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March 29, 1990


The opinion of the court was delivered by: Leisure, District Judge:


Plaintiff Vincent M. Iavarone has brought suit against defendants Raymond Keyes Associates, Inc. ("RKA"), a New Jersey corporation, Raymond J. Keyes ("Keyes") (Chairman of the Board of Directors of RKA), Kenneth McCurdy (President of RKA and a member of the Board of Directors), and six other members of the Board of Directors of RKA. Plaintiff Iavarone is a former President and current shareholder of RKA. He alleges that defendants have violated section 14(e) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(e), for failure to disclose certain material facts in connection with an alleged tender offer being planned by the Board of Directors of RKA.*fn1 Iavarone also charges that defendants intend to take action which will violate their fiduciary duties to the shareholders of RKA, will consist of unlawful self-dealing, and will violate New Jersey Statute 14A:7-14.1 which prohibits a distribution by a corporation causing the corporation's liabilities to exceed its assets.

The origin of this lawsuit is a transaction proposed by the Board of Directors of RKA to issue new preferred stock to shareholders in return for common stock (the "transaction," or the "proposed transaction"). As will be discussed in detail below, Iavarone alleges that this transaction is unfair and unlawful. The Board of RKA is intending, at its next meeting, to consider and vote on an amendment to RKA's certificate of incorporation which would permit the creation of the new preferred stock. Iavarone has moved for a preliminary injunction postponing the Board's meeting and its vote on the proposed amendment. Defendants have opposed Iavarone's motion, and have cross-moved to dismiss the complaint under Fed.R.Civ.P. 12(b).


In July, 1985, plaintiff Iavarone and defendant Raymond Keyes executed a stock purchase agreement under which Iavarone purchased common stock of RKA at a price of $33.33 per share. Affidavit of Vincent M. Iavarone, sworn to on January 24, 1990, ¶ 4 ("Iavarone Aff."); Affidavit of Raymond J. Keyes, sworn to on March 1, 1990, ¶ 9 ("Keyes Aff."); plaintiff's exhibit A. Keyes states that the philosophy of the stock purchase agreement was to insure that Iavarone, then President of RKA, devoted "full time, undivided services as President of RKA." Keyes Aff., ¶ 8. In November, 1987, Iavarone resigned as President of RKA, soon after being informed by the Board that he would be discharged as President due to Iavarone's involvement in a real estate venture with one of RKA's clients. Keyes Aff., ¶ 10. In February 1988, RKA and Keyes commenced proceedings against Iavarone in state court, alleging that Iavarone purchased the stock in 1985 with no intention of devoting full time and energy to the presidency of RKA, and demanding return of the stock. Keyes Aff., ¶ 8.

At present, there are twenty-five shareholders of RKA. See Chart at Keyes Aff., ¶ 3. Raymond Keyes and five members of his family own 66.59% of the outstanding shares. Plaintiff Iavarone owns 12.55% of the outstanding shares. The current President of RKA, defendant Kenneth McCurdy, owns 10.02% of the outstanding shares. The remaining shareholders, who hold 2.5% of the stock or less, are either officers or members of the Board of Directors of RKA, with the exceptions of RKA's general counsel and accountant-consultant, who own approximately 0.5% of the stock each. None of the RKA common stock is registered or traded on a recognized exchange. RKA is a Subchapter S corporation for income tax purposes. Keyes Aff., ¶ 3.

On January 16, 1990, Iavarone received a document from RKA entitled "Notice of Special Meeting and Related Matters" which described an upcoming meeting of the shareholders of the corporation (the "Notice"). The Notice stated that the shareholders will vote at the meeting on a proposed amendment to RKA's certificate of incorporation, which amendment would create a series of preferred stock ranking senior to the common stock with respect to dividends and other distributions. Iavarone Aff., ¶ 6; plaintiff's exhibit B. The Notice contained the text of the proposed amendment, and a three-page description of the proposed transaction whereby common stockholders will be given the opportunity to exchange their shares for the newly issued preferred stock. See plaintiff's exhibit B.

Under the proposed transaction, the corporation will allow Keyes and his family to exchange 71% of their shares of common stock for the newly issued preferred stock, and the remaining shareholders to exchange 20% of their common shares. RKA will borrow $3.5 million from Chemical Bank, and in turn lend that money to a newly created Employee Stock Ownership Trust (the "ESOT"). The ESOT will then automatically and immediately purchase the preferred stock from all shareholders at $316 per share.*fn2 The trustees of the ESOT will be Keyes, Board member Edward Devine who is also a defendant, and another individual. The trustees will be able to vote the preferred shares held in the ESOT, each of which has 1.34 votes while each common share has one vote. See plaintiff's exhibit B.

The stated objective of the transaction is to buy out the retiring founder and majority owners of RKA, Raymond Keyes and his family. At the same time, control of RKA will be vested in the new generation of employees, and the corporation will reap the tax benefits of repaying the loan with pre-tax earnings. Keyes Aff., ¶¶ 15-16; Defendants' Memorandum of Law in Opposition to the Motion for a Preliminary Injunction and in Support of the Cross-Motion to Dismiss the Complaint, 3-5. A consultant hired by RKA from the accounting firm of KPMG Peat Marwick states that this type of transaction is "not uncommon," that it is "not unusual" for the retiring leader to be a trustee of the ESOT, and that he is aware of "other ESOP's for closely held companies in which there have been similar disproportions between minority and majority shareholder tender percentages." Affidavit of Ronald M. Siper, sworn to on February 28, 1990, ¶¶ 4-6.

Plaintiff Iavarone challenges the favorable view of the transaction held by defendants. Rather than perceive the transaction as mutually beneficial to both the corporation (shareholders included) and the Keyes family, Iavarone believes that the transaction is a means whereby the Keyes family will squeeze the cash out of RKA for their own benefit, and leave the corporation heavily indebted for many years. Iavarone states:

  [u]pon information and belief, the proposed
  transaction will result in a windfall to Keyes
  and his family in an amount in excess of $3
  Million Dollars, while leaving the Corporation
  debt laden, with a negative net worth, and
  destroying the value of the shares retained by me
  and the other minority shareholders.

Iavarone Aff., ¶ 9. Iavarone claims that the buy-out price of $316 per share is "arbitrary," and points out that RKA is not even obligated to pay this amount under the terms of the transaction. Id.

Plaintiff claims defendants have violated section 14(e) of the Securities Exchange Act, 15 U.S.C. § 78n(e), by making false statements of material facts and omitting to state material facts in connection with the Notice and the proposed transaction. Complaint, ¶ 24. Plaintiff alleges, inter alia, that defendants have failed to disclose the effect of RKA's future negative net worth on its ability to remain financially viable; have failed to demonstrate the fairness of the expected buy-back price of the preferred stock of $316 per share; have not shown how RKA will be able to repay the $3.5 million loan to Chemical Bank; and have failed to describe in sufficient detail RKA's current financial posture and the full effect of the transaction on future operations, especially the payment of dividends on common stock.


I. Plaintiff's Motion for a Preliminary Injunction

In Tucker Anthony Realty Corp. v. Schlesinger, 888 F.2d 969 (2d Cir. 1989), the Second Circuit set out the standard for the issuance of a ...

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