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WILSON v. GREAT AMERICAN INDUSTRIES

September 5, 1990

ALEXANDER WILSON, INDIVIDUALLY AND AS REPRESENTATIVE OF ALL MINORITY SHAREHOLDERS OF CHENANGO INDUSTRIES, INC., OTHER THAN DEFENDANTS ON AND BEFORE OCTOBER 18, 1979, PLAINTIFF,
v.
GREAT AMERICAN INDUSTRIES, INC. AS A CORPORATE ENTITY AND AS A SOLE SHAREHOLDER OF CHENANGO INDUSTRIES, INC., MILTON KOFFMAN, BURTON I. KOFFMAN, RICHARD E. KOFFMAN, AS DIRECTORS OF GREAT AMERICAN INDUSTRIES, INC., CHENANGO INDUSTRIES, INC., JOSEPH M. STACK AS THE REPRESENTATIVE OF CHENANGO INDUSTRIES IN THE MERGER BETWEEN CHENANGO AND GREAT AMERICAN INDUSTRIES, AND GARY CROUNSE, DAVID KEITH DYER AND SHARON LEE DYER, AS CO-EXECUTORS OF THE ESTATE OF DAVID L. DYER, DECEASED, WILLIAM STARNER, AND ANTHONY MINCOLLA AS DIRECTORS OF CHENANGO INDUSTRIES, INC., DEFENDANTS.



The opinion of the court was delivered by: McCURN, Chief Judge.

MEMORANDUM-DECISION & ORDER

Background

The plaintiff, Alexander Wilson, represents a class of former minority shareholders of Chenango Industries, Inc. ("Chenango or Chenango I"), who have brought suit challenging the legality of a joint proxy/prospectus ("proxy") issued by Great American Industries ("GAI") and Chenango as part of Chenango's 1979 merger into GAI. The defendants are GAI, Chenango, and various officers, directors, and attorneys connected with GAI and Chenango who were involved in issuing the proxy. Appeal was taken by plaintiffs from Wilson v. Great American Industries, 661 F. Supp. 1555 (N.D.N.Y. 1987) ("Wilson I"), in which this court granted judgment in favor of the defendants upon the determination that none of plaintiffs' many claims under federal securities statutes had merit.*fn1 In Wilson I, after reviewing evidence and testimony on the question of dmages, this court also held that "the defendants' experts were more credible than those of the plaintiff and conclude[d] that, even if a securities law violation had occurred, the plaintiff and the class members would have suffered no damages because of it." Id. at 1578.

The Second Circuit reversed, Wilson v. Great American Industries, Inc., 855 F.2d 987, 991 (2nd Cir. 1988), ("Wilson II"), holding that the proxy statement issued by the defendants contained five material omissions and mis-representations in violation of Section 14(a) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78n(a), and Rule 14a-9, 17 C.F.R. § 240.14a-9.*fn2 The five topics on which the proxy failed to properly inform the minority shareholders were: (1) Judge Duffy's decision adverse to GAI in United Rubber, Cork, Linoleum and Plastic Workers of America, AFL-CIO v. Great American Industries, Inc., 479 F. Supp. 216 (S.D.N.Y. 1979); (2) Chenango's substantial expansion plans which were made possible by the Broome County Industrial Development Authority's ("IDA") approval of a $1.8 million loan; (3) the non-disclosure of potential conflicts of interests due to the business relationships between David Dyer, Joseph Stack, Anthony Mincolla and the Koffmans; (4) the true worth of Lancaster Towers, a federally subsidized housing project owned and operated by Chenango; and (5) the true value of the Great American Corrugated Container Corporation ("GACCC") a subsidiary of GAI. The Second Circuit found each named defendant liable under Section 14(a) of the Act. Wilson II, 855 F.2d at 995. The appellate court then remanded the action with instructions that the plaintiff should be given a second opportunity to prove their damages. Id. at 997.

