Petition — Coleco Industries, Inc. v. Berman

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Text

~ $upreme Court, U.S, .

{ FILED \

JUN 2 1978

IN THE . > |

Seasons Gent tt ti Cetet Gees

October Term, 1977

No. i i ] 725

COLECO INDUSTRIES, INC.,

Petitioner,

ABE BERMAN, JOSEPH RUBIN, IRVING COHEN,

LEWIS M. COHEN, FREDERICK COHEN,

ZELNICK, SOBELMAN & COMPANY,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

JOSEPH A. YABLONSKI

DANIEL B. EDELMAN

Yablonski, Both & Edelman

1150 Connecticut Avenue, NW

Suite 500

Washington, DC 20036

Attorneys for Coleco Industries, Inc.

NT YN

THE CASILLAS PRESS, INC. —1717 K Street N W —Westungton, 0. C.~223-1220

= -*

(i)

TABLE OF CONTENTS

Page

EY 6 o00nb.0n6ee0esbeGh ae entabacedanendens 1

EE ne eveneeneseenhennces 4b.400600 ke Cae tbs 2

ee oi ce deadccepeewdeeldeetes duces 2

ED cass cwnneddhéséeceheusontecues 2

EY SE. ik. vc cnesccccedctueudbeeousd< 2

Bp TRUCE eh occ cdccevecencccécncsenessins 3

B. The District Court's Preclusion Ruling and

GEN 0 00:66 oneecb cen ehed.00666s 000080600 es000 7

C. The Court of Appeals Opinion. ............600e ee eee 9

REASONS FOR GRANTING THE WRIT

THIS COURT SHOULD EXERCISE ITS CER-

TIORARI POWER TO RESTORE THE PRETRIAL

PROCESS TO THE FORM INTENDED BY RULE

16, F.R.C.P. AND TO RESOLVE THE CONFLICT

AMONG THE CIRCUITS REGARDING THE

PRECLUSION OF EVIDENCE NOT SPECIFIED IN

A PRETRIAL MEMORANDUM ...........0050000005 10

SED 265 oe Cece dddaden eenidcdss eecesubeenssaeé 17

(ii)

TABLE OF AUTHORITIES

Page

Cases

Dudley v. South Jersey Metal. Inc..

I i Na I ed a i)

Foman v. Davis,

re i A el de ecb ccecakens 14

Jones v. Union Automobile Indemnity Ass'n..

a ec i ab dic ceed in keeelan 11

McCargo v. Hedrick, .

SS 13, 15, 16

Meyers v. Pennypack Woods Home Ownership Ass'n..

Er ee 9

Padovani v. Bruchhausen,

ES Se De 17

Peter Eckrich & Sons, Inc. v. Selected Meat Co..,

SP es TaMUOED oc cccecccctccccccscccciecece 15

Schlagenhauf v. Holder.

I a 13,14

Societe Internationale v. Rogers,

I i 14

Statutes and Rules

Federal Rules of Civil Procedure.

Pi nine ChUCEKEdS uENe ees cu, 2.5, 9, 10, 11, 13, 1S, 16, 17

Local Rules for the United States District Court

for the Eastern District of Pennsylvania .

EER ek Se ane ee 2,3, 4,5,9

(iii)

United States Judicial Code, 28 U.S.C.

Burger, Address to the National Conference on the

Causes of Popular Dissatisfaction with the Admin-

istration of Justice, 70 F.R.D. 79(1976) ... 6... 6c eee ee eees 12,

Clark, Seminar on Procedures for Effective Judicial

Administration, 29 F.R.D. 191 (1961)... 2... ee eee eee

Pollack, Pretrial Procedures More Effectively

Handled, 65 F.R.D. 47S (1975S) 2... eee eee eee 12, 13

Wright, Address to the Judicial Conference of the

Tenth Circuit, as quoted in Pollack, Pretrial

Conferences, An Address to the Judicial Conference

of the Eighth Judicial Circuit of the United

States. SOP.R.D. 427 (IGT 2. ccc cc cccccccccccccccveees

Dobie, The Federal Rules of Civil Procedure 25

WA, Bie, BERIT cw ccc ccccccccccccvcccscsccceseces

A 0 ee en -

IN THE

Supreme Comt of the Anited States

October Term, 1977

COLECO INDUSTRIES, INC..,

Petitioner,

ABE BERMAN, JOSEPH RUBIN, IRVING COHEN,

LEWIS M. COHEN, FREDERICK COHEN,

ZELNICK, SOBELMAN & COMPANY,

Respondents.

PETITION FOR A WRIT OF CERTIORARI TO

THE UNITED STATES COURT OF APPEALS

FOR THE THIRD CIRCUIT

The Petitioner, Coleco Industries, Inc. respectfully prays

that a Writ of Certiorari issue to review the decision of the

United States Court of Appeals for the Third Circuit en-

tered in this proceeding on November 25, 1977.

OPINIONS BELOW

The Opinion of the United States Court of Appeals for

the Third Circuit is officially reported at 567 F.2d 569. It is

appended to this Petition as Appendix A (1la-18a).

The Opinion and Order of the United States District

Court for the Eastern District of Pennsylvania is reported at

423 F.Supp. 275 and is appended to this Petition as Ap-

pendix B (19a-14Sa).

