552 F.Supp. 439 (S.D.N.Y. 1982), 79 Civ. 2474, Chemical Bank v. Arthur Andersen & Co.
|Docket Nº:||79 Civ. 2474 (GLG), 79 Civ. 2533 (GLG) and 79 Civ. 2928 (GLG).|
|Citation:||552 F.Supp. 439|
|Party Name:||CHEMICAL BANK, Plaintiff, v. ARTHUR ANDERSEN & CO., Gerald Lee, Mervyn Silver, Joseph Heilbrun, and John Does, Numbered One through Twenty, the latter being fictitious names, Defendants. MANUFACTURERS HANOVER TRUST COMPANY and First Pennsylvania Bank, N.A., Plaintiffs, v. ARTHUR ANDERSEN & CO., Gerald Lee, Mervyn Silver and Joseph Heilbrun, Defenda|
|Case Date:||December 21, 1982|
|Court:||United States District Courts, 2nd Circuit, Southern District of New York|
[Copyrighted Material Omitted]
Patterson, Belknap, Webb & Tyler, New York City, for plaintiff; Michael B. Mukasey, Ann R. Loeb, New York City, of counsel.
Weil, Gotshal & Manges, New York City, for plaintiffs Manufacturers Hanover Trust Co., First Nat. Bank, N.A., and Sec. Pacific Nat. Bank; Michael D. Hess, Irwin H. Warren, Florence M. Fass, Ira N. Glauber, New York City, of counsel.
Breed, Abbott & Morgan, New York City, and Wilson & McIlvaine, Chicago, Ill., for defendant Arthur Andersen & Co.; Edward J. Ross, New York City, and Charles W. Boand, Chicago, Ill., of counsel.
GOETTEL, District Judge:
This is an action 1 for violations of section 10(b) and rule 10b-5 of the Securities Exchange Act of 1934 (1934 Act), section 17(a) of the Securities Act of 1933 (1933 Act), and state common law. Before this Court is defendant Arthur Andersen & Co.'s (Andersen) motion to dismiss and for summary judgment.
The plaintiffs in this action are four commercial banks, Manufacturers Hanover Trust Company (MHT), First Pennsylvania Bank, N.A. (First Pennsylvania), Chemical Bank (Chemical), and Security Pacific National Bank (Security Pacific). (They will be referred to collectively as the Banks. 2 The principal defendant 3 is Andersen, a public accounting firm with offices throughout the United States and the world. From 1973 until 1979, Andersen was the independent public accountant for the Frigitemp Corporation (Frigitemp), a New York corporation that is now in bankruptcy. 4
This lawsuit arises from a series of loans made by the Banks to Frigitemp and one of its wholly owned subsidiaries, Elsters, Inc. (Elsters). During the mid-1970's, Frigitemp, which had earlier embarked upon a course of rapid expansion, required large amounts of capital, and it looked to the Banks for financing. The Banks obliged.
The money was advanced and the obligations of the parties defined in three transactions. The first will be called the Secured Credit Transaction. In a contract dated December 31, 1975 (the Secured Credit Agreement), the Banks agreed to provide Frigitemp with a line of credit up to $8 million. Beginning in 1976, the Banks advanced approximately $6.5 million to Frigitemp. These advances were secured by a pledge of Frigitemp's customer notes receivable and were evidenced by Frigitemp's promissory notes.
The second transaction will be called the Unsecured Loan Transaction. In September 1976, the Banks and Frigitemp began discussing the need to restructure Frigitemp's debt. Pending formal restructuring, which was expected to occur in 1977, Frigitemp asked for and received a $5 million short term loan from MHT, Chemical, and Security Pacific. The funding took place in two stages. In September 1976, the Banks advanced $1.5 million to Frigitemp, and Frigitemp gave a one month promissory note to each bank. In October 1976, the three banks advanced $3.5 million to Frigitemp, and Frigitemp gave each bank a three month promissory note that reflected the September 1976 financing and that matured on February 28, 1977. (The maturity of these notes was later extended to April 30, 1977.) In February 1977, Frigitemp received an additional $4 million unsecured loan from all four banks and gave each bank a promissory note that matured on April 30, 1977.
The final transaction occurred in August 1977. From March 1977 until August 1977, Frigitemp's management and members of the Banks' senior management discussed Frigitemp's future financial needs and the terms and conditions of the debt restructuring. The fruit of these negotiations was the August 1977 transaction, in which the Banks restructured Frigitemp's debt and provided $4 million in new financing to Elsters.
