Brennan v. EMDE Medical Research, Inc.

• Decision Date: 24 December 1986
• Docket Number: No. CV-R-83-396-ECR.,CV-R-83-396-ECR.
• Citation: 652 F. Supp. 255
• Parties: Louis BRENNAN, Individually and as a trustee; Cynthia B. Brennan, individually and as a trustee; Trinity Family Church; Creature Care Foundation, a California corporation; Frederick R. Kreuger and Teresa Jan Kreuger, Plaintiffs, v. EMDE MEDICAL RESEARCH, INC.; Robert B. Stone; Elizabeth Stone; E.J. Snyder; Mike Snyder; James Buckingham; Does I Through X, inclusive, Defendants.
• Court: U.S. District Court — District of Nevada

652 F. Supp. 255

Louis BRENNAN, Individually and as a trustee; Cynthia B. Brennan, individually and as a trustee; Trinity Family Church; Creature Care Foundation, a California corporation; Frederick R. Kreuger and Teresa Jan Kreuger, Plaintiffs, v. EMDE MEDICAL RESEARCH, INC.; Robert B. Stone; Elizabeth Stone; E.J. Snyder; Mike Snyder; James Buckingham; Does I Through X, inclusive, Defendants.

No. CV-R-83-396-ECR.

United States District Court, D. Nevada.

December 24, 1986.

Richard O. Kwapil, Jr., Reno, Nev., for plaintiffs.

Ronald J. Logar, and Hamilton & Lynch, Reno, Nev., for defendants.

ORDER

EDWARD C. REED, Jr., Chief Judge.

This case comes to the Court by way of a report and recommendation by the United States Magistrate. In this action, the plaintiffs have filed suit under § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), contending that the actions of the defendants in allegedly preventing them from exercising their preemptive rights in the newly issued shares of a particular corporation violated the Act's directives. The defendants have moved for summary judgment, contending that a previous state court action between some of the parties in this suit has disposed of the claim under the 1934 Act, and has already resolved all relevant fact issues in this action. In the opposition to the Magistrate's report, the defendants also attempt to argue the merits of the plaintiff's § 10(b) claim. The defendants did not raise these issues in the original summary judgment motion and they will not be considered now. If defendants so choose, they may file another summary judgment motion on these grounds at a later date. The Court will presently consider only those claims properly raised in the first summary judgment motion. On the grounds of res judicata and collateral estoppel, therefore, the defendants claim that the plaintiffs are prevented from bringing this suit.

FACTS

In 1977, EMDE MEDICAL, one of the defendants in this suit, was incorporated as a Nevada corporation for the primary purpose of developing and marketing medical devices. The corporation had an initial authorized capital stock issue of 15,400 shares at $10.00 par value. Plaintiffs Louis Brennan and Frederick Kreuger were among the incorporators, and subscribed to 1100 shares each of the initial issue.

In February of 1978, the corporation authorized its officers to apply to increase the authorized capital stock of the corporation to 50,000 shares at the same par value. At that time, 12,650 of the original 15,400 shares had been subscribed. At this same meeting, the corporation also authorized a three for two stock split. Later in the year, the corporation was in financial difficulties, and required loans and advances from shareholders in order to stay alive. The company then instituted a warrant program, in the course of which the shareholders would loan funds themselves or guarantee other loans to the company. In return, these shareholders would receive warrants authorizing them to purchase additional shares at an established price within the given time frame. Several of the plaintiffs apparently participated in this program, through which they increased their ownership percentage in the corporation.

Previous to April, 1980, the corporation's Articles had contained a standard preemptive rights clause, which enabled a shareholder to subscribe for or purchase a proportional part of any new shares issued by the corporation. In April of 1980, however, the corporation, by a majority vote of the shareholders present, voted to amend the Articles so as to delete this provision. This amendment was not recorded with the Secretary of State until September, 1983.

In late 1979 and early 1980, a dispute had arisen among some of the shareholders regarding the invention of a modification to one of the patented EMDE devices. Donald Bailey, the corporate officer in charge of research and development, and invented this new device with EMDE resources under an agreement which provided that all future inventions would belong to EMDE. He and other EMDE stockholders created a new corporation to patent and market the modified device.

