Madigan, Incorporated v. Goodman, 73-1628.

• Decision Date: 06 June 1974
• Docket Number: No. 73-1628.,73-1628.
• Citation: 498 F.2d 233
• Parties: MADIGAN, INCORPORATED, et al., Plaintiffs-Appellants, v. Gilbert GOODMAN et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

498 F.2d 233 (1974)

MADIGAN, INCORPORATED, et al., Plaintiffs-Appellants, v. Gilbert GOODMAN et al., Defendants-Appellees.

No. 73-1628.

United States Court of Appeals, Seventh Circuit.

Heard February 28, 1974.

Decided June 6, 1974.

COPYRIGHT MATERIAL OMITTED

Fred H. Bartlit, Jr. and Frank Cicero, Jr., Kirkland & Ellis, Chicago, Ill., for plaintiffs-appellants.

Joseph P. Della Maria, Jr., Michael J. Guinan, Sheldon Karon, Russell J. Topper, Chicago, Ill., for defendants-appellees.

Before SWYGERT, Chief Judge, CUMMINGS and PELL, Circuit Judges.

CUMMINGS, Circuit Judge.

Four corporate plaintiffs and five of their directors, collectively known as the Madigan Group, sued seven former shareholders of Fidelity General Insurance Company and the receiver of Dealers National Insurance Company and Liberty Universal Insurance Company, who held title to 1,071,650 shares of Fidelity's common stock. The complaint asserted that defendants made false representations concerning Fidelity's financial situation to the detriment of the Madigan Group. The amended complaint makes clear that the defendant receiver is not charged with fraud and is joined only to insure the enforceability of any relief affecting title to the Fidelity shares. Count I of the complaint was based on the Securities Exchange Act of 1934 (15 U.S.C. § 78a, et seq.) and SEC Rule 10b-5 (17 C.F.R. § 240.10b-5). Count II was based on Illinois common law fraud. After considering plaintiffs' answers to defendants' interrogatories, the district court rendered an opinion dismissing the complaint. 357 F.Supp. 1331 (N.D.Ill.1973). Because of the court's reliance on those answers, its ruling was actually a summary judgment for defendants. Rule 12(b) of the Federal Rules of Civil Procedure. Plaintiffs' subsequent motion for leave to file an appended amended complaint was denied. We will consider the allegations of the amended complaint, since its filing should have been permitted. See Austin v. House of Vision, Inc., 385 F.2d 171, 172 (7th Cir. 1967).

According to the complaint, the Madigan Group purchased 51% of the common stock of Fidelity from defendants for $1,750,895.50 in December 1968. At the same time, the Madigan Group contracted to make a tender offer for the remaining Fidelity shares before June 30, 1969. In September 1969, the Madigan Group sold its Fidelity stock to Texas Consumer Finance Corporation for $1,750,895. Texas Consumer Finance Corporation was an affiliate of the Madigan Group. It and two other affiliates assumed the obligation to make the tender offer and purchased 506,845 shares of Fidelity from various sellers for $1,571,219.50 in the summer of 1969. None of these three companies are parties to this lawsuit.

The complaint asserted that as a result of defendants' understatement of the reserves for losses and loss adjustment expenses of Fidelity, plaintiffs expended $3,322,115 to buy Fidelity stock; expended additional sums in an effort to prevent the insolvency of Fidelity; lost $1,000,000 in expected profits; incurred substantial expenses in defending lawsuits resulting from their purchase of Fidelity stock; might incur substantial losses (possibly exceeding $48,000,000 according to the opinion below) in connection with Fidelity-related litigation; and were unable to plan and conduct their financial affairs in an orderly manner due to the same litigation.

In its opinion, as noted, the district court relied on the Madigan Group's answers to defendants' interrogatories. These answers claimed that Fidelity was insolvent in 1968 and that in November and December of that year defendants orally and in writing falsely represented its financial condition, "including its reserve for losses and loss expenses." The answers also asserted that subsequent to December 31, 1968, defendants submitted under oath a 1968 Fidelity annual statement to the Illinois Director of Insurance that falsely represented its financial condition. Assertedly thereafter, defendants "caused revisions to be made to the 1968 Fidelity general annual statement and offered false explanations for the revisions while concealing the true reasons for the revisions." Defendants supposedly continued to conceal Fidelity's true financial condition by "concealing from the plaintiffs actions that had been taken by several state insurance regulatory bodies because of the financial condition of Fidelity * * *." The answers also state that the Illinois Department of Insurance concluded subsequent to Fidelity's liquidation that it "would have been insolvent as of December, 1968 had its financial condition been accurately reported then." September 1969 was stated to be the first time that plaintiffs became aware that defendants had misrepresented Fidelity's financial condition. To prevent Fidelity's insolvency, plaintiffs allegedly contributed $500,000 to Fidelity's capital on April 30, 1970, but nevertheless on December 4, 1970, the Circuit Court for Sangamon County, Illinois, found Fidelity to be insolvent and ordered that it be placed in liquidation.

