McLean v. Alexander

• Decision Date: 31 March 1978
• Docket Number: Civ. A. No. 3972.
• Citation: 449 F. Supp. 1251
• Parties: Malcolm P. McLEAN, Individually, Plaintiff, v. Jack ALEXANDER, Daniel D. Friel, Bernard Hessler, Jr., Trustee, Helen June Friel, Trustee, Frederick A. Lang, Robert R. Walsh, Frank B. Francis, Bernard Hessler, Jr., Martin A. Apostolico, Merle R. Aiken, Shelley P. Jones, Thomas B. Baker, Shields & Company, Incorporated, and Cashman & Schiavi, Defendants.
• Court: U.S. District Court — District of Delaware

449 F. Supp. 1251

Malcolm P. McLEAN, Individually, Plaintiff, v. Jack ALEXANDER, Daniel D. Friel, Bernard Hessler, Jr., Trustee, Helen June Friel, Trustee, Frederick A. Lang, Robert R. Walsh, Frank B. Francis, Bernard Hessler, Jr., Martin A. Apostolico, Merle R. Aiken, Shelley P. Jones, Thomas B. Baker, Shields & Company, Incorporated, and Cashman & Schiavi, Defendants.

Civ. A. No. 3972.

United States District Court, D. Delaware.

March 31, 1978.

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John J. Schmittinger, of Schmittinger & Rodriguez, Dover, Del., William P. Verdon, and Donald A. Kessler of Meyner, Landis & Verdon, Newark, N. J., for plaintiff.

Richard L. Sutton, of Morris, Nichols, Arsht & Tunnell, Wilmington, Del., for individual defendants Jack Alexander, Daniel D. Friel, Bernard Hessler, Jr., individually and as Trustee for the children of Defendant Daniel D. Friel, Helen June Friel, Trustee for her children, Frederick A. Lang, Robert R. Walsh, Frank B. Francis, Martin A. Apostolico, Merle R. Aiken, Thomas B. Baker.

B. Wilson Redfearn, of Tybout & Redfearn, Wilmington, Del., Russel H. Beatie, Jr., and John M. Friedman, Jr., of Dewey, Ballantine, Bushby, Palmer & Wood, New York City, for defendant Shields & Co., Inc.

Arthur G. Connolly, Jr., of Connolly, Bove & Lodge, Wilmington, Del., Milton V. Freeman, Edgar H. Brenner, Robert D. Rosenbaum, and Hadrian R. Katz, of Arnold & Porter, Washington, D. C., Francis J. Trzuskowski, of Trzuskowski & Kipp, Wilmington, Del., for defendant Cashman & Schiavi.

Shelley P. Jones, pro se.

OPINION

MURRAY M. SCHWARTZ, District Judge.

Before the Court for resolution is the issue of damages suffered by plaintiff in relying on the misleading report of an accountant as one factor in his decision to purchase all the stock of Technidyne, Inc. A necessary adjunct to the determination of damages is the accountant's cross-claim for indemnification and contribution¹ against the settling defendants, namely the individual shareholders and Shields & Company, Incorporated ("Shields"), an investment banking corporation. All of the co-defendants were released and with one exception indemnified by the plaintiff Malcolm P. McLean ("McLean") as part of a settlement agreement.² The facts which are more fully set out in an earlier opinion holding the accountant Schiavi ("Schiavi") of Cashman & Schiavi liable under Rule 10b-5 and common law fraud, may be briefly summarized here. McLean v. Alexander, 420 F.Supp. 1057 (D.Del.1976).

In 1970, McLean, who had extensive holdings in companies specializing in both technological and traditional products, purchased all of the stock of Technidyne, a fledgling company whose double beam laser tool, the Model V, among other applications, had the perceived potential of revolutionizing the business of laying pipe. McLean's interest in the private placement of Technidyne was predicated upon many factors, not the least of which was his belief that its laser systems could efficiently replace the arduous 200 year old method of manually aligning and laying pipe. As a prospective buyer, McLean received a management report which has come to be known as the Friel Document,³ a recommendation by the underwriter known as the Shields Report⁴ and the opinion audit of an independent accountant.⁵ McLean conferred with Jack Alexander ("Alexander"), President of Technidyne, Bob Walsh ("Walsh"), Vice-President and General Manager, Shelley Jones ("Jones"), Vice-President in charge of Sales and Daniel Friel ("Friel"), major shareholder and chief negotiator of the sale.

During the course of negotiations, McLean learned and relied on two critical pieces of information, both of which proved to be false. The first was that American Vitrified Products ("Amvit") had been Technidyne's exclusive distributor and had sold some 114 units in the 2½ years prior to cancellation of its distribution contract in April 1969.⁶ The second was that Jones, the sales manager had sold 41 units to dealers of which 16 were completed within his first three months at Technidyne ending November 1969.⁷ Confirming the existence of the 16 sales and impliedly a market for the Model V was the defendant accountant's certified audit stating that the accounts receivable of $73,733 were "considered fully collectible."⁸ The audit was silent regarding Technidyne's dealings with Amvit. As it turned out, statements describing not only the collectibility but also the existence of the accounts receivable were fallacious as were the company's representations concerning the number of sales made by Amvit.

