Merino Vinas v. Boto

• Decision Date: 02 July 1993
• Docket Number: Civ. No. 90-1970 HL.
• Citation: 827 F. Supp. 83
• Parties: Rafael MERINO VINAS, et al., Plaintiffs, v. Alfonso BOTO, et al., Defendants. Ferreteria Merino, Inc., Nominal Defendant.
• Court: U.S. District Court — District of Puerto Rico

827 F. Supp. 83

Rafael MERINO VINAS, et al., Plaintiffs, v. Alfonso BOTO, et al., Defendants.

Ferreteria Merino, Inc., Nominal Defendant.

Civ. No. 90-1970 HL.

United States District Court, D. Puerto Rico.

July 2, 1993.

COPYRIGHT MATERIAL OMITTED

Patrick D. O'Neill-Cheyney, Ruben Nazario-Velasco, Patrick D. O'Neill-Cheyney, Martinez, Odell & Calabria, Hato Rey, PR, for plaintiffs.

Roberto Corretjer-Piquer, Hato Rey, PR, Guillermo J. Bobonis, Condado, PR, for defendants.

OPINION AND ORDER

LAFFITTE, District Judge.

Before the Court are cross-motions for summary judgment in this derivative action for declaratory and injunctive relief brought under section 10(b)¹ of the Securities Exchange Act of 1934 and Rule 10b-5.² Plaintiffs³ are shareholders of nominal defendant Ferreteria Merino, Inc., a close corporation⁴ organized under the laws of Puerto Rico, with its principal place of business in San Juan. Defendants are also shareholders in Ferreteria Merino. At the time that this lawsuit was originally brought, the Defendants and Plaintiff Victor Merino Calenti sat on Ferreteria Merino's board of directors.

Section Five of Ferreteria Merino's Articles of Incorporation establishes a capital structure consisting of two classes of stock: common and preferred.⁵ Both types of shares have a par value of $100. The corporation has issued 6,000 shares of common stock and 4,000 shares of preferred stock. All but one of the Plaintiffs and all Defendants in this action own, in varying ratios, both common and preferred stock.⁶ Preferred stock does not include a right to vote or to be called for shareholder meetings. It does, however, have a right to receive full dividends before common stock receives any dividend payments. Preferred stock also has the right, in the event of a liquidation, to receive its par value plus any due dividends before any payment is made to the common stock. Section Five of the Articles of Incorporation also provides that Ferreteria Merino has the right to redeem the preferred stock at its par value plus accumulated dividends, if the board of directors votes to do so any time after three years from the date of the preferred stock's issuance.⁷

In 1988 the board of directors began to consider selling Ferreteria Merino. At a board meeting Victor Merino Calenti asserted that before the corporation could be sold, it would have to redeem out its preferred shares at $100 per share. Defendants opposed this proposal on the grounds that preferred stock had always been traded at the same price as common stock, that this price was over $100, and that it would therefore be unfair to pay the holders of preferred stock only $100 per share. In order to prevent this redemption from taking place, Defendants sought to amend Section Five of the Articles of Incorporation and eliminate the corporation's right to redeem the preferred stock at $100 per share. At a meeting on June 12, 1990, Defendants proposed an amendment to Section Five of the Articles of Incorporation that read in part:

Preferred shares will not be redeemable by the corporation and will be quoted at and will participate in the value and increment of the same under the same conditions as common shares, including in the case of dissolution and liquidation of the corporation, be it voluntarily or not; except that they shall have the right to receive full payment on all due and unsatisfied dividends before any of the common stockholders are paid any amount.⁸

Under this proposed amendment, preferred stock would continue to receive priority with regard to receiving dividend payments. Preferred stock would not have the right to vote, except when a shareholders meeting would consider a proposed amendment to the Articles of Incorporation that would alter the preferences, rights, numbers, or par values of any class of stock.⁹ The board voted on the proposed amendment at the June 12 meeting. Defendants, who constitute a majority of the board of directors, approved it. Victor Merino Calenti opposed it. On the following day, the secretary of the corporation sent a notice to all shareholders that a shareholders meeting would be held on July 28, 1990 to vote on the proposed amendment. The notice also stated that a majority of the board approved the proposal based on the beliefs that it would be in the corporation's best interest and that it would prevent one class of stock from unfairly displacing any other class.¹⁰

Before the shareholders' meeting could be held, Plaintiffs brought this action, alleging a violation of section 10(b) and Rule 10b-5. Plaintiffs claimed that the proposal would, in effect, amount to the issuance of a new class of stock. According to Plaintiffs, Defendants were using their controlling interest on the board of directors to have this new class of stock issued to them for inadequate consideration, in violation of Rule 10b-5. Plaintiffs further alleged that the information included in the notice to the shareholders contained material misrepresentations and omissions of material facts, thereby preventing the shareholders from making an informed decision on the proposed amendment. Plaintiffs also claimed that the proposed amendment violated Puerto Rico corporations law and the terms of Ferreteria Merino's Articles of Incorporation. Plaintiffs sought a declaratory judgment that the proposed amendment was illegal. They also sought preliminary and permanent injunctive relief to prevent Defendants from proceeding with their plan.

