Lama Holding Co. v. Smith Barney Inc.

Citation88 N.Y.2d 413,668 N.E.2d 1370,646 N.Y.S.2d 76
Parties, 668 N.E.2d 1370 LAMA HOLDING COMPANY et al., Appellants, v. SMITH BARNEY INC. et al., Respondents.
Decision Date13 June 1996
CourtNew York Court of Appeals
OPINION OF THE COURT

SMITH, Judge.

This action arises out of the sale by defendant Smith Barney Inc. of all of its stock in a merger with Primerica Corporation. The primary issue here is whether the complaint states any cause of action entitling plaintiffs to recover a $33 million tax liability or any other relief. Because we agree that the complaint fails to state any cause of action, we affirm the order of the Appellate Division dismissing the complaint in its entirety.

In 1987, defendant Smith Barney and Primerica merged, with Primerica acquiring all of the shares of Smith Barney. At the time of the merger, plaintiff Lama Holding Company owned approximately 24.9% of the shares of Smith Barney. Lama was at all times the largest single shareholder of Smith Barney. The stock purchased by Lama was designated "Rana Common Stock." Lama, incorporated under the laws of Delaware, was formed expressly to acquire and hold stock in Smith Barney for resale at a profit. Lama had purchased its interest in Smith Barney in 1982, for approximately $40 million, through a tritiered corporate structure. Lama was owned by two foreign entities, with 66.6% owned by Rana Investments Ltd., a British Virgin Islands corporation, and 33.3% owned by Rasha Investments, N.V., a Netherlands Antilles corporation. Rana owned 100% of Rasha, and both were part of a Middle Eastern investment group. The acquisition of Smith Barney stock by Lama was part of a complex structure created to take advantage of favorable United States tax treatment under the "General Utilities Doctrine," pursuant to which a domestic corporation could sell its assets under certain circumstances without incurring tax liability.

When Lama purchased the Smith Barney stock in 1982, it entered into a shareholders' agreement (the June 1982 agreement) whereby it agreed not to sell its Smith Barney stock for four years. Under the 1982 agreement, Lama was granted the right of first refusal on any merger, and Smith Barney's right to sell the remainder of its shares was limited. Lama decided to sell some or all of its Smith Barney stock in 1986 and, in September 1986, retained Bankers Trust Company as its financial advisor and sales representative. Plaintiffs, however, were unsuccessful in their attempt to sell any of their shares. Plaintiffs maintain that by various unlawful means, Smith Barney affirmatively tried to block, frustrate and hinder the sale of Lama's Smith Barney stock.

During 1986 and 1987 Smith Barney negotiated a merger with Primerica and, by May 1987, negotiations were apparently in their final stages. On May 19, 1987, Smith Barney's chairman and president (the individual defendants) held a meeting in London (the May 19, 1987 meeting) with representatives of Lama. Lama was informed that Smith Barney had secured a merger partner who was prepared to purchase all of Smith Barney's stock; that virtually all of the other Smith Barney shareholders were expected to vote in favor of the merger and such majority would insure consummation of the merger without the support of Lama; and that because of considerations of time and secrecy Lama would have to decide immediately (without the benefit of financial or legal counsel) whether it would vote its shares in favor of the merger. Lama's representatives were additionally informed that if Lama chose not to vote in favor of the merger, it would be left in an unfavorable position as a minority shareholder in a reconstituted Smith Barney. Lama, thereafter, executed a one-page agreement to vote its shares in favor of the merger and waived its right of first refusal.

Lama contends that its consent to the merger was fraudulently induced. Specifically, Lama maintains that at the May 19, 1987 meeting, defendants failed to disclose that the merger partner was Primerica, Primerica would or could withdraw from the merger if 5% of the holders of Smith Barney common stock did not approve the transaction, Smith Barney did not reveal the terms of the proxy statement which contained important tax information, and Smith Barney failed to advise Lama of the potential tax consequences of the sale of Lama's Smith Barney stock.

