Marsh v. Armada Corp.

• Decision Date: 07 May 1976
• Docket Number: No. 75-1885,75-1885
• Citation: 533 F.2d 978
• Parties: Fed. Sec. L. Rep. P 95,496 Charles E. MARSH, and Detroit Bank and Trust Company as co-trustees under the Trust of Albert and Minnie Marsh, and James S. Rothschild, Plaintiffs-Appellants, v. ARMADA CORPORATION et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Sixth Circuit

Page 978

533 F.2d 978

Fed. Sec. L. Rep. P 95,496

Charles E. MARSH, and Detroit Bank and Trust Company as co-trustees under the Trust of Albert and Minnie Marsh, and James S. Rothschild Plaintiffs-Appellants, v. ARMADA CORPORATION et al., Defendants-Appellees.

No. 75-1885.

United States Court of Appeals Sixth Circuit.

Argued Dec. 17, 1975.

Decided April 5, 1976.

Rehearing Denied May 7, 1976.

Frank B. Vecchio, Milmet, Vecchio, Kennedy & Carnago, Detroit, Mich., for Marsh.

Kreindler & Kreindler, Howard Silver, Ronald Litowitz, New York City, Sommers, Schwartz, Silver, Swartz, Tyler & Gordon, Southfield, Mich., for Rothschild.

David E. Cary, D. Michael Kratchman, Evans & Luptak, Detroit, Mich., for defendants-appellees.

Before WEICK and LIVELY, Circuit Judges, and MARKEY, ^* Chief Judge, United States Court of Customs and Patent Appeals.

WEICK, Circuit Judge.

This action is one of an increasing number of lawsuits in which minority shareholders, dissatisfied with the merger terms under which their stock is to be converted into cash or stock of the controlling corporation, seek a federal remedy by alleging violations of Section 10(b) of the Securities Act of 1934 (hereinafter Exchange Act) and Rule 10b-5 promulgated thereunder. ¹

A common feature in this type of lawsuit is what is in reality a state law claim for unfairness or breach of fiduciary duty on the part of corporate officers and directors. Also common to this type of lawsuit is an alleged Rule 10b-5 claim which requires the court to explore the frontiers of statutory interpretation in order to ascertain whether federal question jurisdiction exists. Thus in dealing with the issues raised here we are not faced with the question whether the defendants' alleged wrongs call for a remedy, but only whether plaintiffs should have access to the federal courts as well as the state courts to seek the remedy.

In 1973 Armada Corporation made a written tender offer for shares of Hoskins Manufacturing Company, in which Armada sought to acquire up to 51% of the outstanding shares of Hoskins, and offered to pay therefor $20 per share. The market price of Hoskins shares at that time was $15 to $15.75 on the American and Detroit Stock Exchanges. Hoskins had paid regular quarterly dividends to its shareholders for forty years prior to the tender offer. The tender offer stated that Armada intended to merge Hoskins into Armada if Armada could gain control of Hoskins, and that Armada contemplated eliminating the dividend paid to Hoskins shareholders.

During the course of the tender offer Armada sent a letter to Hoskins shareholders The Hoskins management wants you to believe that the tender offer will fail, yet their attorneys have argued in court for days that the Hoskins shareholders have the choice of tendering their shares now for $20 a share or take Armada stock. This is an admission that Armada will succeed; and they are right, we will win.

which repeated the offer and then made the following statements:

If Armada acquires control of Hoskins, as stated in the tender offer, we will attempt to merge; and if we merge, we believe that those Hoskins shareholders who retain their shares will be satisfied with the merger, even if we should reduce or eliminate dividends and utilize the liquid resources for expansion and acquisitions, as stated in the tender offer.

THE CHOICE IS YOURS TENDER YOUR SHARES NOW FOR $20 A SHARE OR HOLD AND SEE WHAT HAPPENS.

The tender offer was successful; Armada purchased 53% of the outstanding Hoskins stock. In August, 1973 Armada elected six of the nine-man Hoskins Board of Directors. In September the board voted to eliminate Hoskins' quarterly dividend, and announced that dividends would not be paid in the future. In December the companies announced a proposed merger agreement in which Hoskins shareholders would receive 1.27 Armada shares for each share of Hoskins.

The market value of Hoskins and Armada shares had declined since the tender offer. In December Armada shares had a market value of $7.25 and Hoskins shares about $9.25. Thus Hoskins shareholders were to receive about $9.25 worth of Armada stock for each Hoskins share. In June, 1974 the merger was approved; under the laws of Michigan only a majority of shares need approve a merger, and no appraisal rights existed in this case.