The Court scheduled a hearing to show cause as to why Plaintiffs should not be granted preliminary injunctive relief. At the hearing, the parties reached a temporary agreement. Plaintiffs agreed to withdraw their petition for injunctive relief without prejudice, and Defendants agreed not to hold a shareholders' meeting to vote on the proposed amendment. The parties also agreed that the corporation would not redeem any stock.¹¹ It appeared that the parties might settle their dispute, but no settlement was ever reached, despite extensive negotiations.¹² Subsequently, Plaintiffs' filed a motion for summary judgment requesting both a declaration that the proposed amendment violates section 10(b) and an injunction preventing Defendants from holding a shareholders' meeting to consider the amendment. Defendants have opposed the motion and have moved for summary judgment, arguing that the proposed amendment is not illegal and that the shareholders should be allowed to consider it. For the reasons set forth below, the Court grants Defendants' motion for summary judgment.

DISCUSSION

At the outset, the Court notes that summary judgment is appropriate if "there is no genuine issue as to any material fact and ... the moving party is entitled to a judgment as a matter of law." Fed.R.Civ.P. 56(c). The party moving for summary judgment bears the initial responsibility of demonstrating the absence of a genuine issue of material fact. Celotex Corp. v. Catrett, 477 U.S. 317, 323, 106 S.Ct. 2548, 2553, 91 L.Ed.2d 265 (1986). The opposing party must then designate specific facts that show that there is a genuine triable issue. Id. at 324, 106 S.Ct. at 2553; Fed.R.Civ.P. 56(e).

The federal securities laws that Plaintiffs invoke emerged in response to the stock market crash in 1929. See Ernst & Ernst v. Hochfelder, 425 U.S. 185, 194-95, 96 S.Ct. 1375, 1381-82, 47 L.Ed.2d 668 (1976). The fundamental purpose of the Securities Exchange Act of 1934 is to ensure that there be honest publicity and full disclosure in securities transactions. Basic Inc. v. Levinson, 485 U.S. 224, 230, 108 S.Ct. 978, 982-83, 99 L.Ed.2d 194 (1988); Santa Fe Industries, Inc. v. Green, 430 U.S. 462, 476-77, 97 S.Ct. 1292, 1302-03, 51 L.Ed.2d 480 (1977). Accordingly, section 10(b) of the 1934 Act and Rule 10b-5 prohibit the use of manipulative or deceptive devices in sales of securities. Holmes v. Bateson, 583 F.2d 542, 551 (1st Cir.1978). To establish a claim under section 10(b) and Rule 10b-5, the plaintiff must show that a defendant, with scienter and in connection with the sale of a security, "falsely represented or omitted to disclose a material fact upon which the plaintiff justifiably relied." Kennedy v. Josephthal & Co., 814 F.2d 798, 804 (1st Cir.1987); see also Holmes, 583 F.2d at 551; Pike v. Edgar, 801 F.Supp. 907, 912 n. 15 (D.N.H.1992). A plaintiff in a Rule 10b-5 claim must first prove that the defendant has made a misrepresentation or material omission. Lefkowitz v. Smith Barney, Harris Upham & Co., 804 F.2d 154, 155 (1st Cir.1986) (per curiam). The materiality of any undisclosed information is an essential element to a plaintiff's case. Milton v. Van Dorn Co., 961 F.2d 965, 969 (1st Cir.1992). Omitted information is material only if there is a substantial likelihood that a reasonable shareholder would consider the information important and would view its nondisclosure as significantly altering the "total mix" of information available to him. Levinson, 485 U.S. at 232-33, 108 S.Ct. at 983; Milton, 961 F.2d at 969.

Plaintiffs argue that Defendants' violated section 10(b) and Rule 10b-5 by failing to disclose that (1) the proposed amendment would be a conversion of preferred stock into common stock, and would be tantamount to issuing additional shares of common stock for inadequate consideration; (2) the amendment would thus dilute the value of the common stock; (3) the amendment would also cause the corporation to relinquish a valuable asset — the right to redeem preferred stock at $100 per share; (4) the holders of common stock would have nothing to gain by this amendment; and (5) the Defendants would receive pecuniary benefits if the amendment were approved. The Court disagrees with Plaintiffs' characterization of the proposed amendment as a conversion of preferred stock into common stock or as an issuance of additional common stock. Under the proposed amendment to Section Five, preferred and common stock will continue to be different classes of...