Smallwood v. Pearl Brewing Company

• Decision Date: 19 February 1974
• Docket Number: No. 72-2342.,72-2342.
• Citation: 489 F.2d 579
• Parties: Joe L. SMALLWOOD, Plaintiff-Appellant, v. PEARL BREWING COMPANY, Southdown, Inc., Zapata Norness, Inc., Albert J. Range and D. Doyle Mize, Defendants-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

489 F.2d 579 (1974)

Joe L. SMALLWOOD, Plaintiff-Appellant, v. PEARL BREWING COMPANY, Southdown, Inc., Zapata Norness, Inc., Albert J. Range and D. Doyle Mize, Defendants-Appellees.

No. 72-2342.

United States Court of Appeals, Fifth Circuit.

February 19, 1974.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

John L. Hauer, Robert E. Goodfriend, Dallas, Tex., for plaintiff-appellant.

John C. Held, William C. Harvin, Houston, Tex., J. Burleson Smith, San Antonio, Tex., Stanley McMurry, Dallas, Tex., for defendants-appellees.

Before WISDOM, DYER and INGRAHAM, Circuit Judges.

WISDOM, Circuit Judge:

This appeal raises a variety of difficult questions under the Securities Exchange Act of 1934. Suing individually, as the representative of a class, and derivatively, Joe L. Smallwood, plaintiff-appellant, charged the defendants with a multitude of sins, including violations of the Proxy Rules, the tender offer provisions of the Williams Act, and Rule 10b-5. The defendants demanded a jury trial. After special issues were submitted to the jury and returned, the district court ruled that no violations of the securities laws had been established. We affirm.

I. FACTS

The story begins innocuously enough in the summer of 1968 with the commencement of a search by Pearl Brewing Company for a suitable merger partner.¹ Seeking further diversification, Pearl, a Texas corporation engaged in the manufacture of beer, soft drinks, and candy, rejected feelers from other firms in the consumer foods industry. Then, in the spring of 1969, three new merger candidates appeared—Aztec Oil & Gas Company, Infotech, and Southdown, Inc. Infotech was a start-up enterprise with no business history, and its merger offer was quickly dismissed. Aztec, a natural gas producer, offered a straight stock-for-stock exchange. Southdown, a Louisiana corporation with interests in sugar production, oil and gas, and real estate, originally offered to purchase a controlling interest in Pearl stock for cash.² After some preliminary negotiations, Southdown altered its proposal to provide the option of a stock-for-stock exchange in a tax-free merger.³ The Aztec and Southdown proposals were referred to Duff, Anderson & Clark, Inc., a Chicago financing and consulting firm, for study.

On June 26, 1969, representatives of Duff, Anderson & Clark orally reported to the Pearl Board of Directors that in their opinion both proposals would benefit Pearl, but that the Aztec offer was slightly the better of the two because it had "more upside potential near term". When the Pearl Board met again on July 7, 1969, representatives of Aztec and Southdown appeared to present their proposals. After the presentations, one of Pearl's attorneys reported to the Board that El Paso Natural Gas Company, Aztec's chief customer, was under no obligation to continue purchasing gas from Aztec. The Pearl Board then informally indicated its approval of the Southdown proposal and instructed Pearl's attorneys to meet with Southdown's attorneys in an attempt to work out a merger agreement.

A merger agreement between Pearl and Southdown was approved by the Pearl Board on July 11, 1969. The agreement provided that Pearl would be merged into Southdown and that for each share of Pearl common stock owned a shareholder would receive one share of Southdown convertible preferred stock. Pearl's obligation to consummate the merger was subject to "the fulfillment (or waiver by Pearl in writing)" of certain conditions, the most important of which would permit Pearl shareholders to "sell out" at least 45 percent of their newly acquired Southdown preferred stock on consummation of the merger for $45 a share:

"Southdown shall have procured a firm commitment from a group of underwriters (which commitment shall be satisfactory in form and substance to the Board of Directors of Pearl) by which such underwriters will agree, for a period of ten days following the Effective Date, to purchase from those stockholders who desire to sell the same, at a price of $45 net per share, up to 45 percent of the shares of Southdown Preferred Stock into which the shares of Pearl Stock held by such stockholders on the Effective Date will have been converted upon consummation of the merger."