As a result of the development of this new device by another corporation, plaintiffs Louis Brennan and Frederick Kreuger joined in March, 1980 with a group of other persons not party to this action in making a demand upon EMDE for the right to inspect the corporation's books and records. The corporation resisted this demand, and this group then filed a petition for a writ of mandamus in state court to compel disclosure of the documents. Subsequent to the filing of that suit, the parties to that action who are not plaintiffs in this federal action settled their claims. The defendants then moved to dismiss the petition, contending that the remaining parties, Louis Brennan and Frederick Kreuger, lacked the requisite fifteen percent of the shares of the corporation to force disclosure of the corporate information. Brennan and Kreuger argued in response that they had together initially owned over nineteen percent of the shares, but that the defendants had illegally diluted their ownership interest by fraudulently amending the Articles to do away with preemptive rights, and then issuing more shares. The state court, however, granted the defendants' motion for summary judgment, finding, apparently, that Brennan and Kreuger did lack the necessary fifteen percent to inspect the corporate books.

DISCUSSION

In their motion for summary judgment in this Court, the defendants argue that the present action is barred entirely by the doctrine of res judicata, and, alternatively, that various critical fact issues have been resolved by collateral estoppel. The Magistrate has examined the motion, the opposition, and the reply, and has recommended that the summary judgment motion be denied. Initially, however, the Magistrate found it necessary to examine the issue of standing sua sponte, and concluded that the plaintiffs did have standing to sue.

STANDING TO SUE

Section 10(b) of the Securities Exchange Act of 1934 provides in part that

it shall be unlawful for any person, directly or indirectly by the use of any means or instrumentality of interstate commerce or of the mails, or any facility of any national securities exchange —

. . . . .

(b) To use or employ, in connection with the purchase or sale of any security registered on a national securities exchange or any security not so registered, any manipulative device or contrivance 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.

15 U.S.C. § 78j. The Supreme Court has long held that there exists a private cause of action under this statute, but has also required that the plaintiff seeking private relief must be a "buyer or seller" of securities in order to have standing to sue. See Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 731, 95 S.Ct. 1917, 1923, 44 L.Ed.2d 539 (1975). The Ninth Circuit, however, has read the Blue Chip Stamps case broadly, such that the holder of a contract to buy or sell who is prevented from consummating the transaction because of fraud will have standing under the Act. See Mosher v. Kane, 784 F.2d 1385, 1389 (9th Cir.1986). In this case, therefore, the question of standing resolves itself to a determination of whether preemptive rights created in the Articles of a corporation can be viewed as a contract to buy or sell securities.

In finding that preemptive rights were contractual enough in nature to allow standing under § 10(b), the Magistrate relied upon Roberson v. Cate, 454 F.Supp. 13 (E.D.Tenn.1978). In this case, the plaintiff alleged that he had purchased less stock than he could have under a binding shareholder's agreement because of the defendant's allegedly fraudulent misrepresentations about the stock's value. The defendant, however, moved to dismiss the case for lack of standing, in that the plaintiff was merely an aborted purchaser under the agreement.

The court found the defendant's standing argument unavailing. Where the "plaintiff possessed a `contractual right' to purchase securities and allegedly failed to exercise that right because of a violation of Section 10(b) and Rule 10b-5," the court found, "then the plaintiff would have standing to bring this action." Id., at 14. In this case, continued the court, the plaintiff alleged that he had preemptive right to purchase 50% of the shares held by the defendant by virtue of the binding shareholder agreement. Id. Because of this binding contract, the court found that the plaintiff had the requisite contractual rights to be an aborted buyer for the purposes of § 10(b).

In the present case, the plaintiff held a preemptive right in the corporation's newly issued shares that was created by the Articles of the corporation, not by a binding shareholder agreement. This distinction is not critical, however, in that contractual rights in the common law sense do not appear to be required to state a cause of action under § 10(b). See Mullen v. Sweetwater Development Corp., 619 F.Supp. 809, 814 (D. Colo. 1985) ("purchase and sale" within the meaning of the 1934 Act is not necessarily used in the common law sense). It appears that the 1934 Act requires the existence of a binding agreement for the transfer of securities in order to state a cause of action, regardless of the form of the agreement. See Dudley v. Southeastern Factor and Finance Corp., 446 F.2d 303, 306 (5th Cir.) cert. denied, 404 U.S. 858, 92 S.Ct. 109, 30 L.Ed.2d 101 (1971); McCloskey v. McCloskey, 450 F.Supp. 991, 996 (D.Pa.1978); Carpenter v. Hall, 311 F.Supp. 1099, 1106 (D.Tex.1970). In this sense, preemptive rights in Nevada corporations fall within the definition of "contracts for purchase" of securities, in that such rights are binding on the corporations and are enforceable in the courts. See NRS §...