Gaudin v. KDI Corp.

• Citation: 576 F.2d 708
• Decision Date: 23 May 1978
• Docket Number: No. 76-2070,76-2070
• Parties: Fed. Sec. L. Rep. P 96,453 E. L. GAUDIN, Executor of the Estate of Margaret W. Gaudin, Deceased, Plaintiff-Appellant, v. KDI CORPORATION, Walter G. Cox, Charles F. Hartsock, Cors, Hair & Hartsock, Defendants-Appellees.
• Court: United States Courts of Appeals. United States Court of Appeals (6th Circuit)

Page 708

576 F.2d 708

Fed. Sec. L. Rep. P 96,453

E. L. GAUDIN, Executor of the Estate of Margaret W. Gaudin Deceased, Plaintiff-Appellant, v. KDI CORPORATION, Walter G. Cox, Charles F. Hartsock, Cors Hair & Hartsock, Defendants-Appellees.

No. 76-2070.

United States Court of Appeals Sixth Circuit.

Argued Feb. 13, 1978.

Decided May 23, 1978.

Robert E. Manley, Cincinnati, Ohio, for plaintiff appellant.

Thomas S. Calder, Cincinnati, Ohio, for KDI and Cox.

Ralph F. Mitchell, Michael Maundrell, Douglas G. Cole, Cincinnati, Ohio, for Hartsock and firm.

Before WEICK, EDWARDS and ENGEL, Circuit Judges.

WEICK, Circuit Judge.

The action in the District Court was instituted by plaintiffs to recover compensatory and punitive damages for alleged fraudulent representations which caused them to enter into a contract with KDI Corporation (KDI) on or about April 8, 1970. The contract provided for an extension of a guarantee period with respect to a previous purchase of shares of stock, as consideration for which extension plaintiffs agreed to refrain from selling certain shares of stock for a period of time. The suit was brought under the authority of §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b), 78t(a), and Rule 10b-5, 17 C.F.R. § 240.10b-5, and related federal laws.

Pendent jurisdiction was claimed under the common law of Ohio relating to fiduciaries and malpractice by an attorney, with respect to defendant Hartsock and his law firm.

The District Court granted summary judgment in favor of the defendants, holding that plaintiffs' claim was not for the sale or purchase of shares of stock and therefore § 10(b) of the Act and Rule 10b-5 were not violated. The Court further held that the suit was barred by the applicable state statute of limitations. The plaintiffs appealed. We affirm.

I

The controversy grew out of the sale of assets of Herbert Chemical Company (Herbert), a corporation to KDI Corporation in exchange for shares of KDI stock and pursuant to a Reorganization Agreement entered into between KDI, Herbert and the plaintiffs.

After the sale was consummated on August 30, 1969 Herbert was dissolved, and 136,368 shares of KDI stock, which Herbert had received, were distributed to Herbert's shareholders. Plaintiffs, who were the controlling shareholders of Herbert, received 87,191 shares of KDI stock.

The 1969 Reorganization Agreement contained a guaranty protecting both plaintiffs and KDI from changes in the market price of KDI stock. The agreement contained three separate guaranties. With respect to 23,647 shares KDI promised to compensate plaintiffs by transferring additional shares if the market price of the stock was below $22 per share at the end of six months; and plaintiffs promised to return shares to KDI if the price was higher than $35 per share at the end of six months. A similar agreement protected an additional 23,647 shares for a period of one year if the market price was below $22 per share, or was higher than $40 per share. An additional 47,294 shares were protected for two years from the date of the agreement, with a low of $22 per share and a high of $50 per share.

By March 1, 1970 plaintiffs had decided to sell the 23,647 shares whose six-month guaranty had expired on that date. Plaintiffs alleged in their Complaint, and the District Court accepted arguendo, that they were dissuaded from selling their shares because of representations by defendants Cox and Hartsock, acting for KDI, that approval for the listing of KDI shares on the New York Stock Exchange had been given; that the actual listing was a mere formality which would take place within a very short time, but not later than June 30, 1970; and that the effect of plaintiffs' proposed sale of such a large block of stock might depress the market for said shares and might deprive shareholders of profits that could be made from the rise in value usually experienced by newly listed shares of stocks.

Plaintiffs contend that because of these representations they accepted defendants' promise, which the parties embodied in their written agreement of April 8, 1970, to reinstate its $22 price guaranty from that date until 150 days after the listing of KDI shares on the New York Stock Exchange. In exchange for this promise plaintiffs agreed to refrain from selling or offering for sale their shares until sixty days after such listing. ¹

Plaintiffs, received 80,668 additional shares of KDI stock in September, 1970 by exercising their rights under the second part of the guaranty (the one year provision).

