Northway, Inc. v. TSC Industries, Inc.

• Decision Date: 05 March 1975
• Docket Number: No. 73-1922,73-1922
• Citation: 512 F.2d 324
• Parties: Fed. Sec. L. Rep. P 95,007 NORTHWAY, INC., a Delaware Corporation, Plaintiff-Appellant, v. TSC INDUSTRIES, INC., a Delaware Corporation, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 324

512 F.2d 324

Fed. Sec. L. Rep. P 95,007

NORTHWAY, INC., a Delaware Corporation, Plaintiff-Appellant, v. TSC INDUSTRIES, INC., a Delaware Corporation, et al Defendants-Appellees.

No. 73-1922.

United States Court of Appeals Seventh Circuit.

Argued Sept. 12, 1974.

Decided March 5, 1975.

Arnold I. Shure, Stanley B. Block, Willard J. Lassers, Harry B. Reese, Chicago, Ill., for plaintiff-appellant.

Barry B. Nekritz, Chicago, Ill., for intervenors.

Joseph N. Morency, Jr., Jerald P. Esrick, Chicago, Ill., Robert B. Fiske, Jr., New York City, for defendants-appellees.

Before SWYGERT, CUMMINGS and PELL, Circuit Judges.

SWYGERT, Circuit Judge.

This appeal concerns violations of Rules 14a-3 and 14a-9 issued by the Securities Exchange Commission pursuant to section 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a). This section makes it unlawful for any person to solicit by mail or other means of interstate commerce proxies of a registered security in violation of rules promulgated by the Commission pursuant to the statute. The appeal also concerns alleged violations of section 78j(b) of the Securities Exchange Act of 1934 and Rule 10b-5 thereunder.

Plaintiff Northway, Inc. brought this action against defendants National Industries, Inc. and TSC Industries, Inc. for alleged violations of section 14(a) in connection with the acquisition of TSC by National in a stock-for-stock purchase. Northway alleges that these corporate defendants issued a joint proxy statement in connection with a takeover, which statement was incomplete and materially misleading. In addition, Northway brought suit against Charles E. Schmidt and various members of his family alleging that these defendants also violated the Securities and Exchange Act by selling their controlling interest in TSC without adequately protecting the interests of its other shareholders. The Schmidt defendants were also charged with aiding and abetting the corporate defendants. Northway appeals from orders of the district court denying its motion for summary judgment on the issue of liability of the corporate defendants, denying its similar motion as to the Schmidt defendants, and granting a cross-motion for summary judgment filed by the Schmidt defendants. Appeal is taken by leave pursuant to 28 U.S.C. § 1292(b), the district court and this court having found that the disposition of these motions involves controlling and important questions of law as to which there is substantial ground for difference of opinion, and that immediate appeal may materially advance the ultimate termination of this litigation. We affirm the granting of summary judgment for the Schmidt defendants, but reverse the denial of summary judgment as to the liability of the corporate defendants.

I

Plaintiff Northway is a Delaware corporation doing business in Illinois, where it maintains its principal place of business. In January and February of 1969 Northway owned 200 shares of Common Stock in TSC Industries, also a Delaware corporation. Northway continued to own the TSC stock throughout the period of the transactions challenged in this lawsuit.

As of January 16, 1969 Charles E. Schmidt, Sr. and various members of his family owned approximately one third of the outstanding voting shares in TSC. ¹ In addition, Mr. Schmidt and his son, Charles E. Schmidt, Jr., were members of the TSC board of directors. On that day, Mr. Schmidt was approached by representatives of National Industries, Inc., a Kentucky corporation, who inquired into the possibility of acquiring all of the Schmidt family interest in TSC. ² After reviewing his own financial position and after an evaluation of National Industries and its key personnel Mr. Schmidt determined that he would move ahead with the sale. On January 30, 1969 a stock purchase agreement was signed. Under the agreement, the Schmidt defendants were to receive substantially the then market value for their TSC securities. Payment was to be in cash and National's 5% notes payable in six annual installments. ³ Immediately after signing the agreement Mr. Schmidt tendered his resignation from the board of directors of TSC. Mr. Schmidt's son, Charles E. Schmidt, Jr., tendered his resignation from the TSC board of directors on February 7, 1969, the date of closing of the stock transfer. The Schmidt defendants had no further contact with TSC or National after February 7, 1969.