JURISDICTION

The jurisdiction of this Court is invoked under 28 U.S.C.

1254(1). The decision of the United States Court of Appeals

was entered on November 25, 1977. A timely filed petition

for rehearing and suggestion for rehearing en banc was

denied on January 6, 1978. By orders dated March 28, 1978

and April 26, 1978, Mr. Justice Brennan extended the time

for filing this Petition to and including June S, 1978.

QUESTION PRESENTED

The issue presented is whether precluding a party from

submitting evidence which the Court later finds ‘‘critical”’

to its claim can be justified where the trial court has not en-

tered a pre-trial order pursuant to Rule 16 and the party

precluded has made massive pre-trial filings describing its

anticipated proof.

STATUTES INVOLVED

This Petition involves Rule 16 of the Federal Rules of

Civil Procedure and Local Rule 7 of the Rules of the United

States District Court for the Eastern District of Pen-

nsylvania which are appended as Appendix C (143a, 144a-

154a).

STATEMENT OF THE CASE

This action arises from a 1973 Agreement by Coleco In-

dustries, Inc. (“Coleco’’) to purchase a swimming pool

manufacturing company, Royal All-Aluminum Swimming

Pools, Inc. (“‘Royal’’) from Royal’s shareholders, Abe Ber-

man, Joseph Rubin and the Cohen brothers, Respondents

herein. The selling price included $500,000, to be paid ir:

three annual installments, and additional, contingent

payments based upon Royal’s after-tax earnings in the

three years following acquisition.

Within six months after the acquisition, Royal failed. In

December, 1973, Coleco filed suit against the selling

shareholders and Royal’s accountant, Zelnick, Sobelman &

Company. Claiming, among other things, a material breach

of the Purchase Agreement, Coleco sought to recover its

first installment payment of $135,000 and more than

$800,000 in additional damages, representing Coleco’s out-

of-pocket losses in Royal. Respondents counterclaimed and

sought damages inter alia for the balance of the Purchase

Price — $365,000, plus interest from the date of purchase.

In defending the contract counterclaim, Coleco maintained

that the materiality of Respondents’ contract breach

relieved it of any further obligation to pay the balance of

the non-contingent purchase price. Thus, materiality of

Respondents’ breach was critical, not just to the

prosecution of Coleco’s claims, but to its defense as well.

A. The Pretrial Period.

In the eighteen months after suit was filed, the parties

engaged in extensive discovery, including voluminous

depositions, interrogatories and requests for documentary

production. By any yardstick, the case was massive and

complex. On July 31, 1975, the district court entered an or-

der requiring the completion of the discovery by October 1,

1975, setting a final pre-trial conference for late October

and a trial date of November 10, 1975. One week later, the

Court entered a lengthy “form’”’ order directing the filing of

“final Pretrial Briefs.’’ At that time, Rule 7 of the Local

Rules for the United States District Court for the Eastern

District of Pennsylvania outlined the items to be included

in a pre-trial memorandum, but permitted each Judge to

establish his own requirements:

“(a) . . . Unless otherwise determined by the

judge such pre-trial memorandum shall contain

the following:

(1) A brief summary of both the facts of the case

and counsel’s contentions as to the liability of

defendant... .”

(2) A brief description of the damages claimed

and the basis thereof. . . .

** *

(b) Except for witnesses called on rebuttal or

surrebuttal, a witness neither (1) named in any

pre-trial memorandum or supplements thereto of

any party, nor (2) authorized by the court in order

to prevent manifest injustice, may not testify at

the trial if timely objection is made by opposing

counsel.

require more or less elaborate pre-trial memoran-

da and may publish his own standing order with

respect to the manner in which he intends to hold

pre-trial conferences and his requirements of

counsel in respect of pre-trial procedures.”’ (144a-

145a) (Emphasis supplied).

Judge Huyett’s order did not contemplate the brevity

suggested by the Local Rules; rather, his order directed

‘plaintiff’ to file a Final Pretrial Brief “*. . . which shall not

thereafter be amended or supplemented and shall contain

in the following order:”

‘“(a) Proposed stipulations of specific facts

framed for reading to the jury;

(b) Plaintiff's contentions on specific disputed

facts;

specific issues of law;

(d) Plaintiff's final designation of witnesses to

be called at trial, listed in the order in which they

will be called and briefly identifying each witness

and specifying the evidence which the witnesses

will give;

(e) Plaintiff's final designation of the specific

portions of deposition testimony which they will

offer in evidence at the trial;

(f) Plaintiff's designation of specific answers to

interrogatories which they will offer in evidence at

trial;

(g) Plaintiffs designation of the specific

documents which they will introduce at the trial;

(h) Requests for instructions to the jury;

(i) Proposed special interrogatories to the jury.”

Neither the Local Rule nor Judge Huyett’s order stated that

evidence of specific facts not included in the memoranda

would be precluded at trial." On October 28, 1975, in com-

pliance with Judge Huyett’s order, Coleco filed a massive

Pretrial Brief, 157 pages in length and containing a total of

‘The Local Rules were amended after trial, but before a decision was

rendered. The Local Rules, as amended, are reproduced in Appendix C

(146a-154a). The amended rules set forth four pages of items to be in-

cluded in each party’s pre-trial memorandum (150a-153a), require a

pre-pre-trial conference among counsel, and provide that the pre-trial

order will be written by the parties and only signed by ihe Court, ali of

which are contrary to the letter and spirit of Rule 16, F.R.C.P. See pp.

