As for the estimates of Plastics' 1987-1990 earnings, Judge Walker recognized in one of his prior opinions that plaintiffs allege these later forecasts were "'based in part on the allegedly false 1986 forecasts." 728 F. Supp. at 942-43. Plaintiffs' fraud claim arising out of these later estimates poses triable issues of fact.
Defendants argue that since plaintiffs' investment bankers at the Boston office of Drexel Burnham Lambert formulated their own reduced projection for 1987 through 1990 earnings, Polycast cannot be said in law to have relied upon the higher estimates furnished by defendants on July 2, 1986. It is true that Drexel Boston performed such calculations in connection with the private placement memorandum issued by plaintiffs in October 1986. But the jury could find that all plaintiffs and their advisers did was to reduce the 1987-1990 forecasts proportionately to Uniroyal's reduction of Plastics' 1986 earnings to $ 13.3 million, so that in practical effect defendants were also responsible for these later projections by the other side.
Next the defendants argue that plaintiffs cannot prove causation. With respect to the $ 13.3 million 1986 estimate, they argue, first, that the estimate did not cause Polycast any "cognizable damages"; and second, that even if damages occurred, plaintiffs cannot prove loss causation.
On the first of these contentions, defendants rely upon particular declarations made by or on behalf of plaintiffs which they regard as admissions against interest. In February 1987 Schneider met with officers of the Continental Illinois Bank and Trust Company of Chicago, a potential lender, and said according to contemporaneous documentary evidence that the $ 110 million purchase price paid "is fair from an historical earnings viewpoint but can be considered a bargain price if the future potential of the company is considered."
Secondly, defendants point to consolidated financial statements in UPAC's Form 10K for the year ended September 1987. Those financials included an entry for $ 75 million of goodwill arising from the acquisition of Plastics, which defendants say "reflects the difference between the $ 110 million purchase price, plus contingent liabilities recorded, less the value of Plastics' assets." Main brief at 38. The SEC staff, responding to that Form 10K, noted that while UPAC recognized and recorded on its balance sheet in September 27, 1987 $ 75 million in goodwill resulting from the acquisition of Plastics, it had also disclosed that Polycast had commenced suit against Uniroyal for not less than $ 75 million in damages caused by misrepresentations concerning Plastics' financial state, earnings potential and operating conditions. The SEC staff regarded these statements as inconsistent and asked for an explanation. Defendants contend that the reference to goodwill demonstrates as a matter of law that the purchase of Plastics caused plaintiffs no cognizable damage, as that concept is defined in section 10(b) actions by Randall v. Loftsgaardan, 478 U.S. 647, 661-662, 92 L. Ed. 2d 525, 106 S. Ct. 3143 91986) (out-of-pocket measure of damages consists of the difference between the fair value of all that the purchaser received and the fair value of what he would have received had there been no fraudulent conduct).
Plaintiffs respond that Schneider's statements to the Continental Illinois Bank as reflected in the pertinent exhibit could not have been made later than February 1987, when Schneider made his presentation to that potential investor. Schneider told the bank that, based upon his then existing impressions, Plastics would earn $ 10 million in 1986 and $ 17 million in 1987. These amounts were less than defendants had represented. More significant to the present question, plaintiffs say without contradiction that the field work on the audit of Plastics' financial statements for the ten months ended October 31, 1986 was not completed until May 1987; and it was not until then that Polycast learned that Polycast that Plastics only earned $ 3.709 million for those 10 months. Plaintiffs say that Schneider's statements to the bank in February 1987 prove nothing more than the depth of defendants' deception.
As for UPAC's correspondence with the SEC staff, plaintiffs point out that eventually the SEC concluded there was no inconsistency between the lawsuit's claims against Uniroyal and the goodwill entry in the Form 10K. That was because UPAC had allocated the goodwill to Plastics' profitable businesses, which were expected to generate sufficient pre-tax income to allow amortization of the allocated goodwill over 14 years. At the conclusion of the correspondence, the SEC was content to require UPAC and Polycast to agree that they would credit any recovery from the litigation to goodwill.
These declarations are admissible against plaintiffs under Rule 801(d)(2), F.R.Evid. However, they fall well short of establishing as a matter of law that plaintiffs suffered no cognizable economic loss, particularly since economic loss in section 10(b) cases may in certain circumstances be measured by "out-of-pocket loss, the benefit of the bargain, or some other appropriate standard." Osofsky v. Zipf, 645 F.2d 107, 111 (2d Cir. 1981). Conceptually at least, a party's admissions may demonstrate beyond cavil that it has suffered no economic loss; but plaintiffs' explanations for and interpretations of the declarations upon which defendants rely pose triable issues.
