DeHaas v. Empire Petroleum Company

• Decision Date: 10 July 1968
• Docket Number: Civ. A. No. 66-C-167.
• Parties: Wm. F. deHAAS, Charles J. Wiley, Ralph W. Riggins, and Colorado International Corp., a Colorado corporation, Plaintiffs, v. EMPIRE PETROLEUM COMPANY, a Colorado corporation, Eugene M. Stone and American Industries, Inc., a Nevada corporation, Defendants, Third-Party Plaintiffs, and Cross Claimants, v. William R. LOEFFLER, Third-Party Defendant, and Defendant on Cross Claim.
• Court: U.S. District Court — District of Colorado

286 F. Supp. 809

Wm. F. deHAAS, Charles J. Wiley, Ralph W. Riggins, and Colorado International Corp., a Colorado corporation, Plaintiffs, v. EMPIRE PETROLEUM COMPANY, a Colorado corporation, Eugene M. Stone and American Industries, Inc., a Nevada corporation, Defendants, Third-Party Plaintiffs, and Cross Claimants, v. William R. LOEFFLER, Third-Party Defendant, and Defendant on Cross Claim.

Civ. A. No. 66-C-167.

United States District Court D. Colorado.

July 10, 1968.

COPYRIGHT MATERIAL OMITTED

James W. Heyer and Portis G. Welch, Denver, Colo., for plaintiffs.

Holmes Baldridge, Chicago, Ill., and Arlen S. Ambrose, Denver, Colo., for defendants, third-party plaintiffs and cross claimants.

John S. Carroll, Denver, Colo., for third-party defendant and defendant on cross claim.

MEMORANDUM OPINION AND ORDER

WILLIAM E. DOYLE, District Judge.

This is a derivative action brought by four stockholders of American Industries, Inc.,¹ for damages and equitable relief in connection with a merger which occurred in 1962 and allegedly involved violations of Rule 10b-5 promulgated by the Securities Exchange Commission pursuant to Section 10(b) of the Securities Exchange Act of 1934. The defendants have filed a third-party complaint² against William R. Loeffler, seeking indemnification and affirmative relief. The case is presently before the Court on defendants' motion for summary judgment of dismissal of the original complaint, and Loeffler's motion for summary judgment of dismissal of the third-party complaint. These questions have been briefed and argued by the parties and they now stand submitted.

The essential facts are as follows. In January, 1962, defendant Empire Petroleum Company was the sole owner of two subsidiaries—Mutual Supply Company and American Industries, Inc. Empire also effectively controlled Inland Development Corporation, owning 43% of its stock with the remaining 57% being dispersed among 1400 public shareholders.³ Both wholly-owned subsidiaries were apparently in serious financial trouble. American's primary asset was a 50% interest in unproductive oil property, which it had originally purchased for approximately $1,000,000 but had an appraised value of only $34,800 in 1962. Mutual Supply Company, which operated combination service stations and merchandise stores, had suffered losses of $259,000 since its inception, and was allegedly suffering a continuing loss of $10,000 each month. The partially-owned subsidiary, Inland Development Corporation, owned assets worth approximately $1,000,000, but was producing little, if any, net income.

Defendant Stone held important positions in the management of all the corporations involved. He was president, chairman of the board, and chief executive officer of Empire, American and Mutual, and was president and a director of Inland Development Corporation. The plaintiffs allege that he dominated and controlled all of these companies.

The allegedly fraudulent transactions occurred during June and July of 1962, when a consolidation of American Industries, Mutual Supply and Inland Development took place. The consolidation was accomplished by Empire's sale of Mutual to American, and the subsequent merger of American and Inland Development, with American as the survivor. The plaintiffs allege that the consent of Inland's public shareholders was obtained through the use of proxy solicitations which contained the following misrepresentations and omissions:

(a) Failure to disclose that Mutual was a loss operation and that the surviving corporation had contracted to save Empire harmless from Mutual's creditors;

(b) Failure to disclose that American's stock had been arbitrarily valued at $5.00 per share, whereas it had little or no value as of the date of merger;

(c) Failure to disclose that Stone had exacted a salary of $20,000 from American to be paid with Inland's funds after the impending merger;

(d) Failure to disclose that Stone had obtained an option to purchase 100,000 shares of American stock for $1.00 per share;

(e) Falsely representing that the merged corporation could "look forward to rapid growth and expansion."

After the merger in which Empire gained a majority of the stock in the surviving corporation, the plaintiffs allege that encouraging letters were periodically sent to the shareholders until July 28, 1965, when the directors of Empire were compelled by a court order to send an annual report and financial statements to all shareholders. As a result of the information revealed in those reports, the plaintiffs initiated the present action.

