Briskin v. Ernst & Ernst, 75-2851

• Decision Date: 15 December 1978
• Docket Number: No. 75-2851,75-2851
• Citation: 589 F.2d 1363
• Parties: Judith Wilder BRISKIN, Manuel F. Rothberg, Marshall Irwin Siskin, et al., Appellants, v. ERNST & ERNST, a Co-Partnership, Newton Glekel, Mark Williams, et al., Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 1363

589 F.2d 1363

Judith Wilder BRISKIN, Manuel F. Rothberg, Marshall Irwin Siskin, et al., Appellants, v. ERNST & ERNST, a Co-Partnership, Newton Glekel, Mark Williams, et al., Appellees.

No. 75-2851.

United States Court of Appeals Ninth Circuit.

Dec. 15, 1978.

Peter Abrahams, Los Angeles, Cal., for appellants.

Joel B. Gardner, Michael B. Targoff, Bartlett H. McGuire, New York City, for appellees.

Appeal from the United States District Court for the Central District of California.

Before MERRILL, GOODWIN and TANG, Circuit Judges.

GOODWIN, Circuit Judge:

A group of former shareholders of a closely held furniture company (Sloane) ¹ sued officers and agents of Beck Industries, Inc., and Beck's accounting firm, for damages arising out of losses sustained by Sloane shareholders following the acquisition of Sloane by Beck. The cases were dismissed as time-barred, and the shareholders appeal.

Two actions were commenced on June 13, 1973, by nine Sloane shareholders. One was against Ernst & Ernst, Beck's accounting firm; the other, against the other appellees. A few days later, the nine attempted by another complaint to convert the actions into class actions, but the district court denied certification. Thereafter, the two cases proceeded as one, and through joinder combined the claims of 45 shareholders. We treat the cases as consolidated.

The theory of liability is that the individual defendants made material misrepresentations in the negotiations leading up the acquisition of Sloane by Beck, and that the accounting firm was "reckless" in failing to reveal inaccuracies in Beck's financial statements. ²

The only question before us is, when did California's three-year statute of limitations begin to run?

All parties agree that the applicable statute of limitations is Cal.Civ.Proc.Code § 338(4). This court has held that Section 338(4) applies in actions brought in California under Section 10(b) of the Securities Exchange Act. United California Bank v. Salik, 481 F.2d 1012 (9th Cir.), Cert. denied, 414 U.S. 1004, 94 S.Ct. 361, 38 L.Ed.2d 240 (1973).

Cal.Civ.Proc.Code § 338(4) provides that an action for fraud must be brought within three years after the cause of action has accrued, but that "(t)he cause of action in such case (is) not to be deemed to have accrued until the discovery, by the aggrieved party, of the facts constituting the fraud or mistake." The district court held as a matter of law that the relevant "discovery" occurred more than three years before June 13, 1973.

The negotiations between Beck and Sloane began in October of 1968 when defendant Charles McDevitt telephoned one of the Sloane directors to discuss the possible acquisition of Sloane by Beck. As a result of this call, on October 9, 1968, McDevitt met with plaintiffs Irwin and Bernard Greenberg in Los Angeles. McDevitt told them that the Beck management planned to transform Beck from a women's shoe company into a fashion conglomerate. McDevitt stated that Beck was in strong financial condition and was capable of implementing its planned acquisitions without difficulty.

On November 5, 1968, McDevitt met with the board of directors of Sloane and made representations to the members about Beck's financial strength. McDevitt stated at this meeting that Beck's shoe inventory was valued at $12,000,000. He asserted that not more than ten per cent of the shoes in the inventory were out of style and unsaleable. (These points later were alleged as fraud.)

Because the Sloane shareholders were too numerous to participate directly in the negotiations with Beck, they agreed to have the Greenbergs, Manuel Rothberg, and Leo and Marshall Siskin (all stockholders active in the management of Sloane) conduct the negotiations on behalf of Sloane and report back to the others.

The negotiators obtained written financial information about Beck, including Beck's 1967 annual report, a projected balance sheet as of December 31, 1967, two financial analyses of Beck published by investment companies, and a 1968 proxy statement. Alleged misstatements in these documents are charged as fraud.

Early in December of 1968, the parties reached an agreement in principle, subject to the approval of the Sloane shareholders. The agreement provided for the exchange of all of the stock of Sloane for Beck common stock plus cash.

In early March of 1969, Manuel Rothberg learned that Beck planned to acquire a group of stores called Unimart. Rothberg telephoned McDevitt and told him that the principals of Sloane might stop negotiations in light of the Unimart purchase. McDevitt asked Rothberg and Bernard Greenberg go come to New York to discuss the effect of the Unimart acquisition.