Defendants also note that Polycast sold three of Plastics' businesses for amounts totalling $ 91 million, and indicated to the SEC that it had received offers for others. Defendants say that accordingly the total proceeds of the divesture of Plastics' businesses "would far exceed the price Polycast paid for Plastics," main brief at 40, so that Polycast suffered no loss. Plaintiffs respond that these gross sales prices were acquired at the cost of plaintiffs assuming "immense liabilities" under the SPA, such as unfunded pension liabilities (estimated at approximately $ 75 million before tax or $ 54 million net of tax) and environmental liabilities (estimated at $ 13 million). Defendants reply that nonetheless, Polycast has realized a net gain (that is, the price exceeded the cash cost and the liabilities assumed) on the businesses it has sold. Reply brief at 21 n. 13.
I decline to hold this record or in response to these arguments that plaintiffs cannot establish a cognizable economic loss as a matter of law. Defendants confine their analysis to out-of-pocket loss, but this is not an exclusive measure of compensatory damages, as the Second Circuit held in Osofsky. Benefit-of-the-bargain is a possible alternative measure of compensatory damages. In Levine v. Seilon, Inc., 439 F.2d 328, 334 (2d Cir. 1971), Judge Friendly said in dictum that in section 10(b) cases a defrauded buyer of securities "is entitled to recover only the excess of what he paid over the value of what he got, not, as some other courts had held, the difference between the value of what he got and what it was represented he would be getting." More recently the Second Circuit has extended the benefit-of-the-bargain measure of damages under the 1934 Act to the "limited situation" where "misrepresentation is made in the tender offer and proxy solicitation materials as to the consideration to be forthcoming upon an intended merger." Osofsky at 114. But see Freschi v. Grand Coal Venture, 588 F. Supp. 1257, 1259 (S.D.N.Y. 1984) (limiting Orofsky to its facts and applying out-of-pocket measure of loss to section 10(b) claim).
On this motion for summary judgment, I need not further consider the present state of appellate authority on the measures of compensatory damages available to buyers under the 1934 Act because plaintiffs at bar also assert claims for common law fraud. In Osofsky the Second Circuit said that "the benefit-of-the-bargain measure of compensatory damages is recognized as the preferable measure in common law fraud actions." Citing Prosser's text and the Restatement (Second) of Torts (1977) for that proposition, Judge Oakes went on to say at 114:
Thus, the Restatement (Second) of Torts § 549(2) (1977) provides, in the case of a fraudulent misrepresentation in a business transaction, for the recovery of "damages sufficient to give [the recipient] the benefit of his contract with the maker, if these damages are proved with reasonable certainty." Though out-of-pocket loss may be the usual and logical form of compensatory relief in tort actions, Comment g on section 549(2) explains that this measure of damages does not always afford "just and satisfactory" compensation when the plaintiff has made a bargain based on fraudulent representations by the defendant. Therefore "the great majority of the American courts [have adopted] a broad general rule giving the plaintiff, in an action of deceit, the benefit of his bargain with the defendant in all cases, and making that the normal measure of recovery in actions of deceit." Id. Otherwise, in situations such as that involved in the instant case, "the defendant [would be] enabled to speculate on his fraud and still be assured that he [could] suffer no pecuniary loss," id. at Comment i.
That analysis applies squarely to the present plaintiffs' common law fraud claim, which a jury could conclude had been shown by clear and convincing evidence.
Even if the analysis be confined to out-of-pocket compensatory damages, plaintiffs' expert witness is prepared to testify that "Plastics was worth approximately $ 60 million on October 31, 1986." Plaintiff's brief at 67. If the jury accepts that figure, the $ 110 million purchase price establishes an out-of-pocket losses. To be sure, expert evaluations are subject to cross-examination and challenge; but that is the function of plenary trials, not summary dispositions.
Defendants are not entitled to summary judgment on the basis that plaintiffs suffered no cognizable damage as a matter of law. In reaching that conclusion, I have considered all of the evidence culled by the defendants from the extensive discovery record in support of their contentions, whether or not specifically addressed supra.
The C&D defendants require separate consideration. They contend that even if "there is sufficient evidence as to misrepresentation and loss causation to go to the jury," defendants' brief at 88 (and there is), nonetheless the fraud claims must be dismissed as to the C&D defendants because there is no evidence suggesting they were involved in the formulation of Plastics' earning projections, including the $ 13.3 million projection upon which plaintiffs' fraud claims are primarily based, or that the C&D defendants had the intent to deceive plaintiffs.
