Berkman v. Rust Craft Greeting Cards, Inc.

• Decision Date: 21 July 1978
• Docket Number: No. 78 Civ. 2931 (LFM).,78 Civ. 2931 (LFM).
• Citation: 454 F. Supp. 787
• Parties: Jack N. BERKMAN and Myles P. Berkman, Plaintiffs, v. RUST CRAFT GREETING CARDS, INC., Robert Goldhammer, Marshall L. Berkman, John Young and Robert A. Paul, Defendants.
• Court: U.S. District Court — Southern District of New York

454 F. Supp. 787

Jack N. BERKMAN and Myles P. Berkman, Plaintiffs, v. RUST CRAFT GREETING CARDS, INC., Robert Goldhammer, Marshall L. Berkman, John Young and Robert A. Paul, Defendants.

No. 78 Civ. 2931 (LFM).

United States District Court, S. D. New York.

July 21, 1978.

COPYRIGHT MATERIAL OMITTED

Donovan, Leisure, Newton & Irvine by Roger W. Kapp, J. Peter Coll, Jr., Margaret A. Bancroft, John E. Linville and Kevin J. Walsh, New York City, for plaintiffs.

Paul, Weiss, Rifkind, Wharton & Garrison by Jay Topkis and Richard M. Zuckerman, New York City, for defendants.

OPINION

MacMAHON, District Judge.

Pursuant to Rule 65(a), Fed.R.Civ.P., plaintiffs move for an order granting a preliminary injunction.

This case arises out of an intra-corporate dispute among the members of the board of directors of Rust Craft Greeting Cards, Inc. ("Rust Craft"), a Delaware corporation engaged in the manufacture and sale of greeting cards and allied products. Rust Craft's shares are publicly held and traded on the American Stock Exchange. Plaintiffs, Jack Berkman and Myles Berkman, shareholders and directors of Rust Craft, sue individually and derivatively on behalf of Rust Craft. The complaint challenges the sufficiency of proxy materials sent to the Rust Craft shareholders in connection with the reelection of directors to the Rust Craft board. The individual defendants, Robert Goldhammer, Marshall Berkman, John Young and Robert Paul, are also directors of Rust Craft.

We adjudicate this motion upon the supporting and opposing affidavits and the other papers submitted since no party has requested an evidentiary hearing. See Jacobson & Co. v. Armstrong Cork Co., 548 F.2d 438, 441-42 (2d Cir. 1977). The following facts appear from these papers:

During the summer of 1977, the Ziff Corporation ("Ziff") made a friendly tender offer to pay cash for all outstanding Rust Craft shares. The Rust Craft board then retained the investment banking firms of Lehman Brothers, Kuhn Loeb, Inc. ("Lehman") and Kidder, Peabody & Co., Inc. ("Kidder") to prepare and submit opinions to the board concerning a fair cash price for Rust Craft's shares. Unknown to the Rust Craft board, however, Kidder, on the day preceding its retention in the Ziff matter, had bought for its own account $750,000.00 principal amount of Rust Craft's 5¼% debentures, convertible into common stock at $25.00 per share, for a total price of $676,800.00. Kidder did not disclose the fact of its ownership of the debentures to the Rust Craft board. Rather, it accepted the assignment from the board and prepared the requested opinion.

On August 2, 1977, the Rust Craft board met to consider the opinions of the investment banking firms. Before the meeting, defendant Goldhammer gave defendant Young an SEC Form 13D reporting Kidder's purchase of the Rust Craft debentures. Young informed defendant Marshall Berkman, who in turn informed defendant Paul. These four defendants, a minority of the Rust Craft board, however never informed the other members of the board. The meeting went forward, and Kidder presented its report recommending a per share price of $24.00 to $30.00. Lehman recommended a somewhat higher price of $30.15 to $33.30.

After further negotiations, Ziff offered $26.50 per Rust Craft share and sought to consummate the transaction through some form of merger. On September 15, 1977, the Rust Craft board, subject to stockholder approval, agreed to a proposed merger with a Ziff subsidiary through which, the proposed proxy statement explained, each Rust Craft share "will be converted into (and the holder shall be entitled to receive) $26.50 in cash."