12, 15-16, infra.

715 paragraphs of proposed stipulations, factual and leg.l

contentions and lists of documents and witnesses.

The core of Coleco’s contract claim was that Royal’s

profit and loss statement, warranted as accurate by the

selling shareholders, overstated gross profits as 35% rather

than 14%. To support its claim, Coleco planned to show

that Royal’s financial statements understated the cost of

goods sold during the quarter immediately preceding

acquisition by $130,000. Two errors which accounted for

approximately $50,000 of the understatement were essen-

tially undisputed and were ultimately conceded. Coleco

contended that the remaining discrepancy of $80,000 oc-

curred because the constituent pool parts had actually cost

more than indicated by the warranted statements.

Believing Royal’s actual costs to be undisputed, Coleco

moved for partial summary judgment on its contract claim

more than one month before trial, appending an affidavit

and invoices for goods purchased by Royal during 1973.

The summary judgment motion was not argued until

November 3, 1975, one week before trial was to begin. At

that hearing Respondents resisted summary judgment,

arguing for the first time, as the district court later

acknowledged (8Sa-86a & n.46), that because Royal utilized

First-In, First-Out accounting, Coleco should have shown

the costs of goods purchased in 1972 which remained in in-

ventory at the beginning of the accounting period in

question. (85a-86a & n.46). In ether words, Respondents

argued that Coleco could prove the additional $80,000 error

only through 1972 invoices and not through the 1973 in-

voices as Coleco had done in its summary judgment motion

and appended affidavit and exhibits.

Preparation for trial proceeded while the motion was sub

judice. A pre-trial conference was held in late October. No

pre-trial order was entered in any way limiting the evidence

to be presented at trial.

B. The District Court’s Preclusion Ruling

and Opinion.

Coleco’s Motion for Summary Judgment was denied on

the first day of trial, thereby highlighting the importance to

Coleco of proving that 1972 costs were at least equivalent to

those in 1973. Accordingly, Coleco undertook a comparison

of Royal’s 1972 and 1973 invoices. In the second week of

trial,? Coleco called F. James Hubert, its Controller, to

prove errors in the Profit and Loss Statement including the

errors of undercosting.

Counsel for Respondents were permitted to take a ‘dry

run”’ of Hubert’s testimony outside the hearing of the jury

during which Hubert testified that he determined that the

actual cost of pools was much higher than represented by

the accounting papers based upon his review of the 1973 in-

voices (Tr. 1152). On cross-examination by counsel for the

Cohens, with the jury not present, Hubert stated that he

had also reviewed the 1972 invoices (Tr. 1166-67); and on

redirect, he testified that the 1972 costs were, if anything,

higher than 1973 costs (Tr. 1168-69). Before Hubert

resumed his testimony involving costs before the jury, Judge

Huyett permitted his deposition to be taken by Respon-

dents during the evening recess (Tr. 1178-11824).

When Hubert took the stand before the jury, the Court,

over Coleco’s objection, precluded Coleco from offering

evidence regarding 1972 costs stating that such evidence

was not listed in its Pretrial Brief and that admission of

such evidence would unduly prejudice the Respondents.

The Court stated that Coleco had not sought to amend its

pretrial memorandum. Neither the Court nor Respondents’

counsel could then — nor at any time since then — point to

any paragraph or even a phrase in Coleco’s pretrial

Ultimately the trial lasted thirty-four days. It began as a jury trial,

but at mid-point, all parties agreed to dismiss the jury and try the case

to the Court.

memorandum which necessitated any amendment.’

Nothing in Coleco’s submission required amendment or

modification because Coleco did not state in its pre-trial

memorandum how it would prove the $80,000 undercosting

error. Rather, its memorandum stated that the quarterly

financial statement preceding acquisition overstated in-

ventory and understated costs of goods sold by a total of

$130,000 which included the undisputed errors of

$17,372.88 and $32,550. No specific documents were relied

upon or listed as supportive of the remaining $80,000 un-

dercosting error. Coleco did, however, identify in its pre-

trial memorandum — in a list ten pages long — various

documents which might be introduced at trial including

both the 1972 and 1973 invoices.‘ Thus, even if the

Petitioner’s own pre-trial memorandum somehow acquired

the force and effect of an order, there was nothing in the

memorandum which was misleading or required amend-

ment.

In its Opinion and Order, the District Court

acknowledged that the “‘blow’’ dealt to Coleco by the

preclusion ruling was fatal to Coleco’s attempt to prove the

$80,000 undercosting error (86a & n. n. 46). By preventing

Coleco from establishing the materiality of Respondent's

breach, the ruling deprived Coleco both of its contract

*The error committed by the Court in excluding this evidence was, in

Coleco’s view, compounded when, following cross-examination of

Hubert regarding statements contained in his summary judgment af-

fidavit to the effect that he was then relying upon 1973 invoices, the

Court prohibited Coleco from rehabilitating Hubert on redirect by

showing that the 1972 costs were equal or more than 1973 costs. (Tr.

1435-1438).

