Cortec Industries, Inc. v. Sum Holding L.P.

Decision Date08 November 1991
Docket NumberD,No. 1456,1456
PartiesFed. Sec. L. Rep. P 96,406, 21 Fed.R.Serv.3d 75 CORTEC INDUSTRIES, INC. and Cortec Holdings, Inc., Plaintiffs-Appellants, v. SUM HOLDING L.P., Dubin Clark & Company, Inc., Dubin Clark Capital Corp., Ronald N. Dubin, J. Thomas Clark, Jean Pierre Dammann, Norman J. Yerke, Michael Canipe, Woodlawn Foundation, Westinghouse Credit Corporation, Bowles Hollowell Conner & Co., Ernst & Young, Defendants, Westinghouse Credit Corporation, Defendant-Appellee. ocket 91-7099.
CourtU.S. Court of Appeals — Second Circuit

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949 F.2d 42
Fed. Sec. L. Rep. P 96,406, 21 Fed.R.Serv.3d 75
CORTEC INDUSTRIES, INC. and Cortec Holdings, Inc.,
SUM HOLDING L.P., Dubin Clark & Company, Inc., Dubin Clark
Capital Corp., Ronald N. Dubin, J. Thomas Clark, Jean Pierre
Dammann, Norman J. Yerke, Michael Canipe, Woodlawn
Foundation, Westinghouse Credit Corporation, Bowles
Hollowell Conner & Co., Ernst & Young, Defendants,
Westinghouse Credit Corporation, Defendant-Appellee.
No. 1456, Docket 91-7099.
United States Court of Appeals,
Second Circuit.
Argued May 13, 1991.
Decided Nov. 8, 1991.

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Michael H. Barr, New York City (Mark S. Pomerantz, Sonnenschein Nath & Rosenthal, of counsel), for plaintiffs-appellants.

Christopher P. Hall, New York City (Jane A. Rue, Jones, Day, Reavis & Pogue, of counsel), for defendant-appellee.

Before CARDAMONE, WALKER and FRIEDMAN, * Circuit Judges.

CARDAMONE, Circuit Judge:

This appeal from a dismissal made pursuant to Fed.R.Civ.P. 12(b)(6) in a securities fraud action asks what documents a district court judge may consider when disposing of a motion to dismiss a complaint for failure to state a claim. Here in drafting their complaint plaintiffs relied upon documents transmitted to them by defendants, though they neglected to attach these papers to, or incorporate them by reference in, the complaint. When defendants made a Rule 12(b)(6) motion to dismiss utilizing the same documents, plaintiffs insisted the district court not consider them, but instead was required to limit its inquiry regarding the complaint's viability to its four corners. Plaintiffs' failure to include matters of which as pleaders they had notice and which were integral to their claim--and that they apparently most wanted to avoid--may not serve as a means of forestalling the district court's decision on the motion.

Plaintiffs sought damages and rescission of a stock purchase agreement allegedly entered into in violation of the securities laws, civil RICO, and the common law. The United States District Court for the Southern District of New York (Haight, J.) in an opinion and order dated January 3, 1991 dismissed, without leave to replead, plaintiffs' claim that Westinghouse Credit Corporation (Westinghouse) violated § 12(2) of the Securities Act of 1933 in connection with the sale of Cortec Industries, Inc., finding that the complaint itself demonstrated that Westinghouse was not a statutory seller as that term is defined in § 12(2) of the Securities Act of 1933, 15 U.S.C. § 771(2).


Cortec is engaged in the business of manufacturing pre-engineered metal buildings, and consists of three divisions: Rib-Roof Industries, Summit Buildings, and Inland Buildings. On May 12, 1989 plaintiffs purchased all of Cortec's stock and its outstanding debt for $53 million. Plaintiffs are "new" Cortec Industries, Inc. and Cortec Holdings, Inc. (Cortec or plaintiffs). Prior to this transaction "old" Cortec, for purposes of clarification, was held by four different categories of owners: defendants affiliated with Dubin Clark & Company, Inc. that had formed old Cortec, defendants that were current members of old Cortec's management, and the defendant Woodlawn Foundation, a not-for-profit corporation. These defendants together owned 1,000 shares of old Cortec stock. The fourth entity with an ownership interest was defendant Westinghouse, holder of a warrant to purchase 111 shares of old Cortec stock for $111. Westinghouse had received the warrant in connection with its financing of old Cortec's earlier purchase of one of its divisions.

