726 F.2d 930 (2nd Cir. 1984), 109, Chemical Bank v. Arthur Andersen & Co.
|Docket Nº:||109, Docket 83-7290.|
|Citation:||726 F.2d 930|
|Party Name:||CHEMICAL BANK, Plaintiff-Appellee, v. ARTHUR ANDERSEN & CO., Defendant-Appellant. MANUFACTURERS HANOVER TRUST COMPANY and First Pennsylvania Bank, N.A., Plaintiffs-Appellees, v. ARTHUR ANDERSEN & CO., Defendant-Appellant. SECURITY PACIFIC NATIONAL BANK, Plaintiff-Appellee, v. ARTHUR ANDERSEN & CO., Defendant-Appellant.|
|Case Date:||January 20, 1984|
|Court:||United States Courts of Appeals, Court of Appeals for the Second Circuit|
Argued Oct. 17, 1983.
Peter Gruenberger, Weil, Gotshal & Manges, New York City, for plaintiffs-appellees Manufacturers Hanover Trust Co., First Pennsylvania Bank, N.A. and Security Pacific Nat. Bank.
Patterson, Belknap, Webb & Tyler, New York City, for plaintiff-appellee Chemical Bank.
Edward J. Ross, New York City, Breed, Abbott & Morgan, New York City, and Wilson & McIlvaine, Chicago, Ill., for defendant-appellant Arthur Andersen & Co.
Before FRIENDLY, VAN GRAAFEILAND and MESKILL, Circuit Judges.
FRIENDLY, Circuit Judge:
Arthur Andersen & Co. (Andersen) appeals, pursuant to 28 U.S.C. Sec. 1292(b), from so much of an order of Judge Goettel in the District Court for the Southern District of New York, 552 F.Supp. 439 (1982), as denied its motion to dismiss the claims alleging violations of the federal securities laws in three actions brought by four commercial banks 1 which had made loans to Frigitemp Corporation (Frigitemp) and its wholly owned subsidiary, Elsters, Inc. (Elsters).
The appeal raises important issues concerning the application of Sec. 10(b) of the Securities Exchange Act of 1934 and the SEC's Rule 10b-5 and of Sec. 17(a) of the Securities Act of 1933 to commercial bank loans evidenced by notes and, in one instance, secured by a pledge of a security.
Frigitemp was a publicly held company whose stock was listed on the American Stock Exchange. The company was primarily in the business of selling, manufacturing and installing interior furnishings in hotels, restaurants, institutions and ships. During the early and mid-1970's, Frigitemp embarked on a course of rapid expansion, acquiring a number of other companies. It acquired Elsters for stock on January 11, 1977, effective as of December 31, 1976. In the early 1970's Frigitemp financed its operations by obtaining various secured and unsecured credit lines extended by several institutions, including Manufacturers Hanover and Security Pacific National Bank. The company's rapid expansion over the next several years, however, required larger amounts of capital to sustain its operations. After having mixed success in forays into the public debt and equity markets, 2 Frigitemp looked to the Banks for financing.
By 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. Pursuant to the Secured Credit Agreement, the Banks advanced $6.5 million to Frigitemp beginning in 1976. The loans were evidenced by Frigitemp's promissory notes maturing on July 1, 1977, and were secured by a pledge of Frigitemp customer notes receivable.
In September, 1976, the Banks and Frigitemp began discussing the need to restructure Frigitemp's debt. Pending such restructuring, three banks in September, 1976, advanced $1.5 million evidenced by Frigitemp's one month promissory note to each bank; in October, 1976, they advanced an additional $3.5 million. Frigitemp gave each bank a promissory note maturing on February 28, 1977, which included the $1.5 million owed on the September financing. This maturity was later extended to April 30, 1977. In February, 1977, Frigitemp received an additional $4 million unsecured loan from all four banks, evidenced by promissory notes also maturing April 30, 1977.
In addition to the loans evidenced by the $6.5 million of secured notes maturing July 1, 1977, and the $9 million of unsecured notes maturing April 30, 1977, Frigitemp had other financial needs. As described by the report of Worden & Risberg, management consultants, 3 Frigitemp, in the latter half of 1976,
experienced a substantial buildup of trade payables due to cost incurred on customer-caused delays--for which they have not yet been reimbursed--and to a substantial increase in contract backlog--for which they had to begin placing purchase commitments. These factors have created a serious working capital deficit that is now affecting both vendor confidence and job completion.
