One-O-One Enterprises, Inc. v. Caruso, ONE-O-ONE

• Decision Date: 07 June 1988
• Docket Number: ONE-O-ONE,No. 87-7195,87-7195
• Citation: 848 F.2d 1283,270 U.S. App. D.C. 251
• Parties: , Fed. Sec. L. Rep. P 93,796 ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. Richard E. CARUSO, et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — District of Columbia Circuit

Page 1283

848 F.2d 1283

270 U.S.App.D.C. 251, Fed. Sec. L. Rep. P 93,796

ONE-O-ONE ENTERPRISES, INC., et al., Plaintiffs-Appellants, v. Richard E. CARUSO, et al., Defendants-Appellees.

No. 87-7195.

United States Court of Appeals District of Columbia Circuit.

Argued April 26, 1988.

Decided June 7, 1988.

Allan S. Hoffman, with whom Samuel H. Seymour, Washington, D.C., was on the brief for plaintiffs-appellants.

Michael A. Schlanger, with whom Stephen R. Mysliwiec, Washington, D.C., was on the brief, for defendants-appellees.

Before RUTH BADER GINSBURG and SENTELLE, Circuit Judges and PALMIERI ^*, Senior District Judge.

Opinion for the court filed by Circuit Judge RUTH BADER GINSBURG.

RUTH BADER GINSBURG, Circuit Judge:

Plaintiffs-appellants One-O-One Enterprises, Inc., Guld, Inc., and Ulysses G. Auger, Sr. (hereafter referred to jointly as One-O-One) appeal from an order of the district court dismissing their complaint against defendants-appellees Richard E. Caruso, James M. Sullivan, and For Trish Co., Inc., for failure to state a claim upon which relief can be granted. One-O-One Enters., Inc. v. Caruso, 668 F.Supp. 693 (D.D.C.1987). Appellants' complaint tendered securities fraud claims under section 10(b) of the Securities Exchange Act of 1934 (SEA) and Rule 10b-5 promulgated thereunder, pendent state common law fraud and breach of contract claims, and a RICO claim. Appellants are not appealing dismissal of the RICO claims.

Because One-O-One failed to identify any fraudulent representations upon which it reasonably could have relied or any plausible interpretation of the contract upon which a claim of breach could be stated, we affirm the decision of the district court. Nevertheless, although it does not affect the outcome of this appeal, we indicate why we do not approve the portion of the district court's opinion, 668 F.Supp. at 699-701, concerning the existence of a security.

I.

This case arises out of an agreement between defendants and plaintiffs concerning the disposition of 39 debt-ridden Ponderosa Steak Houses in Maryland and Virginia owned by plaintiffs. At the time the complaint was filed, Auger, Sr. and his wife owned 100% of the capital stock in Guld, Inc., a D.C. corporation that in turn owned 100% of the capital stock in One-O-One Enterprises, Inc., a Maryland corporation engaged in the business of owning and operating the 39 Ponderosa Steak Houses. Defendants Caruso and Sullivan own all the capital stock in For Trish Co. (Trish), a Delaware shell corporation "without financial substance or sufficient capital to enable it to engage in any business activities without access to the financial resources of its stockholder/principals." Complaint p 6. Caruso and Sullivan were, until June 1985, also controlling stockholders in Tenly Enterprises, Inc. (Tenly), a Pennsylvania corporation engaged in the business of owning and operating more than 70 Rustler Steak Houses in the Mid-Atlantic states.

Beginning in June 1984, Caruso and Sullivan expressed interest in purchasing One-O-One's heavily leveraged Ponderosa restaurants and converting them to Rustlers. On July 31, 1984 Caruso submitted an initial written proposal for the purchase of the Ponderosas. Plaintiffs rejected that proposal, but negotiations continued and eventually yielded a preliminary letter agreement, dated October 8, 1984, among Tenly, Auger, Sr., his son Auger, Jr., One-O-One, and Guld. According to plaintiffs' complaint, which we take to be true for purposes of this appeal, the October 8 preliminary agreement reflected prior oral representations made by defendants that they intended to maintain and expand the Rustler Steak House business "for the long-term future" and that they did not intend "to sell or dispose of their ownership interest in Tenly in the near or foreseeable future." Complaint p 20.

In an endeavor to implement the October 8 preliminary agreement, defendants drafted a detailed formal agreement. This formal agreement--between One-O-One and Tenly--included provisions incorporating defendants' prior representations regarding their long-term commitment to the Rustler business. Ultimately, however, the parties were unable to conclude a final agreement based on the October 8 preliminary plan.