Sometime prior to December 13, 1988 the Dubin Clark and management defendants decided to sell old Cortec and retained the investment banking firm of Bowles Hollowell, Conner & Co. (Bowles) located in Charlotte, North Carolina to assist them in that objective. After Leach McMicking & Co., the parent corporation for the purchasing corporations, received an offering memorandum prepared by Bowles dated December 13, 1988, it became interested in acquiring old Cortec. The offering memorandum contained a broad range of information concerning old Cortec, such as its operation

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in the industry as a whole, including detailed descriptions and historical analyses of its financial performance, what segment and position it occupied in the industry, and its projected financial results for 1988, 1989 and subsequent years. The memorandum also contained a series of related representations concerning the growth of old Cortec's business and its prospects, which was used to bolster the various optimistic financial projections.

The offering memorandum led Leach McMicking to pursue the acquisition. Its first offer of $21 million plus repayment of existing debt of nearly $26 million was rejected. After further negotiations and representations from the owners and managers of old Cortec--referred to in plaintiffs' complaint as the "selling defendants," Leach McMicking submitted a revised offer of $22.5 million together with repayment of debt, which the selling defendants accepted.

The transaction was structured as follows. First, Leach McMicking created three new corporations: plaintiff Cortec Holdings, Inc. (Holdings), a Delaware corporation with its principal office in San Francisco, California; plaintiff Cortec Industries, Inc. (Cortec), a Delaware corporation with its principal office in Milwaukee, Wisconsin and a wholly-owned subsidiary of Holdings; and Cortec Acquisitions, Inc. (Acquisition) another wholly-owned subsidiary of Holdings formed for the purpose of engaging in the transaction at issue in this suit. Second, on April 11, 1989, Acquisition entered into a Stock Purchase Agreement with the selling defendants, Westinghouse and Woodlawn, pursuant to which Acquisition agreed to purchase all the shares of old Cortec and old Cortec agreed to use some of the money paid by Acquisition to purchase and cancel the Westinghouse warrant.

The Stock Purchase Agreement contained certain representations and warranties, as well as certain conditions precedent to plaintiffs' obligations to purchase old Cortec. The representations and warranties were that the sellers had furnished audited financial statements for 1986, 1987 and 1988 prepared in accordance with generally accepted accounting principles and on which the accounting firm of Ernst & Young, also a defendant in this litigation, had expressed an unqualified opinion to the effect that since January 1, 1989 there had not been any material adverse changes in the business or financial condition of old Cortec, Cortec's personal property was not encumbered except as specified, and the information concerning old Cortec set forth in the Stock Purchase Agreement and other documents furnished or to be furnished by the sellers contained no untrue statements of material facts and did not omit material facts. The conditions precedent included the correctness of any representations and warranties when made and as of the date of closing, and that Ernst & Young would deliver a "comfort letter" to Acquisition concerning 1989's first quarter financial data.

The comfort letter was sent, no clarifications or alterations of prior representations were made, and the transaction closed on May 12, 1989. And then the third and final step of the transaction occurred: Holdings, through Acquisition, acquired all of old Cortec's shares, and old Cortec purchased and cancelled Westinghouse's warrant. Acquisition was then merged into old Cortec, and "new" Cortec emerged as the surviving corporate entity.

In their complaint, plaintiffs allege they would not have entered into this transaction "if not for defendants' repeated fraudulent or negligent misrepresentations and omissions concerning old Cortec's financial condition, operations and prospects." The particular misrepresentations fall roughly into three categories: failure to state the true nature of the uncollectability of accounts receivable or to provide for adequate loss reserves; failure to base income projections and financial statements on reasonable assumptions or historical analysis; and a miscellaneous list of items that were not disclosed and which negatively affected old Cortec's actual net worth and future financial stability.

On the basis of these allegations, plaintiffs asserted claims against the following

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defendants: the selling defendants, Ernst & Young and Bowles for violations of § 10(b) of the 1934 Securities Act; all defendants, except Ernst & Young, for violation of § 12(2) of the 1933 Securities Act; all defendants for violation of § 17(a) of the 1933 Act; the selling defendants under civil RICO and for common law fraud; Sum Holding--a Dubin Clark-controlled company that owned 750 shares of old Cortec prior to the transaction--and former old Cortec president Norman Yerke for breach of contract; and Ernst & Young for negligence.

All the defendants moved under Fed.R.Civ.P. 12(b)(6) to dismiss the complaint for failure to state a claim. The district court's January 3, 1991 opinion consisted of several parts, only one of which is the subject of this appeal, that is, the part that granted dismissal without leave to replead plaintiffs' claim against Westinghouse under § 12(2). Based solely on its perusal of the complaint the district court expressed its view of plaintiffs' claim as follows:

At the time of the transaction, [Westinghouse] owned a warrant which if exercised entitled [Westinghouse], on conversion, to 111 Cortec shares. The warrant had not been exercised. [Westinghouse] held no Cortec shares. In order to consummate plaintiff's [sic] purchase of Cortec, it was necessary to do something about the [Westinghouse] warrant. The parties to the transaction took care of the matter by having the warrant's issuer, "old" Cortec, request [Westinghouse] to surrender it....

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