Norte & Company v. Huffines

• Decision Date: 27 June 1968
• Docket Number: No. 62 Civ. 3390.,62 Civ. 3390.
• Citation: 288 F. Supp. 855
• Parties: NORTE & COMPANY, Plaintiff, v. R. L. HUFFINES, Jr., Victor Muscat, L. F. Serrick, Alfred O'Gara, Edward Krock and Defiance Industries, Inc., Defendants.
• Court: U.S. District Court — Southern District of New York

288 F. Supp. 855

NORTE & COMPANY, Plaintiff, v. R. L. HUFFINES, Jr., Victor Muscat, L. F. Serrick, Alfred O'Gara, Edward Krock and Defiance Industries, Inc., Defendants.

No. 62 Civ. 3390.

United States District Court S. D. New York.

June 27, 1968.

Milton Paulson, New York City, for plaintiff.

Royall, Koegel, Rogers & Wells, New York City, for defendant R. L. Huffines, Jr.

Goldstein, Judd & Gurfein, New York City, for defendant Victor Muscat.

Hugh P. Mullen, New York City, for defendant Defiance Industries, Inc.

MANSFIELD, District Judge.

Following non-jury trial of this consolidated derivative stockholders' action in which Defiance Industries, Inc. ("Defiance" herein) was awarded damages in the sum of $3,199,297, plus interest, defendants Muscat and Huffines move for a new trial pursuant to Rules 52, 59 and 60, F.R.Civ.P., or, alternatively, for rehearing on the issue of damages on the ground of newly discovered evidence and that the damages awarded are excessive.

The damages awarded in favor of Defiance against the individual defendants Muscat and Huffines, directors of Defiance, resulted from two transactions that were authorized and participated in by them at Defiance's expense:

(1) "The 1962 Exchange," i. e., the issuance by Defiance of 487,502 shares of its Class B Voting Stock in exchange for all the outstanding stock of Insurance and Industrial Enterprises, Inc. ("IIE" herein), 77% owned by Muscat, Huffines and their co-venturer, Edward Krock, pursuant to defendants' recommendation valuing the IIE stock at $70.51 per share; and

(2) "The September 6, 1961 Transaction," i. e., acquisition of 10,507 shares of IIE stock (representing approximately 10% of its issued stock) by the triumvirate of Muscat, Huffines and Krock at a price of $20.94 per share, which they then caused Defiance to acquire as part of the aforementioned 1962 Exchange at a value of $70.51 per share, realizing a profit of approximately $520,832.

Damages in the sum of $2,993,000 were awarded in favor of Defiance against defendants Muscat and Huffines on the ground that approval of the 1962 Exchange by Defiance stockholders was secured by defendants through false and misleading proxy material in violation of §§ 10(b) and 14 of the Securities Exchange Act of 1934, 15 U.S.C.A. §§ 78j(b) and 78n, and SEC Rule 10b-5 issued thereunder, and also on the ground that it was a self-dealing transaction grossly unfair to Defiance in that is was required to pay an excess of $29.93 per share for approximately 100,000 shares of IIE. With respect to the September 6, 1961 Transaction, damages in the sum of $206,357 were awarded on the ground that defendants deprived Defiance of a corporate opportunity to purchase the IIE shares at the lower price and reaped a profit at the expense of Defiance.

Defendants' post-trial motions raise no substantial question with respect to the September 6, 1961 Transaction or their liability for any damages caused by the 1962 Exchange. With respect to the question of damages awarded on account of the 1962 Exchange, defendants do not now attack the valuation of IIE stock received by Defiance in the exchange,¹ an issue fully litigated at trial, where it was determined to be worth $40.58 per share rather than the $70.51 per share adopted by defendants, an excess of $29.93 per share for approximately 100,000 shares of IIE, or $2,993,000.

The gist of defendants' present contentions is that the loss suffered by Defiance on the exchange was less than $2,993,000, and may even be eliminated completely, because the stock issued by Defiance in payment for the IIE shares was worth less than the $14.49 per share found by the Court so that, at the exchange ratio of 4 7/8 Defiance shares per one IIE share, Defiance did not pay as much as $70.51 per IIE share.

The issue of damages was before the Court at trial and was fully litigated, and defendants do not suggest that there is any pertinent newly discovered evidence. Accordingly defendants' motion to reopen the case for the introduction of additional evidence is denied. Defendants rely primarily on material already in the record, such as market data in the pretrial order, and also raise questions of law in urging that the damages awarded are excessive.