In his opinion reported at 728 F. Supp. 926, Judge Walker held that Polycast's third amended complaint (identical to the present pleading in this respect) sufficiently alleged scienter on the part of the C&D defendants. Judge Walker focused upon the alleged participation of Rice and Dubilier in the events surrounding the offering of Plastics for sale and the ultimate consummation of the sale to Polycast. Judge Walker concluded his discussion on the point by saying: "Polycast's allegations of Rice and Dubilier's beneficial interest in Uniroyal's assets implicitly established a motive for committing fraud. The allegations of their involvement in the preparation of the offering memorandum demonstrate an opportunity for doing so and support the inference of knowledge on their part." Id. at 936.
The C&D defendants now argue that the allegations sufficient to support an inference of scienter have been proven hollow by the evidence, or lack of evidence, adduced during discovery. They pray for summary judgment dismissing the fraud claims against them for that reason. Consistent with the authorities cited supra, my proper function is to assess whether the C&D defendants' scienter (obviously a material fact under the governing law) presents a genuine issue requiring trial. In answering that question, I resolve all ambiguities in the evidence and draw all reasonable inferences in favor of plaintiffs and against the C&D defendants.
The motive of Rice and Dubilier to commit fraud upon a purchaser of a Uniroyal asset such as Plastics is manifest. Rice and Dubilier managed all the C&D Entities. Those entities held a 32.5% equity interest in Uniroyal. The leveraged buyout had saddled Uniroyal with $ 900 million in debt. To maximize a return to the C&D entities, it was necessary to maximize the sale price of a Uniroyal asset like Plastics. These economic truths are illustrated by a post-closing cash distribution which occurred in December 1986. At that time C&D Private Equity received 32.5% of the cash distribution, or $ 60,206,250; C&D Associates received $ 6 or $ 7 million; and Rice and Dubilier each received approximately 45% of that amount.
A section 10(b) plaintiff must prove its case by a preponderance of the evidence only, and not by clear and convincing evidence. See Herman & MacLean v. Huddleston, 459 U.S. 375, 390-91, 74 L. Ed. 2d 548, 103 S. Ct. 683 91983). As for scienter the Court said at 390 n.30:
The Court of Appeals also noted that the proof of scienter required in fraud cases is often a matter of inference from circumstantial evidence. If anything, the difficulty of proving the defendant's state of mind supports a lower standard of proof. In any event, we have noted elsewhere that circumstantial evidence can be more than sufficient. 9citing cases).
Motive based upon personal gain is a recognized circumstance from which intent to commit fraud may be inferred. Rice and Dubilier had that motive to commit fraud upon a purchaser of Plastics.
Another circumstance is whether Rice and Dubilier should be regarded as "insiders" or "outsiders" in the conduct of Uniroyal's affairs.
At the pertinent times Rice and Dubilier, together with Flannery, Uniroyal's chairman, chief executive officer and president, comprised the company's three-man executive committee. Nonetheless, Rice and Dubilier say they should not be considered Uniroyal insiders. They cite Lanza v. Drexel & Co., 479 F.2d 1277, 1306 (2d Cir. 1973) for that proposition. In Lanza the Second Circuit adopted an academic definition of "outside directors -- i.e., directors who are not full-time employees of the corporation." Id. at 1306 (quoting Bishop, Sitting Ducks and Decoy Ducks: New Trends in the Indemnification Of Corporate Directors and Officers, 77 Yale L.J. 1078, 1092 (1968)).
More recently, the Second Circuit has said in evaluating a pleading of fraud under Rule 9(b), Fed.R.Civ.P. that no specific connections between fraudulent representations and particular defendants are necessary where "defendants are insiders or affiliates participating in the offer of the securities in question." Luce v. Edelstein, 802 F.2d 49, 55. See also DiVittorio v. Equidyne Extractive Industries, Inc., 822 F.2d 1242, 1247 (2d Cir. 1987) (citing and applying Luce).
Applying that somewhat expanded definition of "insider" to the proof developed through discovery, I conclude that a jury could rationally regard Rice and Dubilier as Uniroyal "insiders or affiliates participating in the offer" of Plastics for sale. Accordingly the status of Rice and Dubilier is also a circumstance which the jury may consider on the issue of scienter.