On March 12, 1969, Rothberg and Greenberg met with McDevitt. McDevitt told them that Beck was planning to acquire the Unimart stores by having Beck's subsidiary corporations acquire the leasehold interests and fixtures of the stores. He said that Beck, the parent corporation, had committed only $400,000 of its own capital to the acquisition of the Unimart stores and only $2,700,000 in additional Beck capital would be required for inventory. McDevitt assured the Sloane group that Beck would not be liable for rent on the Unimart leases.

At the March 12 meeting, McDevitt also told Rothberg and Greenberg that Beck had recently completed a private placement of 250,000 shares of Beck common stock at more than $287/8 per share. McDevitt said that he could not tell them the exact price because the transaction had not yet been reported to the SEC. This statement of the price is also alleged to have been fraudulent; plaintiffs contend the real price was $25 per share.

McDevitt assured Rothberg and Greenberg once again that Beck was in strong financial condition, it had enough working capital to handle the financing of its acquisition plans, and it had a management team capable of planning retail centers for the new acquisitions.

Beck's 1968 financial statement, certified by Ernst & Ernst, was issued in March of 1969. This statement is the foundation of one of the claims against the accounting firm.

In August and September of 1969, the parties restructured the merger agreement to provide for Sloane's acquisition by Beck in exchange for preferred stock in Beck. The preferred stock was to have a guaranteed redemption price after five years of $120 per share. The parties executed the final merger agreement on September 26, 1969.

The plaintiffs claim that they first became aware on June 16, 1970 that McDevitt might have misrepresented material facts during the 1969 merger negotiations. On that day, Rothberg read in Home Furnishings Daily that Food Giant was suing Beck over the Unimart leases, claiming that Beck was fully liable for them. On June 18, 1970, Bernard Greenberg met with a Los Angeles attorney to discuss rescission of the Sloane-Beck merger.

On July 11, 1970, Rothberg and Bernard Greenberg represented Sloane at a meeting with Beck management in New York. McDevitt announced at this meeting that Beck was considering bankruptcy.

The original complaint by nine shareholders was filed, as noted, on June 13, 1973 within three years of the appearance of the story in Home Furnishings Daily that Beck was, if not in financial difficulty, at least being sued for rent. The amended complaints bringing in additional parties plaintiff were not filed until June 29, 1973, and service on various defendants was accomplished over a period of time thereafter. For the purposes of this case, however, we hold that the action was commenced on June 13, 1973. The claims of the plaintiffs who joined after the action was commenced are entitled to the relation-back principle of Fed.R.Civ.P. 15(c) and will be treated as having been filed with those of the original nine on June 13, 1973.

The California "discovery" test is stated in Schaefer v. Berinstein, 140 Cal.App.2d 278, 294-95, 295 P.2d 113, 124 (1956):

"The statute commences to run only after one has notice of circumstances sufficient to make a reasonably prudent person suspicious of fraud, thus putting him on inquiry. * * * Where there is a duty to investigate, the plaintiff may be charged with knowledge of the facts which would have been disclosed by an investigation; but where there is no prior duty to investigate, the statute does not run until he has notice or knowledge of facts sufficient to put a reasonable man on inquiry."

See also Stevens v. Marco, 147 Cal.App.2d 357, 381, 305 P.2d 669, 683-84 (1956); Tognazzini v. Tognazzini, 125 Cal.App.2d 679, 687, 271 P.2d 77, 82 (1954). ³

" Discovery" occurs (1) when the plaintiff had actual knowledge of facts sufficient to arouse suspicion in a reasonably prudent person, or (2) when the plaintiff had access to the "means of knowledge" of such facts and a reasonably prudent person would have used those means before making the relevant financial decision. Moreover, if a prudent person would have become suspicious from the knowledge obtained through the initial prudent inquiry and would have investigated further, a plaintiff will be deemed to have knowledge of facts which would have been disclosed in a more extensive investigation.

The trial judge concluded as a matter of law that the plaintiffs knew or should have known the falsity of McDevitt's misrepresentations before June 13, 1970. The several alleged misrepresentations will be discussed separately.

Misrepresentation about the Unimart acquisition.

The trial judge concluded that the plaintiffs had "discovered" the falsity of McDevitt's misrepresentations about the Unimart deal before June 13, 1970 because the "true" details of the deal were revealed in Beck's prospectuses of October and May, 1970 (which stated that Beck had the Unimart "leasehold interest"), and in the June 3, 1970 issue of a trade paper to which three of the plaintiffs subscribed.

The plaintiffs argue that the wording of the prospectuses did not reveal the falsity of the...