Brug v. The Enstar Group, Inc.

• Decision Date: 24 January 1991
• Docket Number: Civ. A. No. 90-89-JRR.
• Parties: Harold BRUG and Harvey D. Fiechtner, Plaintiffs, v. THE ENSTAR GROUP, INC. (F/K/A Kinder Care, Inc.), Richard J. Grassgreen, Perry Mendel, Lodestar Associates, L.P., Lodestar Management, Inc., Starchild Investment Partnership L.P., Starchild Holding Partnership L.P., Lodestar Partners, L.P., Starchild SBS Limited Partnership, L.P., and Lodestar Group, Defendants.
• Court: U.S. District Court — District of Delaware

755 F. Supp. 1247

Harold BRUG and Harvey D. Fiechtner, Plaintiffs, v. THE ENSTAR GROUP, INC. (F/K/A Kinder Care, Inc.), Richard J. Grassgreen, Perry Mendel, Lodestar Associates, L.P., Lodestar Management, Inc., Starchild Investment Partnership L.P., Starchild Holding Partnership L.P., Lodestar Partners, L.P., Starchild SBS Limited Partnership, L.P., and Lodestar Group, Defendants.

Civ. A. No. 90-89-JRR.

United States District Court, D. Delaware.

January 24, 1991.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Edward T. Ciconte of Ciconte & Roseman, Wilmington, Del.; Kenneth G. Gilman, David Pastor, and John T. Maher of Gilman and Pastor, Revere Beach, Mass., of counsel, for plaintiffs.

Martin P. Tully, and Luke W. Mette of Morris, Nichols, Arsht & Tunnell, Wilmington, Del.; Charles B. Paterson, Executive Vice-President and Gen. Counsel, Enstar Group, Inc., Montgomery, Ala. and Glenn R. Reichardt, Jonathan N. Eisenberg, and Lisa L. Ferneau of Kirkpatrick & Lockhart, Washington, D.C., of counsel, for defendants Enstar Group, Inc. Grassgreen and Mendel.

Edward P. Welch, Esquire and Robert A. Glen of Skadden, Arps, Slate, Meagher & Flom, Wilmington, Del.; Henry P. Wasserstein, Jonathan M. Gutoff, and Michael I. Allen of Skadden, Arps, Slate, Meagher & Flom, New York City, for defendants Lodestar Associates, L.P., Lodestar Management, Inc., Starchild Inv. Partnership, L.P., Starchild Holding Partnership, L.P., Lodestar Partners, L.P., Starchild SBS Ltd. Partnership, L.P. and Lodestar Group.

OPINION

ROTH, District Judge.

Plaintiffs Harold Brug and Harvey D. Fiechtner filed this action on behalf of themselves and others who purchased shares of Kinder-Care, Inc. common stock during the period from March 26, 1989 through September 23, 1989. Kinder-Care, Inc. ("KCI") is presently called The Enstar Group, Inc. The defendants in this action are The Enstar Group, Inc., Richard J. Grassgreen, Perry Mendel, Lodestar Associates, L.P., Lodestar Management, Inc., Starchild Investment Partnership L.P., Starchild Holding Partnership L.P., Lodestar Partners, L.P., Starchild SBS Limited Partnership, L.P., and Lodestar Group. The complaint alleges violations of federal securities laws and state law claims all arising out of a planned corporate reorganization by KCI.

In response to the complaint, the various defendants have filed two motions to dismiss, both of which are presently before this Court. The first motion was filed by The Enstar Group, Inc., Richard J. Grassgreen, and Perry Mendel (collectively the "Kinder-Care Defendants"). The remaining defendants listed above (collectively the "Lodestar Defendants" or "Lodestar") have also filed a motion to dismiss. Both motions seek dismissal of the complaint pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6). Since many of the grounds raised in the two motions to dismiss are similar and the Lodestar Defendants have also adopted the Kinder-Care Defendants' motion, we will discuss the two motions together. For the reasons stated below, we will grant both motions to dismiss, but will also grant plaintiffs leave to amend their complaint.

I. PLAINTIFFS' COMPLAINT

As a preliminary matter, we note that the Kinder-Care Defendants have filed, with their opening brief on their motion to dismiss, an appendix, which contains several of the documents discussed in the plaintiffs' complaint. These documents, however, were not attached to the complaint and are not part of the pleadings on file. Cf. Provident Nat'l Bank v. Frankford Trust Co., 468 F.Supp. 448, 450 & n. 2 (E.D.Pa.1979) (considering documents attached to complaint as exhibits and "incorporated into the pleadings"). Moreover, it would be inappropriate to convert the motion to dismiss into a motion for summary judgment pursuant to Fed.R.Civ.P. 12(b), since there has been no discovery conducted in the present case. Therefore, in considering the motions to dismiss, we will review only the plaintiffs' complaint. See Melo v. Hafer, 912 F.2d 628, 634 (3d Cir. 1990); Ospina v. Department of Corrections, 749 F.Supp. 572, 574 (D.Del.1990).

