Reliance Finance Corp. v. Miller

• Decision Date: 18 July 1977
• Docket Number: No. 75-2216,75-2216
• Parties: Fed. Sec. L. Rep. P 96,177 RELIANCE FINANCE CORPORATION and Romer, O'Connor & Co., Inc., Appellants, v. Clyde E. MILLER and Arline A. Miller, Appellees.
• Court: U.S. Court of Appeals — Ninth Circuit

Page 674

557 F.2d 674

Fed. Sec. L. Rep. P 96,177

RELIANCE FINANCE CORPORATION and Romer, O'Connor & Co., Inc., Appellants, v. Clyde E. MILLER and Arline A. Miller, Appellees.

No. 75-2216.

United States Court of Appeals, Ninth Circuit.

July 18, 1977.

Victor J. Haydel, III, argued, Farella, Braun & Martel, San Francisco, Cal., for appellants.

William F. Murphy, San Mateo, Cal., argued for appellees.

Appeal from the United States District Court for the Northern District of California.

Before CHOY and KENNEDY, Circuit Judges, and FERGUSON, ^* District Judge.

FERGUSON, District Judge:

This case arose as the result of the sale of a California collection agency, Romer, O'Connor & Company, Inc. ("Romer"). When business became impaired shortly after the consummation of the sale, the purchaser, Reliance Finance Corp. ("Reliance") and the Romer agency sued the seller, Clyde E. Miller, for damages and rescission on a number of theories. Mrs. Miller, who joined in the sale, was also named in the complaint but played no active role in the events at issue. Federal jurisdiction was predicated on the alleged violation of 15 U.S.C. § 78j(b) and Rule 10b-5; pendent claims were stated under state securities law and on several other theories (fraudulent misrepresentation, negligent misrepresentation, failure of consideration, breach of contract and breach of warranty). The complaint was amended just prior to trial to add an additional count, mutual mistake of fact. Defendants stated several counterclaims, seeking payment on a promissory note made and executed by Reliance in connection with the sale, damages for breach of an employment contract between Miller and Reliance and related expenses due in connection therewith, money due under a contingent fee contract between Miller's law firm and Reliance, and damages for injury to Miller's credit reputation and for defamation. The 8-day trial was to the court. The trial judge found for the seller, Miller, and entered findings of fact and conclusions of law. Reliance appeals. We affirm.

Although the parties dispute many basic factual points, the general course of events leading to the litigation is fairly clear. Romer, incorporated in 1932, was a relatively successful collection agency with offices in San Francisco and Los Angeles. It had an annual volume of business of nearly $2.6 million. A substantial portion of Romer's work stemmed from a single client, the Atlantic-Richfield Company ("ARCO"), whose retail and wholesale divisions provided 48 percent of the San Francisco business and 65 percent of that in Los Angeles. During the course of a long association with the agency, Miller, a lawyer, and his wife Arline had become the sole owners of all Romer stock.

Early in 1973, Miller decided to sell the business. He began negotiations with officials of the Van Ru Credit Corporation, a competitor of Romer. Negotiations with Van Ru ultimately stalled, allegedly because ARCO could or would give no assurances of continued business with Romer, and because the parties could not agree on a formula for reducing the purchase price if Romer's volume of business declined. Allen Trant, a former lawyer and businessman in the collections field, also became interested in the business. In July 1973, Miller permitted an accounting firm chosen by Trant to audit Romer's books. Trant eventually became a middleman and agent for Reliance, a Hawaiian corporation. Throughout the negotiations, Miller asked that all discussion be kept confidential and that no contact with Romer's clients be made. He repeatedly refused to guarantee that current clients of Romer would continue their business with the firm. He did, however, stress that Romer had enjoyed lengthy and pleasant relationships with a number of its clients, including ARCO, and claimed that he knew of no information indicating that ARCO or any other client intended to reduce or terminate its business with the agency.

A lengthy contract to purchase the stock of Romer was drafted and signed by Miller on September 20, 1973. The contract referred to a September 29 closing date and contained no escrow provisions. It was signed by Reliance's officers on October 8. While there was at trial substantial disagreement as to the effective closing date of this agreement, that dispute has not been pursued on appeal. Two related agreements were also entered into at this time, the first employing Miller as a business and management consultant to Reliance once the Romer agency changed hands, and the second utilizing Miller's law firm to do legal work in connection with collection claims on a contingent fee basis for a set term.