The essential terms of the merger agreement have previously been set forth as:

  (1) GAI acquired Chenango for the book value of
  its stock, which totaled approximately
  $1,200,000; (2) Chenango's shareholders exchanged
  their Chenango shares, which individually had a
  book value of $4.00, for newly issued GAI Series
  B preferred stock with a $10.00 per share par
  value. Accordingly, the exchange was made at a
  rate of two and a half Chenango shares for each
  share of GAI Series B preferred; (3) GAI Series B
  preferred stock would pay a six percent annual
  dividend; (4) GAI Series B preferred stock could
  be converted into GAI common stock at a rate of
  six Series B preferred shares for five shares of
  GAI common stock; (5) GAI had the right to redeem
  Series B preferred stock for $10.00 per share
  after five years; and (6) Chenango shareholders
  who owned fewer than 110 shares could receive
  $5.00 per share instead of exchanging their stock
  for GAI Series B preferred.

Wilson I, 661 F. Supp. at 1561; see also Wilson II, 855 F.2d at 990. The conditions and timing of the shareholders' approval of the merger was also set out previously.

  A meeting of Chenango's shareholders was held on
  October 18, 1979 in order for the shareholders to
  vote on the merger. The plaintiff, along with the
  majority of the other shareholders, voted in
  favor of the merger. Five shareholders, who owned
  4,500 of Chenango's 300,777 outstanding shares,
  dissented. The transaction officially closed on
  October 31, 1979, and Chenango became Chenango
  II, a wholly-owned subsidiary of GAI. After the
  merger, an appraisal was done, and cash
  settlements were reached with

  those shareholders who dissented from the merger.

Wilson I, 661 F. Supp. at 1561; see also Wilson II, 855 F.2d at 990. None of the individuals who dissented and received cash settlements are members of the plaintiff class.

Measure of Damages

When discussing the appropriate measure of damages to be applied by this court on remand the appellate court stated:

    We hold that the plaintiffs are entitled to
  recover damages equivalent to the benefit of the
  bargain they would have obtained had full
  disclosure been made. The determination of damages
  should include a valuation of Chenango's future
  earning power viewed prospectively from the date of
  the merger.
    Despite the somewhat speculative nature of the
  defendants' profit as viewed from the date of the
  merger, once it is established that the
  defendants acquired the company by fraud, "the
  profit was the proximate consequence of the
  fraud;" it is thus "more appropriate to give the
  defrauded party the benefit even of windfalls
  than to let the fraudulent party keep them."
  Janigan v. Taylor, 344 F.2d 781, 786 (1st Cir.),
  cert. denied, 382 U.S. 879, 86 S.Ct. 163, 15
  L.Ed.2d 120 (1965). When, as here, the fraudulent
  buyer received more than the seller's actual loss,
  damages are the amount of the defendant's profit.
  Affiliated Ute Citizens of Utah v. United States,
  406 U.S. 128, 155, 92 S.Ct. 1456, 1473, 31 L.Ed.2d
  741 (1972); see also Osofsky v. Zipf, 645 F.2d 107,
  112-13 (2d Cir. 1981).
    The defendants' argument that Janigan is limited
  to cases in which the purchaser resold the
  securities at a profit prior to the litigation is
  without merit. A court may award a plaintiff the
  unrealized appreciation of securities acquired
  through fraud. Gerstle v. Gamble-Skogmo, 478 F.2d
  at 1305.

Wilson II, 855 F.2d at 996 (emphasis added). Though Wilson II does not provide a precise methodology for measuring damages in the present action, it does supply a number of instructions which will guide this court's determination. These instructions are:

(1) that the defendants acted fraudulently;

  (2) plaintiffs are entitled to the benefit of the
  bargain they would have obtained absent the
  fraud;
  (3) that any determination of damages must
  include a valuation of Chenango's future earning
  power viewed prospectively from the date of the
  merger;
  (4) damages must be set at the amount of the
  defendants' improperly obtained profit;
  (5) damages may include an award to the
  plaintiffs of the appreciation in value of
  securities acquired through the fraud; and
  (6) the better course is to give the defrauded
  plaintiffs the "benefit even of windfalls" than
  to allow the defendants to profit from the fraud.

Id.

Determining precisely which profits were earned by the defendants as a "proximate consequence of the fraud" is a thorny issue. Defendants maintain that the plaintiffs are "entitled to recover the difference in value, if any, between what [they] received for [their shares of Chenango] and the price [they] might have received for those shares at the time of the merger if Joseph Stack's projections of the future earning power of Chenango I had been disclosed." Defendants' Post Trial Brief on Remand, at 5. This measure of damages would apparently focus solely upon the alleged undervaluation of Chenango in the proxy, and set damages at the difference between the actual and the proxy price of Chenango.

