Harnett v. Billman

• Decision Date: 16 September 1986
• Docket Number: 85-2339,Nos. 85-2338,s. 85-2338
• Citation: 800 F.2d 1308
• Parties: Fed. Sec. L. Rep. P 92,919 William J. HARNETT, Appellee, v. Tom J. BILLMAN; Clayton C. McCuistion, Appellants, and Epic Mortgage, Inc., a Delaware corporation; Cavalier Oil Corporation, a Delaware corporation; Epic Realty Services, Inc., a Delaware corporation, Defendants. William J. HARNETT, Appellant, v. Tom J. BILLMAN; Clayton C. McCuistion, Appellees, and Epic Realty Services, Inc., a Delaware corporation, Defendants.
• Court: U.S. Court of Appeals — Fourth Circuit

Page 1308

800 F.2d 1308

Fed. Sec. L. Rep. P 92,919

William J. HARNETT, Appellee, v. Tom J. BILLMAN; Clayton C. McCuistion, Appellants, and Epic Mortgage, Inc., a Delaware corporation; Cavalier Oil

Corporation, a Delaware corporation; Epic Realty

Services, Inc., a Delaware corporation,

Defendants.

William J. HARNETT, Appellant, v. Tom J. BILLMAN; Clayton C. McCuistion, Appellees, and Epic Realty Services, Inc., a Delaware corporation, Defendants.

Nos. 85-2338, 85-2339.

United States Court of Appeals Fourth Circuit.

Argued July 14, 1986.

Decided Sept. 16, 1986.

John R. Fornaciari, Washington, D.C. (Robert M. Disch, Steele, Simmons & Fornaciari, Washington, D.C., on brief), for appellants/cross appellees, Billman and McCuistion.

Thomas Earl Patton, Washington, D.C. (Brett L. Antonides, Louis R. Moffa, Jr., Schnader, Harrison, Segal & Lewis, Washington, D.C., John E. Harrison, Light & Harrison, P.C., McLean, Va., on brief), for appellee/cross appellant.

Before RUSSELL, PHILLIPS and CHAPMAN, Circuit Judges.

JAMES DICKSON PHILLIPS, Circuit Judge:

Tom Billman and Clayton McCuistion appeal from the district court's judgment, after a bench trial, awarding William Harnett more than $60,000 in compensatory damages and $35,000 in punitive damages on his claims of common-law fraud. Harnett has cross-appealed from orders of the district court granting summary judgment against some of his claims on res judicata grounds and dismissing other claims based on federal and state securities law violations and on alleged breaches of fiduciary duty. We conclude that Harnett's fraud claims, as well as much of the securities and fiduciary duty claims upon which he did not prevail, were subject to the bar of a prior judgment involving these same parties. We also hold that to the extent that Harnett's securities and fiduciary duty claims survived the prior judgment, they were properly dismissed because, as a matter of law, Harnett could not prevail on these claims. We therefore reverse the judgment in favor of Harnett on his fraud claim and affirm the dismissal of his other claims.

I

In 1975, Harnett purchased 1,250 shares of the Equity Programs Investment Corporation (EPIC) for $5,000. By 1983, Billman and McCuistion together owned more than 90% of EPIC's shares. Over the years, EPIC had become the parent corporation of a number of subsidiaries, including EPIC Mortgage, Inc. (EMI) and EPIC Realty Services, Inc. (ERSI).

In June 1982, ERSI became an independent corporation in a spin-off transaction, and a separate spin-off from EMI led to the creation of EPIC Mortgage Servicing, Inc. (EMSI) on March 1, 1983. Harnett received shares in both of the new companies equal to what the defendants represented was his proportion of ownership in EPIC. In December 1984, ERSI was absorbed in a Delaware short form merger by Realty Services Holdings, Inc., and in November 1984, EMSI was similarly merged into Cavalier Oil Corp. (Cavalier). Billman and McCuistion are the principal shareholders of Cavalier. A short form merger permits the "freezing out" of minority shareholders. Harnett had received stock in ERSI and EMSI when they were spun off, but was frozen out in the short form mergers.

After the spin-offs of ERSI and EMSI, Harnett still remained a shareholder in the original EPIC corporation. In early 1983, however, EPIC and its EMI subsidiary were purchased by Community Savings and Loan, Inc. (CSL), a Maryland-chartered savings and loan association. Billman and McCuistion also owned a controlling interest in CSL. In January 1983, Harnett received a notice seeking the approval by EPIC's shareholders of a merger of EPIC into a CSL subsidiary. EPIC shareholders were to receive non-voting preferred CSL stock. For various reasons, most apparently relating to the nature of the stock he would receive, Harnett was unsatisfied with the merger plan. By February 1983, Harnett had become the sole remaining minority shareholder of EPIC. Harnett refused Billman's offer to purchase Harnett's shares in EPIC.