“Because of its length and the numerous subjects required to be in-

cluded by the Court's order, Coleco’s Pre-Trial Memorandum was not

consecutively paginated. References in the text are to the parts of the

Memorandum entitled “April 30, 1973 Financial Statement,”

paragraphs 11, 12, 17-19, and a section entitled ‘‘Documents,”’

paragraph 16 (ee) and (ff).

damages for material breach and its defense of material

breach to Respondents’ counterclaims, which uitimately

resulted in an over-all loss to Coleco of more than one-half

million dollars. (110a-1 11a, 140a-141a).

C. The Court of Appeals Opinion.

In its opinion, disposing of the various issues raised by

Coleco and Respondents in their cross-appeals (3a-18a), the

Third Circuit affirmed the preclusion ruling.

Acknowledging that Judge Huyett’s ruling had “‘drastic’’

consequences for Coleco and noting that “two recent

decisions of this Court have applied relatively strict scrutiny

for abuse of discretion in cases of evidentiary exclusions”

(13a & n.14),° the Court, nevertheless, found ‘‘no excuse”’

presented for Coleco’s ‘‘failure to advise the Court earlier

that the evidence would be offered. . . .”’ (12a-13a). (The

Court was aware that Coleco did not even have reason to

check the 1972 invoices until the issue was first raised at the

summary judgment argument, a week before trial). The

Court of Appeals, without reference to Rule 16, F.R.C.P.,

found that the Local Rule in effect at the time of trial —

Local Rule 7 — “made no explicit provision for a pretrial

order, and indeed contemplated the required pretrial

memorandum [submitted by each party] as having

preclusive effect, at least as to witnesses.”’ (12a & n.13).

“Most importantly’, the panel decision found that the

pretrial order issued by Judge Huyett required ‘‘Plaintiffs’

final designation of witnesses to be called at trial . . . briefly

identifying each witness and specifying the evidence which

the witnesses will give.” (12a) The Third Circuit held that

“given this order” it could not conclude that it was ‘‘an

“Meyers v. Pennypack Woods Home Ownership Assn., 559 F.2d 894

(C.A. 3, 1977); Dudley v. South Jersey Metal, Inc., SSS F.2d 96 (C.A. 3,

1977).

abuse of discretion to prevent the plaintiffs [sic] from in-

troducing a study of 1972 invoices which they [sic] neglected

to mention before its introduction at trial.” (12a & n.13)

REASONS FOR GRANTING THE WRIT

THIS COURT SHOULD EXERCISE ITS CER-

TIORARI POWER TO RESTORE THE PRETRIAL

PROCESS TO THE FORM INTENDED BY RULE 16,

F.R.C.P. AND TO RESOLVE THE CONFLICT

AMONG THE CIRCUITS REGARDING THE

PRECLUSION OF EVIDENCE NOT SPECIFIED IN A

PRETRIAL MEMORANDUM.

When the Federal Rules of Civil Procedure were

promulgated by this Court in 1937, they contained in Rule

16 an entirely new concept for the Federal Courts. Under

this Rule, District Court judges could — in their discretion

— direct counsel to appear for a pretrial conference to con-

sider:

“(1) The simplification of the issues;

(2) The necessity or desirability of amendments to

the pleadings;

(3) The possibility of obtaining admissions of fact

and of documents which will avoid un-

necessary proof;

(4) The limitation of the number of expert wit-

nesses;

(S) The advisability of a preliminary reference of

issues to a master for findings to be used as

evidence when the trial is to be by jury;

(6) Such other matters as may aid in the

disposition of the action.”’

The Rule further provides that ‘‘the Court shail make an

order which recites the action taken at the conference... ;

and such order when entered controls the subsequent cour-

se of the action .. . .”” Professor, and later Judge, Dobie

hailed the pre-trial procedure as ‘‘a device with magnificent

potentialities if properly used by abie and fearless judges

dealing with fair-minded lawyers.” Dobie, The Federal

Rules of Civil Procedure, 25 Va. L. Rev. 261, 269 (1939). In

too many instances, however, the pre-trial process has not

measured up to the expectations of Judge Dobie or the in-

tent of Rule 16’s framers. The instant case illustrates — as

well as any — the pitfalls of the process when it is applied in

a wooden and unyielding fashion to the substantial

economic harm of a litigant. In this case, because Coleco

did not state in its massive Pretrial Brief that it would prove

understatements of costs by reference to 1972 invoices, it

was prohibited from proving $80,000 in damages and held

liable for more than $430,000. Unfortunately, the present

case is not a “sport’’ or exception. Abuses of the pre-trial

procedure are the subject of a growing number of appellate

decisions — which contrast sharply with the decision below

— and a stream of criticism from esteemed members of the

bench and bar. Review of the present case is essential to

restore Rule 16 to its proper function in federal litigation

and to resolve a growing and deepening division between

the circuits.

At the outset, it should be noted that the precluded evi-

dence was not contrary to any limitation embodied in a pre-

trial order entered by the Court following the pre-trial con-

ference because no such order was entered here. Rule 16

makes clear — contrary to the decision below — that it is

the order of the Court and not the memoranda of the par-

ties that controls and limits the issues at trial: ‘‘such order

when entered controls the subsequent course of the action .

...”’ (Emphasis supplied). It is axiomatic that “‘i}f pre-trial

is to be used for such a purpose [—#.e., to limit issues for

trial —] there must be a pre-trial order.”’ Jones v. Union

Automobile Indemnity Assn., 287 F.2d 27, 29 (C.A. 10,

1961).

