Zobrist v. Coal-X, Inc.

• Decision Date: 11 April 1983
• Docket Number: COAL-,Nos. 82-1055,82-1104,INC,s. 82-1055
• Citation: 708 F.2d 1511
• Parties: Fed. Sec. L. Rep. P 99,163 Herman ZOBRIST, Neil Rasmussen and Phil Rasmussen, Plaintiffs-Appellees, Cross- Appellants, v., a corporation, Emmet L. Shultz and Paul B. Baker, Defendants- Appellants, Cross-Appellees, and Gulf Energy Corporation, a corporation, Russell L. Greene and Does I Through XX, Defendants, Cross-Appellees.
• Court: U.S. Court of Appeals — Tenth Circuit

Page 1511

708 F.2d 1511

Fed. Sec. L. Rep. P 99,163

Herman ZOBRIST, Neil Rasmussen and Phil Rasmussen Plaintiffs-Appellees, Cross- Appellants, v. COAL-X, INC., a corporation, Emmet L. Shultz and Paul B Baker, Defendants- Appellants, Cross-Appellees and Gulf Energy Corporation, a corporation, Russell L. Greene and Does I Through XX, Defendants, Cross-Appellees.

Nos. 82-1055, 82-1104.

United States Court of Appeals Tenth Circuit.

April 11, 1983.

Rehearing Denied July 1, 1983.

Robert A. Peterson of Van Cott, Bagley, Cornwall & McCarthy, Salt Lake City, Utah, for plaintiffs-appellees, cross-appellants.

Daniel L. Berman of Berman & Anderson, Salt Lake City, Utah (Gary F. Bendinger and Richard W. Casey of Giauque & Williams, Salt Lake City, Utah, with him on briefs), for defendants-appellants, cross-appellees.

Before HOLLOWAY, BARRETT and LOGAN, Circuit Judges.

BARRETT, Circuit Judge.

Phil Rasmussen, appellee in No. 82-1055, and Neil Rasmussen and Herman Zobrist, cross-appellants in No. 82-1104, brought an action pursuant to section 10(b) of the Securities and Exchange Act of 1934 and rule 10b-5 promulgated under that section, against Coal-X, Inc., Emmet L. Shultz, and Paul B. Baker (defendants). The jury rendered a special verdict in the amount of $50,000 in favor of Phil Rasmussen against the three defendants. Although there was a slight ambiguity in the verdict, the trial judge entered a judgment in that amount against the defendants. In the special verdict, however, the jury determined that Neil Rasmussen and Herman Zobrist were not entitled to damages and judgment was entered accordingly. In No. 82-1055, the defendants appeal from the judgment in favor of Phil Rasmussen, while in No. 82-1104, Neil Rasmussen and Herman Zobrist appeal from the judgment in favor of the defendants.

I.

Both appeals arise from the same business transaction, the organization of Coal-X, Ltd./'76 (Coal-X '76), a Utah limited partnership formed to raise venture capital for a coal mining operation in West Virginia. Coal-X, Inc. is the general partner in Coal-X '76. At the time relevant here, the summer of 1976, Emmet Shultz was the president and a director of Coal-X, Inc., while Paul Baker was a vice-president and a director of that entity. While employed by the Huntsman Coal Company, Shultz, with the assistance of independent geologists, evaluated a certain coal property in West Virginia. Based on those evaluations, the Huntsman Coal Company entered into a sublease which granted it the right to develop the coal on that property. The company prepared a private placement memorandum and certain projections in anticipation of selling limited partnership interests to finance the development of the property. Later, for disputed reasons, Huntsman Coal Company abandoned the project and sold its entire interest in the project, including the private offering materials, to Shultz for $5,000. Shultz subsequently left Huntsman Coal Company and prepared to develop the coal property through Coal-X '76.

Pursuant to section 4(2) ¹ of the Securities Act of 1933, and rule 146 ² promulgated thereunder, interests in Coal-X '76 were marketed through a private placement offering. Accordingly, interests in Coal-X '76 could be offered only to a limited number of investors, all of whom either possessed "such knowledge and experience in financial and business matters that [they were] capable of evaluating the merits and risks of the prospective investment" or were persons "who [were] able to bear the economic risk of the investment". Rule 146(d)(1), 17 C.F.R. Sec. 230.146 (1981) (removed at 47 Fed.Reg. 11261 (1982)). Herman Zobrist, Neil Rasmussen, and Phil Rasmussen were among the investors contacted by the defendants to purchase interests in Coal-X '76.

Shultz and Baker, and their representatives, met with Zobrist and the Rasmussens several times over a period of about thirty to forty-five days before any interests were sold. At those meetings, the defendants described the investment as a good opportunity and provided oral and written projections which presented the potential benefits of the investment. Although there was conflict in the evidence, the jury apparently determined that Baker represented to Phil Rasmussen that the investment "couldn't miss" and was a "sure thing". When Phil Rasmussen challenged those assertions, the defendants assured him that there were "no risks" in the investment and that they would guarantee with their stock that the investment would work out as projected.