According to the supplemental interrogatory answers filed by plaintiffs,

"The information concerning the true financial condition of Fidelity General concealed by defendants could have been ascertained only by an exhaustive study of Fidelity\'s books and records including all of its claims files and its records relating to loss reserves which was unnecessary in view of the legal duty of defendants not to conceal such information and not to misrepresent the true condition of Fidelity General."

The supplemental answers also state that a partial audit of Fidelity's reserves for losses conducted in September 1969 by the accounting firm of Lybrand, Ross Bros. & Montgomery "indicated deficiencies." In the supplemental answers, plaintiffs also stated that among the losses incurred in attempting to prevent the insolvency of Fidelity was $2,053,629 "ceded by Fidelity General to Dealers National Insurance Company during 1969, while Dealers National was virtually a wholly owned subsidiary of Madigan."

The district court held that since the plaintiffs resold the Fidelity securities purchased from the defendants for the same price at which those securities were acquired, they suffered no loss. In their supplemental answer to defendants' interrogatory 31(a) and in their proposed amended complaint, plaintiffs no longer claim damages based on loss of purchase price. The court reasoned that in such circumstances plaintiffs had no cause of action based on any violation of the Securities Exchange Act of 1934 or SEC Rule 10b-5.

The court held that the Madigan Group could not recover the $18,384 commission that it had paid to a broker in connection with its December 1968 purchase of Fidelity securities, stating:

"In fact, under the `out of pocket rule\' the plaintiff Madigan Group sold the Fidelity stock for what it purchased it for and thus was not damaged. Chasins v. Smith Barney & Co., 438 F.2d 1167 (2nd Cir. 1970)."

It may be noted that Chasins does not discuss recoverability of commissions as an element of damages in a securities fraud case.

The district court also held that defendants' liability "does not include the speculative fruits of unrealized profit," so that plaintiffs were not permitted to recover the million dollars they claimed in expected profits and benefits.

As to expenses undertaken by plaintiffs to prevent Fidelity's insolvency, citing Mott v. Tri-Continental Financial Corp., 330 F.2d 468 (2d Cir. 1964), the court held that since such "indirect injuries" related to matters after they sold their stock, there could be no recovery under the Securities Exchange Act. Mott is no bar to relief here, for Mott sought only recission, despite the fact that he no longer owned the securities. He alleged no substantial damages apart from the securities purchase price that he had recouped nor did he invoke Rule 10b-5.

The court applied the same reasoning to expenses incurred by plaintiffs in defending lawsuits resulting from their purchase of securities from the defendants, and to plaintiffs' claim for damages due to their inability to plan and conduct financial affairs as a result of said lawsuits. The court also held that these damages were not attributable to defendants.

The court also indicated its view that the five individual plaintiffs and two of the four corporate plaintiffs (Ward Cut-Rate Drug Company and Mading-Dugan Drugstores, Inc.) had neither purchased nor sold Fidelity stock and therefore had no standing to assert a claim under Rule 10b-5, citing Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir. 1952), and Herpich v. Wallace, 430 F.2d 792 (5th Cir. 1970). As a result of this finding, in the proposed amended complaint "only those plaintiffs who purchased Fidelity General stock seek recovery of damages apparently as opposed to indemnification or contribution caused by defendants' security fraud" (plaintiffs' reply brief 6, n. 3). In view of this construction of the amended complaint, we will not consider the effect of Eason v. General Motors Acceptance Corp., 490 F.2d 654 (7th Cir. 1973), on the standing question. The district court did not consider the Illinois common law fraud count, nor have the parties briefed that question in this Court. Therefore, we will not consider it either.

On appeal, the Madigan Group first argues that its members are entitled to indemnification or contribution from defendants for any liability to which plaintiffs may be exposed in the pending action filed against them by the Illinois Director of Insurance as liquidator of Fidelity. That suit, Mauck v. Mading-Dugan Drug Co. et al., No. 70 C 2151, is still pending before the same district judge. The defendants include the five individual plaintiffs herein. $16,500,000 in damages are sought in addition to equitable relief.

The liquidator's complaint states a quite different version of the facts. He alleges that Fidelity was solvent when purchased...