Nearly twenty years ago, Judge Clark, Reporter and a

Charter member of the Advisory Committee on the Rules,

expressed alarm that preclusion orders were ‘‘depriving

litigants of fundamental rights’ Seminar on Procedures for

Effective Judicial Administration, 29 F.R.D. 191 (1961):

“My concern arises because I fear the pressure of

congested calendars and overburdened courts has

worked toward the resort to ever severer pre-trial

orders based at bottom on the failure of a litigant

or, perhaps more, his lawyer to reveal all, even

down to the legal theories of his case.” Jd. at 456.

Commenting on the Local Rules for the Southern District

of New York, which required detailed submissions by the

parties similar to the pre-trial order entered here, Judge

Clark argued that ‘‘they appear . . . to bring back the

outlawed special pleading with, indeed, a bang.” ‘‘[The]

multitude of details as to which counsel for both sides must

set forth in writing in advance of the pre-trial hearing [un-

der threat of sanctions of preclusion, default or dismissal]

. would seem to require detailed pleading contrary to

[Rule] 8a)... . And this requirement of a kind of pre-pre-

trial special pleading seems at war with the basic concept of

F.R. 16 looking to a conference of Court and trial counsel,

settling points of agreement between them.” Jd. at 458-459.

(Emphasis in original.¥

More recently, Chief Justice Burger identified pre-trial

procedures as one of the nine areas of concern requiring

fundamental changes:

*Fourteen years later, District Judge Milton Pollack echoed similar

criticisms of the Local Rules of the Southern District of New York:

“(1) they represent a mere compilation of legalistic con-

tentions and pleadings without any real analysis of the par-

ticular case, (2) they result in formal agreements on

minutiae which have no significant effect on the result of

the case, (3) they represent a burdensome chore in cases

“Now . . . after more than 35 years’ experience

with pretrial procedures, we hear widespread

complaints that they are being misused and

overused. . . . The complaint is that misuse of

pretrial procedures means that ‘‘the case must be

tried twice.’ The responsibility for correcting this

lies with lawyers and judges for the cure is in our

hands.”’ Address to the National Conference on

the Causes of Popular Dissatisfaction with the

Administration of Justice. 70 F.R.D. 79, 95-96

(1976). (Emphasis supplied.)

Elaborating on the concern of trying a case twice, expressed

by the Chief Justice, the Fourth Circuit has held that ‘Rule

16 was never meant to make lawyers try a case on paper...

.”” before trying it in a federal courtroom. McCargo v.

Hedrick, SAS F.2d 393, 401 (C.A. 4, 1976). See also, Ad-

dress of Judge J. Skelly Wright to the Judicial Conference of

the Tenth Circuit, reproduced in part at SO F.R.D. 454-56

(1970).

Given the abuses which have elicited expressions of alarm

from such sources, there can be little doubt that the present

case presents an issue urgently requiring this Court’s at-

tention. This Court has recognized its unique responsibility

to oversee the construction and application of the Federal

Rules. Thus, in Schlagenhauf v. Holder, 379 U.S. 104

(1964), it was noted that “{njormally, wise judicial ad-

ministration would counsel remand of the cause to the

Court of Appeals... .”

“However, in this instance the issue concerns the

construction and application of the Federal Rules

of Civil procedure. It is thus appropriate for us to

determine on the merits the issues presented and

plainly destined to be settled before trial, and (4) they are

ceremonial, ritualistic exercises with little actual impact or

actual value to the Bar or the trier of fact.”

to formulate the necessary guidelines in this area.

See Van Dusen v. Barrack, 376 U.S. 612, 84 S.Ct.

805, 11 L.Ed.2d 945. As this Court stated in Los

Angeles Brush Mfg. Corp. v. James, 272 U.S. 701,

706, 47 S.Ct. 286, 288, 71 L.Ed. 481:

‘(We think it clear that where the subject con-

cerns the enforcement of the * * * rules which by

law it is the duty of this court to formulate and

put in force * * * it may * * * deal directly with

the District Court * * *.’

See McCullough v. Cosgrave, 309 U.S. 634, 60

S.Ct. 703, 84 L.Ed. 992, 379 U.S. at 112.” 379

U.S. at 111-112.

See also Societe Internationale v. Rogers, 357 U.S. 197, 203

(1958). Moreover, the admittedly ‘‘drastic’’ consequences

which befell Coleco as a result of an alleged single misstep

by counsel is directly at odds with the entire spirit of the

Rules.

“It is too late in the day and entirely contrary to

the spirit of the Federal Rules of Civil Procedure

for decisions on the merits to be avoided on the

basis of such mere technicalities. ‘The Federal

Rules reject the approach that pleading is a game

of skill in which one misstep by counsel may be

decisive to the outcome and accept the principle

that the purpose of pleading is to facilitate a

proper decision on the merits.’ Conley v. Gibson,

355 U.S. 41, 48, 78 S.Ct. 99, 103, 2 L.Ed. 2d 80.

The Rules themselves provide that they are to be

construed ‘to secure the just, speedy, and inex-

pensive determination of every action.’ Rule 1.”