The plaintiffs, on the other hand, have set forth three alternate measures of damages in their pre-trial memorandum which they believe are appropriate under Wilson II. Plaintiffs claim to have incurred damages both as a result of the undervaluation of their shares of Chenango in the proxy and the overvaluation of what they received for their Chenango stock — the GAI Series B preferred. The first proposal would permit plaintiffs to recover the actual "value of what they sold, their interest in Chenango, [minus] the [actual] value of what they received, the shares of Series B preferred." Plaintiff's Pre-Trial Brief at 4.

Plaintiffs second and third alternatives are more complex; they attempt to account for the appreciation in value of GAI and Chenango following the 1979 merger up until 1985 — when the Koffmans took GAI (and its Chenango subsidiary) private. These alternatives are based, in part, upon the language in Wilson II which states that "[a] court may award a plaintiff the unrealized appreciation of securities acquired through fraud." 855 F.2d at 996. The second alternative focuses on the post-merger value of Chenango and is aimed at disgorging the profits earned by the defendants upon the "resale" of Chenango in 1985. Under this formula the court would determine Chenango's value, as a subsidiary of GAI, at the time it was taken private. Upon this finding, plaintiffs assert, the court could measure the amount of fraudulently obtained profits as the difference between all that the plaintiffs received for their Chenango stock in 1979 (i.e. the actual value of the GAI Series B preferred stock and the dividends received on that stock) and what the plaintiffs would have received if they had maintained their equity position in Chenango until 1985 and then sold their stock when the company was taken private. Plaintiffs' Pre-Trial Brief at 4.

The third measure of damages is a variation on the second measure of damages. It is premised on the concept that had full disclosure been made, the plaintiffs would have received a more favorable exchange of GAI Series B preferred stock for their shares of Chenango.*fn3 The 1979 merger, therefore, would have provided plaintiffs with a substantially larger proportion of the ownership of GAI, and consequently, a greater share in the "bargain" contemplated in the merger — participation in the future growth and profits of GAI. The plaintiffs contend that they would have realized the benefit of this increased participation when GAI was taken private in 1985. Plaintiffs' Mem. at 5-6. Damages would be calculated as the difference between the fair value of all that the plaintiff class received for their Chenango Stock in 1979 (again, the actual value of the GAI Series B preferred and the dividends received on that stock) and what the plaintiffs would have received if they had been given fair compensation in 1979, transferred that compensation into GAI stock, maintained their equity position in GAI until 1985, and then sold their stock when the company was taken private. This measure of damages would presumably include a factor which would account for the greater amount of dividends the plaintiffs would have received due to their ownership of a larger number of shares of GAI Series B preferred.

The seminal case in this area is Janigan v. Taylor, 344 F.2d 781 (1st Cir.), cert. denied, 382 U.S. 879, 86 S.Ct. 163, 15 L.Ed.2d 120 (1965), which set out the measure of damages in a situation where, as here, securities had been sold to a fraudulent party.*fn4 The Supreme Court has cited Janigan favorably on at least two occasions for the proposition that "where the defendant received more than the seller's actual loss . . . damages are the amount of the defendant's profit." Affiliated Ute Citizens of Utah v. United States, 406 U.S. 128, 155, 92 S.Ct. 1456, 1473, 31 L.Ed.2d 741 (1972); Randall v. Loftsgaarden, 478 U.S. 647, 663, 106 S.Ct. 3143, 3153, 92 L.Ed.2d 525 (1986). The aim of the Janigan measure of damages is to prevent "unjust enrichment of a fraudulent buyer." Randall, 478 U.S. at 663, 106 S.Ct. at 3153. Under Janigan a court may, given appropriate circumstances, "award a plaintiff the unrealized appreciation of securities obtained through fraud" even in "situations where the purchaser [has not resold the securities] within a short time." Gerstle v. Gamble-Skogmo, Inc., 478 F.2d 1281, 1305 (2nd Cir. 1973).