Shortly after the acquisition of the Schmidt interests, on March 31, 1969, four National nominees were elected to the ten-man board of directors of TSC. ⁴ On that same day, Stanley R. Yarmuth, president and chief executive officer of National, became the chairman of the TSC board of directors and Charles F. Simonelli, executive vice president of National, became chairman of TSC executive committee.

On October 16, 1969, a proposal to liquidate and dissolve TSC and to sell all its assets to National was considered at a meeting of the TSC board of directors. Under the proposal National was to acquire all TSC assets in return for National securities. Eight members of the TSC board of directors attended this meeting. ⁵ The proposition received the affirmative votes of four non-National directors. The three National nominees on the TSC board attending the meeting abstained from voting on the advice of their attorneys. One non-National director also abstained.

On November 12, 1969, TSC and National issued a joint proxy statement to the shareholders of TSC concerning the proposed liquidation and sale. The statement urged TSC shareholders to approve the transaction. Sufficient proxies were received and voted in favor of the proposal to cause it to be approved. TSC was placed in liquidation and dissolution and notices were sent to all TSC stockholders advising them that they were required to exchange their TSC shares for National securities. Shares were exchanged and the transaction completed.

II

Corporate defendants National Industries, Inc., and TSC, Inc. are charged with violations of § 14(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78n(a), ⁶ and Rules 14a-3 and 14a-9 thereunder. ⁷ The 14a-3 claim is based on the failure of the corporate defendants to include in the joint proxy statement the conclusion that a change in control of TSC had taken place as a result of the transfer of the Schmidt interests in TSC to National. ⁸ The 14a-9 claim is based on the failure of the corporate defendants to include certain material information in the joint proxy statement concerning the degree of potential influence of defendant National in the management of TSC, the favorability of the terms of the National acquisition proposal to the TSC shareholders, and the formal approval by the TSC board of directors of the resolution of liquidation and dissolution. ⁹

We agree with the district court that the issue of control is a factual issue presently in dispute and that summary judgment as to the Rule 14a-3 claim would have been inappropriate. The essence of the 14a-3 claim is that the proxy statement failed to disclose, in accordance with Schedule 14A, that a change of control of TSC had taken place during the preceding fiscal year. Each side has presented exhibits and affidavits tending to support their conflicting views on the control issue. The trial court properly denied Northway's motion in the face of this bona fide dispute.

Plaintiff's Rule 14a-9 motion for summary judgment is quite different from the 14a-3 motion. The central question under Rule 14a-9 is whether, considering all of the circumstances which existed at the time the joint proxy statement was issued, the proxy statement was false or misleading in its presentation of a material fact or in its failure to include such a fact. Northway contends that the statement was misleading because of five omissions of fact, all of which it says were material. To prevail on the 14a-9 issue Northway must establish undisputed facts sufficient to show that one or more of the omitted items is material as a matter of law. To do this, it must demonstrate that reasonable minds could not differ on the question of materiality. Johns Hopkins University v. Hutton, 422 F.2d 1124, 1129 (4th Cir. 1970); Beatty v. Bright, 318 F.Supp. 169, 173 (S.D.Iowa 1970); Berman v. Thompson, 312 F.Supp. 1031, 1034 (N.D.Ill.1970).

In Mills v. Electric Autolite Co., 396 U.S. 375, 90 S.Ct. 616, 24 L.Ed.2d 593 (1970), the Supreme Court addressed itself to the elements of a cause of action brought under Rule 14a-9. The Court held that once materiality is established, specific proof of causation is unnecessary providing it is shown that the proxy statement itself was an essential link in the transaction. The Court thus recognized that the concept of materiality is itself defined in terms of potential sausative effects. ¹⁰

Since Mills, some uncertainty has developed as to which language in that opinion represents the proper test to apply in determining the materiality of an omitted fact. Different results could flow from the test requiring only that the omitted fact "might have been considered important by a reasonable shareholder who was in the process of deciding how to vote" than would flow from a test requiring that the fact have "a significant propensity to affect the voting process." ¹¹ On a motion for summary judgment, the "might have" test would ask whether a reasonable mind could conclude that the omitted fact is so irrelevant that it would never reasonably be considered important. The "significant propensity" test would ask whether a reasonable mind could conclude that the fact is less than significant in its potential to affect the voting process. Many facts which are relevant within the first test could reasonably be said to have less than a significant propensity to affect the voting process taken as a whole, even though for some few stockholders these same facts could be determinative.

We believe the policies which underlie § 14(a) and ...