Appeal and cross-appeal from judgment of the United States District Court for the District of Connecticut (Dorsey, J.), imposing liability on defendants for negligently promoting coal mining venture and dismissing plaintiffs' claims for violations of federal and state securities laws as well as the third-party claim for indemnification. Affirmed in part, reversed in part, and remanded.
Kaufman and Miner, Circuit Judges, Conner,*fn* District Judge. Hon. William C. Conner, Senior United States District Judge, Southern District of New York, sitting by designation.
Plaintiffs Daniel Capri, et al., and defendants-third-party plaintiffs C. Gordon Murphy, et al., appeal from a judgment of the United States District Court for the District of Connecticut (Dorsey, J.), imposing liability on defendants for negligently promoting a coal-mining venture and dismissing plaintiffs' claims under federal and Connecticut securities laws as well as the third-party claim against Gates Engineering Company ("Gates") for indemnification. For the reasons that follow, we affirm the district court on the negligence claim, reverse the court's dismissal of plaintiffs' claims under section 12(2) of the Securities Act of 1933 and Conn. Gen. Stat. § 36-498(a), and remand with instructions to enter judgment against defendants Murphy and Greenwich Coal Company, to make further factual findings with respect to defendant Liberty Capital Group, and to amend the determination of plaintiffs' damages.
Plaintiffs invested $522,500 in cash and notes as limited partners in Greenwich Coal Associates ("GCA"), a coalmining venture formed on December 29, 1977. GCA was intended to be a "year-end" tax shelter, whose purpose was to mine coal from property owned by Herbert and Effie Pauley in West Virginia. Plaintiffs, collectively, represented 45% of the ownership interest in GCA. Defendant C. Gordon Murphy, who had extensive experience in developing and mining coal properties, was one of two general partners in GCA and owned 1% of the partnership. Defendant Greenwich Coal Company, a corporation formed on or about December 29, 1977, was the other general partner in GCA, owning 49% of the partnership. The remaining 5% interest was owned by two investors who are not plaintiffs here. For their 50% interest in GCA, Murphy and Greenwich Coal Company invested $125,000. Greenwich Coal Company, in turn, was owned two-thirds by Liberty Capital Group ("LCG"), a partnership consisting of Murphy, Robert Reardon and Marshall Brown, and one-third by Energy Resources, a corporation whose stock was owned by Robert Fain and Fain's law partners and associates. Murphy, Reardon and Brown all were experienced in owning, structuring and managing coal properties. Fain, whose law firm drafted the prospectus and performed other legal work in connection with the venture, also was President of Greenwich Coal Company.
In November 1977, Liberty Capital Group acquired two sixty-day options to lease the Pauley property. The GCA general partners set up the venture so that LCG would exercise its option to lease the Pauley property, and the Pauleys would receive a royalty of 6% of the gross selling price or an annual minimum royalty of $24,000. LCG would then sublease the property to GCA, and LCG would receive a royalty of $3.00 per ton or an annual minimum of $480,000. The LCG royalty was intended to maximize the limited partners' tax write-offs for 1977.
In early November, Murphy hired Gates Engineering Company to determine the economic feasibility of mining the property and to recommend a plan for mining and selling the coal. However, Gates never was told of GCA's obligation to pay royalties, a necessary factor in determining the economic feasibility of the venture. Gates produced a preliminary report ("Gates Report"), dated December 10, 1977, which concluded that two coal seams on the Pauley property were "minable and merchantable." The Gates Report projected a selling price of $45.00 per ton for the "No. 2 Gas" seam and $22.50 per ton for the "Stockton" seam. Gates later revised the price of the "No. 2 Gas" seam to $33.50 per ton and informed Murphy of the revision in February 1978. However, neither the original nor the revised Gates Report reflected any expenses for washing or selling the coal, which would have adversely affected profitability.
The original Gates Report also noted the need to construct a three-mile road suitable for heavily-loaded trucks in order to transport the coal; however, Murphy failed to obtain an estimated cost for the road construction and to assess the impact of that cost prior to the closing of the deal. The parties later discovered that the road would cost up to $1.5 million, which would substantially and adversely affect the feasibility of the project. In addition, Murphy knew of the recent enactment of the Surface Mining Act of 1977 prior to the closing and understood that this legislation was a "drastic change in the law" which "revolutionized" coal strip mining in the United States. Nevertheless, the impact of this legislation on the project never was communicated to plaintiffs either personally or in the prospectus.
In mid-December, Fain's law firm prepared a draft prospectus. The prospectus projected profits of between $409,000 and $691,000 from the "Stockton" seam and between $6,411,000 and $6,690,000 from the "No. 2 Gas" seam. Although none of the plaintiffs knew any specific facts about the venture other than those stated in the prospectus, all of the plaintiffs made commitments, and six plaintiffs paid their entire subscription costs, before the prospectus ever was issued. None of the plaintiffs had experience in the coal business prior to investing in GCA. Each plaintiff relied upon the representations of Murphy, Reardon and Fain, as communicated by Fain and Daniel Conover, regarding the venture's potential. Conover was a former partner in Fain's law firm. Many of these same representations later were included in the prospectus. From the beginning, plaintiffs' primary motivation for investing in the project was to obtain tax write-offs.
On December 29, 1977, LCG exercised its option and entered into a lease with the Pauleys, providing for payments to the Pauleys commencing on November 1, 1978. LCG subleased the property to GCA, with royalty payments to LCG commencing upon the closing. That day, GCA paid LCG $480,000, but LCG defaulted on its obligation to pay the minimum due the Pauleys. LCG eventually paid the Pauleys a total of $8,000, resulting in litigation with the Pauleys and termination of the lease.
Despite the parties' intentions, the coal-mining venture never came to fruition. Defendants had intended to hire an operator to mine the coal, which would be sold through Neville Coal Sales Company, a corporation of which Liberty Capital Group was a shareholder. Well into 1978, Murphy's communications to the limited partners reflected enthusiasm and optimism for the project. However, GCA never mined any coal, and the IRS subsequently disallowed the limited partners' deductions for payments to GCA, concluding that the project lacked economic viability at inception. In December 1978, Murphy flagged most of the project's problems in a letter to plaintiffs, but he did not inform them of the project's economic infeasibility until July 1979.
In December 1980, sixteen of the seventeen limited partners instituted this action, seeking recovery of their total principal invested in GCA, plus interest, punitive damages, costs and attorneys fees. Plaintiffs' complaint alleged that GCA's general partners omitted or misrepresented material facts in promoting the partnership, in violation of: sections 12(2) and 17(a) of the Securities Act of 1933 (Count I); section 10(b) and Rule 10b-5 of the Securities Exchange Act of 1934 (Count II); sections 36-472 and 36-498(a) of the Connecticut Securities Act (Count III); and the Connecticut Unfair Trade Practices Act (Count IV). In addition, plaintiffs claimed that defendants: were negligent in omitting or misrepresenting material facts (Count V); had engaged in fraudulent misrepresentation (Count VI); and had breached their fiduciary obligations to plaintiffs (Count VII). Plaintiffs also brought a derivative suit against LCG, claiming that LCG entered into the sublease with GCA solely to obtain the minimum annual royalty from GCA despite knowledge of the project's economic infeasibility (Count VIII).
Defendants filed a third-party complaint against Gates, alleging that Gates should have foreseen the economic infeasibility of mining and selling the coal. Defendants claimed that Gates' failure constituted tortious conduct and that Gates ...