Escott v. BarChris Construction Corporation

• Citation: 283 F. Supp. 643
• Decision Date: 29 March 1968
• Docket Number: No. 62 Civ. 3539.,62 Civ. 3539.
• Parties: Barry ESCOTT et al., on behalf of themselves and in a representative capacity on behalf of all other present and former holders of 5½% subordinated debentures (due May 1, 1976) of the BarChris Construction Corporation, similarly situated, Plaintiffs, v. BARCHRIS CONSTRUCTION CORPORATION et al., Defendants.
• Court: U.S. District Court — Southern District of New York

283 F. Supp. 643

Barry ESCOTT et al., on behalf of themselves and in a representative capacity on behalf of all other present and former holders of 5½% subordinated debentures (due May 1, 1976) of the BarChris Construction Corporation, similarly situated, Plaintiffs, v. BARCHRIS CONSTRUCTION CORPORATION et al., Defendants.

No. 62 Civ. 3539.

United States District Court S. D. New York.

March 29, 1968.

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Garey & Garey, New York City, for plaintiffs, Wm. Francis Corson, Allan K. Peckel, New York City, of counsel.

Alex L. Rosen, New York City, for defendant, BarChris Construction Corp.

Davis, Polk & Wardwell, New York City, for defendants Drexel & Co., and others, Ralph M. Carson, Thomas P. Griesa, New York City, of counsel.

Milbank, Tweed, Hadley & McCloy, New York City, Attorneys for defendant, Peat, Marwick, Mitchell & Co., A. Donald MacKinnon, Andrew J. Connick, New York City, of counsel.

Olwine, Connelly, Chase, O'Donnell & Weyher, New York City, for defendant, Grant, John Logan O'Donnell, James E. Tolan, New York City, of counsel.

Sims & Friedman, New York City, for defendants, Vitolo, Russo and Pugliese, Theodore R. Schreier, New York City, of counsel.

Emmet, Marvin & Martin, New York City, for defendants, Kircher and Trilling, James J. Higginson, New York City, of counsel.

Schoengold & Sporn, New York City, for defendant, Birnbaum, Max Schoengold, New York City, of counsel.

Ferris, Bangs, Davis, Trafford & Syz, New York City, for defendant, Auslander, Lyon Boston, New York City, of counsel.

Mullane & Moukad, New York City, for defendant, Rose, Joseph E. Moukad, New York City, of counsel.

OPINION

McLEAN, District Judge.

This is an action by purchasers of 5½ per cent convertible subordinated fifteen year debentures of BarChris Construction Corporation (BarChris). Plaintiffs purport to sue on their own behalf and "on behalf of all other and present and former holders" of the debentures. When the action was begun on October 25, 1962, there were nine plaintiffs. Others were subsequently permitted to intervene. At the time of the trial, there were over sixty.

The action is brought under Section 11 of the Securities Act of 1933 (15 U.S.C. § 77k). Plaintiffs allege that the registration statement with respect to these debentures filed with the Securities and Exchange Commission, which became effective on May 16, 1961, contained material false statements and material omissions.

Defendants fall into three categories: (1) the persons who signed the registration statement; (2) the underwriters, consisting of eight investment banking firms, led by Drexel & Co. (Drexel);¹ and (3) BarChris's auditors, Peat, Marwick, Mitchell & Co. (Peat, Marwick).

The signers, in addition to BarChris itself, were the nine directors of BarChris, plus its controller, defendant Trilling, who was not a director. Of the nine directors, five were officers of BarChris, i. e., defendants Vitolo, president; Russo, executive vice president; Pugliese, vice president; Kircher, treasurer; and Birnbaum, secretary. Of the remaining four, defendant Grant was a member of the firm of Perkins, Daniels, McCormack & Collins, BarChris's attorneys. He became a director in October 1960. Defendant Coleman, a partner in Drexel, became a director on April 17, 1961, as did the other two, Auslander and Rose, who were not otherwise connected with BarChris.

Defendants, in addition to denying that the registration statement was false, have pleaded the defenses open to them under Section 11 of the Act, plus certain additional defenses, including the statute of limitations. Defendants have also asserted cross-claims against each other, seeking to hold one another liable for any sums for which the respective defendants may be held liable to plaintiffs.

This opinion will not concern itself with the cross-claims or with issues peculiar to any particular plaintiff. These matters are reserved for later decision. On the main issue of liability, the questions to be decided are (1) did the registration statement contain false statements of fact, or did it omit to state facts which should have been stated in order to prevent it from being misleading; (2) if so, were the facts which were falsely stated or omitted "material" within the meaning of the Act; (3) if so, have defendants established their affirmative defenses?

