Umstead v. Durham Hosiery Mills, Inc.

• Decision Date: 26 January 1984
• Docket Number: No. C-83-1168-D.,C-83-1168-D.
• Citation: 578 F. Supp. 342
• Court: U.S. District Court — Middle District of North Carolina
• Parties: A. Bruce UMSTEAD, Margaret W. Umstead and Willie Lea Farthing, Plaintiffs, v. DURHAM HOSIERY MILLS, INC., and George A. Cralle, H.E. Schoenhut, Jr., John P. Barnett, and Frederick L. Russell, Individually, Defendants.

578 F. Supp. 342

A. Bruce UMSTEAD, Margaret W. Umstead and Willie Lea Farthing, Plaintiffs, v. DURHAM HOSIERY MILLS, INC., and George A. Cralle, H.E. Schoenhut, Jr., John P. Barnett, and Frederick L. Russell, Individually, Defendants.

No. C-83-1168-D.

United States District Court, M.D. North Carolina, Durham Division.

January 26, 1984.

COPYRIGHT MATERIAL OMITTED

William Woodward Webb of Broughton, Wilkins & Webb, Raleigh, N.C., Kevin P. Roddy, Charlottesville, Va., for plaintiffs.

L. Bruce McDaniel of DeBank, McDaniel; Heidgerd & Holbrook, Raleigh, N.C., G. Eugene Boyce of Boyce, Mitchell, Burns & Smith, Raleigh, N.C., for defendants.

MEMORANDUM OPINION AND ORDER

HIRAM H. WARD, Chief Judge.

Before the Court is defendants' pre-Answer Motion to Dismiss the Complaint (October 31, 1983) for lack of subject matter jurisdiction and for failure to state a claim upon which relief can be granted pursuant to Fed.R.Civ.P. 12(b)(1), (6). (November 22, 1983). Defendants have requested a hearing, but the Court finds that a hearing would not aid resolution of this matter. The Court will deny the Motion, but will require plaintiff to file a more definite statement in accordance with Fed.R.Civ.P. 12(e).

For purposes of this Motion, the allegations of the Complaint are accepted as true. Adams v. Bain, 697 F.2d 1213, 1216 (4th Cir.1982). Plaintiffs are minority shareholders of Durham Hosiery Mills, Inc. (Durham Hosiery). On January 15, 1981, a majority of the voting shares approved a plan of reorganization or merger of the existing Durham Hosiery, a North Carolina corporation, into DHM, Inc., a new Virginia corporation with its principal place of business in Danville, Virginia. Prior to the merger, defendants Cralle and Schoenhut were directors and officers of Durham Hosiery. Defendant Barnett desired to invest in Durham Hosiery if he could obtain a controlling corporate interest and defendant Russell, Barnett's attorney, formulated a stock purchase plan which would enable Barnett to control the merger vote. During the fall of 1980, Barnett acquired 38,966 (54.8%) of the corporation's outstanding shares. Cralle purchased 28,188 shares from brokers in New York and New Jersey for Barnett and also bought a number of shares directly from shareholders without disclosing that he was acting on Barnett's behalf. Barnett purchased the remainder of his shares from Cralle and Schoenhut at inflated prices. Materials concerning the proposed merger were mailed to the shareholders on December 22, 1980. Plaintiffs contend that the materials misrepresented the market price of the stock and the statutory rights of dissenting shareholders and omitted material facts concerning the corporate financial condition and the above described relationship among Barnett, Cralle, and Schoenhut. Plaintiffs voted against the merger, and their subsequent demands to be paid their stocks' fair value were denied.

Defendants first argue that the Court lacks subject matter jurisdiction over plaintiffs' claims because any rights plaintiffs have as dissenting shareholders to the fair value of their stock is governed solely by North Carolina or Virginia state law. Defendants assert that Virginia law controls, and plaintiffs' failure to appropriately pursue their appraisal remedy under Va.Code § 13.1-75 precludes the instant action.

Plaintiffs advise the Court that the Durham Hosiery merger has been the subject of several other judicial proceedings in various state and federal courts. Portions of those actions are instructive here. Defendants have made similar arguments in these cases but their position on which state appraisal remedy applies has vacillated.¹ The Court finds that N.C.Gen.Stat. § 55-113 grants plaintiffs an appraisal remedy and that this remedy is not exclusive. Section 55-113 applies to shareholders of both successor and predecessor corporations in a merger, and it expressly states that a shareholder may seek payment under the statute "in addition to any other right he may have in law or equity." N.C.Gen.Stat. § 55-113(a)(2), (b). Plaintiffs here are merely pursuing other rights.

The four count Complaint alleges (1) a breach of fiduciary duty, (2) a violation of Rule 10b-5, (3) common law fraud, and (4) racketeering.² Corporate directors, officers and majority shareholders owe fiduciary duties to minority shareholders. Meiselman v. Meiselman, 58 N.C.App. 758, 295 S.E.2d 249 (1982); N.C.Gen.Stat. § 55-35. Defendants contend no breach of any fiduciary duty occurred and, not surprisingly, their version of the merger is quite different from plaintiffs'. However, plaintiffs' allegation, taken as true, that defendants intended to freeze out the minority shareholders adequately states a breach of fiduciary duty claim.

