Fidelis Corporation v. Litton Industries, Inc.

• Decision Date: 24 September 1968
• Docket Number: No. 67 Civ. 3662.,67 Civ. 3662.
• Citation: 293 F. Supp. 164
• Parties: FIDELIS CORPORATION, Richard T. Lovelace, Bartlett Burnap, William S. Fryer and Hearsh Bros., a partnership, Plaintiffs, v. LITTON INDUSTRIES, INC., Defendant.
• Court: U.S. District Court — Southern District of New York

293 F. Supp. 164

FIDELIS CORPORATION, Richard T. Lovelace, Bartlett Burnap, William S. Fryer and Hearsh Bros., a partnership, Plaintiffs, v. LITTON INDUSTRIES, INC., Defendant.

No. 67 Civ. 3662.

United States District Court S. D. New York.

September 24, 1968.

COPYRIGHT MATERIAL OMITTED

Davis & Cox, New York City, for plaintiffs, Maxwell E. Cox, Howard M. Jaffe, New York City, of counsel.

Webster, Sheffield, Fleischmann, Hitchcock & Brookfield, New York City, for defendant, James V. Ryan, Byron Keith Huffman, Jr., New York City, of counsel.

OPINION

BONSAL, District Judge.

Plaintiff Fidelis Corporation (Fidelis) and plaintiffs Lovelace, Burnap, Fryer, and Hearsh Bros., on behalf of themselves and the other beneficial owners of Fidelis common stock (the individual plaintiffs) instituted this action against defendant Litton Industries, Inc. (Litton). The complaint alleges that Litton violated

(a) Sections 5 and 12(1) of the Securities Act of 1933 (the 1933 Act), (15 U.S.C. §§ 77e, 77l(1));

(b) Sections 12(2) and 17(a) of the 1933 Act (15 U.S.C. §§ 77l(2), 77q(a));

(c) Section 10(b) of the Securities Exchange Act of 1934 (the 1934 Act) (15 U.S.C. § 78j(b)) and Rule 10b-5 promulgated pursuant thereto (17 C.F.R. § 240.10b-5);

(d) contractual obligations and fiduciary duties; and

(e) the common law of fraud and deceit,

with respect to a transaction, described more fully below, by which Litton acquired in 1964 substantially all the assets of Fidelis in exchange for shares of Litton common stock (Litton stock).

In January 1964, Litton and Fidelis, then known as Advance Data Systems Corporation, entered into negotiations with respect to Litton's acquisition of substantially all the assets of Fidelis in exchange for Litton stock. Under an agreement signed on January 31, 1964 (the Acquisition Agreement), Litton acquired substantially all the assets of Fidelis and in exchange therefor agreed to issue Litton stock up to the value of $360,000 (Initial Consideration) and thereafter an additional amount of Litton stock (Additional Consideration) dependent upon the earnings of the Fidelis assets for the five years following the acquisition, such Additional Consideration, together with Initial Consideration, not to exceed $20,000,000 in value of Litton stock. The amount of Litton stock to be issued as Initial Consideration and Additional Consideration depended upon an election by each Fidelis shareholder as to whether he would prefer to receive a portion of the Initial Consideration or only a portion of the Additional Consideration.

On January 23, 1964, Fidelis' Board of Directors approved a Plan of Liquidation and Dissolution (the Plan) which incorporated the principal features of the Acquisition Agreement.

On January 28, 1964, Fidelis' Board of Directors submitted to each of the Fidelis shareholders (1) the Plan; (2) the Acquisition Agreement; (3) a Consent Form to be signed if the shareholder approved the Plan and the Acquisition Agreement; (4) a form on which the shareholder could elect whether and the extent to which he desired to receive a portion of the Initial Consideration; and (5) a copy of Schedule J to the Acquisition Agreement which described the manner in which Litton proposed to operate the Fidelis assets.

The holders of about 97% of the common stock of Fidelis approved the Plan and Agreement. By January 31, 1964, the Fidelis shareholders had elected as to whether they wished to receive Initial Consideration.

The memorandum of the closing which took place on February 17, 1964, indicates that Litton stock having a value of $324,000 was issued to Fidelis as the Initial Consideration and was distributed by Fidelis to the shareholders electing to receive Initial Consideration. According to the affidavit of the Secretary of Fidelis, Fidelis shareholders owning approximately one-third of its outstanding shares elected not to receive Litton shares issued as Initial Consideration, and no Additional Consideration has been issued by Litton. From the papers, it appears that on April 19, 1967, Litton addressed a letter to the Fidelis Shareholders Protective Committee stating that the financial performance of the Fidelis assets under the Litton management did not warrant any Additional Consideration under the Acquisition Agreement.