There were essentially three parts to this transaction, although the Banks maintain that "[a]ll three agreements (plus the Pledge and Guarantee) were structured as, and were intended to be, part of one single, integrated refinancing package." O'Neill Affidavit ¶ 26. First, the Banks extended the maturity date on the unsecured notes from April 30, 1977 to March 31, 1978. To reflect this change, Frigitemp executed new notes in substitution for the prior indebtedness. (These will be called the Replacement Notes.) Second, the Banks extended the maturity date on the notes issued pursuant to the Secured Credit Agreement from July 1, 1977 to July 1, 1978. See id. ¶ 28. To reflect this change, the notes were amended by endorsements dated August 9, 1977. (These will be called the Note Endorsements.) Finally, the Banks advanced $4 million to Elsters. Elsters gave the Banks promissory notes that matured on March 31, 1978; Frigitemp guaranteed the loan and pledged 100% of Elsters common stock, 750 shares, pursuant to a Pledge and Security Agreement.
Thus, as of August 1977, Frigitemp and Elsters owed the Banks approximately $19.5 million. By the time that Frigitemp filed its bankruptcy petition in 1978, however, only approximately one-third of that amount had been repaid. 5
The Banks commenced this action in 1979 in what is essentially an attempt to hold Andersen liable for these losses. They allege that they entered into the transactions with Frigitemp and Elsters in reliance on Frigitemp's financial statements audited and certified by Andersen for the years 1973-1976 and that these statements were
materially false and misleading. 6 According to the Banks, Andersen's conduct in preparing and certifying these statements amounted to violations of the securities laws: the first claim is that Andersen violated section 17(a) of the 1933 Act and section 10(b) and rule 10b-5 of the 1934 Act; the fourth claim is that Andersen aided and abetted violations of these provisions. 7
Andersen filed this motion in 1982, after extensive discovery. It contends that this Court lacks jurisdiction because the alleged fraud was not "in connection with" the purchase or sale of a security and that the complaint fails to state a claim against Andersen as either a primary violator of the securities laws or as an aider and abettor. 8 For the reasons stated below, Andersen's motion is denied. 9
I. Jurisdiction Under the Securities Laws
The sine qua non of a federal court's jurisdiction to hear a claim under section 10(b) of the 1934 Act is a misrepresentation "in connection with the purchase or sale of [a security]," 1934 Act § 10(b), 15 U.S.C. § 78j(b) (1976); under section 17(a) of the 1933 Act, it is a misrepresentation "in the offer or sale of [a security]," 1933 Act § 17(a), 15 U.S.C. § 77q(a) (1976). The Banks assert that these requirements are satisfied by virtue of the notes issued in connection with the August 1977 transaction and the pledge of Elsters stock. Andersen, on the other hand, argues that the notes are not securities 10 and that the alleged fraud was not "in connection with" the pledge of Elsters stock.
A. The Notes As Securities
Three types of notes were issued in connection with the August 1977 transaction. First, there were the Replacement Notes issued by Frigitemp to the Banks in substitution for the prior unsecured indebtedness. These notes were issued on August 9, 1977 and matured on March 31, 1978, a period of approximately eight months. They provided for a definite rate of interest tied to the prime rate of the lending bank, and they were unsecured. Second, there were the Note Endorsements that amended the notes issued pursuant to the Secured Credit Agreement. The endorsements were dated August 9, 1977 and extended the maturity date on the notes to July 1, 1978. The notes, as amended, provided for a definite rate of interest tied to the prime rate of the lending bank, and they were secured by Frigitemp's customer notes receivable. Third, there were the notes issued by Elsters to reflect the $4 million advance. These notes were issued on August 9, 1977 and matured on March 31, 1978, a period of approximately eight months. They provided for a definite rate of interest tied to the prime rate of the lending bank, and they were secured by Frigitemp's pledge of Elsters common stock. Moreover, the underlying loan agreement provided that the proceeds of the loan were to be added to Elsters' working capital for use in the ordinary course of business.
Whether these notes are securities is not an easy question. The 1933 Act provides that, unless the context otherwise requires, "[t]he term 'security' means any note." 1933 Act § 2(1), 15 U.S.C. § 77b(1) (1976). Although "[a]ny note ... which arises out of a current transaction or the proceeds of which have been or are to be used for current transactions, and which has a maturity at the time of issuance of not exceeding nine months, exclusive of days of grace, or any renewal thereof the maturity of which is likewise limited," is exempt from the 1933 Act's registration requirements, 1933 Act § 3(a)(3), 15 U.S.C. § 77c(a)(3) (1976), it is clear that this exemption does not apply to the Act's antifraud provisions. Exchange National Bank v. Touche Ross & Co., 544 F.2d 1126, 1131 (2d Cir.1976) (quoting
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