Negotiations resumed among the parties until they reached a new preliminary letter agreement on January 14, 1985. The new agreement, which substituted Trish for Tenly as a corporate party, contained these essential features:

(a) One-O-One would permanently convey ten of its restaurant units to Trish Co., for no cash consideration;

(b) One-O-One would convert 25 of its remaining 27 restaurant units to Rustler Steak Houses, at its own expense, and would dispose of its other two units;

(c) One-O-One would be authorized to operate the units it converted as Rustler Steak Houses for a period of up to seven years, without payment of any fees or royalties, and Trish Co. would provide advertising and promotional support for One-O-One's units at no cost to One-O-One;

(d) Auger would grant to Trish Co. an option to purchase all of the capital stock of Guld (and with it all of the capital stock of One-O-One) for the nominal sum of $100;

(e) During the six-year option period, One-O-One and Guld would apply all available revenues generated by One-O-One's Rustler Operations to reduce their outstanding indebtedness;

(f) Auger personally would service all existing Guld and One-O-One interest-bearing debt in excess of $10,200,000 in total liabilities as of the date of the final agreement, as well as any additional interest-bearing debt incurred thereafter; and

(g) Upon exercise of its option, Trish Co. would assume the liabilities of Guld and One-O-One up to a maximum amount of $10,200,000, less the amount by which their outstanding indebtedness had been reduced during the option period, and Auger would assume responsibility for the remainder of One-O-One's and Guld's obligations.

Complaint p 26. A Final Agreement dated February 4, 1985 embodying these terms was executed by the parties and delivered on March 8, 1985; One-O-One thereupon conveyed to Tenly, as Trish's assignee, nine of its ten specified restaurant properties and began to convert 25 of its remaining Ponderosas to Rustlers. This 1985 Final Agreement, in contrast to the previous formal agreement based on the understandings reflected in the October 8, 1984 letter agreement, contained no statement regarding Tenly's long-term commitment to the Rustlers. The Agreement did, on the other hand, conclude with an integration clause in which the parties agreed that the Final Agreement "supercede[d] any and all previous understandings and agreements." Joint Appendix (J.A.) at 194.

Beginning in November 1984, continuing through June 1985, and unknown to plaintiffs, Caruso and Sullivan entered into negotiations to sell Tenly to Sizzler Restaurants, Inc. (Sizzler), a California corporation that owns, operates, and franchises steak houses under the Sizzler name. Sizzler intended to phase out the Rustler system after acquiring Tenly. In late June of 1985 Sizzler purchased Tenly and obtained an option to purchase all of Trish's stock.

By the time One-O-One learned that Sizzler had purchased Tenly, One-O-One had converted a number of its restaurants to Rustlers and was in the process of converting the rest. As Sizzler began converting Tenly's Rustlers to Sizzlers, the level of promotional effort devoted to Rustlers diminished markedly, "causing One-O-One's Rustler units economically to perform far more poorly than if the Rustler chain were aggressively promoted, supported with an adequate advertising and marketing effort and, generally, managed and operated with a view towards the perpetuation and expansion of the Rustler Steak House system." Complaint p 36. By the end of 1985, One-O-One could no longer sustain the continuing losses on its remaining Rustlers. On May 2, 1986, One-O-One sold all but one of its Rustlers to Sizzler, having already sold the 25th Rustler to another buyer in February 1986.

On July 15, 1986, more than one year after One-O-One learned of the sale of Tenly to Sizzler, plaintiffs filed the present action seeking to recover approximately $7,600,000 in damages (or thrice that under the now-abandoned RICO claim) that they allegedly sustained because defendants fraudulently induced them to enter into a contract granting Trish an option to purchase the stock of One-O-One.

The defendants moved to dismiss the complaint for failure to state a claim, and the district court granted the motion, finding inter alia: (1) the representations upon which plaintiffs based their fraud, securities fraud, and RICO claims were not reasonably relied upon because the contract at issue was fully integrated; (2) the provision of the contract upon which plaintiffs based their breach of contract claim unambiguously precluded such a claim; and (3) the stock option for which the contract provided did not qualify as a security for purposes of stating a securities fraud claim under the SEA. Plaintiffs-appellants timely appealed the district court's dismissal order; we affirm the judgment of that court but correct its misstep with respect to the definition of a security.

II.

A. Fraud

To state a claim of fraud or securities fraud upon which relief can be granted, plaintiffs' allegations must indicate that their reliance on the allegedly fraudulent representations was reasonable. See Kennedy v. Josephthal & Co., 814 F.2d 798, 804 (1st Cir.1987) ("To establish a claim under section 10(b) of the Securities Exchange Act, a plaintiff must prove, in connection with the purchase [or sale] of a security ... that [its] reliance [upon false representations or omissions] was justifiable."); Feinman v. Schulman Berlin & Davis, 677 F.Supp. 168, 170 (S.D.N.Y.1988) (same); Call Carl, Inc. v. BP Oil Corp., 554 F.2d 623, 629 (4th Cir.) (applying Maryland common law of fraud), cert. denied, 434 U.S. 923, 98...