Foman v. Davis, 371 U.S. 178, 181-82 (1962) (Em-

phasis supplied).

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Finally, the decision below collides not only with other

decisions of the Third Circuit noted above, supra n. S, but

also with a growing number of decisions from other circuits

which have reversed preclusion or dismissal orders on the

grounds that the underlying pre-trial process was wholly in-

consistent with Rule 16. In Peter Eckrich & Sons, Inc. v.

Selected Meat Co., 512 F.2d 1158 (C.A. 7, 1975), the lower

court had excluded the testimony of Plaintiff's expert wit-

nesses because the witnesses had not been listed in the pre-

trial order. The Seventh Circuit reversed, holding:

“Rule 16 was never intended to be a trap for un-

wary counsel and their litigants. The rule itself in-

dicates that these conferences are held in order to

produce agreement among the parties and the

trial judge. . . . The order which follows such con-

ferences is intended to be tailored to the par-

ticular case and to reflect ‘agreements made by

the parties.’”’ 512 F.2d at 1163-1164.

There, as here, “the pretrial order was little more than

boiler plate. . . .” /bid. Finally, the Seventh Circuit held

that preclusion of Plaintiffs expert proof was

“unreasonable and unfair’:

“It is often said that a trial is not a game of tac-

tics, but a proceedings designed to achieve sub-

stantial justice among the parties. Here the trial

was a game, and thus resulted in a denial of sub-

stantial justice because it was essential to its case

to have expert testimony.” /d. at 1164

More recently, the Fourth Circuit struck down a Local Rule

which required submission of pretrial memoranda virtually

identical to those required by the order entered by Judge

Huyett.” McCargo v. Hedrick, 545 F.2d 393 (C.A. 4, 1976).

"The Local Rules, as amended (146a-154a), exacerbate the in-

consistency between pre-trial in the Eastern District of Pennsylvania

and Rule 16. See n.1, supra.

In ruling that Local Rule 2.08 of the United States District

Court for the United States District Court for the Northern

District of West Virginia was inconsistent with Rule 16,

F.R.C.P., the late Judge Craven noted that good pretrial

practice “is always simple” — its purpose is to strip each

case to its essentials. Then, speaking on behalf of the Four-

th Circuit, he found:

“Local Rule 2.08 is a distortion of such pur-

poses. Simplicity has been forgotten. The theory

seems to be that if two pages are good, four must

be better, and ten or 13 or 21 may prevent a trial

altogether, as happened here. Rule 16 was never

meant to make lawyers try a case on paper instead

of in a courtroom. In fact, it contemplates that the

district judge himself will dictate the pretrial or-

der. Of course, the court may seek the aid of

counsel in preparing the order, but Rule 16

should not be implemented in such a manner that

the pretrial procedure itself is more difficult and

time consuming than the actual trial.

Local Rule 2.08 subordinates the role of the

lawyer to that of the administering magistrate,

reducing counsel to the role of clerical assistants

who are to anticipate imaginatively what other

matters ought to be embraced within an endless

pretrial order.

The Federal Rules of Civil Procedure freed us

from common law pleading. Under the guise of

‘implementing’ Rule 16, Local Rule 2.08 puts

back into a pretrial order that which was so pain-

fully removed from the complaint and the answer

less than 40 years ago.’’ 545 F.2d at 401 (Em-

phasis supplied).

_—

The foregoing quotations place the Fourth and Seventh

Circuits in irreconcilable conflict with the decision below as

to the intent of Rule 16 as well as its application. See also

Padovani v. Bruchhausen, 293 F.2d 546, 548-549 (C.A. 2,

1961). Review by this Court is essential to resolve this con-

flict, to correct the abuses of the pretrial process embodied

in many Local Rules and “standing orders’ of the in-

dividual district judges and to restore pre-trial to the pur-

poses envisioned by this Court and the framers of Rule 16

when it was initially adopted.

CONCLUSION

For the reasons stated herein, the Petition for Certiorari

should be granted, the judgment of the Court of Appeals

reversed and the cause remanded for further proceedings.

Respectfully submitted,

JOSEPH A. YABLONSKI

DANIEL B. EDELMAN

Yablonski, Both & Edelman

1150 Connecticut Avenue, NW

Suite SOO

Washington, DC 20036

Attorneys for Coleco Industries, Inc.

APPENDIX A

UNITED STATES COURT OF APPEALS

For toe Tump Crmcvir

Nos. 76-2328, 76-2329, 76-2330, 76-2331

COLECO INDUSTRIES, INC.,

Appellant in No. 76-2328

ABE BERMAN; JOSEPH RUBIN; IRVING COHEN;

LEWIS M. COHEN ; FREDERIC COHEN ; and ZEL-

NICK, SOBELMAN & COMPANY

Joseph Rubin, Irvin Cohen, Lewis M. Cohen,

etc., appellants in No. 76-2329

Zelnick, Sobelman & Company, appellant in

No. 76-2330

Abe Berman, appellant in No. 76-2331

On Appzat From tHe Unrrep Srares District Court

For THe Eastern District oF PENNSYLVANIA

C.A. No. 73-2790

Argued October 18, 1977

Before: Apams and Gartu, Circuit Judges, and Layton,

District Judge.*

* United States District Judge for the District of Delaware, sitting by

designation.

