Canfield v. Reynolds
| Decision Date | 09 September 1980 |
| Docket Number | No. 1099,D,1099 |
| Citation | 631 F.2d 169 |
| Parties | Fed. Sec. L. Rep. P 97,631 Jane S. W. CANFIELD and William Douglas Burden, as Trustees U/A/F/B/O William Douglas Burden, Jr., and William Douglas Burden, Jr., Plaintiffs-Appellees, v. William G. REYNOLDS, Defendant-Appellant, Paul Belmont, Michael Santangelo and Highway Safety Materials Corporation, Defendants. ocket 79-7788. |
| Court | U.S. Court of Appeals — Second Circuit |
Victor A. Kovner, New York City (Wayne N. Outten, Harriette K. Dorsen, Lankenau Kovner & Bickford, New York City, on the brief), for defendant-appellant.
William C. Viets, New York City (Lola S. Lea, Trubin Sillcocks Edelman & Knapp, New York City, on the brief), for plaintiffs-appellees.
Before MANSFIELD and KEARSE, Circuit Judges. *
William G. Reynolds appeals from a judgment of the United States District Court for the Southern District of New York, Richard Owen, Judge, granting to plaintiffs Jane S. W. Canfield and William Douglas Burden ("the trustees"), and William Douglas Burden, Jr. ("Burden"), rescission of an agreement to purchase from Reynolds 25,000 shares of the stock of Highway Safety Materials Corporation ("HSM"). 1 The controversy centers on an undertaking by Reynolds, given at the time of sale, to cause HSM to file with the Securities and Exchange Commission ("SEC") a registration statement covering the stock purchased by Burden. No such filing was ever made; the district court held that Reynolds had therefore breached the contract of sale. The court held also that Reynolds had violated § 10(b) of the Securities Exchange Act of 1934 ("1934 Act"), 15 U.S.C. § 78j(b) (1976), and Rule 10b-5 promulgated thereunder, 17 C.F.R. § 240.10b-5 (1980), by failing to disclose, at the time of sale, that he did not intend to cause a registration statement to be filed unless certain conditions favorable to a public underwriting were met. The court then found that damages could not be ascertained "with reasonable certainty," and granted plaintiffs rescission.
For the reasons below, we affirm the district court's determination that Reynolds breached the contract of sale, but reverse the finding of Rule 10b-5 liability. Since we also find that Burden is not entitled to rescission, we remand for a determination of damages.
The mise en scene of this controversy is the Securities Act of 1933 ("1933 Act"), 15 U.S.C. §§ 77a et seq. (1976). Broadly speaking, that Act prohibits the sale of securities to the public unless a registration statement covering the securities has been filed with and declared effective by the SEC. 1933 Act §§ 5, 4(1), 15 U.S.C. §§ 77e, 77d(1) (1976). See generally SEC v. North American R. & D. Corp., 424 F.2d 63 (2d Cir. 1970). Under Schedule A of the 1933 Act, 15 U.S.C. § 77aa (1976), and the applicable SEC regulations, the registration statement must include, along with various detailed disclosures concerning the issuer, a description of the plan of distribution by which the securities will be marketed. The most common form of distribution to the public involves an underwriting by investment bankers. See Jennings & Marsh, Securities Regulation 21-22 (4th ed. 1977).
Obviously, a prohibition against sales to the public severely restricts a security's marketability. Thus, the purpose of a promise to register stock-such as that at issue here-is generally to enhance the marketability, and hence the value, of that stock. A crucial consideration, with respect to such a promise, is the question of who must bear responsibility for developing the plan of distribution. With this setting in mind, we turn to the facts of this case.
HSM was formed in June 1969 to exploit mineral rights that Reynolds held in 90,000 acres of land near Brownsville, Kentucky. This land contained, among other things, deposits of rock asphalt, "heavy oil," silicone and coal. Reynolds acquired the mineral rights in the late nineteen-fifties, and subsequently formed Gripstop Company, which produced asphalt for use in paving highways. Gripstop apparently had little success; HSM was Gripstop's successor, and was apparently intended to be a somewhat more ambitious venture.
