107.750 %
200 0 100.775
and thereafter at 100%; provided, however, that prior to May 15, 1991, the Company may not redeem any of the Debentures pursuant to such option from the proceeds, or in anticipation, of the issuance of any indebtedness for money borrowed by or for the account of the Company or any Subsidiary (as defined in the Indenture) or from the proceeds, or in anticipation of a sale and leaseback transaction (as defined in Section 1008 of the Indenture), if, in either case, the interest cost or interest factor applicable thereto (calculated in accordance with generally accepted financial practice) shall be less than 16.08% per annum.
The May 12, 1981 Prospectus and the Indenture pursuant to which the Debentures were issued contain substantially similar language.
The Moody's Bond Survey of April 27, 1981, in reviewing its rating of the Debentures, described the redemption provision in the following manner:
"The 16% sinking fund debentures are nonrefundable with lower cost interest debt before April 15, 1991. Otherwise, they are callable in whole or in part at prices to be determined.
The proceeds of the Debenture offering were applied to the purchase of long-term government securities bearing rates of interest below 16.089%.
ADM raised money through public borrowing at interest rates less than 16.08% on at least two occasions subsequent to the issuance of the Debentures. On May 7, 1982, over a year before the announcement of the planned redemption, ADM borrowed $50,555,500 by the issuance of $400,000,000 face amount zero coupon debentures due 2002 and $100,000,000 face amount zero coupon notes due 1992 (the "Zeroes"). The Zeroes bore an effective interest rate of less than 16.08%. On March 10, 1983, ADM raised an additional $86,400,000 by the issuance of $263,232,500 face amount Secured Trust Accrual Receipts, known as "Stars," through a wholly-owned subsidiary, Midland Stars Inc. The Stars carry an effective interest rate of less than 16.08%. The Stars were in the form of notes with varying maturities secured by government securities deposited by ADM with a trustee established for that purpose. There is significant dispute between the parties as to whether the Stars transaction should be treated as an issuance of debt or as a sale of government securities. We assume, for purposes of this motion, that the transaction resulted in the incurring of debt.
In the period since the issuance of the Debentures, ADM also raised money through two common stock offerings. Six million shares of common stock were issued by prospectus dated January 28, 1983, resulting in proceeds of $131,370,000. And by a prospectus supplement dated June 1, 1983, ADM raised an additional $15,450,000 by issuing 600,000 shares of common stock.
Morgan Stanley, the plaintiff in this action, bought $15,518,000 principal amount of the Debentures at $1,252.50 per $1,000 face amount on May 5, 1983, and $500,000 principal amount at $1,200 per $1,000 face amount on May 31, 1983. The next day, June 1, ADM announced that it was calling for the redemption of the 16% Sinking Fund Debentures, effective August 1, 1983. The direct source of funds was to be the two ADM common stock offerings of January and June, 1983. The proceeds of these offerings were delivered to the Indenture Trustee, Morgan Guaranty Trust Company, and deposited in a special account to be applied to the redemption. The amount deposited with the Indenture Trustee is sufficient to fully redeem the Debentures.
Prior to the announcement of the call for redemption, the Debentures were trading at a price in excess of the $1,139.50 call price. At no time prior to the June 1 announcement did ADM indicate in any of its materials filed with the Securities and Exchange Commission or otherwise that it intended to exercise its redemption rights if it felt it was in its self-interest to do so. Nor did it express any contemporaneous opinion as to whether it was entitled under the terms of the Indenture to call the Debentures when it was borrowing funds at an interest rate less than 16.08% if the source of such redemption was other than the issuance of debt.
Plaintiff's allegations can be reduced to two general claims: First, plaintiff contends that the proposed redemption is barred by the express terms of the call provisions of the Debenture and the Indenture Agreement, and the consumation of the plan would violate the Trust Indenture Act of 1939, 15 U.S.C. § 77aaa et seq. and common law principles of contract law. The plaintiff's claim is founded on the language contained in the Debenture and Trust Indenture that states that the company may not redeem the Debentures "from the proceeds, or in anticipation, of the issuance of any indebtedness... if... the interest cost or interest factor... [is] less than 16.08% per annum." Plaintiff points to the $86,400,000 raised by the Stars transaction within 90 days of the June 1 redemption announcement, and the $50,555,500 raised by the Zeroes transaction in May, 1982 -- both at interest rates below 16.08% -- as proof that the redemption is being funded, at least indirectly, from the proceeds of borrowing in violation of the Debentures and Indenture agreement. The fact that ADM raised sufficient funds to redeem the Debentures entirely through the issuance of common stock is, according to the plaintiffs, an irrelevant "juggling of funds" used to circumvent the protections afforded investors by the redemption provisions of the Debenture. Plaintiff would have the Court interpret the provision as barring redemption during any period when the issuer has borrowing at a rate lower than that prescribed by the Debentures, regardless of whether the direct source of the funds is the issuance of equity, the sale of assets, or merely cash on hand.