Review of that record reveals that defendants' present contention to the effect that Defiance stock was over-valued is not only belated, but contrary to, and inconsistent with, the proof offered by the parties and the position taken by the defendants both at pretrial and trial. Until the Court's decision the $14.49 price was accepted by them as a fair and reasonable figure resulting from an appraisal (Ex. 13 in evidence) made by well-recognized independent experts retained by the defendants themselves to evaluate Defiance's stock for the purpose of determining how many shares would be required to acquire IIE, which was valued at $7,050,759. At no point prior to the present post-decision motions did defendants question the value of $14.49 per Defiance share. Instead, defendants took the position that the study and report made at defendants' request by Hayden Stone & Co., a well known firm of highly regarded experts specializing in independent appraisal of corporate holdings, which evaluated Defiance as having a fair value of $14.49 per share, was entitled to great weight in determining the relative values and ratios to be assigned to the stocks of the companies involved. Referring to the retention of Hayden Stone, Muscat testified:

"Q Who, on behalf of the company, that is, Defiance, negotiated with whom on behalf of the stockholders of I. and I. E.?

A The way the whole transaction was set up was that we wanted strictly impartial people to make the report, and to set it up, so the only discussion, actually, was after the Hayden Stone report.

Q As you said before, the exchange ratio was made on the basis of the Hayden Stone report?

A Right." (Muscat Dep. pp. 43-44)

"Q * * * Do you know of any reason why Hayden Stone didn't use the figures I have just read to you from Exhibit 2 for identification at Pages 4 and 5?

A Mr. Paulson, I am sure you know that we picked the best accountants, the best legal people, and the best investment houses to make these full studies. And each one may have their own interpretation. But I can assure you that they are the ones that put these figures together. I have not gone into the details at all, because if I could do it, I wouldn't need Peat Marwick, or Hayden Stone or anybody else.

So whatever they put down, I am sure is the way the S. E. C. wanted that report. I am sure on this report Hayden Stone was presenting the good sides, the bad sides. They may have their own interpretation.

All I can do is go to the best people in the country and ask them to help us out." (Muscat Dep. pp. 61-62)

In its opinion the Court found that the value of $14.49 per Defiance share recommended by Hayden Stone was sound, but concluded that Hayden Stone had erred in its evaluation of IIE for the reason that it had been misled by certain inflated earnings figures furnished to it by the defendants for IIE's principal subsidiary, Nablico, all of which is more fully detailed in the Court's earlier opinion.

The methods used by Hayden Stone in the study leading to this report are well recognized and have been repeatedly accepted by the courts. The report states (P. Ex. 13, p. 1) that the appraisals of Defiance and IIE "attempt to take into account all relevant factors, including asset values, earning power, and past performances as well as future potentials. Due to the substantially different natures of the companies concerned, the approach for each is by necessity different in certain aspects."²

After careful review of all of the principal factors affecting the value of Defiance's stock, Hayden Stone, stating that its appraisal was for the purpose of determining the value of Defiance shares that might be issued in connection with a proposed merger, concluded that "the common equity of the Serrick Corporation Defiance is appraised at a fair value of * * * $14.49 per Class B share" (P. Ex. 13, p. 22). Thus, in order to acquire assets found to be worth between $6,751,686 and $7,350,338 Defiance would be required to issue almost 500,000 shares of Class B common stock.

Accepting this evaluation of Defiance stock by independent experts as fair and reasonable, the defendants used it as the basis for their recommendation to Defiance stockholders "that the proposed ratio of exchange is a fair one" (Proxy Statement, P. Ex. 1, p. 10), and relied upon it throughout the trial. Now for the first time they seek to impeach the evaluation, arguing that Hayden Stone improperly considered book value, liquidation value and replacement value. This argument is without merit. Valuation of Defiance by the capitalization of earnings approach was inappropriate because of significant recent losses. Furthermore, although Hayden Stone took into account the current market value of Defiance shares, which had been recently traded on the American Stock Exchange at $13 per share, it refused to accept such market price as equivalent to "fair value," and properly so because of the light trading in the stock; for example, of 220,000 shares outstanding, only 2,600 shares were traded in June, 1961. Market price is significant only

"where there is a free and open market and the volume of transactions and conditions make the market a fair reflection of the judgment of the buying and selling public." Application of Marcus, 273 App.Div. 725, 727, 79 N.Y.S.2d 76, 78 (1st Dept. 1948), app. dism., 277 App.Div. 963, 99 N.Y. S.2d 849 (1st Dept. 1950), affd., 303 N.Y. 711, 103 N.E.2d 338 (1951).

The thinness of the market in Defiance stock was recognized by the defendants as rendering current market prices inappropriate for evaluation purposes. The defendant Huffines testified "* * * it was a very thin market, very little trading," (Huffines Dep. p. 35), and Muscat...