Gwozdzinsky On Behalf of Revco v. Zell/Chilmark, 95 CIV. 10563(JES).

• Decision Date: 17 October 1997
• Docket Number: No. 95 CIV. 10563(JES).,95 CIV. 10563(JES).
• Citation: 979 F.Supp. 263
• Parties: Margaret GWOZDZINSKY, Derivatively on Behalf of REVCO D.S., INC., Plaintiff, v. ZELL/CHILMARK FUND, L.P. and Revco D.S., Inc., Defendants.
• Court: U.S. District Court — Southern District of New York

979 F.Supp. 263

Margaret GWOZDZINSKY, Derivatively on Behalf of REVCO D.S., INC., Plaintiff, v. ZELL/CHILMARK FUND, L.P. and Revco D.S., Inc., Defendants.

No. 95 CIV. 10563(JES).

United States District Court, S.D. New York.

October 17, 1997.

Ostrager, Chong & Flaherty, P.C., New York, NY (Glenn F. Ostrager, of counsel), Bragar & Wexler, P.C., New York, NY (Paul D. Wexler, of counsel), for Plaintiff.

Seyfarth, Shaw, Fairweather & Geraldson, New York, NY (John C. Sabetta, of counsel), Seyfarth, Shaw, Fairweather & Geraldson, Chicago, IL (Alan L. Unikel, James M. Wyman, of counsel), for Defendant.

MEMORANDUM OPINION AND ORDER

SPRIZZO, District Judge.

Plaintiff Margaret Gwozdzinsky ("Gwozdzinsky") brings this derivative action against defendant Zell/Chilmark Fund L.P. ("Zell/Chilmark"), alleging that Zell/Chilmark, as an "insider" of Revco D.S., Inc. ("Revco"), violated Section 16(b) of the Securities Exchange Act of 1934 (the "Exchange Act") by writing short put options or call equivalent positions under two standby purchase agreements, thereby resulting in shortswing profits in the form of standby purchase fees.

Pursuant to Federal Rule of Civil Procedure 56, Zell/Chilmark moves for summary judgment on the grounds that Gwozdzinsky has failed to state a cause of action under Section 16(b) of the Exchange Act and that her claim with respect to the first standby purchase agreement is time-barred by the applicable statute of limitations. Gwozdzinsky cross-moves for summary judgment. For the reasons set forth below, Zell/Chilmark's motion for summary judgment is granted and Gwozdzinsky's cross-motion for summary judgment is denied.

BACKGROUND

Revco, one of the largest drug retail chains in the United States, is a Delaware corporation with its principal place of business in Ohio. See Complaint ¶ 2; Defendant's Southern District of New York Civil Rule 3(g) Statement of Undisputed Facts ("Def.'s 3G Statement") ¶ 1. Revco stock trades on the New York Stock Exchange. See Defendant's Memorandum in Support of Motion for Summary Judgment ("Def.'s Memo") at 2. Gwozdzinsky is a Pennsylvania resident who owns Revco stock. See Plaintiff's Memorandum of Law in Opposition to Motion for Summary Judgment and in Support of Cross-Motion for Summary Judgment ("Pl.'s Memo") at 4. Zell/Chilmark is an investment fund that owns roughly twenty percent of Revco's outstanding common stock and is controlled by Samuel Zell ("Zell") and David Schulte ("Schulte"). Id. at 3. At all relevant times, both Zell and Schulte were members of Revco's Board of Directors and Zell was Co-Chairman of Revco's Executive Committee. Id. at 3-4.

On June 1, 1992, Revco emerged from bankruptcy under a plan of reorganization (the "Plan"). See Def.'s 3G Statement ¶ 5. Part of the Plan required Revco to issue an aggregate of $433.2 million in debt securities with interest rates of eleven percent or higher. Id. ¶ 6. Revco adopted a recapitalization plan which included raising $110 million in equity through the sale of 13,750,686 shares of common stock in a pro rata rights offering to shareholders of record on December 28, 1992 (the "1992 Rights Offering").¹ Id. ¶¶ 8, 10, 12. Under the 1992 Rights Offering, a shareholder would receive 0.384 rights for each share of common stock owned. Id. ¶ 12. One full right entitled a shareholder to buy one share of the available 13,750,686 shares of common stock for $8.00 per share, thus raising a total of $110,005,488 in equity. Id. In addition, an oversubscription privilege was available to each shareholder who exercised all of his accumulated rights. Id. ¶ 13. This privilege enabled the shareholder to purchase at $8.00 per share any shares remaining unissued, up to the number of shares that the shareholder initially purchased under his accumulated rights. Id.

On December 15, 1992, to ensure that this $110 million in equity would be raised, Revco entered into a Standby Purchase Agreement (the "1992 Standby Purchase Agreement") with Zell/Chilmark and Magten Asset Management, Inc. ("Magten").² See Def.'s 3G Statement ¶ 11. The latter parties agreed that they would (a) exercise all of the rights distributed to them under the 1992 Rights Offering and (b) purchase, at $8.00 per share, any shares that remained unsold, up to an aggregate cost of $150 million. Id. ¶ 14. As compensation for assuming this obligation, Zell/Chilmark and Magten received a standby purchase fee of $1,452,448, of which Zell/Chilmark received $841,265. Id. ¶ 15.