Litton moves (1) for an order, pursuant to Rule 56, F.R.Civ.P., (a) dismissing all claims based upon a violation of sections 5 and 12(1) of the 1933 Act; and (b) dismissing all claims alleged on behalf of the individual plaintiffs and the class they purport to represent; and (2) for an order pursuant to Rule 23, F.R.Civ.P., directing that the individual plaintiffs' action is not maintainable as a class action.

MOTION TO DISMISS CLAIMS UNDER SECTIONS 5 and 12(1)

Section 5 of the 1933 Act provides that

"unless a registration statement is in effect as to a security, it shall be unlawful for any person * * * to sell such security * * *."

Section 12(1) of the 1933 Act provides for civil liability for any person who violates Section 5.

It is conceded by the parties that Litton did not file a registration statement with respect to the securities it issued in exchange for the Fidelis assets. However, Litton claims an exemption from the necessity of filing a registration statement by virtue of Rule 133 of the General Rules and Regulations promulgated pursuant to the 1933 Act (17 C.F.R. § 230.133). Rule 133 provides that

(a) For purposes only of section 5 of the Act, no "sale", "offer", "offer to sell", or "offer for sale" shall be deemed to be involved so far as the stockholders of a corporation are concerned where, pursuant to statutory provisions in the State of incorporation * * * there is submitted to the vote of such stockholders * * a proposal for the transfer of assets of such corporation to another person in consideration of the issuance of securities of such other person * * * under such circumstances that the vote of a required favorable majority (1) will operate to authorize the proposed transaction so far as concerns the corporation whose stockholders are voting * * * and (2) will bind all stockholders of such corporation except to the extent that dissenting stockholders may be entitled * * * to receive the appraised or fair value of their holdings.

Litton contends that the "no-sale" provision of Rule 133 applies to this transaction and moves to dismiss the claims of Fidelis and the individual plaintiffs under sections 5 and 12 of the 1933 Act.

Fidelis and the individual plaintiffs contend that Rule 133 does not apply to this transaction because the vote of the Fidelis shareholders did not determine the amount of Litton stock the Fidelis shareholders would receive or the number which would be distributed. Therefore, Fidelis and the individual plaintiffs argue that the vote of the required favorable majority did not bind all the Fidelis shareholders, as required by Rule 133(a) (2).

As a corporation organized under the laws of California, Fidelis could not sell all or substantially all of its assets except

"under authority of a resolution of its board of directors and with the approval of the principal terms of the transaction and the nature and amount of the consideration by vote or written consent of shareholders entitled to exercise a majority of the voting power of the corporation * * *" (Section 3901(b), California Corporation Code.)

It is conceded that section 3901(b) was complied with; therefore, the only question is whether Rule 133 has likewise been complied with, since each shareholder had an election to choose the nature of the compensation he would receive.

Rule 133 exempts from the registration requirements of the 1933 Act the shares of a corporation issued to another corporation pursuant to an acquisition agreement in exchange for that other corporation's assets. Sowards, Federal Securities Act § 2.03 1 iii, in 11 Business Regulation—Securities Regulation. However, Rule 133 does not exempt transactions where the stockholders of the selling corporation may individually accept or reject an offer of a new security in exchange for their old stock. 1 Loss, Securities Regulation 521 (2d ed. 1961). The requirements of Rule 133 were met here. Pursuant to section 3901(b), California Corporation Code, the Fidelis shareholders voted to approve the Acquisition Agreement and thereby authorized the sale of substantially all the Fidelis assets to Litton, and bound themselves to the Acquisition Agreement.

Therefore, since Rule 133 exempts the issuance of the Litton stock to Fidelis from sections 5 and 12(1) of the 1933 Act, Litton's motion to dismiss those sections of the complaint alleging violations of sections 5 and 12(1) is granted.

MOTION TO DISMISS CLAIMS ALLEGED BY INDIVIDUAL PLAINTIFFS

Litton moves to dismiss the remaining claims alleged in the complaint on the grounds that (1) the individual plaintiffs lack the capacity to sue as individuals; and (2) the individual plaintiffs were not purchasers of securities from Litton.

1. Capacity to sue

First, as to the individual plaintiffs' capacity to sue, the individual plaintiffs allege inter alia that they are shareholders of Fidelis, that Litton made fraudulent and materially false representations to them for the purpose of inducing them to agree to the sale of the Fidelis assets to Litton and to take Additional Consideration, when and if issued, instead of their proportionate part of the Initial Consideration, and that some of the plaintiffs elected to take Additional Consideration, when and if issued, and not to take Initial Consideration. The plaintiffs point out that in fact no Additional Consideration was issued.

Although usually shareholders do not have the capacity to sue individually for wrongs committed against the corporation, see Berzin v. Litton Industries, Inc., 24 A.D.2d 740, 263 N.Y. S.2d 485 (1965); Evangelista v. Longo, 13 A.D.2d 834, 216 N.Y.S.2d 194 (1961); Sutter v. General Petroleum Corp.,...