Landy v. Mitchell Petroleum Technology Corp.
| Decision Date | 05 April 1990 |
| Docket Number | No. 88 Civ. 2932 (PKL).,88 Civ. 2932 (PKL). |
| Citation | 734 F. Supp. 608 |
| Parties | Thomas M. LANDY, et al., Plaintiffs, v. MITCHELL PETROLEUM TECHNOLOGY CORPORATION; Worldco Services Group, Inc.; Herman Finesod; Petro-Tech Limited Partnership I; Petro-Tech Limited Partnership II; Petro-Tech Limited Partnership III; Petro-Tech Limited Partnership IV; Petro-Tech Limited Partnership V; Ray Wilson; Aquanetics, Inc.; Robert Haig Hachadoorian; CNA Investor Services, Inc.; Friedman & Shaftan, P.C.; Wilfred T. Friedman; Marcia Shaftan, as executrix of the estate of Robert P. Shaftan; Michael E. Greene; Heller, White & Company; and World Information Systems, Defendants. |
| Court | U.S. District Court — Southern District of New York |
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Beigel & Sandler, New York City, for plaintiffs.
Gold, Wachtel & Miller, New York City (Elliot Silverman, of counsel), for defendants Mitchell Petroleum, Worldco Services, Herman Finesod, Petro-Tech Ltd. Partnerships I-V, Aquanetics and Robert Haig Hachadoorian.
Shea & Gould, New York City (Adam B. Gilbert and Karim G. Lynn, of counsel), for defendants Friedman & Shaftan, Wilfred T. Friedman, Michael E. Greene and Marcia S. Shaftan.
Ferber Greilsheimer Chan & Essner, New York City (Robert N. Chan and Robert M. Kaplan, of counsel), for defendant CNA Investor Services.
Abady & Jaffe, New York City (Samuel A. Abady and Matthew G. Dineen, of counsel), for defendant World Information Systems.
This is a securities fraud action brought pursuant to §§ 10(b) and 20(a) of the Securities Exchange Act of 1934, 15 U.S.C. §§ 78j(b) and 78t(a), § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a), the Racketeer Influenced and Corrupt Organizations Act ("RICO"), 18 U.S.C. § 1961 et seq., and common law principles. Defendants1 have moved on various grounds to dismiss the claims against them.
In late 1983, plaintiffs,2 citizens of fourteen different states,3 invested in four limited partnerships, known as Petro-Tech Limited Partnership I, Petro-Tech Limited Partnership II, Petro-Tech Limited Partnership III, and Petro-Tech Limited Partnership V ("the partnerships"). The investments ranged from $15,000 to $100,000. Each of the partnerships was essentially identical. The purpose of the partnerships was to market a product designed to recycle and reclaim used lubricating oils. Each of the five partnerships was assigned an exclusive territory in which to market the product.
Since the early years of this century, industry has attempted to reclaim used lubricating oils. By removing impurities, including air, gases, and particulates, that accumulate during the lubricating process, the original lubricating properties of the oil can be restored and the oil can be reused. In 1977, defendant Robert Haig Hachadoorian ("Hachadoorian") received a patent for a new oil reclamation process. The process was developed through the auspices of defendant Aquanetics, Inc. ("Aquanetics"), a New York corporation, of which Hachadoorian was president. From 1978 to 1983, when the offerings of the partnerships were prepared, Aquanetics managed to sell only 40 of its oil reclamation systems. Nonetheless, in 1981, defendant Mitchell Petroleum Technology Corporation ("Mitchell") signed an agreement with Aquanetics whereby Mitchell was granted a five year exclusive right to market Aquanetics' products in the United States. The agreement further provided that Mitchell had non-exclusive marketing rights for an additional 20 years after the initial five year period.
Upon signing its agreement with Aquanetics, Mitchell then subdivided its licensing rights geographically, and marketed those rights through partnerships which would be given marketing sublicensing rights for a fee. Mitchell acted as the promoter of the partnerships. Defendant Worldco Service Group ("Worldco") was a broker of interests in the partnerships. Defendant Herman Finesod ("Finesod") was a principal in both Mitchell and Worldco. Defendant Ray Wilson ("Wilson") was allegedly a general partner of the partnerships.4 Defendant Friedman & Shaftan is a New York City law firm that prepared legal opinions, including tax opinions, which appeared in the offering memoranda of the partnerships. Defendants Wilfred T. Friedman and Michael Greene are members of that law firm, and defendant Marcia Shaftan represents the estate of Robert Shaftan, a deceased member of the firm. Defendant Heller & White, apparently a market research firm, prepared a report on the current state of and potential for the oil reclamation industry, and defendant World Information Systems ("WIS") prepared a report on the market potential of the Aquanetics product. Defendant CNA Investor Services ("CNA"), a financial services and brokerage firm, sold units in the partnerships to certain of the plaintiffs.