Before discussing these questions, some background facts should be mentioned. At the time relevant here, BarChris was engaged primarily in the construction of bowling alleys, somewhat euphemistically referred to as "bowling centers." These were rather elaborate affairs. They contained not only a number of alleys or "lanes," but also, in most cases, bar and restaurant facilities.

BarChris was an outgrowth of a business started as a partnership by Vitolo and Pugliese in 1946. The business was incorporated in New York in 1955 under the name of B & C Bowling Alley Builders, Inc. Its name was subsequently changed to BarChris Construction Corporation.

The introduction of automatic pin setting machines in 1952 gave a marked stimulus to bowling. It rapidly became a popular sport, with the result that "bowling centers" began to appear throughout the country in rapidly increasing numbers. BarChris benefited from this increased interest in bowling. Its construction operations expanded rapidly. It is estimated that in 1960 BarChris installed approximately three per cent of all lanes built in the United States. It was thus a significant factor in the industry, although two large established companies, American Machine & Foundry Company and Brunswick, were much larger factors. These two companies manufactured bowling equipment, which BarChris did not. They also built most of the bowling alleys, 97 per cent of the total, according to some of the testimony.

BarChris's sales increased dramatically from 1956 to 1960. According to the prospectus, net sales, in round figures, in 1956 were some $800,000, in 1957 $1,300,000, in 1958 $1,700,000. In 1959 they increased to over $3,300,000, and by 1960 they had leaped to over $9,165,000.²

For some years the business had exceeded the managerial capacity of its founders. Vitolo and Pugliese are each men of limited education. Vitolo did not get beyond high school. Pugliese ended his schooling in seventh grade. Pugliese devoted his time to supervising the actual construction work. Vitolo was concerned primarily with obtaining new business. Neither was equipped to handle financial matters.

Rather early in their career they enlisted the aid of Russo, who was trained as an accountant. He first joined them in the days of the partnership, left for a time, and returned as an officer and director of B & C Bowling Alley Builders, Inc. in 1958. He eventually became executive vice president of BarChris. In that capacity he handled many of the transactions which figure in this case.

In 1959 BarChris hired Kircher, a certified public accountant who had been employed by Peat, Marwick. He started as controller and became treasurer in 1960. In October of that year, another ex-Peat, Marwick employee, Trilling, succeeded Kircher as controller. At approximately the same time Birnbaum, a young attorney, was hired as house counsel. He became secretary on April 17, 1961.³

In general, BarChris's method of operation was to enter into a contract with a customer, receive from him at that time a comparatively small down payment on the purchase price, and proceed to construct and equip the bowling alley. When the work was finished and the building delivered, the customer paid the balance of the contract price in notes, payable in installments over a period of years. BarChris discounted these notes with a factor and received part of their face amount in cash. The factor held back part as a reserve.

In 1960 BarChris began a practice which has been referred to throughout this case as the "alternative method of financing." In substance this was a sale and leaseback arrangement. It involved a distinction between the "interior" of a building and the building itself, i. e., the outer shell. In instances in which this method applied, BarChris would build and install what it referred to as the "interior package." Actually this amounted to constructing and installing the equipment in a building. When it was completed, it would sell the interior to a factor, James Talcott Inc. (Talcott), who would pay BarChris the full contract price therefor. The factor then proceeded to lease the interior either directly to BarChris's customer or back to a subsidiary of BarChris. In the latter case, the subsidiary in turn would lease it to the customer.

Under either financing method, BarChris was compelled to expend considerable sums in defraying the cost of construction before it received reimbursement.⁴ As a consequence, BarChris was in constant need of cash to finance its operations, a need which grew more pressing as operations expanded.

In December 1959, BarChris sold 560,000 shares of common stock to the public at $3.00 per share. This issue was underwritten by Peter Morgan & Company, one of the present defendants.

By early 1961, BarChris needed additional working capital. The proceeds of the sale of the debentures involved in this action were to be devoted, in part at least, to fill that need.

The registration statement of the debentures, in preliminary form, was filed with the Securities and Exchange Commission on March 30, 1961. A first amendment was filed on May 11 and a second on May 16. The registration statement became effective on May 16. The closing of the financing took place on May 24. On that day BarChris received the net proceeds of the financing.

By that time BarChris was experiencing difficulties in collecting amounts due from some of its customers....