Rule 10b-5, 17 C.F.R. § 240.10b-5, promulgated under the authority of section 10(b) of the Securities and Exchange Act of 1934, 15 U.S.C. § 78j, provides:

It shall be unlawful for any person, directly or indirectly, by the use of any means or instrumentality of interstate commerce, or of the mails or of any facility of any national securities exchange,

(a) To employ any device, scheme, or artifice to defraud,

(b) To make any untrue statement of a material fact or to omit to state a material fact necessary in order to make the statements made, in the light of the circumstances under which they were made, not misleading, or

(c) To engage in any act, practice, or course of business which operates or would operate as a fraud or deceit upon any person,

in connection with the purchase or sale of any security.

The four elements in a Rule 10b-5 action are (1) conduct by defendant which is prohibited by the Rule, (2) purchase or sale of security by plaintiff in connection with defendant's conduct, (3) damages, and (4) scienter. Gilbert v. Bagley, 492 F.Supp. 714, 727 (M.D.N.C.1980).

Plaintiffs' allegations that the notices and information generated by defendants and sent to them as shareholders omitted certain financial information which would establish the true financial condition of Durham Hosiery and materially misrepresented the terms and circumstances of recent "market transactions" which affected the value of the corporate stock are sufficient. Whether the plaintiffs sold or purchased stock in connection with such prohibited conduct is not so easily decided. In Blue Chips Stamps v. Manor Drug Stores, 421 U.S. 723, 95 S.Ct. 1917, 44 L.Ed.2d 539 (1975), the Supreme Court reaffirmed the rule that a private damages suit under Rule 10b-5 is confined to actual purchasers or sellers of securities, a rule first established in Birnbaum v. Newport Steel Corp., 193 F.2d 461 (2d Cir.), cert. denied, 343 U.S. 956, 72 S.Ct. 1051, 96 L.Ed. 1356 (1952). There are, however, exceptions to this rule and plaintiffs contend that they are excepted as "constructive sellers" under the "forced seller doctrine." A shareholder should be treated as a seller when the nature of his investment has been fundamentally changed from an interest in an ongoing enterprise to a right solely to payment of money for his shares. Vine v. Beneficial Finance Co., 374 F.2d 627 (2d Cir.), cert. denied, 389 U.S. 970, 88 S.Ct. 463, 19 L.Ed.2d 460 (1967) (sufficient number of corporate stocks acquired by one party permitted a short-form merger without approval of class of shareholders of which plaintiff was a member). When a shareholder has in substance become a seller despite the fact that he still holds stock certificates in a non-functioning corporation, the purchase/sale element of Rule 10b-5 is not a bar to recovery. Coffee v. Permian Corp., 434 F.2d 383, 386 (5th Cir.1970).

While the instant case is factually distinguishable from Vine in that the Durham Hosiery merger was not a short-form merger but was approved by a majority of the shareholders, the facts of this case warrant finding plaintiffs were effectively Rule 10b-5 purchasers. In S.E.C. v. National Securities, Inc., 393 U.S. 453, 89 S.Ct. 564, 21 L.Ed.2d 668 (1969), shareholders who voted in favor of a merger and obtained stock in the new corporation were deemed to have "purchased" stock in the new company by exchanging it for their old stock. Plaintiffs are not "deferred sellers" who have no standing under Rule 10b-5. See Gurley v. Documation Inc., 674 F.2d 253 (4th Cir.1982) (deferred seller claim barred because of the high risk of manufactured, nuisance suits). Rather, by voting against the merger, plaintiffs effectively purchased stock in the new Durham Hosiery. Their failure to allege that they sold or exchanged their shares is inconsequential since the merger was consummated. Marsh v. Armada Corp., 533 F.2d 978 (6th Cir.1976), cert. denied, 430 U.S. 954, 97 S.Ct. 1598, 51 L.Ed.2d 803 (1977). The merger itself effected an exchange which satisfies the purchase or sale requirement, and the allegations that plaintiffs have been denied the fair value of their shares as a result of the defendants' willful and fraudulent behavior are adequate to withstand the motion to dismiss.³

In substance, common law fraud is a false representation of a material fact calculated to deceive and which does deceive one to his injury. Johnson v. Phoenix Mutual Life Ins. Co., 300 N.C. 247, 252, 266 S.E.2d 610, 615 (1980). The Complaint adequately states a claim for fraud.

In Count IV, plaintiffs allege a violation of section 1962(c) and (d) of the Racketeer Influenced and Corrupt Organization (RICO) chapter of Title 18 of the United States Code, 18 U.S.C. §§ 1961-68. In order to withstand a motion to dismiss, the Complaint must sufficiently allege that (1) an enterprise existed; (2) illegal activity was used to conduct the enterprise; (3) the illegal activity was a pattern of racketeering as proscribed by RICO; and (4) the necessary interstate commerce connection existed. Gilbert v. Bagley, No. 78-335-WS (M.D.N.C. September 17, 1982). None of defendants' arguments warrant dismissal at this time, and the plaintiffs alleged the RICO cl...