JosepH A. YaBLONSKI

Cuar.es R. Boru

Daniet B. Everman

Yablonski, Both & Edelman

Washington, D.C. 20036

Davip BEercer

Ricuarp A. Spracve

Micuakt K. Simon

David Berger, P.A.

Philadelphia, Pa.

Attorneys for Appellant,

Coleco Industries, Inc.

Daxret B. Prersoy, V.

Pierson, Jones & Nelson,

P.C,

Philadelphia, Pa. 19107

Attorney for Appellant,

Joseph Rubin

THeEopore R. Mann

Barry E. Uncar

Larry H. Spector

Mann and Ungar,

Prof. Assoc.

Philadelphia, Pa. 19103

Attorneys for Appellants

Irvin Cohen, Lewis M. Cohen

and Frederick Cohen

Guzxn C. Egur

Bruce D. Lomsarpo

Rosert J. McKer, Jr.

Harvey, Pennington, Hert-

ing & Renneisen, Ltd.

Or CounsEL:

Harvey, Pennincton, Hert-

nG & Rewveisen, Lrp.,

Philadelphia, Pa. 19103

Martin J. Resnick

E. Harris Baum

Zarwin, Baum, Arangio &

Somerson, P.C.

Philadelphia, Pa. 19107

Attorneys for Appellant,

Abe Berman

————

OPINION OF THE COURT

(Filed November 25, 1977)

Per Curmum:

This factually-complex case arises out of the 1973

acquisition of Royal All-Aluminum Swimming Pool Corp.

by a 100% stock purchase on the part of Coleco Industries,

Inc. Royal’s shareholders were Abe Berman, Joseph

Rubin, and Irvin, Lewis and Frederick Cohen. Berman

acted as president and sales manager, Rubin functioned as

vice president, design engineer and production manager,

while the Cohens provided financial support to Royal.

Berman, Rubin and the Cohens, along with Zelnick, Sobel-

man and Co., Royal’s accountants, were the defendants in

the $1.3 million securities fraud action which forms the

nucleus of the complaint in this case.

The trial court’s extensive opinion, reported at 423 F.

Supp. 275-324 (E.D. Pa. 1976), sets forth the circumstances

of this case in detail. We therefore present only a capsule

review of the events giving rise to the lawsuit.

I. Txe Facts

A. History of the Case

In 1971, Berman, Rubin and the Cohens incorporated

Royal, with the objective of using Berman and Rubin’s ex-

pertise in manufacturing and marketing above-ground

aluminum swimming pools. Royal had a moderately suc-

cessful year in 1972, making inroads on other pool sup-

pliers’ markets, but sold 600 instead of an expected 900

pools, sustaining a net loss of $172,000.’

The combination of a potentially-successful product

and a financial squeeze caused by under-capitalization at-

tracted the attention of Coleco, a Connecticut corporation

active in the swimming pool field. After initial inquiries

in January of 1973, negotiations commenced regarding the

1. The initial capitalization of the firm was $84,000 and a bank loan pro-

vided an additional $100,000.

purchase of Royal by Coleco. While the original proposi-

tion discussed was a $1 million acquisition, the Coleco prin-

cipals wished to defer consummating the arrangement in

order to await the performance of a certified audit of Royal.

The Royal officials pressed for an immediate purchase,

contending that Royal’s current financial situation was so

fragile that an immediate infusion of new capital was

necessary.

The difference was resolved by a purchase agreement

which provided for a firm $500,000 to be paid in four in-

stallments, and $500,000 of the purchase price to be made

contingent upon the profitability of Royal in succeeding

years. In addition, the Royal principals warranted the

correctness of Royal’s financial statement for the first

quarter of 1973 (April 30 statement). Rubin and Berman

were to be retained to manage the company at specified

salaries. The agreement of sale was signed on June 4, 1973.

It is conceded that the April 30th statement underestimated

the total inventory set forth by Royal by at least $49,922.

By November 1973, Rubin had quit, Berman had been

fired, Coleco had expended—by its estimates—$1.3 million

on Royal, Royal had barely broken even, and Coleco was in

the process of transferring what was left of Royal to its

subsidiary ABCO.

Coleco filed suit on December 4, 1973. The proceeding

began as a jury trial, but halfway through the jury was

dismissed. After the evidence was closed, Judge Huyett

made extensive findings of fact and conclusions of law

which are set forth in the course of his opinion.

The interpretation of how matters advanced through

each of the various stages is, of course, hotly contested.

The first dispute centers on the representations which were

made to Coleco before the sale. Coleco claims it was misled

as to the profitability of Royal. It points out that on April

18, 1973 Rubin told a Coleco principal that Royal was

realizing a gross profit of $500 per pool, and that the April

30, 1973 first quarter report showed a gross profit of

$200,000 on the sale of 400 pools.

All parties agree that the April 30 statement was in

error, underestimating the cost of the pools manufactured

by $49,922, as a result of accounting errors. In addition,

Coleco claims that by comparing the April 30 figures with

the figures derived from a June, 1973 audit, the cost of the

400 pools was understated by an additional $80,272.

Berman, Rubin and the Cohens (hereinafter the ‘‘ Royal

defendants’’) respond that the April 18 representation re-

garding the gross profit per pool was made in good faith.