One of the unsettling factors was a receivable of $11 million from Litton Industries, Inc.; the 1976 year-end financial statements of Frigitemp, certified by Andersen and dated May 10, 1977, recognized $8.9 million of this as income. 4 However, the
receivable remained unpaid and Frigitemp's working capital deficit was interfering with its ability to operate. Suppliers, for example, were beginning to hold up on deliveries. As the consultants' report concluded, and as the Banks realized, Frigitemp needed "approximately $4 million additional working capital to get through the current cash crunch it [was] experiencing." Frigitemp thus needed not only to refinance the $15.5 million owing under the Secured Credit Agreement and the unsecured loan transactions, but to obtain an additional $4 million. It sought to achieve this latter financing by a loan to its newly acquired subsidiary Elsters, as described below.
The restructuring transaction occurred in early August, 1977. Although evidenced by three different agreements, an officer of Manufacturers Hanover averred that these "were structured as, and were intended to be, part of one single, integrated refinancing package", and we shall assume for present purposes that this was the case.
Under one set of agreements, the Banks extended the maturity date of the $6.5 million of notes issued under the Secured Credit Agreement from July 1, 1977 to July 1, 1978; the notes were amended by endorsements dated August 9, 1977 (the Note Endorsements). Under a second set of agreements, substituting for the $9 million of unsecured notes which had become due on April 30, 1977, Frigitemp issued to the Banks the same amount of unsecured notes dated August 9, 1977 and maturing March 31, 1978 (the Replacement Notes). Finally, the Banks advanced $4 million to Elsters for which they received promissory notes dated August 8, 1977, maturing March 31, 1978; Frigitemp guaranteed these notes and pledged as security 100% of Elsters' common stock, 750 shares, pursuant to a Pledge and Security Agreement.
Frigitemp filed a petition in bankruptcy on March 20, 1978. By that time only approximately $4 million of the $15.5 million Frigitemp debt had been repaid. 5 At the same time Elsters ceased engaging in business. The Banks have realized some $2 million on the Elsters notes.
In this action, commenced in 1979, the Banks seek to hold Andersen and three principal officers of Frigitemp liable for their losses. The complaints allege that the Banks 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. 6 The Banks allege that Andersen knew that Frigitemp's financial statements were false and misleading in numerous respects, including the following: material overstatement of profits from long term contracts because of consistent understatement of the cost to Frigitemp of fulfilling such contracts; material overstatement of Frigitemp's income and current assets by inclusion of amounts claimed for material costs and work done as addition to or changes from specifications; and material overstatement of Frigitemp's accounts receivable by the inclusion of overbillings, of inclusion of unbilled and unbillable amounts, allocation of payments on current to older receivables, the $8.9 million Litton claim mentioned above, and other claims for work not performed. The first claim in the complaints alleges that in making such certifications Andersen violated or aided and abetted in the violation of Sec. 17(a) of the Securities Act of 1933, 7 Sec. 10(b) of the Securities
Exchange Act of 1934, 8 and Rule 10b-5 issued thereunder. 9 Three other claims in the complaints allege violations of state law.
After answer and extensive discovery Andersen moved, in February, 1982, upon the affidavit of its counsel, Edward J. Ross, the exhibits submitted therewith, the pleadings and all the prior proceedings, for an order pursuant to Fed.R.Civ.P. 12(b)(1) and (6) and 56(b) dismissing the actions for lack of subject matter jurisdiction or, in the alternative, granting summary judgment in its favor on the claims pleaded under the federal securities laws, and, in either event, dismissing the pendent claims. In April, 1982, the Banks submitted an answering affidavit of one of their counsel, an affidavit of Richard J. O'Neill, a Vice-President of Manufacturers Hanover, who had been involved in the transactions between the Banks and Frigitemp, and a statement of material facts, pursuant to S.D.N.Y.Civ.R. 3(g). Mr. Ross submitted a further affidavit accompanied by numerous exhibits in May, 1982.
After receiving briefs and hearing argument, Judge Goettel filed a comprehensive opinion denying Andersen's motion, 552 F.Supp. 439 (S.D.N.Y.1982). He first addressed the question whether any of the Frigitemp notes were securities within the pertinent provisions of the 1933 and 1934 Acts. He discussed the relevant authorities, particularly this court's decision in Exchange National Bank v. Touche Ross & Co., 544 F.2d 1126, 1137-38 (1976). We will analyze that decision in detail below; it is sufficient here to say that we noted that under the statutes, any note having a maturity exceeding nine months was a security under the 1934 Act and any note was a security under the antifraud provisions of the 1933 Act unless the context otherwise required. We proceeded to give many instances...
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