The Janigan measure of damages may be juxtaposed against what is commonly referred to as "out-of-pocket" damages, that is, "the difference between the fair value of all that the [plaintiff] received and the fair value of what he would have received had there been no fraudulent conduct." Randall v. Loftsgaarden, 478 U.S. at 661-62, 106 S.Ct. at 3152. A further twist in the methodology for assessing damages has been termed the "benefit-of-the-bargain rule." This measure of damages permits a defrauded seller of securities to collect "the difference between what was represented as coming to the [sellers] and what they actually received." Osofsky v. Zipf, 645 F.2d 107, 114 (2nd Cir. 1981). However, in the present case this court has been directed to assess damages as the amount of the defendants' profit. Wilson II, 855 F.2d at 996. The Second Circuit's directive permits this court, taking into account the particular circumstances of this case, the narrow discretion to taylor a measure of non-punitive damages which are not too speculative and which does the best job of compensating an injured plaintiff while disgorging improperly obtained profits. See also Gerstle v. Gamble-Skogmo, Inc., 478 F.2d at 1303-06; Osofsky v. Zipf, 645 F.2d at 111-14 (Section 28(a) of the Securities Exchange Act of 1934 "speaks only in general terms, but we do not believe that its overall intent is to restrict the forms of nonspeculative, compensatory damages available to defrauded parties. . . . [W]e believe that the purpose of section 28(a) is to compensate civil plaintiffs for economic loss suffered as a result of wrongs committed in violation of the 1934 Act, whether the measure of those compensatory damages be out-of-pocket loss, the benefit of the bargain, or some other appropriate standard." Id. at 111).

This court holds that the appropriate measure of damages is the first alternative proposed by the plaintiff, that is, the difference in the actual value of all that the plaintiffs should have received for their shares of Chenango and the actual value of what they received in exchange for their Chenango stock (i.e. the GAI Series B preferred stock). Under this formula, the court will have to engage in a prospective valuation of both Chenango and the GAI Series B preferred as of the date of the 1979 merger. However, the court will not engage in an evaluation of the post-merger appreciation in the value of GAI or Chenango, nor will the court award damages based upon this post-merger accretion in value. Rather, an award of interest, if necessary, will compensate the plaintiff fairly and adequately for any loss. This measure of damages will most effectively disgorge the profits earned by the defendants because it is aimed at taking from the defendants and providing to the plaintiffs all that the defendants might have earned on the 1979 merger. It compensates the plaintiff class for any overvaluation of GAI Series B preferred and any undervaluation of Chenango.

The second and third alternate measures of damages proposed by the plaintiffs, both of which would take into account post-merger appreciations in the value of Chenango or GAI over a five year period, would cause this court to award damages which are too speculative in nature. As stated by the Second Circuit, "[t]he passage of time introduces so many elements . . . that extreme prolongation of the period for calculating damages may be grossly unfair." Gerstle v. Gamble-Skogmo, Inc., 478 F.2d at 1306 and n. 27. There is no comprehensive information before the court on what caused the post-merger appreciation in value of GAI. It could have been management, market conditions or a number of other complex factors. This is particularly so with respect to the plaintiffs' second proposed measure of damages which would involve a valuation of Chenango as it existed in 1985 — approximately five years after being made a subsidiary of GAI. The second measure of damages proposed by the plaintiffs would essentially be asking this court to "unscramble the eggs." The plaintiffs' third proposed measure of damages has some appeal because it does stick to the bargain contemplated in the merger. However, the court finds it difficult to accept the proposition that a stock price set on an arbitrary merger date in 1985 would fairly represent the damages incurred by the plaintiffs, or the profits earned by the defendants, which were a "proximate consequence" of the 1979 fraud.

Moreover, there is little information before the court on whether the plaintiffs as a class retained their shares of GAI Series B preferred, exchanged this stock for GAI common stock, or sold the GAI stock altogether and used the proceeds for some other purpose. To proceed with either the second or third measure of damages proposed by the plaintiff would cause this court to engage in certain assumptions that may well be incorrect. Finally, this merger involved a stock for stock transaction. The court does not know, and cannot really know, whether a non-fraudulent transaction which supplied the plaintiffs with an appropriate amount of GAI Series B preferred would have resulted in a dilution of the value of each individual share of GAI common. If a non-fraudulent ...


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