The defendant would have the Court construe the language more narrowly as barring redemption only where the direct or indirect source of the funds is a debt instrument issued at a rate lower than that it is paying on the outstanding Debentures. Where, as here, the defendant can point directly to a non-debt source of funds (the issuance of common stock), the defendant is of the view that the general redemption schedule applies.
Plaintiff's second claim, brought under federal and state securities laws and state business law, is based on the alleged failure on to the part of ADM to reveal three material facts in any of the documents with the Securities and Exchange Commission or otherwise: (1) that ADM held a "highly restrictive" view of the redemption language that prohibited it from calling the Debentures only where such redemption was funded directly from an account holding the proceeds of a prohibited borrowing; (2) that ADM contemplated redemption when it deemed it to be in ADM's self-interest despite contemporaneous borrowing at rates below 16.08%; and (3) that ADM intended to use the proceeds from sale of the Debentures for speculation in long-term government securities in conjunction with a plan to call the Debentures if and when interest rates dropped. Morgan Stanley contends that the failure to disclose these facts amounted to a deceptive, misleading, and manipulative course of conduct because it fostered what it describes as the prevailing view among investors that ADM could not and would not call its Debentures in the near future.
According to Morgan Stanley, the fact that the Debentures were trading at levels above the call price prior to the redemption announcement bolsters the argument that the investing public thought it was protected against early redemption. The plaintiff asserts that it would not have bought the Debentures without what it perceived to be protection against premature redemption.
ADM contends that plaintiff's allegations of securities fraud stem in the first instance from its strained and erroneous interpretation of the redemption language. Defendant argues that the redemption language itself -- a boilerplate provision found in numerous Indenture Agreements -- was sufficient disclosure. Moreover, defendant asserts that it had no plan or scheme at the time the Debentures were issued to exercise its call rights in conjunction with speculation in government securities or otherwise and that the provision existed solely to offer the issuer "financial flexibility." More important, defendant contends that its view of the Debenture language was the one commonly accepted by both bondholders and the investing public. In support of this contention, defendant points to the only case directly to address the issue, Franklin Life Insurance Co. v. Commonwealth Edison Co., 451 F. Supp. 602 (S.D. Ill. 1978), aff'd per curiam on the opinion below, 598 F.2d 1109 (7th Cir.), rehearing and rehearing en banc denied, id.id., cert. denied, 444 U.S. 900, 62 L. Ed. 2d 136, 100 S. Ct. 210 (1979). Franklin held, with respect to language almost identical to that contained in the ADM Debentures, that a redemption directly funded through equity financing was not prohibited despite contemporaneous borrowing by the issuer.
Defendant contends that it first seriously contemplated redemption in the Spring of 1983 upon the suggestion of Merrill Lynch, one of its investment bankers. Merrill Lynch had received legal advice that a redemption transaction of the sort contemplated was proper under the language of the Debenture and the analysis of the Court in Franklin. Moreover, the defendant asserts that Morgan Stanley itself was fully aware of this interpretation of the redemption language, although it may have disagreed with it. ADM explains the high price at which the Debentures were trading prior to the redemption announcement not as a reflection of investors' belief that the Debentures were not currently redeemable, but rather as a reflection of the belief that ADM itself, or some other interested buyer, might seek to purchase the Debentures through a tender offer or other financial transaction.
This Circuit will grant preliminary injunctive relief only upon a showing of (a) irreparable harm and (b) either (1) a likelihood of success on the merits or (2) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting preliminary relief. E.g.,Sierra Club v. Hennessy, 695 F.2d 643, 647 (2d Cir. 1982); Sperry Int'l Trade, Inc. v. Israel, 670 F.2d 8, 11 (2d Cir. 1982).Morgan Stanley fails to satisfy these criteria in all respects.
First, plaintiff has failed to present any facts supporting a contention that money damages would be an inadequate remedy should it prevail in this action. Where money damages are available, there can be no finding of irreparable harm.E.g., Jackson Dairy, Inc. v. H.P. Hood & Sons, Inc., 596 F.2d 70, 72 (2d Cir. 1979).