Plaintiffs' complaint contains three counts. Count I alleges that all defendants violated both Section 10(b) of the Securities Exchange Act of 1934 and Securities and Exchange Commission Rule 10b-5 promulgated thereunder. This count includes claims of individual violations, as well as charges of conspiracy and of aiding and abetting. The second count is for fraud and deceit under Delaware state law, and similarly alleges individual violations as well as conspiracy and aiding and abetting. Count III asserts a claim for negligent misrepresentation under Delaware state law.

In brief outline, the facts alleged in plaintiffs' complaint are as follows. Prior to May, 1989, KCI was a holding company, which owned 87% of Kinder-Care Learning Centers, Inc. ("Learning Centers"). On or about May 26, 1989, KCI and Learning Centers jointly issued a press release, announcing a corporate reorganization plan. Under the plan, the two corporations would split into two unrelated public companies: Learning Centers, which would operate child care services, and KCI, which would conduct financial services. This press release was followed by KCI's issuance of a Form 8-K on or about June 9, 1989, which detailed the terms of the reorganization.

Among the terms of the plan were a provision entitling KCI shareholders to rights to purchase KCI common stock at a preferred price, and a term providing for a distribution of Learning Centers stock to KCI shareholders. The plan also stated that Lodestar would be given the opportunity to purchase shares of Learning Centers stock at a discounted price, and would commit to purchase any unsold shares of KCI. After the two public statements announcing the reorganization were issued, the price per share of Learning Centers stock rose significantly, and that of KCI stock remained stable.

However, on or about September 22, 1989, KCI issued a new press release and a new Form 8-K stating that the companies had abandoned the previously announced restructuring plan, and had substituted a new plan in its place. The new plan did not include either a rights offering to KCI shareholders at discounted prices or a distribution of Learning Centers common stock to KCI shareholders. In addition, the September plan altered the involvement of Lodestar, so that Lodestar would purchase Learning Centers directly, rather than through KCI as an intermediary. Following this September announcement, the prices of both KCI and Learning Centers stock dropped sharply, and both fell to levels lower than those existing before the publication of the original reorganization plan. The revised reorganization plan was actually implemented. As a result, Lodestar acquired 63% of Learning Centers common stock. KCI then changed its name to The Enstar Group, Inc. ("Enstar"). Finally, on November 10, 1989, Enstar issued its third quarter earnings report which revealed a net loss of $99,427,000 or $1.81 per share for that quarter.

Throughout these events, the Lodestar Defendants, all of which are subsidiaries or affiliates of Defendant Lodestar Group, acted as financial partner and financial advisor to KCI and Learning Centers. Also throughout this time, Defendant Richard J. Grassgreen ("Grassgreen") was President, Secretary and a Director of KCI. In November, 1989, he became Chairman of the Board of Enstar. Defendant Perry Mendel ("Mendel") was Chairman of the Board of KCI from October, 1985 through October, 1989 and thereafter became Chairman of the Board of Learning Centers.

The plaintiffs and the members of the class they seek to represent all bought shares of KCI common stock between May 26, and September 23, 1989. Plaintiffs do not allege that they themselves, or the members of the class they seek to represent, read the May 26th press release or June 9th Form 8-K. They do allege, however, that they and all class members purchased KCI stock "in anticipation of" the opportunities presented by the original reorganization plan.

The complaint alleges that the defendants committed several misrepresentations or omissions of material facts when announcing the original reorganization plan in May and June, 1989. As more specific averments, plaintiffs allege the failure to disclose: (1) that the defendants did not actually intend to consummate the original restructuring plan; (2) that there were serious problems and risks associated with gaining a favorable ruling from the Internal Revenue Service regarding the distribution of Learning Centers stock; (3) that if the restructuring plan were revised KCI shareholders would be forced to relinquish their equity interests in Learning Centers; (4) that if the reorganization plan were revised it would include less advantageous terms for KCI shareholders; (5) that KCI would incur enormous operating losses in its quarter ending September 30, 1989; and (6) that pending legislation governing the savings and loan industry would impose increasingly stringent capital and investment requirements on KCI, and could threaten the abandonment of the original restructuring plan. Complaint ¶¶ 30-35.

II. FAILURE TO COMPLY WITH FED. R.CIV.P. 9(b) IN COUNTS I AND II

The first ground raised in both motions to dismiss is failure to comply with Fed.R. Civ.P. 9(b). Defendants argue that plaintiffs have failed to plead fraud with particularity, and therefore Rule 9(b) requires the dismissal of both of the two fraud claims: Count I which alleges violations of federal securities laws, namely Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated thereunder, and Count II which charges fraud and deceit under Delaware state law. Plaintiffs contend that they have met the requirements of Rule 9(b) and consequently dismissal is not warranted.

A. The Standards

The standards for proving fraud claims under federal securities law and under Delaware state law are similar. The elements that p...