Shortly after HSM was formed, Reynolds and two associates, Paul Belmont and Michael Santangelo, began to look for outside financing, and investigated a number of different possibilities. First, Belmont and Santangelo sought to arrange for a public offering of HSM stock. On August 1, 1969, Tobey & Kirk, a New York investment firm, provided HSM with a nonbinding letter of intent, expressing its willingness to act as principal underwriter for a public offering of 250,000 shares of HSM stock at $8 per share. Second, HSM representatives explored the possibility of forming joint ventures with other companies to exploit various of the mineral deposits. In September 1969, HSM obtained a letter of intent from Major Oil Corporation, expressing interest in a joint venture to extract "heavy oil," and a letter of intent from Demag Elektrometallurgie concerning a joint venture to produce silicone. Finally, in late September 1969, HSM began to negotiate for an investment by Chemical Bank. The negotiations culminated in an agreement by the bank, executed on November 24, 1969, to lend HSM $400,000 at 8% interest, convertible into HSM stock at a price of $4 per share. The loan agreement provided that Chemical Bank could designate one director on the HSM board. It also provided that HSM would use its "best efforts" to register with the SEC any HSM stock that Chemical Bank obtained thereunder. 2 When it secured the loan from Chemical Bank, HSM determined to postpone any public offering for at least a year.
The first HSM stock was issued in November 1969. The HSM board of directors met in New York on November 7 and accepted two subscription offers for the stock. Under the first, Reynolds purchased 12,500 shares for $50,000. Under the second, Reynolds and Santangelo received 694,000 and 173,500 shares, respectively, in exchange for a deed to the company of certain of the Brownsville mineral rights, and an option to purchase the balance of those rights. None of the stock issued at this time was registered with the SEC; it was therefore not readily marketable. In connection with the second subscription, however, the HSM board passed the following resolution:
RESOLVED: That the Company hereby agrees to prepare and file one registration statement at any time after January 1, 1971, to be filed with the Securities and Exchange Commission to cover a public offering of such 867,500 shares of Capital Stock for the account of the holders of such stock on condition that the Company receive written request for such registration by the holders of not less than fifty percent (50%) of said 867,500 shares, such registration to be at the expense of such holders.
Reynolds has at all times held more than 50% of the 867,500 shares issued pursuant to the second subscription. Thus, it has always been within Reynolds' power to require HSM to prepare and file a registration statement covering those shares.
Burden first became interested in HSM after meeting Belmont and Santangelo in August 1969. Burden had previously worked on and invested in a number of venture capital projects, including several mining ventures, although none of the latter had involved the kinds of mineral deposits that HSM intended to exploit. Burden and the HSM representatives were soon discussing the possibility of Burden's becoming president of, and acquiring stock in, HSM. On August 28, Burden traveled to Richmond, Virginia and conferred with Reynolds about HSM and its prospects. By the middle of October, Burden had become substantially involved in HSM affairs, and had begun to act as president of the corporation. In October and November, Burden went to Brownsville, Kentucky to view the property and confer with the company's employees. During this period Burden also met with representatives of Major Oil to discuss the proposed "heavy oil" venture and corresponded with Demag Elektrometallurgie and Union Carbide about the possibility of silicone production.
In late November, Burden agreed to purchase 25,000 shares of the unregistered HSM stock from Reynolds for $4 per share. 3 In considering this investment, Burden was advised by his attorney, Sidney Rosoff, and by his investment advisors at Train, Cabot & Associates. Rosoff and Train, Cabot reviewed copies of the Chemical Bank loan closing file, certified HSM financial statements as of November 7, 1969, and the Tobey & Kirk letter of intent. Rosoff also obtained a copy of the HSM board resolutions concerning the issuance of shares to Reynolds.
In connection with Burden's purchase, the parties exchanged several documents which are of central importance to this case. First, Burden signed an investment letter dated November 25, 1969, stating that he was purchasing the stock "for investment, and not with a view to ... distribution," and that he had "made a full investigation of the Company, its properties and proposed operations." The letter also stated:
It is my understanding that the shares which I am purchasing are covered by an agreement on the part of the Company to register such shares with the Securities and Exchange Commission on or after January 1, 1971.
At the time he signed the investment letter, Burden received a form letter from Reynolds, 4 dated November 29, 1969, which had been drafted by John J. Howard, counsel to HSM who was acting as Reynolds' attorney. Reynolds' letter read, in its entirety, as follows:
This day I have sold to you for purposes of investment 25000 shares of capital stock of Highway Safety Materials, Inc. I represent to you that the Company has agreed to register these shares with the Securities and Exchange Commission at any time on or after January 1, 1971 upon my written request and at the expense of the Company. I...
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