Despite what plaintiff's counsel characterizes as the "monumental importance" of the ultimate ruling in this action, this dispute involves a specific quantity of fixed-term financial debentures bearing interest rates and call prices governed by a detailed Indenture. Given this detailed financial information, we can discern no reason why plaintiff could not, should it prevail on the merits, present expert testimony on the present value of debentures with similar characteristics or such other financial data necessary to calculate an income stream comparable to the redeemed Debentures. The ADM Debentures are traded nationally and while the market is rather limited, there appears to be no impediment to introducing historical data on market trends in these or similar securities for purposes of ascertaining damates. Moreover, should this task prove too difficult or imprecise, it is within the power of the Court to order ADM to reissue Debentures for the same term containing the same interest rates, as counsel for ADM conceded at oral argument.
Plaintiff's assertion that the Debentures are somehow "unique" financial instruments for which there are no comparable substitutes is unconvincing. This argument is based on two propositions: first, that the ADM Debentures are "A" rated long-term bonds issued by a financially sound company that pay a high rate of interest. Second, that the present value of the future income stream yielded by the Debentures is a function of each bondholder's subjective perceptions of the market and is therefore not capable of quantification.
The fact that the Debentures are "A" rated and pay a high rate of interest over a significant period of time does not in any sense make them unique. The record reveals a number of financial instruments that are arguably comparable to the ADM Debentures with respect to interest rate, maturity and risk. To be sure, bonds of superior quality may very well be hard to come by in today's market. Nevertheless, this fact does not prove they are unique, but merely that they represent an excellent investment; should plaintiff prevail, its damages would accordingly be greater than they might be were the bonds of a lesser quality.
Plaintiff's second argument is equally unconvincing. Indeed, were the Court to accept the proposition that these Debentures were unique because of the varying subjective evaluations of the individual bondholders, we would be hard pressed to deny preliminary relief in any securities case on the grounds of a failure to show irreparable harm.
Regardless of the strength of plaintiff's claims on the merits, the lack of a colorable showing of irreparable harm would require the denial of preliminary relief on this basis alone. Even if we were to assume, arguendo, that Morgan Stanley had made out a claim for irreparable harm, it has failed to meet the additional criteria necessary for the issuance of a preliminary injunction.
With respect to the likelihood of success on the merits, defendant's interpretation of the redemption provision seems at least as likely to be in accord with the language of the Debentures, the Indenture, and the available authorities than is the view proffered by the plaintiff. We first note that the one court to directly address this issue those to construe the language in the manner set forth in this action by the defendant. Franklin Life Insurance Co. v. Commonwealth Edison Co., 451 F. Supp. 602 (S.D.Ill. 1978), aff'd per curiam on the opinion below, 598 F.2d 1109 (7th Cir.), rehearing and rehearing en banc denied, id.id., cert. denied, 444 U.S. 900, 62 L. Ed. 2d 136, 100 S. Ct. 210 (1979). While plaintiff is correct in noting that this Circuit is not bound by this decision, and while this case can no doubt be distinguished factually on a number of grounds, none of which we deem to be of major significance, Franklin is nevertheless persuasive authority in support of defendant's position.
Defendant's view of the redemption language is also arguably supported by The American Bar Foundation's Commentaries on Model Debenture Indenture Provisions (1977), from which the boilerplate language in question was apparently taken verbatim.In discussing the various types of available redemption provisions, the Commentaries state:
[I]nstead of an absolute restriction [on redemption], the parties may agree that the borrower may not redeem with funds borrowed at an interest rate lower than the interest rate in the debentures. Such an arrangement recognizes that funds for redemption may become available from other than borrowing, but correspondingly recognizes that the debenture holder is entitled to be protected for a while against redemption if interest rates fall and the borrower can borrow funds at a lower rate to pay off the debentures.
Id. at 477 (Emphasis added). We read this comment as pointing to the source of funds as the dispositive factor in determining the availability of redemption to the issuer -- the position advanced by defendant ADM.
Finally, we view the redemption language itself as supporting defendant's position. The redemption provision in the Indenture and the Debentures begins with the broad statement that the Debentures are "subject to redemption"... at any time, in whole or in part, at the election of the company, at the following optional Redemption Price...." Following this language is a table of decreasing redemption percentages keyed to the year in which the redemption occurs. This broad language is then followed by the narrowing provision "provided, however... the Company may not redeem any of the Debentures pursuant to such option from the proceeds, or in anticipation, of the issuance of any indebtedness" borrowed at rates less than that paid on the Debentures.