After executing the May 19, 1987 agreement, Lama learned that the General Utilities Doctrine had been repealed by the Tax Reform Act of 1986 and, as a result, the sale of its Smith Barney shares would constitute a taxable event. With knowledge of the likely substantial tax consequences of the merger, Lama sought to restructure Primerica's acquisition of Smith Barney's stock by having Primerica purchase Lama directly from Rana and Rasha which potentially eliminated Lama's tax liability. Primerica refused, and the Smith Barney-Primerica merger closed in June 1987. As a result of the merger, Lama received over $163 million for its Smith Barney stock (a profit of approximately $90 million) and was subject to United States tax liability of over $33 million.

Lama commenced an action in Federal court against its financial advisor Bankers Trust, its legal advisor Shearman & Sterling, and the defendants herein (Lama Holding Co. v. Shearman & Sterling, 758 F.Supp. 159). The Federal securities claims against the defendants were dismissed for failure to state claims, and the pendent State claims were not retained. Plaintiffs then brought this action in State court, alleging fraud and misrepresentation, breach of fiduciary duty, negligent misrepresentation, tortious interference with contract and advantageous business relations, and breach of contract. Among other things, plaintiffs seek a judgment in the amount of $33 million, the tax liability, a "sum to be determined at trial, for Plaintiffs' reasonably anticipated net financial gain from the disposition of The Smith Barney Investment to a third party purchaser, plus prejudgment interest," and punitive damages.

Supreme Court dismissed with prejudice plaintiffs' fraud, misrepresentation and tortious interference claims in their entirety and dismissed the breach of fiduciary duty cause of action as asserted on behalf of Rana and Rasha. The court also dismissed the breach of contract claims asserted by Rasha on standing grounds.

The Appellate Division modified and granted defendants' motion to dismiss the complaint in its entirety, holding that (1) plaintiffs could "not recover damages in fraud or negligent misrepresentation since damages under those theories are limited to indemnity for actual pecuniary loss, and do not include the greater profit that could have been made but for the false representations," (2) the claims for tortious interference with contract and prospective contract failed because no interference with contract occurred and the prospect of a contract was too speculative and, (3) assuming the truth of the allegations of breach of a fiduciary duty and breach of a contract based upon the shareholders' agreement, plaintiffs received large profits from the sale of Smith Barney stock and the claim for additional damages was speculative (215 A.D.2d 314, 315, 627 N.Y.S.2d 33). This Court granted leave to appeal and we now affirm.

Fraud and Negligent Misrepresentation

Counts one and three allege fraud and negligent misrepresentation. Specifically, plaintiffs argue that defendants misled Lama's representatives at the May 19, 1987 meeting, thereby inducing their vote for the Smith Barney-Primerica merger. They claim as damages the amount of taxes they are required to pay. The issue is whether such consequential damages support the cause of action.

In an action to recover damages for fraud, the plaintiff must prove a misrepresentation or a material omission of fact which was false and known to be false by defendant, made for the purpose of inducing the other party to rely upon it, justifiable reliance of the other party on the misrepresentation or material omission, and injury (see, Channel Master Corp. v. Aluminium Ltd. Sales, 4 N.Y.2d 403, 176 N.Y.S.2d 259, 151 N.E.2d 833; New York Univ. v. Continental Ins. Co., 87 N.Y.2d 308, 318, 639 N.Y.S.2d 283, 662 N.E.2d 763). "The true measure of damage is indemnity for the actual pecuniary loss sustained as the direct result of the wrong" or what is known as the "out-of-pocket" rule (Reno v. Bull, 226 N.Y. 546, 553, 124 N.E. 144; Hanlon v. Macfadden Publ., 302 N.Y. 502, 99 N.E.2d 546). Under this rule, the loss is computed by ascertaining the "difference between the value of the bargain which a plaintiff was induced by fraud to make and the amount or value of the consideration exacted as the price of the bargain" (Sager v. Friedman, 270 N.Y. 472, 481, 1 N.E.2d 971). Damages are to be calculated to compensate plaintiffs for what they lost because of the fraud, not to compensate them for what they might have gained (see, Cayuga Harvester v. Allis-Chalmers Corp., 95 A.D.2d 5, 465 N.Y.S.2d 606). Under the out-of-pocket rule, there can be no recovery of profits which would have been realized in the absence of fraud (Foster v. Di Paolo, 236 N.Y. 132, 140 N.E. 220; AFA Protective Sys. v. American Tel. & Tel. Co., 57 N.Y.2d 912, 456 N.Y.S.2d 757, 442 N.E.2d...

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