The membership of Rice and Dubilier on the three-man Uniroyal Executive Committee is not determinative of the issue, although certainly it is probative. As defendants observe, between meetings of the full board of directors its powers were delegated to the executive committee; "Rice and Dubilier were never officers of Uniroyal or Plastics, and they played no role in the day-to-day management of either company." Reply Brief at 33-34. True enough, if by "day-to-day management" we mean the shipping of orders, collection of bills, and controlling inventory. But the issue is whether Rice and Dubilier were "insiders or affiliates participating in the offer" of Plastics for sale and the consummation of that sale to Polycast. There is sufficient evidence to allow that characterization. On some occasions Dubilier, on other occasions Rice attended meetings or engaged in conversations with officers of Uniroyal concerning forecasts to be included in the offering memorandum, as well as subsequent reductions in the 1986 Plastics earnings estimate, and what should be done about those reductions in the context of the ongoing negotiations with Polycast. These and other meetings and conversations gave rise to contemporaneous notes or testimonial recollections the import of which the parties dispute, but to the extent they militate in favor of plaintiffs must on this motion be construed in their favor. For example, it is common ground that on February 26, 1986 Dubilier had a conversation with Graham about the offering memorandum's references to Uniroyal's projected financials. Graham made a contemporaneous note of that conversation which reads: "M. Dubilier. Tone down the language or increase the forecast." Graham, also a defendant in the case, testified that Dubilier said that the language in the offering memorandum was "too optimistic" because "it doesn't correspond with the numbers. So if the numbers are what they are, you better tone the language down because it's too positive." Graham Dep. at 258. Defendants say in their brief at 95 that "the only reasonable inference" to be drawn from Graham's testimony "is that Dubilier wanted the offering memorandum to be as accurate as possible, and took what steps were necessary to insure that it was." The trouble is that Graham's testimony dealt with only part of what his note records Dubilier as having said, namely, "tone down the language or increase the forecast." A jury could rationally regard the alternative suggested solution, namely increasing the forecast to square with the "positive" language, as a badge of fraud. The jury could also accept the testimony of Jonathan Furer, a Polycast officer, that at the crucial September 5, 1986 meeting where the $ 13.3 million projected 1986 earnings for Plastics was put forward as a rock bottom figure, Rice uttered reassurances purported by based upon his own prior experience in similar situations.
To be sure, there is no evidence in the record directly establishing that either Rice or Dubilier knew that the $ 13.3 million projection was false, or that they had expressed the specific intent to defraud Polycast. But there need not be, given the holding in Herman & Maclean v. Huddelston, supra, that scienter may be and often is proved by inferences from circumstantial evidence. Viewing the evidence in the light most favorable to plaintiffs, as I am required to do, I conclude that the scienter of the C&D defendants is for the jury.
Plaintiffs are also entitled to have the jury consider their alternative theory of section 10(b) liability, that Rice and Dubilier acted with reckless disregard of the fraud of others. Even outside directors may be liable if they "failed or refused, after being put on notice of a possible material failure of disclosure, to apprise themselves of the facts where they could have done so without any extraordinary effort." Lanza v. Drexel & Co., supra, at 479 F.2d 1306 n.98. Rice and Dubilier acknowledged that they knew of Uniroyal's several reductions in the Plastics earnings forecasts during 1986. Rice said he made no effort to find out only the forecasts were reduced, but conceded that "I could pick up the telephone any time I wanted to and call [Flannery] and say, what did the earnings do." Rice Dep. at 329-30. The ability of Rice and Dubilier to get to the bottom of the forecast reductions is inherent in their positions as members of Uniroyal's executive committee. Accepting for the sake of this analysis that Rice & Dubilier knew nothing about the reasons for the reductions in forecasts, there is evidence from which the jury could find that without "extraordinary effort" they could have discovered that Uniroyal officers were engaging in fraud.
Lastly the liability of the C&D defendants, or at least of Rice and Dubilier as controlling persons of Uniroyal, presents a triable issue. As Judge Walker has held in the case at bar, controlling person liability under § 20(a) does not require proof of scienter. Liability attaches if there was a primary violation, control of the primary violator by the defendant and the defendant's culpable participation in the actions forming the predicate for the securities law violation. [1988-89 Transfer Binder]Fed.Sec.L.Rep. (CCH) P94,005 at 90,695-96. Whether or not in the particular circumstances of this case it is the C&D defendants' burden to prove good faith, cf. Marbury Management, Inc. v. Kohn, 629 F.2d 705, 716 (2d Cir.), cert. denied sub nom Wood Walker & Co. v. Marbury Management, Inc., 449 U.S. 1011, 66 L. Ed. 2d 469, 101 S. Ct. 566 91980), the issues of the control Rice and Dubilier exercised over Uniroyal in the conduct of the sales negotiations, and the propriety of that conduct, give rise to triable issues.
