DeHaas v. Empire Petroleum Company

• Citation: 435 F.2d 1223
• Decision Date: 10 February 1971
• Docket Number: No. 22-70.,22-70.
• Parties: William F. deHAAS et al., Plaintiffs-Appellees, v. EMPIRE PETROLEUM COMPANY, a Colorado corporation, Eugene M. Stone, Empire Crude Oil Company, a Nevada corporation, and American Industries, Inc., a Nevada corporation, Defendants-Appellants.
• Court: United States Courts of Appeals. United States Court of Appeals (10th Circuit)

435 F.2d 1223 (1970)

William F. deHAAS et al., Plaintiffs-Appellees, v. EMPIRE PETROLEUM COMPANY, a Colorado corporation, Eugene M. Stone, Empire Crude Oil Company, a Nevada corporation, and American Industries, Inc., a Nevada corporation, Defendants-Appellants.

No. 22-70.

United States Court of Appeals, Tenth Circuit.

December 22, 1970.

Rehearings Denied February 10, 1971.

Holmes Baldridge, Denver, Colo. (Arlen S. Ambrose, Denver, Colo., was with him on the brief) for defendants-appellants.

James W. Heyer, Denver, Colo., for plaintiffs-appellees.

Before LEWIS, Chief Judge, and SETH and HICKEY^*, Circuit Judges.

LEWIS, Chief Judge.

This is a multiple claim stockholders' derivative action brought by plaintiff deHaas as a stockholder of American Industries, Inc., seeking damages and equitable relief against defendants for violations of Rule 10b-5 promulgated by the Securities and Exchange Commission pursuant to section 10(b) of the Securities Exchange Act of 1934. After trial before court and jury in the United States District Court for the District of Colorado two claims survived to judgments in favor of plaintiff totalling $60,000 against defendants Empire Petroleum and Stone and an additional $5,000 against Stone as punitive damage. Defendants do not now question the sufficiency of the evidence to support the findings of fraudulent violation of section 10(b) of the Act; nor do they specifically seek a new trial. Consequently we need not recite in full the complexities of this protracted litigation nor its complete evidentiary background.¹ Defendants have limited the appellate issues to contentions that:

1. Plaintiff's claims were barred by the applicable statute of limitations.

2. Plaintiff was never a shareholder in American.

3. Plaintiff failed to make a demand upon American's board of directors to institute suit prior to his bringing this action.

4. The court erred in allowing an amendment to the complaint at the close of all evidence and further erred in submitting such alleged new claim through a prejudicial form of verdict.

5. The court erred in allowing punitive damage against defendant Stone.

Consideration of these contentions does require a particularization of the evidence in varying extents and in projection from the broad background of the case.

In early 1962, defendant Empire Petroleum Company was the sole owner of Mutual Supply Company and American Industries, Inc. Empire also owned 43 percent of the stock in Inland Development Corp. with the rest distributed among 1400 public stockholders. Both of the wholly-owned subsidiaries were apparently in serious financial trouble and had negligible assets. Inland Development Corp., on the other hand, owned assets worth approximately one million dollars.

Defendant Stone held important ownership interests and management offices in all the corporations involved, and was in a position to dominate all of these companies.

During June and July of 1962, Empire sold Mutual to American and then a merger between Inland and American was consummated, with American as the survivor. American subsequently lost over $318,000 during the next three years in attempting to operate Mutual.

The consent of Inland's public stockholders to the 1962 merger was obtained through the use of proxy solicitations which failed to disclose, among other things, that American had issued $259,000 in interest-bearing notes to Empire in payment for Mutual, that Mutual was a losing operation, and that Inland's assets were expected to pay off the substantial debts of Mutual.

The $259,000 in notes, representing the purchase price of Mutual, was canceled prior to trial.

I. Statute of Limitations

This issue was considered by both court and jury, the court determining the actions to be not barred as a matter of law, 286 F.Supp. 809, 813, and the jury specifically finding, under proper instructions, that the action was not barred in fact. We hold the record to support both determinations.

There is no federal statute of limitations applicable to actions brought under section 10(b) of the Securities Exchange Act of 1934. Hence, the limitations statute of the forum state in which the alleged prohibited acts occurred applies to a private suit for damages under section 10(b). Hooper v. Mountain States Securities Corp., 5 Cir., 282 F.2d 195, 205. In the instant case it is agreed that the Colorado statute of limitation for fraud, C.R.S.1963, 87-1-10, should apply. This statute requires that suit be brought within three years after discovery of fraud by the aggrieved party. See Trussell v. United Underwriters, Ltd., D.Colo., 228 F.Supp. 757, 775-776.