I. THE DEFENDANTS' MOTION FOR SUMMARY JUDGMENT.

Defendants' contentions in support of their motion are: (1) plaintiffs Wiley and Riggins were not shareholders of American at the time the transactions occurred, as required by Rule 23.1(1); (2) plaintiffs deHaas and Colorado International Corporation are barred from prosecuting the suit by the applicable statute of limitations; and, (3) plaintiffs have failed to make a prior demand on American's board of directors, as required by Rule 23.1(2). These questions will be discussed in the order in which they appear above.

A. The Standing of Plaintiffs Wiley and Riggins.

Rule 23.1(1) provides that the complaint shall aver that the plaintiff "was a shareholder or member at the time the transaction of which he complains or that his share or membership thereafter devolved on him by operation of law * * *." The transactions complained of in this case occurred between January and August of 1962. Since neither Riggins nor Wiley purchased his stock until sometime in 1964, both must be dismissed as parties to this suit. Their standing is not enhanced by the allegation in the complaint that the fraud is of a "continuing" nature. As indicated in Pergament v. Frazer, 93 F.Supp. 9, 12 (E.D.Mich. 1949), "every harm to a corporation is `continuing' when someone has taken away some of its assets wrongfully." Rule 23.1(1) clearly requires that the plaintiff be a shareholder when the transactions occurred, and a mere allegation of "continuing" fraud cannot deprive the Rule of its obvious intent. See also, Matthies v. Seymour Mfg. Co., 270 F.2d 365, 373 (2nd Cir. 1959); Weinhaus v. Gale, 237 F.2d 197, 200 (7th Cir. 1956); and Henis v. Compania Agricola de Guatemala, 210 F.2d 950 (3rd Cir. 1954).

Plaintiffs Riggins and Wiley will therefore be dismissed from the suit.

B. The Statute of Limitations Question.

Since there is no federal statute of limitations for actions brought under Section 10(b), the applicable state statute of limitations must be applied. Hooper v. Mountain States Securities Corp., 282 F.2d 195 (5th Cir. 1960). The present case is therefore governed by the Colorado statute of limitations for fraud, C.R.S.1963, 87-1-10, which requires that suit be filed within three years after the discovery of fraud by the aggrieved party. Trussell v. United Underwriters, Ltd., 228 F.Supp. 757, 775 (D.Colo.1964).

The plaintiffs concede that this lawsuit was not filed within three years after the merger of 1962. However, they contend that the statute of limitations was tolled until 1965, because the cause of action was fraudulently concealed until that time and could not have been discovered through the exercise of reasonable diligence. See Wood v. Carpenter, 101 U.S. 135, 25 L.Ed. 807 (1879), and Holmberg v. Armbrecht, 327 U.S. 392, 66 S.Ct. 582, 90 L.Ed. 743 (1946). The defendants argue that the facts conclusively demonstrate that the plaintiffs failed to exercise reasonable diligence in discovering their cause of action. They point out that both remaining plaintiffs had doubts about the advisability of the merger, that both were acquainted with key officers of Empire, and yet failed to make inquiries or protests against the action. However, the plaintiffs contend that while they doubted that the merger was good business practice, they relied upon Stone's integrity and the information provided them by the management. They assert that they had no reason to suspect fraud until they received the annual report and financial statements issued in July of 1965.

We conclude that the documents on file demonstrate a genuine issue of fact which can only be resolved at trial. A decision on this question would require us to make difficult judgments on the amount of knowledge available to the plaintiffs and the reasonableness of their conduct. In such circumstances, the summary judgment procedure is inappropriate. See Moore's Federal Practice ¶ 56.1758. Since the defendants have failed to clearly demonstrate that the plaintiffs were negligent in failing to protect their rights, the motion for summary judgment on the grounds that the action is time-barred must be denied.

C. The Failure to Make Demand on the Board of Directors.

Rule 23.1(2) of the Federal Rules of Civil Procedure provides that the complaint in a derivative action shall allege "with particularity the efforts, if any, made by the plaintiff to obtain the action he desires from the directors or comparable authority and, if necessary, from the shareholders or members, and the reasons for his failure to obtain the action or for not making the effort." The plaintiffs in this case have not made an effort to exhaust their intracorporate remedies. However, the parties apparently agree that a demand on the shareholders would have been an empty formality. The plaintiffs have alleged a number of reasons as to why a demand on the board of directors would also have been futile.

The question whether demand should be required is addressed to the sound discretion of the Court. See, e. g., 3A Moore's Federal Practice 3525, 13 Fletcher, Cyclopedia on Corporations 466 (1961), and cases cited therein. Normally, this decision is made solely on the basis of the allegations in the complaint. DePinto v. Provident Security Life Ins. Co., 323 F.2d 826, 830 (9th Cir. 1963), and Cohen v. Industrial Finance Corp., 44 F.Supp. 491 (S.D. N.Y.1942). However,...