In June 1978, defendant Young and counsel for Rust Craft were preparing proxy materials for a special meeting of the shareholders called to vote upon the proposed merger. Young mentioned the Kidder debenture purchase to counsel, who included information concerning the purchase in the draft of the proxy materials. The draft was presented to the remaining directors, and it was not until then that they learned of the Kidder debenture purchase and Kidder's attendant conflict of interest. The Rust Craft board thereafter called for an additional valuation opinion from yet another investment banker and delayed consummation of the Ziff transaction. As a result, the special meeting of the shareholders to approve the Ziff merger has not yet been held.

A meeting of the board was held on June 19, 1978 for the purpose of nominating a slate of directors for election by the shareholders. Plaintiffs moved that the four directors who knew of, but failed to disclose, the facts surrounding the Kidder conflict of interest not be renominated. The motion was defeated, and the entire slate of incumbent directors renominated by a vote of 7 to 2, plaintiffs dissenting. Proxy materials were then prepared for the regular annual meeting of shareholders, scheduled for July 25, 1978, where the election of directors would take place. Plaintiffs objected to the substance of the proxy materials, arguing that they made inadequate disclosure of the facts surrounding the defendants' failure to disclose Kidder's conflict of interest, as well as inadequate disclosure of the split board vote on the renomination question and the reasons behind the split vote. Nevertheless, the proxy materials were sent to the shareholders without this information.

Plaintiffs then brought this action for violation of Section 14(a) of the Securities Exchange Act of 1934 and Rule 14a-9(a) thereunder, alleging that the election proxy materials are false and misleading in omitting to state:

(1) That the slate of nominees was approved over the dissent of two directors;

(2) That the stated reason for the dissent was that four of Rust Craft's directors had withheld from their fellow directors material information relating to Kidder's debenture purchase and resultant conflict of interest; and

(3) That the Kidder conflict led the board to engage a new and unquestionably independent investment banking firm to render a further opinion concerning a fair cash price for Rust Craft stock.

Plaintiffs seek to enjoin (1) further solicitation of proxies pursuant to the current proxy materials, and (2) the holding of the annual meeting until further proxy materials which are not misleading can be sent to the shareholders.

STANDARDS FOR PRELIMINARY INJUNCTION

A preliminary injunction may issue upon a showing of either:

"(1) probable success on the merits and possible irreparable injury, or (2) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting the preliminary relief."

Sonesta Int'l Hotels Corp. v. Wellington Associates, 483 F.2d 247, 250 (2d Cir. 1973) (emphasis in original). With this standard in mind, we turn to the merits and to the equities of the case.

THE MERITS

The gravamen of the complaint is that the proxy materials are false and misleading in their omission of material facts, in violation of Section 14(a) and Rule 14a-9(a).

Section 14(a) provides:

"It shall be unlawful for any person, by the use of the mails or by any means or instrumentality of interstate commerce or of any facility of a national securities exchange or otherwise, in contravention of such rules and regulations as the Commission may prescribe as necessary or appropriate in the public interest or for the protection of investors, to solicit or to permit the use of his name to solicit any proxy or consent or authorization in respect of any security (other than an exempted security) registered pursuant to section 12 of this title."

Rule 14a-9(a), in turn, provides:

"No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading."

The elements of a private cause of action for a violation of Rule 14a-9(a) are well established. The plaintiff must demonstrate: (1) that the proxy materials contain a false or misleading statement of a material fact or omit to state a material fact necessary in order to make the statement made not false or misleading; (2) that the misstatement or omission of a material fact was the result of knowing, reckless or negligent conduct; and (3) that the proxy solicitation was an essential link in effecting the proposed corporate action. Kennecott Copper Corp. v. Curtiss-Wright Corp., 449 F.Supp. 951 at 956 (S.D.N.Y.1978) (citing cases).

A. Whether Defendants Omitted Material Facts Necessary in Order to Make the Proxy Materials Not False or Misleading.

There can be no doubt that the proxy materials omit the facts concerning the Kidder debenture purchase and conflict of interest, and the split board vote on the renomination of the four individual defendants. The significant issue, however, is whether these omitted facts are material, and, if so, whether their disclosure is necessary to make the proxy materials not false or misleading.

Under TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449, 96 S.Ct. 2126, 2132, 48 L.Ed.2d 757 (1976), an omitted fact is material if there is "a substantial likelihood that a reasonable shareholder would consider it important in deciding how to vote." The first question for us is whether the omitted facts, which plaintiffs claim should have been included in the proxy materials, meet this test.

Kidder's conflict of interest affected Kidder's "credibility" and was highly relevant in...