The merger of CSL and EPIC was consummated on March 14, 1983. Prior to the merger, the principal business of EMI consisted of mortgage servicing, but because for accounting reasons the servicing portfolio then owned by EMI would not be fully reflected on the books of the new CSL/EPIC conglomerate, EMI's existing servicing portfolio became the primary asset of the new spin-off from EMI, EMSI. EMI and EMSI entered into a sub-servicing agreement, dated March 1, 1983, under which EMI performed for a fee the servicing work for mortgages in EMSI's portfolio. After the EPIC/CSL merger, EMI also became the servicer, and itself owner of the servicing rights, of new mortgages originated through the new EPIC/CSL entity. EMSI, which was a company now independent of the EPIC/CSL group, did not receive any of the new servicing business, but retained only the servicing rights in its portfolio at the time of its spin-off from EMI.

In October 1983, Harnett filed an action, which we will refer to as Harnett I, in the United States District Court for the Eastern District of Virginia. The amended complaint in Harnett I alleged claims for common-law fraud, for state and federal securities fraud, and under RICO, as well as a shareholder derivative claim. These claims centered around Harnett's allegations that Billman and McCuistion made fraudulent misrepresentations or omissions in conversations and correspondence to him in late February and early March 1983, that the documents received by Harnett in connection with the EPIC/CSL merger did not make adequate disclosures, and that Billman and McCuistion had misappropriated, through employee stock options and assignments from other shareholders, shares of EPIC. Paragraph 49(h) of the amended complaint in Harnett I stated that "[d]efendants, and each of them, failed to disclose to Harnett that prior to the merger of EPIC into CS & L Service Co. EPIC would spin off its mortgage servicing operation, including escrow account balances, to a new corporation."

Harnett engaged in extensive discovery in Harnett I, and his document production requests in that earlier litigation included requests for the records of EMSI, as well as of other companies connected to EPIC. Ultimately, pursuant to a settlement that permitted Harnett to pursue state appraisal rights in state court, Harnett I was dismissed with prejudice in February 1984.

Harnett was subsequently frozen out of his interests in ERSI and EMSI, and commenced the instant action in the district court in February 1985. The complaint in this case alleged claims under federal and state securities acts, for common-law fraud, and for breaches of fiduciary duty by Billman and McCuistion. The acts that form the predicate for these claims included the dilution of Harnett's interest in the ERSI and EMSI spin-off companies by virtue of the misappropriation of EPIC stock by Billman and McCuistion, alleged misrepresentations to Harnett that the new EMSI company would receive the benefit not only of EMI's existing mortgage servicing business but also that generated by future mortgages originated through the EPIC/CSL group, the execution of an EMI/EMSI sub-servicing agreement, and the alleged concealment from Harnett of the true fact that EMI, and not EMSI, was receiving the servicing business on new mortgages originated through EPIC/CSL.

Following motions for summary judgment by the defendants in this case, the district court dismissed on res judicata grounds Harnett's claims relating to share misappropriations, dismissed the securities law claims as not arising out of "the purchase or sale of securities," and dismissed the fiduciary duty claim because Harnett, who was no longer a shareholder of ERSI or EMSI, had no standing to make a derivative claim. The district court refused, however, to dismiss Harnett's common-law fraud claims relating to the EMSI spin-off and the alleged misrepresentations about the allocation of servicing work between EMI and EMSI.

After discovery, the case proceeded to a bench trial. The district court found in favor of Harnett, crediting Harnett's testimony that Billman and McCuistion represented an original intention that EMSI would receive all future mortgage servicing originated by the EPIC/CSL entity, but had failed to inform Harnett when this representation was no longer the true state of affairs. The court found that Harnett had reasonably relied to his detriment upon the misrepresentations by Billman and McCuistion, and awarded compensatory damages in excess of $60,000 and punitive damages of $35,000. The compensatory award was arrived at by calculating the amount Harnett would have received for his EMSI stock if EMSI had, in fact, done the servicing work retained by EMI. These appeals followed.

II

The principal argument advanced by Billman and McCuistion on appeal is that the district court should have dismissed Harnett's fraud claims, as well as the other claims that were dismissed for other reasons, as barred by the prior judgment entered in Harnett I. Res judicata precludes the assertion of a claim when "a judgment on the merits [in a prior suit] bars further claims by parties or their privies based on the same cause of action." See Montana v. United States, 440 U.S. 147, 153, 99 S.Ct. 970, 973, 59 L.Ed.2d 210 (1979); Nash County Board of Education v. Biltmore Co., 640 F.2d 484, 486 (4th Cir.1981); see also Adkins v. Allstate Insurance Co., 729 F.2d 974, 976 (4th Cir.1984).

There is no question but that the final judgment entered in Harnett I is "a judgment on the merits" involving the same "parties or their privies" as those involved in the instant case. The agreed dismissal of Harnett I binds the parties to that litigation, and each of the parties in this case was a named party or privy to a party in Harnett I. Although Harnett's complaint in this case names some different corporate entities than those named in the earlier litigation, the...