On the basis of misrepresentations in the audit made with the knowledge that they were unsupported and investors would rely on them, the accountant Schiavi was found liable under both Rule 10b-5 and principles of common law fraud. There was no finding, however, that he acted in concert with other defendants or that he misrepresented the Amvit relationship. As non-settling defendant, the accountant now asserts cross-claims for contribution and indemnification against all settling defendants, namely the individual principals and shareholders of Technidyne, and Shields, the investment banker. These claims are derivative in the sense that settling defendants are liable to Schiavi only if plaintiff McLean would have prevailed against them on his original action. Whatever liability attaches to any of these settling defendants, it is noted that all but one were indemnified by the plaintiff McLean from any and all claims arising out of this action with the result that no further damages may be assessed against them directly. Rather McLean in the indemnification agreement consented to a reduction of judgment against Schiavi by the amount attributable to the indemnified defendants.⁹

LIABILITY OF THE INDIVIDUAL DEFENDANTS

Technidyne was a closely held corporation with eleven shareholders of whom only Alexander, Friel, Walsh and Jones were active. The passive shareholders,¹⁰ including one who owned 25% of the company, were not active in the management of the company nor did they actively participate in the sale which precipitated this litigation. Of the inactive shareholders, only Hessler played any part in the sale at all, attending the closing on January 28, 1970 in the role of Technidyne's attorney. He was not privy to the negotiations leading to the sale and thus was unaware of the state of McLean's knowledge.

At the closing, a dispute arose as to whether the dealers with whom Technidyne had been dealing had exclusive rights to distribution. Jeter ("Jeter"), McLean's representative at the sale, reiterated McLean's intention to sell directly to contractors. Cautioned that a departure from dealerships could well jeopardize payment of the outstanding accounts, Jeter demanded that the shareholders guarantee the collectibility of the receivables. During this exchange, Hessler made inquiry of Jones regarding the nature of the dealership contracts and had the purchase orders produced for Jeter's inspection.¹¹ All indications are that Hessler was acting in good faith and without knowledge or acquiescence in any deception.

Of the remaining passive shareholders only Lang is of possible concern. He held 130 shares, was a co-founder and a director who attended directors' meetings but had little daily contact with Technidyne. As an engineer, he occasionally served as a consultant but had nothing to do with the business decisions of the company. The undisputed evidence indicates his knowledge regarding the stability of the company came exclusively from the active shareholders. Alexander and Walsh told him 114 confirmed sales had been consummated through Amvit and Jones informed him that more than 40 current orders had been received.¹² A review of the record reveals no active role by Lang in the administration or sale of Technidyne and consequently no basis for liability under Rule 10b-5 or principles of common law fraud.

In order to prove a Rule 10b-5 violation, one has to show the defendant made material misrepresentations with the intent or knowledge that plaintiff would be misled and that in fact plaintiff did rely on the misrepresentations. Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976); see Kohn v. American Metal Climax, Inc., 458 F.2d 255, 271 (3d Cir.) (Adams, J., concurring), cert. denied 409 U.S. 874, 93 S.Ct. 120, 34 L.Ed.2d 126 (1972). The elements of common law fraud are essentially the same as 10b-5 in the context of this case. The Delaware courts recognize that a defendant who behaves recklessly without regard for the consequences of his actions must be considered to know or to intend the misrepresentations. Twin Coach Company v. Chance Vought Aircraft, Inc., 163 A.2d 278, 284 (Del.Super. Ct.1960); Barni v. Kutner, 76 A.2d 801, 806 (Del.Super.Ct.1950).

In selling their shares to McLean, the inactive shareholders did not knowingly or recklessly make any misleading statements and the plaintiff in no way relied on their conduct. Consequently, the record fails to support a claim founded upon Rule 10b-5 or common law fraud against the inactive shareholders ("inactive shareholders"). The argument that principles of Rule 10b-5 and common law fraud required all selling shareholders to first ascertain the true financial picture of the company and then communicate it to all prospective buyers is not persuasive. Rule 10b-5 does not contemplate that kind of affirmative duty on the part of persons in the position of inactive shareholders.¹³

In contrast, Rule 10b-5 and the principles of common law fraud were violated by the active shareholders. Specifically, Alexander, Friel and Walsh are charged with having misrepresented both the facts underlying Technidyne's current sales and the reasons for terminating its business relationship with Amvit.¹⁴ McLean relied heavily on both misrepresentations. According to his testimony which is credited as honest...