General Builders Supply Co. v. River Hill Coal Venture, 85-1957

• Decision Date: 03 July 1986
• Docket Number: No. 85-1957,85-1957
• Citation: 796 F.2d 8
• Parties: Fed. Sec. L. Rep. P 92,816 GENERAL BUILDERS SUPPLY COMPANY, et al., Plaintiffs, Appellants, v. RIVER HILL COAL VENTURE, et al., Defendants, Appellees.
• Court: U.S. Court of Appeals — First Circuit

Page 8

796 F.2d 8

Fed. Sec. L. Rep. P 92,816

GENERAL BUILDERS SUPPLY COMPANY, et al., Plaintiffs, Appellants, v. RIVER HILL COAL VENTURE, et al., Defendants, Appellees.

No. 85-1957.

United States Court of Appeals First Circuit.

Argued March 6, 1986.

Decided July 3, 1986.

Robert D. Cultice with whom Carl K. King, P.C., Louis J. Scerra, Jr. and Goldstein & Manello, Boston, Mass., were on brief, for plaintiffs, appellants.

Edward Notis-McConarty with whom Kathleen A. Bryan and Hemenway & Barnes, Boston, Mass., were on brief, for defendant, appellee Gerald T. Reilly & Co.

Vincent M. Amoroso with whom Robert T. Gill and Parker, Coulter, Daley & White, Boston, Mass., were on brief, for defendant, appellee Rich, May, Bilodeau & Flaherty.

Before CAMPBELL, Chief Judge, TORRUELLA,

Circuit Judge, and MALETZ, ^* Senior Judge.

TORRUELLA, Circuit Judge.

This case is before us on an appeal by plaintiffs, hereinafter referred to collectively as "the investors," from an order of the United States District Court for the District of Massachusetts awarding defendant/appellees Rich, May, Bilodeau & Flaherty, Francis M. Percuoco and Gerald T. Reilly & Co., summary judgment on the ground that the investors' claims under federal securities laws are time barred. The facts which gave rise to the complaint are as follows:

In March 1978 the appellants began negotiations for the purpose of investing in the River Hill Coal Venture, a coal mining venture located in Tuscarawas County, Ohio. Robert Goldberg, promoter of the venture, organized the project so that it was to be sold in the form of 34 units at a cost of $30,000 per unit. The River Hill venture was presented to the investors and highly recommended by their financial advisor and accountant of many years, Reilly & Co., and specifically its agent Percuoco, the individual with whom appellants had personally dealt. Percuoco counseled the investors, encouraging involvement in the venture because he knew and trusted the individuals who had formed River Hill. He stated that Reilly & Co. had reviewed the documents describing the investment and found them to be in good order. Percuoco failed to inform them, however, that he would receive a commission for selling the units. Percuoco provided each investor with a copy of the River Hill offering memorandum, 217 pages in length, which described the venture and its operation in detail. Besides describing the sale of the units and the purchase plan, ¹ the offering memo contained, inter alia, such diverse documents as the engineering report; the mining contract; a form of opinion of tax counsel; information on risk factors, such as tax consequences, pro forma financial analysis, and numerous exhibits.

The venture was to operate in the following manner: River Hill had obtained from the Washington Coal Trust, an affiliate of the venture manager, River Hill Coal Corp., a sublease whereby it would have all of the rights to mine coal in the subleased area until March 31, 1985, or a period of about seven years from the closing. Under the terms of the sublease, River Hill was required to pay minimum annual royalties of $2,040,000; however, only one quarter of such royalties had to be paid annually in cash during the first two lease years of 1978 and 1979, with the balance payable by non-recourse 4% promissory notes maturing on March 15, 1985. The offering memo predicted a delay in the commencement of mining operations beyond the closing date. The pro forma financial analysis was based upon an estimated commencement date of March 31, 1979--one year after the closing. Such a delay could be reasonable in light of all the preliminary work which had to be accomplished prior to actual mining. The offering memo stated, among other things, that the venture had to first obtain various permits from the state of Ohio, perform substantial development work in order to "face up" the mine in preparation for deep mining, obtain insurance to cover tort liability, and hire a professional mining engineer to render advice on the mining operations and the marketing of coal.

The projections for taxable income estimated that River Hill would produce $10,000,000 in coal sales and would yield a net income of $2,933,200 during the fiscal year ending March 31, 1980.