In May, 1971 plaintiffs applied for and received 72,714 additional shares of KDI, which shares were issued under KDI's Plan of Arrangement under Chapter XI of the Bankruptcy Act. The Chapter XI proceeding was filed in Federal Court on December 30, 1970, in which proceeding the plaintiffs were listed in the schedules as having unliquidated or contingent claims as creditors, in an unknown amount. Instead of filing any claim for damages, the plaintiffs elected to come under the Plan of Arrangement as Class 6 creditors, and received additional shares of stock allotted to that class.

In the proofs of claim filed by plaintiffs in the Bankruptcy proceeding they asserted no claim for damages for fraud, but claimed only additional shares of stock in KDI, the debtor, based on the provisions of the Reorganization Agreement of 1969.

It is noteworthy that plaintiffs have not challenged the Reorganization Agreement nor made any claims of misrepresentation in connection therewith, nor have they challenged the stock values guaranteed in that agreement, nor challenged the 1969 sale of Herbert to KDI. They claim only to have been damaged by the misrepresentations as to the listing of said shares on the New York Stock Exchange, which alleged misrepresentations induced them to enter into the April 8, 1970 agreement.

The District Court held that the plaintiffs, by virtue of the April 8, 1970 agreement, did not purchase or sell any securities. The Court stated:

The undisputed facts of this case do not show any purchase or sale of any security in connection with the transaction in question. The plaintiffs complain that they were induced into signing the April 8, 1970, agreement by fraudulent statements made by defendants herein; and that pursuant to such agreement they did not sell the stock as to which the first part of the original warranty had expired. For the purposes of this jurisdictional inquiry, all that the defendants did was to extend a warranty, and all that the plaintiffs did was agree not to sell their stock. ⁶ There was no purchase, and no sale. There are only two operative sentences in the agreement. The first is that the Gaudins "promise and agree that they will refrain from selling . . ." and the second is that KDI "promises and agrees that it will extend the guarantee of a market value of $22.00 per share . . . ." To the extent that the agreement is anything other than a guarantee extension, it is a promise not to sell. There is no aspect of the transaction in question that qualifies the plaintiffs herein as purchasers or sellers of securities. Accordingly, this Court lacks jurisdiction and this complaint must be dismissed. (A. 475-76)

In reaching its decision the District Court followed the Birnbaum rule, Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952), as applied by the Supreme Court in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), and by this Court in Marsh v. Armada Corp., 533 F.2d 978 (6th Cir. 1976).

In our opinion the District Court correctly applied these decisions.

II

The Securities Act contains no statute of limitations. We are therefore required to apply the state statute of limitations which best effectuates the policy of the federal statute in question. AFL-CIO v. Hoosier Cardinal Corp., 383 U.S. 696, 86 S.Ct. 1107, 16 L.Ed.2d 192 (1966). Ohio has two statutes to be considered. Ohio Rev.Code § 1707.43 contains a limitation of two years for bringing an action for violation of Ohio's Blue Sky Laws. Ohio Rev.Code § 2305.09(C) is a four year statute of limitations applicable to general fraud.

In Nickels v. Koehler Management Corp., 541 F.2d 611 (6th Cir. 1976), cert. denied, 429 U.S. 1074, 97 S.Ct. 813, 50 L.Ed.2d 792 (1977), we held, in an opinion written for the Court by Circuit Judge Wade McCree, that the four year statute of limitation was the most appropriate statute to apply. We will follow that decision by adopting the time period therein contained. We will, however, apply federal law that determines when a statute of limitation begins to run, which is when "the fraud is or should have been discovered." Vanderboom v. Sexton, 422 F.2d 1233, 1240 (8th Cir. 1970).

Federal law applies in determining the date on which the statute of limitation begins to run. Holmberg v. Armbrecht, 327 U.S. 392, 66 S.Ct. 582, 90 L.Ed. 743 (1946); Bailey v. Glover, 88 U.S. 342, 22 L.Ed. 636 (1875); Hupp v. Gray, 500 F.2d 993 (7th Cir. 1974).

In Berry Petroleum Co. v. Adams & Peck, 518 F.2d 402 (2d Cir. 1975), the Court pointed out indicia of when fraud should be discovered, as follows:

In light of the trading suspensions, the precipitous decline in the price of CUC stock, and the other lawsuits by the SEC and private parties, we think that Judge McFadden correctly concluded that plaintiffs with reasonable diligence could and should have discovered the alleged fraud prior to December 15, 1969. (Id. at 410)

The District Court similarly pointed out the indicia existing in the present case:

Plaintiff's (sic ) complaint cites several instances where the plaintiffs were advised that the KDI stock was "very shortly to be listed on the New York Stock Exchange," and "the listing was a mere formality and would be accomplished within a short period of time." KDI stock was never listed on the New York...