Plaintiff concedes that this suit was not brought within three years after the 1962 merger² but contends that the statute of limitations was tolled until 1965 because he did not know about, nor could he reasonably have discovered, the fraud. Defendant, on the other hand, argues that at the time of the 1962 merger plaintiff knew, or by the exercise of due diligence, could have discovered the fraudulent nature of the merger.

Although the limitation period is supplied by the state of Colorado, "it is a matter of federal law as to the circumstances that will toll a state statute applied to private actions under the securities laws." Esplin v. Hirschi, 10 Cir., 402 F.2d 94, 103. The federal doctrine of tolling as applied to fraud actions was enunciated by the Supreme Court in the early case of Bailey v. Glover, 88 U. S. 342, (21 Wall.) 22 L.Ed. 636, 638: "Where the party injured by the fraud remains in ignorance of it without any fault or want of diligence or care on his part, the bar of the statute does not begin to run until the fraud is discovered though there be no special circumstances or efforts on the part of the party committing the fraud to conceal it from the knowledge of the other party." This equitable doctrine has been consistently applied in private fraud actions under section 10(b) of the Securities Exchange Act.³ See Esplin v. Hirschi, supra, 402 F.2d at 103; Hooper v. Mountain States Securities Corp., supra, 282 F.2d at 206.

Several cases since Bailey have attempted to clarify what quantum of knowledge the plaintiff must possess in order to set the statute of limitations running. The analysis in Tobacco & Allied Stocks, Inc. v. Transamerica Corp., D.Del., 143 F.Supp. 323, 331, affd., 244 F.2d 902, 3 Cir., correctly sums up applicable law:

It is impossible to lay down any general rule as to the amount of evidence or number or nature of evidential facts admitting discovery of fraud. But, facts in the sense of indisputable proof or any proof at all, are different from facts calculated to excite inquiry which impose a duty of reasonable diligence and which, if pursued, would disclose the fraud. Facts in the latter sense merely constitute objects of direct experience and, as such, may comprise rumors or vague charges if of sufficient substance to arouse suspicion. Thus, the duty of reasonable diligence is an obligation imposed by law solely under the peculiar circumstances of each case, including existence of a fiduciary relationship, concealment of the fraud, opportunity to detect it, position in the industry, sophistication and expertise in the financial community, and knowledge of related proceedings.

In accord with this standard we need only concern ourselves with the information plaintiff had prior to March 23, 1963, which is three years prior to filing of this suit. Only if plaintiff had sufficient notice before that date, will the statute of limitations be a bar. The most directly relevant information then available to plaintiff was the proxy material sent to him in relation to the merger between Inland and American. This consisted of a letter signed by defendant Stone and mailed to Inland's stockholders giving some explanation of the proposed merger, a copy of the merger agreement, and a proxy card. This material, taken alone, was clearly inadequate to have aroused a reasonable suspicion. No disclosure was made of the financial condition of either company, and although the previous sale of Mutual to American was mentioned, no details were given. In addition, defendant falsely stated in the letter that Mutual was operating a service station in the Denver area when he knew that this enterprise had recently been abandoned.

The other major source of information was the 1961 Empire Annual Report, which was sent to plaintiff as a stockholder of Empire. Note 3B of that report states that Empire's investment in American had been reduced on the basis of appraisal to $34,800. From this plaintiff could have inferred that American was virtually a "shell" corporation, at least before its subsequent purchase of Mutual. The report also listed several commitments Empire had made to guarantee certain long-term debts of Mutual. From this, plaintiff could have inferred that American might be "stuck" with paying these debts if Mutual defaulted. However, in light of the glowing letter recommending the American-Inland merger, plaintiff could reasonably be led to believe that Mutual was making money and could pay its debts.

Defendants additionally stress plaintiff's past connections with the oil business and Empire, his continuing interest as a stockholder, and his admitted concern over the merger of Inland and American. Although plaintiff had been sales manager, officer, and director of Empire, he left the company in 1957 and has not been significantly associated with it since then except as a stockholder. As a stockholder of Empire and Inland, plaintiff received the normal operating reports mailed by the two companies, which he studied and retained. We have already detailed the information contained in this material that was relevant to the 1962 merger. Plaintiff's testimony does indicate that he had some doubt about the 1962 merger, but a close examination shows only a feeling that the merger would accomplish little, if anything, and...