This class action was filed in the Eastern District of Michigan by several Hoskins shareholders in May, 1974 on behalf of all persons holding Hoskins shares continuously from the commencement of the tender offer through the announcement of the proposed merger terms.

The complaint contained three counts, seeking only damages: first, allegations that Armada had violated Rule 10b-5; second, allegations that the directors of Hoskins had breached their fiduciary duty to the shareholders; and third, allegations that the merger terms were unfair and oppressive. The last two counts were state law claims which the District Court declined to consider.

The District Court dismissed the action under Fed.R.Civ.P. 12(b)(1) for failure to state a federal question, holding that federal interest in a tender offer or merger transaction under § 10(b) of the Exchange Act ceases when it becomes apparent that the parties were fully informed of all material facts prior to the transaction, applying the rationale of Popkin v. Bishop, 464 F.2d 714 (2d Cir. 1972).

In an earlier phase of the case Hoskins sought to enjoin the merger but the District Court did not grant such relief. The validity of the merger is not in issue here.

In this appeal Hoskins shareholders argue that the expansive definition of fraudulent activities used by the courts in Rule 10b-5 cases includes conduct of the type encountered here. Specifically, they contend that Armada employed a fraudulent scheme to take control of Hoskins and then to drive down the value of Hoskins stock by omitting dividends so that Hoskins could be merged into Armada more cheaply.

The three acts within this scheme which the shareholders believe to be fraudulent are: 1) the statement in the letter during the tender offer that Hoskins shareholders will be satisfied with the merger terms; 2) the elimination of the dividend to lower the market value of Hoskins shares so that the merger could be accomplished with fewer Armada shares; and 3) the failure to state in the merger proxy statement that Hoskins expected to earn more in 1974 than it earned in 1973.

It will be necessary to examine each of these factors to determine whether this conduct

is proscribed by Rule 10b-5. First, however, the question of standing must be considered.

I STANDING

Armada claims that the complaint must be dismissed because the shareholders did not allege that they purchased or sold shares. Thus they have no standing to sue under Rule 10b-5 which prohibits fraud only in connection with the purchase or sale of a security. The Birnbaum rule, ² recently approved in Blue Chip Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), holds that a plaintiff in a Rule 10b-5 case has standing to sue only if a fraudulent activity caused him to buy or to sell stock. A person who claims that a fraudulent activity caused him to not buy stock which he otherwise would have bought, or to not sell stock which he otherwise would have sold, has no standing to sue under Rule 10b-5.

The basis of the rule is a policy determination that to permit suits by persons who claim inaction in reliance on fraudulent claims would open the door to vexatious and meritless lawsuits by persons who never owned stock but who comb the financial pages for possible inaccuracies which could support colorable claims with significant settlement value. Furthermore, the proof in such a lawsuit would consist of the plaintiff's unsupported testimony that he intended to purchase or sell a certain stock but that he did not do so after reading a certain report. In requiring a purchase or sale to occur, the Birnbaum rule seeks to support a claim of reliance by the fact that the plaintiff purchased or sold stock soon after an allegedly fraudulent act occurred.

The shareholders claim that the statement contained in the letter, ". . . we believe that those Hoskins shareholders who retain their shares will be satisfied with the merger . . ." caused them to retain their shares, to their loss, rather than sell or tender the shares to Armada, and that the statement was false and fraudulent. The shareholders have no standing to sue on this basis. This is the precise type of claim which the Birnbaum rule was intended to prevent, i. e., the "reliance by inaction" claim.

The shareholders further claim that Armada fraudulently caused the value of the stock to drop; the question of standing to sue on this claim is more difficult. The exchange of shares in the merger certainly qualifies as a purchase or sale under the Birnbaum rule; SEC v. National Sec., Inc., 393 U.S. 453, 467, 89 S.Ct. 564, 572, 21 L.Ed.2d 668, 680 (1969). Armada argues that the shareholders failed to allege that they sold or exchanged their stock. However, they did allege that the merger was consummated, and under the liberal rules of notice pleading this allegation is sufficient to meet the Birnbaum requirement of a sale, as were similar allegations in Vine v. Beneficial Fin. Co., 374 F.2d 627 (2d Cir.), cert. denied, 389 U.S. 970, 88 S.Ct. 463, 19 L.Ed.2d 460 (1967).

In Vine the Court discussed the element of reliance and held that reliance need not be shown if the deception complained of was directed at a third person. Armada argues that, unlike Vine, the fraud alleged here created no reliance at all; therefore the exchange of stock cannot be considered a sale for purposes of the Birnbaum rule, and the shareholders have no standing. Vine did not state that reliance must be alleged to gain standing. Only after disposing of the standing issue did the Court in Vine discuss reliance. The presence or absence of a...