While the "plain meaning of this language is not entirely clear with respect to the question presented in this case, we think the restrictive phrasing of the redemption provision, together with its placement after broad language allowing redemption in all other cases at the election of the company, supports defendant's more restrictive reading.
Morgan Stanley asserts that defendant's view would afford bondholders no protection against redemption through lower-cost borrowing and would result in great uncertainty among holders of bonds containing similar provisions. In its view, the "plain meaning" of the redemption bondholders of these bonds and the investment community generally, is that the issuer may not redeem when it is contemporaneously engaging in lower-cost borrowing, regardless of the source of the funds for redemption. At the same time, however, the plaintiff does not contend that redemption through equity funding is prohibited for the life of the redemption restriction once the issuer borrows funds at a lower interest rate subsequent to the Debenture's issuance. On the contrary, plaintiff concedes that the legality of the redemption transaction would depend on a factual inquiry into the magnitude of the borrowing relative to the size of the contemplated equity-funded redemption and its proximity in time relative to the date the redemption was to take place. Thus, a $100 million redemption two years after a $1 million short-term debt issue might be allowable, while the same redemption six months after a $20 million long-term debt issue might not be allowable.
This case-by-case approach is problematic in a number of respects. First, it appears keyed to the subjective expectations of the bondholders; if it appears that the redemption is funded through lower-cost borrowing, based on the Company's recent or prosecptive borrowing history, the redemption is deemed unlawful. The approach thus reads a subjective element into what presumably should be an objective determination based on the language appearing in the bond agreement. Second, and most important, this approach would likely cause greater uncertainty among bondholders than a strict "source" rule such as that adopted in Franklin, supra.
Plaintiff's fear that bondholders would be left "unprotected" by adoption of the "source" rule also appears rather overstated. The rule proposed by defendant does not, as plaintiff suggests, entail a virtual emasculation of the refunding restrictions. An issuer contemplating redemption would still be required to fund such redemption from a source other than lower-cost borrowing, such as reserves, the sale of assets, or the proceeds of a common stock issue. Bondholders would thus be protected against the type of continuous short-term refunding of debt in times of plummeting interest rates that the language was apparently intended to prohibit. See Franklin, supra, 451 F. Supp. at 609. Moreover, this is not an instance where protections against premature redemption are wholly absent from the Debenture. On the contrary, the Debentures and the Indenture explicitly provide for early redemption expressed in declining percentages of the principal amount, depending on the year the redemption is effected.
At this early stage of the proceedings, on the record before us, and for all the reasons outlined above, we find that plaintiff has failed to show a sufficient likelihood of its success on the merits of its contract claims as to entitle it to preliminary injunctive relief.
For many of the same reasons, we also find that plaintiff has failed to show a likelihood of success on its federal and state securities and business law claims. In order to prevail on a claim of securities fraud under § 10(b) of the Securities Act of 1934 and Rule 10b-5 issued thereunder, the plaintiff must prove, inter alia, that the defendant made a material misstatement or nondisclosure, or engaged in a manipulative and deceptive course of conduct, and that the defendant acted with scienter. The requirements for a claim under § 17(a) of the Securities Act of 1933 with respect to these elements are, for purposes of this motion, the same as those under § 10(b), except that in certain cases the plaintiff may need only prove negligence. We find the evidence in the record insufficient to establish a likelihood of success with respect to both of these requirements.
ADM disclosed the redemption language both in its Prospectus and in the Indenture. It also disclosed that the proceeds of the Debenture issue would be "invested in long-term or short-term marketable securities and used to repay short-term borrowings incurred in part to purchase long-term marketable securities." These disclosures appear perfectly consistent with the purchase of long-term government securities with Debenture proceeds, and would, at first blush, appear to be adequate. To add force to its claims, plaintiff would have to establish that, at the time the securities were issued, plaintiff contemplated redeeming the Debentures at an early date in conjunction with liquidation of its government securities as part of an overall investment scheme. Were this the case, it is arguable that the failure to reveal this information misled investors as to the increased likelihood of early redemption.
Plaintiff's strongest evidence in support of this claim is that the investment of the proceeds of the Debenture issue in United States Treasury Bills that paid an interest rate lower than 16.08% made no economic sense except as part of an overall scheme to engage in short-term speculation. While plaintiff's claim in this regard finds some support in the evidence, it also requires the fact-finder to engage in considerable theorizing from the prospective of hindsight. It appears just as likely, based on our review of the record, that ADM did not contemplate early redemption when the Debentures were issued, and that the proceeds of the Debentures were invested in government securities simply as an interim holding until such time as ADM decided to employ such funds for other corporate purposes. The failure specifically to disclose that the proceeds of the Debentures were to be used to purchase long-term government bonds as a hedge against falling interest rates does not, in and of itself, provide a strong securities claim.