Reliance's acquisition of Romer was spectacularly unsuccessful. Within days the business was in trouble. Late in October, ARCO announced the suspension of all retail business in Los Angeles, and the reduction of its San Francisco business by 50 percent. It stated that its decision was primarily due to a comparison of Romer's rate of collection with that of its competitors. Similar problems befell the ARCO wholesale accounts, which amounted to at least 50 percent of ARCO business in Los Angeles. On October 5, the ARCO wholesale representative advised Miller that business would be withdrawn from the Los Angeles office unless a dispute between Miller and his erstwhile law partner, Jack Murphy, were resolved and problems concerning legal supervision and control over collection procedures remedied. A short time later, ARCO did in fact take such action. As a result of these and other client withdrawals, Reliance estimates that 80 percent of Romer's business was lost.

Appellants would fault Miller on two grounds. First, they argue, he breached his duty to inquire and to disclose information which he had or should have had concerning the substantial loss of business that resulted shortly after the sale of the Romer stock to Reliance. Second, they point to a special study of Romer's client trust accounts completed in September 1974 by a private accounting firm commissioned by Reliance. Using different accounting methods than those employed by Romer, the study concluded that, although the trust accounts properly reflected monies received from debtors, liabilities due Romer clients were understated by approximately $33,000 in June and September 1973 (the month the agency was sold), and that as a result income figures were inflated by about $9,000 to $10,000. Reliance contends that this "irregularity" in Romer's accounting system has two-fold significance: that it serves as an additional basis for their misrepresentation claim and that it in and of itself resulted in a mutual mistake which should trigger the remedy they seek, rescission.

The issues on appeal are rather inartfully framed: appellants' argument seems to be that the trial court erred in failing to find in their favor on any and all theories of recovery. In order to consider the merits of this claim systematically, however, we must utilize a three part analysis: (1) did the court err in its handling of appellants' 10b-5 and misrepresentation claims? (2) should the court have granted rescission because of mutual mistake of fact? (3) did the court improperly reject appellants' failure of consideration and breach of warranty theories?

I. Rule 10b-5 and Misrepresentation

In formulating his findings of fact and conclusions of law, the district judge carefully considered the application of the "flexible duty" standard of White v. Abrams, 495 F.2d 724 (9th Cir. 1974), to this case. Because the purchasers were familiar with the unstable collection business and because Miller agreed to and did make available to them for study all of the Romer financial documents, the judge concluded that Miller's duty "was one of less than extreme care." Although Miller was obliged to make reasonable inquiry regarding any foreseeable loss of business and to disclose material information accumulated in the course of that investigation, the court concluded that this duty was not breached.

During the pendency of this appeal, the Supreme Court in Ernst & Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct. 1375, 47 L.Ed.2d 668 (1976), has held that scienter, not simply negligence, is the necessary predicate to liability under Rule 10b-5. If the record supports the trial court's determination that Miller did not fail to proceed with even the low standard of care demanded by White, it follows a fortiori that under the Ernst rule no liability would accrue.

The court below found that Miller did not receive formal notification of the loss of ARCO's retail business until October 29, 1973, after the sale had been completed. Although Reliance contended that Miller had earlier been informed of the imminent loss of business by his law partner, Jack Murphy, the district judge found otherwise. Murphy's inability to remember the source of his information and his failure to commit such vital information to writing gave the trial judge sufficient grounds for disbelief and we cannot say that his finding is clearly erroneous. Butler v. Merrill, Lynch, Pierce, Fenner & Smith, Inc., 528 F.2d 1390, 1391 (9th Cir. 1975).

Reliance also claimed that Miller failed to disclose that loss of ARCO's wholesale business was imminent. Miller testified that he had fully revealed all relevant information to Allen Trant, Reliance's agent, early in October. Trant said otherwise. That the court believed Miller rather than Trant is, again, not clear error. Nor was there knowing misrepresentation or failure to disclose material information concerning the status of Romer's trust accounts. The court found that Miller, who is not an accountant, had no reason to know and could not reasonably have known of the allegedly irregular procedures which only came to light a year after the sale as a result of a study specially commissioned by appellants. It appears from the record that the court could not have found otherwise. We must therefore conclude that there...