I deny the motions of all defendants for summary judgment dismissing the section 10(b) and common law fraud claims.
The Section 12(2) Claim
Plaintiffs' second and third claims allege violation of section 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l (2). The second claim charges all defendants with violating that section. Some are charged as principals, others as aiders and abettors or controlling persons. The third claim charges the C&D defendants as principals.
All defendants contend that section 12(2) is inapplicable to the transaction alleged in the complaint.
Section 12(2) of the 1933 Act provides in pertinent part:
Any person who . . . offers or sells a security . . . by means of a prospectus or oral communication, which includes an untrue statement of a material fact or omits to state a material fact necessary in order to make the statements, in light of the circumstances under which they were made, not misleading (the purchaser not knowing of such untruth or omission), and who shall not sustain the burden of proof that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission, shall be liable to the person purchasing such security from him . . . (emphasis added).
Section 12 deals with the liability of "statutory sellers" of securities. See Pinter v. Dahl, 486 U.S. 622, 100 L. Ed. 2d 658, 108 S. Ct. 2063 91988) (construing section 12(1)). Section 12 liability is broader than liability for fraud. Statutory sellers "may now be liable under section 12 whether or not scienter or loss causation is shown." Wilson v. Saintine Exploration and Drilling Corp., 872 F.2d 1124, 1126 (2d Cir. 1989) (applying Pinter rationale to a section 12(2) claim). See also Capri v. Murphy, 856 F.2d 473, 478 (2d Cir. 1988) (under section 12(2), sellers' "material misrepresentations and omissions render them strictly liable to plaintiffs"); Ballay v. Legg Mason Wood Walker, Inc., 925 F.2d 682, 689 (3rd Cir. 1991) (in contrast to section 10(b), section 12(2) "makes actionable negligent misrepresentation absent proof of scienter or fraud").
Notwithstanding these less demanding standards for liability, a section 12(2) plaintiff must still prove that the defendants sold the security "by means of a prospectus or oral communication." "Prospectus" has a recognized meaning. Congress did not define the words "oral communication" in the 1933 Act. In Ballay the Third Circuit applied to the phrase "prospectus or oral communication" the maxim noscitur a sociis, that a word is known by the company it keeps, and construed the phrase to mean "that buyers may recover for material misrepresentations made in a prospectus or in an oral communication related to a prospectus or initial offering." 925 F.2d at 688. Ballay went on to hold that section 12(2) did not apply to a broker-seller of securities in the secondary market.
While defendants at bar rely on Ballay, plaintiffs correctly observe that the transaction in suit does not involve the secondary market, but rather the direct sale of securities (the outstanding shares of Plastics) as part of the sale of that company to Polycast. Nonetheless, Ballay is instructive in its implicit requirement that the prospectus or oral communication have something to do with the challenged sale.
The Second Circuit had previously made that requirement explicit in Jackson v. Oppenheim, 533 F.2d 826 (2d Cir. 1976). The Second Circuit held that while a section 12(2) plaintiff need not prove the particular kinds of causation required in fraud claims, nevertheless "he must still prove that the challenged sale was effected 'by means of' the communication viewed as a whole. That is to say, the communication as a whole must have been instrumental in the sale" of the securities. Id. at 829-30. Expanding on that concept, the court of appeals said that where the defendant's liability is based on a sale of securities
Section 12(2) requires there to be some causal relationship between the challenged communication and the sale, even if not "decisive." In short, the communication must have been intended or perceived as instrumental in effecting the sale. Id. at 830 n.8.
The inquiry is fact-specific, as illustrated by Judge Tenney's opinion in Eriksson v. Galvin, 484 F. Supp. 1108-1125 (S.D.N.Y. 1980):
The Court concludes, as in Jackson, that neither the challenged communications nor the so-called omissions were responsible for the plaintiff's conduct. "There was an abundance of evidence of the matters the plaintiff really considered important in entering this face to face transaction," Titan Group, Inc. v. Faggen, 513 F.2d 234, 239 (2d Cir.), cert. denied, 423 U.S. 840, 96 S. Ct. 70, 46 L. Ed. 2d 59 (1975), and Eriksson was well aware of the opportunities and risks inherent in his agreement with the defendants. See Seibert v. Sperry Rand Corp., 586 F.2d 949, 952 (2d Cir. 1978); Spielman v. General Host Corp., 538 F.2d 39, 41 (2d Cir. 1976). Accordingly, a section 12(2) claim has not been established because the alleged misrepresentations and omissions were not "instrumental in effecting the sale." Jackson v. Oppenheim, supra, 533 F.2d at 830 n.8.