623 F.2d 422 (6th Cir. 1980), 78-1111, Adams v. Standard Knitting Mills, Inc.
|Docket Nº:||78-1111, 78-1112.|
|Citation:||623 F.2d 422|
|Party Name:||Mary Lillian ADAMS, in her own name and on behalf of all other persons similarly situated, Plaintiffs-Appellees, Barry J. McKean, et al., Paul W. Mankin, et al., Intervenors-Appellees, v. STANDARD KNITTING MILLS, INC., et al., Defendants, Peat, Marwick, Mitchell and Company, Defendant-Appellant.|
|Case Date:||May 02, 1980|
|Court:||United States Courts of Appeals, Court of Appeals for the Sixth Circuit|
Argued Feb. 22, 1979.
Rehearing and Rehearing En Banc Denied July 23, 1980.
William E. Hegarty, Allen S. Joslyn, New York City, Donald F. Paine, Egerton, McAfee, Armistead & Davis, Knoxville, Tenn., for appellant in both cases.
John M. Sikes, Jr., Zusman, Sikes, Prichard & Cohn, Atlanta, Ga., Milton J. Wallace, Wallace & Breslow, Miami, Fla., for Adams in both cases.
Leon Jourolmon, Portland, Or., for McKean in both cases.
Charles E. Rader, Knoxville, Tenn., for Mankin in both cases.
Kenneth J. Bialkin, Louis A. Craco, Lawrence O. Kamin, New York City, for amicus curiae American Institute of Certified Public Accountants in both cases.
Cahill, Gordon & Rindal, New York City, for appellant in 78-1112.
Before WEICK, ENGEL and MERRITT, Circuit Judges.
MERRITT, Circuit Judge.
In this securities fraud case, Peat, Marwick, Mitchell & Co., herein referred to as "Peat," a firm of certified public accountants, appeals from a judgment of the District Court in the amount of $3.4 million, plus pre-judgment interest, plus attorneys' fees of.$1.2 million. The suit is a class action based upon causes of action implied under §§ 10(b) 1 and 14(a) 2 of the Securities Exchange Act of 1934 and SEC Rules
10b-5 3 and 14a-9. 4 It is based on an allegedly false proxy solicitation issued in order to gain shareholder approval of a merger between two corporations, Chadbourn, Inc. and Standard Knitting Mills, Inc., herein referred to as "Chadbourn" and "Standard." The primary issue is whether Peat is liable for a negligent error the failure to point out in the proxy statement sent to stockholders of the acquired corporation that certain restrictions on the payment of dividends by the acquiring corporation applied to preferred as well as common stock. We hold that in the context of this case Peat is not liable for such conduct and reverse the District Court on the issue of liability.
I. STATEMENT OF FACTS RESPECTING RESTRICTIONS ON PAYMENT OF DIVIDENDS
General Terms and Purpose of the Merger
In April 1970, Chadbourn, Inc., a relatively profitable North Carolina hosiery manufacturer listed on the New York Stock Exchange, acquired all of the common stock of Standard Knitting Mills, Inc., a smaller, publicly-held, Knoxville, Tennessee, textile manufacturer, whose stock traded from time to time, although infrequently, in the over-the-counter market. On April 22, 1970, Standard's stockholders at a special meeting agreed to exchange their stock for a package of Chadbourn securities. The meeting occurred after the stockholders received the proxy statement a month earlier from Standard transmitting information about the proposed merger and Chadbourn's financial condition. The proxy statement contained a recommendation by Standard's management favoring the merger, as well as financial statements of Chadbourn prepared by its accountants, Peat Marwick.
Before the merger, Standard's stock traded at around $12.00 a share, although its book value was carried at approximately $21.00 a share, and Chadbourn's stock fluctuated between $8.00 and $14.00 a share. Standard's stockholders exchanged each share of Standard common for 1/10 of a share of Chadbourn common, plus 11/2 shares of Chadbourn convertible, cumulative, preferred stock. The Chadbourn preferred was the main part of the package. According to the terms of the merger agreement, each share of Chadbourn preferred stock given in exchange was supposed to pay annual cash dividends of $.462/3 a share, and Chadbourn was supposed to redeem 20% of these preferred shares each year at $11.00 a share, beginning in 1975. Each preferred share carried a conversion privilege allowing the preferred stockholder to convert a share of preferred into 6/10 of a share of Chadbourn common. The general purpose of the package appears to have been to give each Standard shareholder a set of Chadbourn securities with approximately the same market value as their Standard shares but with more liquidity and higher dividends.