Testimony at trial indicated that the purpose of requiring Southdown to gain a firm underwriting commitment was to accomplish the sell-out provision of the plan without making the merger taxable to Pearl shareholders. Although Southdown was willing to buy up to 45 percent of Pearl's stock for cash, Pearl's attorneys were of the opinion that if Southdown paid cash in addition to securities the merger would lose its tax-free status under Section 354 of the Internal Revenue Code of 1954, and the exchange of shares in the merger would become a taxable event to Pearl shareholders. Jack Guenther, one of Pearl's attorneys, testified that in his negotiations with Southdown he obtained the Pearl Board's right to waive the underwriting commitment so that Southdown could not avoid the merger by failing to procure an underwriting commitment. The purpose of the waiver power was explained to the Board when the Board approved the merger agreement. There was no testimony that it was anticipated at that time that an underwriting commitment would not prove possible. To the contrary, Guenther had received confirmation from Lehman Brothers, an investment banker, that a firm commitment was feasible.

According to testimony in the record the provision that the underwriters would purchase "for a period of ten days following the Effective Date . . . from those stock holders who desire to sell" was intended to indicate when the underwriters would purchase, not when shareholders would tender their shares for sale. The testimony at trial was that permitting shareholders ten days after the merger to tender their shares for sale to underwriters would be inconsistent with underwriters' requirements that they know before purchase the number of shares they must market.

On July 17, 1969, Pearl advised its shareholders by mail of the proposed merger with Southdown. The letter indicated that both the Pearl and the Southdown Boards of Directors believed the merger to be mutually beneficial and recommended shareholder approval. Enclosed with the letter was a copy of a press release describing the basic terms of the merger proposal and stating: "It is a condition to Pearl's obligation to consummate the merger that, on the effective date of the merger, Southdown shall have obtained an underwriting commitment affording the former Pearl stockholders the opportunity to sell, at $45.00 net per share, up to 45% of the Southdown preferred stock received by them in the merger." The power of the Pearl Board to waive the underwriting commitment was not mentioned.

Pearl management communicated again with the shareholders on August 12. The materials distributed that day included a cover letter, a notice of a special shareholders meeting to be held on September 9, 1973, a proxy, and a proxy statement with appendices. The first sentence of the proxy statement referred the reader to the merger agreement between Pearl and Southdown and indicated that a copy of the agreement could be found attached as Appendix II. The agreement, of course, contained the conditions of Pearl's obligation to merge written in full, including the power of the Pearl Board to waive them. Nowhere else in the materials was the waiver power mentioned, although the underwriting condition was referred to four times.

The proxy statement revealed that Albert Range, Executive Vice President of Pearl, would be employed by Southdown under a five-year employment contract at $75,000 per annum and that Range would become a director of Southdown. Moreover, the proxy statement indicated, as a result of the merger Range's 2,620 shares of Pearl stock would be converted into an equal number of Southdown shares. Although during preliminary negotiations between Southdown and Pearl, D. Doyle Mize, the Chairman of Southdown's Board, had promised Range a stock option of 25,000 shares, the proxy materials did not disclose that fact.

On September 9, 1969, the shareholders voted 1,253,337 shares to 35,449 in favor of the merger. December 10, 1969, was tentatively set as the merger date.

To implement the sell-out provision of the merger agreement, Southdown mailed to the Pearl shareholders, on November 18, 1969, a cover letter, a draft of an underwriting agreement, a preliminary prospectus, and forms. The cover letter restated Southdown's obligation to obtain an underwriting commitment, but did not refer to the ten-day period following the merger during which the underwriters would purchase the stock. The shareholders were informed that to sell their shares of Southdown preferred stock to the underwriters upon consummation of the merger they must tender their Pearl stock certificates, with the appropriate deposit forms, to be in the hands of designated exchange agents "prior to 3:30 p.m., EST, on December 2, 1969". By December 2 approximately 545,000 shares, about 58.5 percent of the outstanding Pearl stock, had been deposited.

Through the summer and into the fall of 1969 the price of Southdown common stock had run counter to a general downward trend in the securities market. Testimony indicated that Lehman Brothers had continued to believe, and communicated this belief to Pearl's attorneys and Southdown, that a syndicate of underwriters would purchase up to 45 percent of the Southdown preferred stock at $45 a share. Late in November, however, the price of Southdown common declined precipitously. Lehman Brothers communicated to Southdown that an underwriting for more than 250,000 shares would not be possible. After talking to Mize on December 3, Range wrote to 25 Pearl shareholders, each of whom owned 5,000 or more shares of Pearl stock. He requested that those addressees...