In September 1979, each investor received a newsletter from Goldberg, in his capacity as president of River Hill Corp., advising them that due to recent Environment Protection Agency regulations, he did not expect a market to develop for River Hill's high sulphur coal for about 12 to 18 months. He noted that if the market remained "soft" in 1980, they might be provided additional property with superior reserves. Other newsletters dated March 1980 and October 1980 informed them of actions being taken to promote the sale of coal. None of the newsletters made any mention of the actual commencement of mining or, for that matter, gave any indication that preparation for mining had begun.

Upon receiving the newsletters, each investor contacted Percuoco to obtain his view on the information contained therein. Each time Percuoco corroborated the information and assured the investors that action was being taken to end the delay. In August 1980, investor Katz, on his own behalf and that of General Builders, met with Goldberg to inquire about the status of the investment. Goldberg told him that the market for coal was improving and that River Hill was considering the possibility of a cleaning plant to reduce the sulphur content of the coal. In August 1981, two other investors, in an attempt to secure additional information, wrote a letter to the law firm then representing Goldberg in the formation of coal mining ventures.

The investors allege that they were not alerted to the possibility of fraud until the fall or winter of 1981 when an article appeared in the Boston Globe reporting Goldberg's suspension from doing business in West Virginia and of an investigation of Percuoco's dealings by the Massachusetts division of securities for possible violations of the securities laws.

In December 1981, each investor was notified by the Internal Revenue Service that it was disallowing the income tax deductions taken in relation to the River Hill investments.

It was not until November 15, 1983 that the investors filed this action seeking to recover damages for violation of Sections 10(b) and 20(a) of the Securities Exchange Act of 1934 and Rule 10b-5 of the Securities and Exchange Commission, and for common law fraud and legal malpractice. ² It was their contention that River Hill never mined coal and never intended to do so, and that the accountants and law firm conspired with Goldberg and River Hill to defraud them. A first amended complaint filed shortly thereafter added an additional plaintiff.

On March 1, 1984, the district court heard oral arguments on defendants' motion to dismiss for failure to plead fraud with particularity and for failure to state a claim upon which relief could be granted pursuant to Fed.R.Civ.P. 9(b) and 12(b)(6). In response to the defendants' allegation that the investors' suit was time-barred, the court expressed serious doubt as to whether the complaint alleged sufficient facts to justify application of the doctrine of equitable tolling. The court specifically directed the investors' counsel to "amend to get your strongest facts in. Don't wait until the court rules against you on this point." The court repeatedly expressed concern about the plaintiffs' failure to state what positive action they took to learn what was happening and in what manner they were blocked from finding out.

In response to the court's directive, the investors filed a second amended complaint. The defendants renewed their motions to dismiss, asserting that this new complaint did not cure the defects of the earlier one.

On June 21, 1984, the court found that the revised complaint sufficiently informed the defendants of the claims against them. The court indicated, however, that a question remained concerning compliance with the statute of limitations. On this issue the court concluded that the statute began to run prior to receipt by the investors of their deduction disallowance notices from the IRS. Because the parties had referred to matters outside the pleading the court treated the motions as motions for summary judgment. It specifically found that the investors had not alleged acts of due diligence regarding their inquiry into the status of their investment. The court concluded that a question to be determined was whether the plaintiffs had received sufficient "storm warnings" of possible fraud before November 15, 1980, the date from which the three year statute of limitations would run, ³ thereby placing them on notice to inquire further and triggering a duty to exercise due diligence. If such were the case, their action would be time-barred and summary judgment for defendants would be ordered.

Following a period of discovery on this issue, and the filing of additional documents and motions with the court, a hearing was held. In granting the motion, the court found that the plaintiffs had invested for the purpose of mining coal, and not as tax shelters. It characterized as "thunderstorm warnings" the fact that "there was no coal in prospect previous to November of 1980, certainly during 1979, from the reports that they were receiving indicating that expenses that would have to be incurred previous to commencing the mining had not been paid." In its order on plaintiffs' motion to amend the findings of fact, to alter or amend judgment and for reconsideration, the court reversed its finding on the motive for investing, but stated that, nonetheless, even if the investment was made solely as a tax shelter, plaintiffs were still placed on inquiry notice for the reasons stated by the court in its prior order. That is, even if the purpose in making this investment was solely as a tax shelter, they would be...