Approximately a year after the merger, Chadbourn's sales of hosiery plummeted unexpectedly, and it suffered a loss of $17 million. This loss wiped out its retained earnings and left it with a capital deficit of $7 million. Chadbourn now was unable to redeem or pay dividends on the preferred stock. In October 1972, the former Standard stockholders sued Chadbourn, Standard, their management, their lawyers and the appellant, Peat, which was, as previously stated, the accounting firm that prepared and certified Chadbourn's financial statements in the proxy materials. Plaintiffs entered into a settlement agreement with the defendants other than Peat, under which the former Standard shareholders were awarded control of Chadbourn, renamed "Stanwood Corporation." The District Court did not take into account the value of the settlement received by the plaintiffs in determining damages against Peat. Since we reverse the findings of the District Court on liability, we need not reach questions concerning the measure of damages and the award of attorneys' fees.
Restrictions on the Use of Retained Earnings Contained in
the Chadbourn Loan Agreements
The first restriction on retained earnings is in a 5-year term loan agreement Chadbourn made with three banks in September, 1969. Chadbourn borrowed $6 million from the banks repayable in installments over the 5-year period. In order to protect the banks, the loan agreement contained a provision which prohibited Chadbourn and its subsidiaries in any year during the term of the loan from redeeming or paying dividends "on its capital shares of any class" in an amount in excess of $2 million, less the amount of the repayments on the loan, plus future earnings after the 1968-69 fiscal year. 5 These restrictions would apply to dividend payments on Chadbourn preferred shares issued to Standard shareholders (amounting annually to approximately $450,000) and would apply as well to any distributions to redeem these shares.
The second debt agreement was a little less restrictive. The second contractual restriction on paying out retained earnings is in another debt agreement which Chadbourn also entered into in 1969. Chadbourn borrowed $12.5 million in exchange for an issue of convertible, subordinated debentures. The effect of these restrictions on dividends and distributions was similar, except that under this agreement Chadbourn was free to use its 1968-69 net earnings of $3.1 million, as well as future earnings, for the payment of dividends and stock redemptions.
The net effect of both sets of restrictions on dividends and redemptions, when taken together, was that Chadbourn would either have to continue to make money or refinance its indebtedness in order to meet fully its future dividend and redemption obligations on the preferred stock issued to Standard's shareholders. As is explained above, when the bottom dropped out of its hosiery market and its retained earnings a year after the merger, it could do neither.
The Description of the Restrictions on Retained Earnings
in the Proxy Statement
Standard's proxy statement dated March 27, 1970, contained a 35-page description of the terms of the transaction and its tax-free nature, comparative earnings and stock prices of Standard and Chadbourn and a description of their history, business, managements and properties. The text was followed by 18 pages of financial statements of both companies, including the opinions of Peat with respect to the Chadbourn financial statements and of Ernst & Ernst with respect to the Standard financial statements.
The plan for the exchange of Standard stock for Chadbourn stock was set out at pages 4-8 of the text under the heading "SUMMARY OF PLAN." Pages 6-7 of this portion of the proxy statement accurately describe the two sets of restrictions as follows:
Under the provisions of a term loan with three banks maturing October 1, 1974, Chadbourn cannot, without the consent of such banks, (1) declare any dividend or (2) make any distribution (other than common stock dividends), or (3) acquire any of its stock if, after such action, the aggregate of all dividends (other then stock dividends), other distributions to stockholders and all amounts paid for the acquisition of its stock plus the amounts of all payments made on the term loan, would exceed $2,000,000 plus Chadbourn's consolidated net earnings since August 2, 1969. The Indenture dated as of March 15, 1969, hereinabove referred to contains certain restrictions on the payment of dividends on capital stock, however, such are less restrictive than those contained in the term loan agreement.
Chadbourn's financial statements as of August 2, 1969, and Peat's opinion, dated October 21, 1969, were published in the back of the March 27, 1970, Standard proxy statement. The liabilities and stockholders' equity side of the balance sheet was shown on page F-5 of the proxy statement. This page sets out amounts for current installments of long-term debt, the non-current portion of long-term debt, and "stockholders' equity," which referred in turn to certain notes, including footnote 7.
Footnote 7, paragraphs (c) and (d) erroneously described the two sets of restrictions as follows:
(c) As to the note payable to three banks, the Company has agreed to various...
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