In January 1993, Zell/Chilmark exercised its rights as a Revco shareholder under the 1992 Rights Offering. See Def.'s 3G Statement ¶ 17. Zell/Chilmark purchased 2,706,558 shares of common stock pursuant to its accumulated rights, and 134,982 shares pursuant to the oversubscription privilege. Id. That same month, Zell/Chilmark purchased an additional 517 shares of Revco common stock pursuant to its obligations under the 1992 Standby Purchase Agreement. Id. ¶ 18. In accordance with Section 16(a) of the Exchange Act, see 15 U.S.C. § 78p(a) (1995), Zell/Chilmark disclosed these purchases to the Securities Exchange Commission ("SEC") in its 1993 Form 4 filing. See id. ¶ 19.

In September 1993, after other Revco shareholders had failed "to complete the exercise of their rights" under the 1992 Rights Offering, see Def.'s 3G Statement ¶ 20, Exh. 7 at 3, Zell/Chilmark purchased an additional 17,153 shares of Revco common stock pursuant to the oversubscription privilege, and an additional 12,912 shares pursuant to its obligations under the 1992 Standby Purchase Agreement. Id. ¶ 20. Zell/Chilmark also disclosed these purchases to the SEC in its 1993 Form 4 filing. Id. ¶ 21.

In 1994, Revco effected a second pro rata rights offering (the "1994 Rights Offering") in order to finance its proposed acquisition of another retail drug chain. See Def.'s 3G Statement ¶ 24. While the structure of the 1994 Rights Offering was similar to the one in 1992, Revco's common stock had appreciated considerably since 1992.³ Id. ¶¶ 25-26. For each share of common stock owned, a shareholder would receive 0.305 rights. Id. ¶ 27. Each full right entitled a shareholder to buy one share of the 15,500,000 shares of common stock offered pursuant to the 1994 Rights Offering at a price of $14.00 per share, for a total of $217 million in equity. Id. ¶¶ 25, 27. As with the 1992 Rights Offering, an oversubscription privilege was available to each shareholder who had exercised all rights available under the 1994 Rights Offering. Id. ¶ 28.

On June 8, 1994, Revco entered into a Standby Purchase Agreement with Zell/Chilmark to ensure that this equity would be raised (the "1994 Standby Purchase Agreement"). See Def.'s 3G Statement ¶¶ 29, 32. Zell/Chilmark agreed that it would (a) exercise all of the rights distributed to it under the 1994 Rights Offering, including those offered under the oversubscription privilege, and (b) purchase any shares that remained unsold. Id. ¶ 30. As compensation for assuming this obligation, Zell/Chilmark received a standby purchase fee of $2,839,058 pursuant to the terms of the 1994 Standby Purchase Agreement. Id. ¶ 31.

On July 7, 1994, Zell/Chilmark exercised its rights under the 1994 Rights Offering and purchased 3,025,738 shares of Revco common stock under its accumulated rights and 153,511 shares pursuant to its oversubscription privilege at a price of $14.00 per share. See Def.'s 3G Statement ¶ 34. In addition, Zell/Chilmark purchased 2,589 shares in accordance with its obligations under the 1994 Standby Purchase Agreement. Id. ¶ 35. Zell/Chilmark disclosed these purchases to the SEC in a Form 4 filing on July 27, 1994, and in an amendment to that filing on January 9, 1995. Id. ¶ 37. To date, Zell/Chilmark has not sold any of the stock that it purchased pursuant to its obligations under the 1992 and 1994 Standby Purchase Agreements. Id. ¶¶ 23, 38; see also Def.'s Memo at 14-15.

Gwozdzinsky brings this derivative action, asserting, inter alia, that Zell/Chilmark, as an "insider" of Revco, violated Section 16(b) of the Exchange Act and realized short-swing profits when it entered into the 1992 and 1994 Standby Purchase Agreements and received standby purchase fees. See Pl.'s Memo. at 2. Gwozdzinsky alleges that Zell/Chilmark's purchase obligations under the standby purchase agreements were derivative securities, specifically "call equivalent position[s]⁴," that fall within the scope of Section 16(b). See Complaint ¶¶ 11, 19. Pursuant to Rule 16b-6(d),⁵ see 17 C.F.R. § 240.16b-6(d), Gwozdzinsky therefore seeks the return of the 1992 and 1994 standby purchase fees to Revco. Id. ¶¶ 11, 19.

In the alternative, Gwozdzinsky argues that the transactions at issue here had the potential for speculative abuse and thus are within the scope of those evils which Congress sought to prevent through Section 16(b). See Pl.'s Memo at 20-22. Gwozdzinsky contends that since both the 1992 and 1994 Rights Offerings were planned and administered while Zell and Schulte, Zell/Chilmark's controlling partners, were members of Revco's Board of Directors (the "Board"), while Zell was Co-Chairman of the Board's Executive Committee, and while Zell/Chilmark owned approximately 20% of Revco's common stock, these insiders were able to manipulate the terms of the 1992 and 1994 Rights Offerings using inside information for their own benefit at the expense of the public. Id. at 21.

Pursuant to Federal Rule of Civil Procedure 56(b), Zell/Chilmark moves for summary judgment on four grounds: first, that the challenged transactions were proper business transactions which neither established "options" nor violated Section 16(b), see Def.'s Memo at 9, 11-12; second, that even if these transactions can be considered "options," there could be no "short-swing" profits because Zell/Chilmark engaged in purchases only, and not sales, id. at 9, 14-16; third, that these options did not expire but were in fact exercised by Revco and performed when...