Either prior to the time the Rasmussens and Zobrist purchased their interests in Coal-X '76, or shortly thereafter, the defendants provided each of those investors with a Private Placement Memorandum. ³ The memorandum clearly and specifically stated the risks involved in the investment, including the lack of a firm output contract, the speculative nature of coal mining, the fluctuation of metallurgical coal prices in response to fluctuations in steel production, and competition from larger, more experienced coal mining companies. Prior to the time of their purchases, Zobrist and the Rasmussens each signed an "Application Form and Subscription Agreement" which included a statement that the investor recognized that the investment was subject to the risks set forth in the Private Placement Memorandum. Phil Rasmussen also completed and signed an "Investment Questionnaire" wherein he responded affirmatively to questions inquiring whether he had read the memorandum and whether he understood the nature of the investment and the risks involved. It is undisputed, nevertheless, that Zobrist and the Rasmussens in fact did not read the Private Placement Memorandum prior to investing in Coal-X '76.

Herman Zobrist and Phil Rasmussen each purchased two units in Coal-X '76 at $35,000 per unit and Neil Rasmussen purchased one unit. Pursuant to Utah law, each investor was afforded an opportunity to rescind his purchase but declined to do so. Due to permitting problems and unusually severe weather, Coal-X '76 did not commence commercial production until 1977. After production began, labor strikes impeded the development of the venture and declining steel production depressed the price offered for metallurgical coal. Consequently, Coal-X '76 lost between $800,000 and $900,000 between 1977 and 1979, which in turn reduced the value of a limited partnership interest in Coal-X '76. Gulf Energy, a parent of Coal-X, Inc., loaned over $800,000 to Coal-X '76 to keep the mine in operation. The mine remains in operation today and has produced at levels exceeding what was originally projected.

In 1979, however, the Rasmussens and Zobrist became convinced that the investment had missed, and filed this action, claiming damages as a result of violations of section 10(b) of the Securities and Exchange Act of 1934 ⁴ and rule 10b-5 promulgated thereunder. ⁵ Phil Rasmussen claimed that the defendants' assertions and guarantees that the investment involved no risk were misrepresentations of material facts in violation of rule 10b-5. In addition, the Rasmussens and Zobrist asserted that the defendants violated rule 10b-5 by failing to disclose material facts. The jury, in a special verdict, found that each of the defendants knowingly violated rule 10b-5 by misrepresenting material facts to Phil Rasmussen, that he justifiably relied on those misrepresentations, and that as a result, he suffered $50,000 in damages. With respect to Neil Rasmussen and Herman Zobrist, however, the jury found that while the defendants violated rule 10b-5 by knowingly failing to disclose material facts to those investors, the investors had not justifiably relied on those failures to disclose. Thus, the jury found that Neil Rasmussen and Zobrist were not entitled to any damages.

On appeal, the primary contention of the defendants is that, as a matter of law, Phil Rasmussen's reliance on the misrepresentations that the investments involved no risk could not be "justifiable" when those representations were contradicted by the warnings in the Private Placement Memorandum, which he failed to read. The defendants also contend that there was not evidence to support the damage award of $50,000, that the damage award was based on an ambiguous special jury verdict, and that the trial court's instruction on scienter was erroneous. ⁶ The cross-appellants, Neil Rasmussen and Zobrist, contend that because the defendants failed to disclose material facts, reliance should have been presumed. In addition, Zobrist and both the Rasmussens argue that the trial court erred in not granting them a rescissional measure of damages.

II.

A.

We will first examine the contention of the defendants that Phil Rasmussen did not "justifiably rely" on the misrepresentations as to the risk involved in the investments. In a misrepresentation case under rule 10b-5, a plaintiff generally must establish that in connection with the purchase or sale of a security, the defendant, with scienter, made a false representation of a material fact upon which the plaintiff justifiably relied to his or her detriment. See Holdsworth v. Strong, 545 F.2d 687, 694 (10th Cir.1976), (en banc), cert. denied, 430 U.S. 955, 97 S.Ct. 1600, 51 L.Ed.2d 805 (1977). In the instant case, the jury found that the defendants did make the "no risk" representations, that Phil Rasmussen relied on those misrepresentations, and that such reliance was justifiable. The defendants argue that since Phil Rasmussen was a sophisticated businessman with prior investment experience, his reliance on the no risk representations without reading the Private Placement Memorandum, which expressly warned of risks, was not justifiable as a matter of law. Phil Rasmussen responds that the jury examined the defendants' entire course of conduct in finding that his reliance was justifiable. If the effect of such conduct can be mitigated by "boiler plate" recitations of risk in a prospectus, he contends, the...