The second basis of Morgan Stanley's securities claim -- that ADM failed to reveal its "restrictive" view of the redemption language -- also suffers from serious problems, at least with respect to the alleged failure to disclose such view at the time the Debentures were first issued. In order for Morgan Stanley to prevail on this claim, it would have to show that the interpretation of the provision urged by the defendant was contrary to that prevailing in the investment community when the Debentures were issued. Plaintiff's main evidence on this point is the affidavit testimony of a number of Morgan Stanley employees and other bondholders, presumably representing the informed view of the investment community, stating their opinion that redemption is prohibited where a company engages in contemporaneous lower-cost borrowing. An equally plausable interpretation, and indeed the view supported by plaintiff's own affidavits, is that few investors had ever seriously considered the legal ramifications of redemption under the circumstances faced by ADM. Indeed, the record reveals a clear awareness on the part of institutional professionals that the right to redemption from the proceeds of a stock issue was very much an open question and that therefore there was a likelihood that an aggressive company in a position similar to that of ADM would attempt to call its bonds under just such circumstances.One bond salesman for Morgan Stanley candidly stated:
Quite frankly... the question whether a court would ultimately find that a call was lawful or unlawful was largely irrelevant to my view of the economic risks for bondholders if any corporation announced a call....
No portfolio manager with whom I have dealt has ever expressed to me a view, one way or the other, as to whether a call by [Archer Daniels] of the Debentures would violate the nonrefunding provisions that govern the Debentures. As far as I know, no institution that I deal with has ever considered the question.
Deposition of Frederic W. Levin, Affidavit of Catherine R. Flickinger, Ex. B. See also Affidavit of Joseph W. Hill, Flickinger Aff., Ex. C.
Given evidence of these views, Morgan Stanley will have some difficulty maintaining that ADM's interpretation of the redemption provision "drastically changed the plain meaning on which investors relied." Plaintiff's Memorandum in Support, at 17. Moreover, defendant plausibly explains the high price at which Archer Debentures were trading prior to the redemption announcement as reflecting anticipation of a likely tender offer. Even were this not the case, one would presume that 16% Debentures would trade at a price at least somewhat in excess of the call price during times of lower interest rates unless the possibility of redemption was near to certain. The market price at which ADM Debentures were trading was not doubt more reflective of the investment community's perception of what ADM might do that it was of what ADM had the legal right to do.
The view more readily supported by the facts in this record is that ADM revealed all the facts that were required with respect to its rights under the redemption provision and that, indeed, the untested downside risk of the redemption provision had been fully taken into account in evaluating the market value of ADM's securities. On these facts we cannot say that plaintiff has shown a likelihood of showing both a material misstatement or omission and the level of intent necessary to constitute a violation of federal and state securities laws.
Plaintiff's strongest claims, and those most readily supported by the evidence, are that ADM failed to make adequate disclosure with respect to the Stars transaction and its most recent issues of common stock. In addition, a relatively strong argument could be made that, at some point subsequent to these transactions, after ADM began seriously considering an early redemption of its Debentures, and in light of its knowledge of the prevailing market price of the Debentures, plaintiff's failure to disclose its interpretation of the redemption provision amounted to a negligent or reckless material omission. Nevertheless, in light of the evidence presented in support of plaintiff's other securities and business law claims, and viewing the complaint in its entirety, we find that the plaintiff has failed to show a likelihood of success on the merits.
We turn, finally, to the second, alternative prong of the requirement for preliminary relief. While plaintiff has doubtless presented serious questions going to the merits making a fair ground for litigation, it has made no showing of a balance of hardships tipping decidedly in its favor. Moreover, in this regard, we find quite persuasive the comments of counsel for Morgan Guaranty, the Indenture Trustee. While expressing no position on the merits, counsel urged that the hardships that would result in the event we were to grant preliminary relief at this late date would be incalculable to bondholders other than the plaintiff who already may have made firm business commitments in anticipation of receipt of the redemption funds as of August 1. In this regard, defendant has agreed to treat all bondholders equally after a trial on the merits or other dispositive motions. Defendant has further agreed that it will not contend that there is a waiver of any rights on the part of any of bondholder who cashes checks issued pursuant to this redemption.
For all of the above reasons, and on the record now before us, plaintiff's application for preliminary injunctive relief is hereby denied.
Decision on the parties' cross-motions for summary judgment is reserved.