The purpose of the partnerships is described in detail in the offering memoranda. Each partnership received from Mitchell a sublicense which permitted the partnership to market Aquanetics' product in a specified geographic region. For that right, each partnership was to pay Mitchell a fee far greater than the license fee Mitchell was paying to Aquanetics. Potential investors were repeatedly warned in the offering memoranda that investment in the partnerships was risky, and that the potential for profit was speculative. Indeed, each offering memorandum included on its first page a notice in bold type and all capital letters, set off from the rest of the print on the page by spaces and lines which stated, "These securities involve a high degree of risk (See `Risk Factors')". The body of each offering memorandum contained approximately five pages under the heading "Risk Factors," outlining management risks, transactional risks and tax risks, among others. Further, the offering memoranda indicated that potential investors in the partnership should have a liquid net worth of at least $250,000, and annual income placing the individual in the Federal income tax bracket then taxed at a 49% marginal rate.
It appears from the offering memoranda that the focus of the partnerships was the potential tax advantages that could be reaped from the probable losses to be suffered during at least the first few years of the partnerships. A significant portion of each offering memorandum was dedicated to the potential tax advantages for an investor. Each memorandum included an extensive tax analysis and opinion prepared by defendant Friedman & Shaftan. The analysis opined that it was likely that investors, who would become limited partners, would be able to deduct a portion of the partnership losses for income tax purposes. Further, the second page of the offering memoranda trumpeted the potential tax consequences for an investor, estimating that tax deductions could reach 400% of initial cash investments.
However, the offering memoranda also were explicit in warning potential investors that the potential tax benefits of the partnerships could not be guaranteed. On the fourth page of each memorandum, investors were warned, "THERE IS ALSO A SUBSTANTIAL RISK THAT THE INTERNAL REVENUE SERVICE WILL SEEK TO SET ASIDE ALL OR A PORTION OF THE DEDUCTIONS CLAIMED BY THE PARTNERS...." This warning was repeated in detail under the heading "Risk Factors," and also in the tax opinion letter prepared by Friedman & Shaftan. Despite this focus on tax losses, the offerings did not state that the partnerships were without profit potential. While the offerings do not indicate great optimism about future profits, it could be implied from the offerings that the promoters expected that profit might be realized, despite the risks.
Irrespective of the explicit references to risk in the offering memoranda, plaintiffs in this action invested in these partnerships. Each investor signed a subscription agreement, describing the obligations of the investor, and certifying that said investor had received and reviewed carefully the offering memorandum, the partnership agreement, and the subscription agreement. The investor further certified by signature that he or she had sufficient financial acumen to understand the offering memorandum and partnership agreement, understood that the investment had a high degree of risk, and understood that the potential tax advantages of the partnership might be disallowed by the Internal Revenue Service.
In July 1986, three years after the formation of the partnerships, the eventuality occurred about which the investors had been forewarned: the Internal Revenue Service disallowed all income tax deductions arising from participation in the partnerships. Eighteen months after the tax disallowance, plaintiffs filed the instant action. Plaintiffs allege that defendants acted individually and in concert to defraud investors, by intentionally misrepresenting the value of the partnerships. In particular, they allege that defendants represented that the partnerships had profit potential when defendants knew or should have known that in fact there was absolutely no possibility of the partnerships ever showing a profit. The gravamen of plaintiffs' amended complaint is that defendants Mitchell, Finesod, Aquanetics, Hachadoorian and the partnerships conspired "to organize limited partnerships involving the sublicense of the Aquanetics system which was grossly overvalued, so that significant tax benefits and profits could be promised to investors." Amended Complaint ¶ 10. The other defendants, who supplied supporting data for the offering memoranda or marketed the partnerships, allegedly knew or should have known of the promoters' intent.
All defendants, except Heller, White, have now come before the Court seeking various forms of relief from the Court. All represented defendants have moved for dismissal of the fraud claims in the amended complaint pursuant to Fed.R.Civ.P. 9(b); for dismissal of claims under § 17(a) of the Securities Act of 1933, under §...
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