The trial court agreed, finding that the representation was

that Rubin ‘‘believed’’ that he was making $500 per pool,

and that such was in fact the state of Rubin’s belief (423

F. Supp. 285, 289). Moreover, the Royal defendants chal-

lenge the plaintiff’s accounting methods, admitting only the

$49,992 discrepancy, and argue that they were misled as

much as the plaintiff by the errors of Zelnick, their ac-

countant. The trial court did not pass on this contention

explicitly, although it found Zelnick liable to the defendants

for the $49,922 error, on the basis of Zelnick’s ‘‘obvious

and mechanical’’ mistakes (423 F.Supp. 308-310, 310 n.59).

The major factual disagreement between the parties

regarding the various events following the purchase cor-

cerns the cause of the business difficulties experienced by

Royal. All admit that by the end of the summer, Royal

was unable to meet the orders for which it had contracted,

and that its operation was beginning to fall apart despite

overtime work on the part of Rubin.

Coleco claims that the operation was doomed from the

start, given the underestimated profit margin. The Royal

defendants contend that the root of the problems was mis-

management by Coleco. While the trial court found that

2. Coleco also claimed at trial that one of the new lines of Is manu-

factured in 1973 by Royal was defectively A ae and that ls hem was

vered the warranties accom ing sa

7 The Royal defendants con that the subsequent failures in the pools

were the result of shoddy workmanship by suppliers, and that Coleco had been

informed of difficulties experienced in obtaining appropriate work from sup-

pliers before the Coleco purchase. This dispute to the background on

appeal, perhaps because the trial court found that even assuming that the pool

failures were actionable, no damages had been proven as a result of such

failures.

Rubin had informed Coleco that successful operation on the

scale it contemplated would require immediate infusions of

capital, along with personnel and materiel from Coleco, in

fact the expenditures of money by Coleco on the Royal

operation were delayed, and the men and materials never

arrived. Moreover, Coleco’s management antagonized both

Rubin and Berman, the lynchpins of the operation, to the

point where one left and the other had to be discharged.

The trial court supported the Royal defendants, finding

that ‘‘Royal failed, we find it much more probable than not,

because Coleco mismanaged it after the acquisition.’’*

Berman and Rubin both assert that they were driven

out—Berman that he was fired without cause, and Rubin

that he was forced to resign by intolerable working condi-

tions and lack of cooperation. Both seek to recover the

salaries promised them under the contract. Coleco responds

that Berman had been derelict in his duty, and that under

New Jersey law Rubin’s resignation bars recovery on an

employment contract. The trial court found for Rubin and

against Berman.

B. The Suit

By the time this case reached trial, each of the parties,

except Zelnick, had invoked a plethora of remedies. Zelnick,

however, had settled with Coleco for $350,000 and had be-

came a third-party defendant. In broad overview, the

holdings of the trial court were as follows:

(1) Coleco had no valid claim under 15 U.S.C.

§78j}(b) and SEC Rule 10b-5. Whatever misrepre-

sentations occurred were made in the belief of their

truth or were not ‘‘studied.’’ Thus the scienter neces-

sary for a securities violation was lacking.

(2) Coleco had no valid common-law fraud claim.

The scienter necessary for a 10b-5 violation is identical

to that essential for fraud. Since the former was ab-

sent, the latter was also lacking.

3. 423 F. Supp. at 293.

a ee

(3) Coleco was entitled to recover for breach of

warranty, but:

(a) no damages were proved for the design

defect contention (the court assumed without deciding

that the warranty had been breached) ;

(b) the disputed $80,272 discrepancy was not

properly proved;

correctness of the April 30 statement were limited to

the actual discrepancy between the correct figures and

the ones warranted, and recovery on this item was thus

limited to $49,992.

(4) Whatever recovery Coleco was entitled to on

the breach of warranty was satisfied by the settlement

with Zelnick, under the New Jersey ‘‘one settlement’’

rule.

(5) The Royal defendants were entitled to recover

the unpaid portion of the $500,000 non-contingent sales

price and for the loans they had made to Royal, because

the financial discrepancy was not a material breach and

because to interpret the purchase agreement as barring

recovery would be to read it as a penalty which would

be unenforceable. The total amount awarded on this

claim was $480,000.

(6) The Royal defendants were not entitled to re-

cover their share of future profits, since such profits

could not be proved with sufficient certainty.

(7) Rubin was entitled to his total remaining

$70,506 salary, because he left after his position had

been made intolerable by Coleco.

(8) Berman was not entitled to his salary, since

his discharge was with cause.

(9) Zelnick was liable to the Royal defendants for

the damages awarded on the basis of the breach of

financial warranty (in fact, nothing).

(10) Coleco was entitled to only $15,000 of the

claimed $410,550 counsel fees.

With the exception of the design-defect finding and

the award of counsel fees,‘ all the parties appealed from

the determinations adverse to their contentions. The Royal

defendants then moved to dismiss Zelnick’s appeal as moot,

since under the district court’s order, Zelnick has no re-

maining liability.

We affirm the trial court’s decision on issues 1, 2 3,

4, 5, 6, and 8; remand for recomputation of damages on

issue 7; and dismiss the appeal as moot on issue 9.

II. Tue Issves

In view of Judge Huyett’s extensive opinion, we shall

canvass in summary fashion the areas of agreement with

his holdings.

A. Securities Fraud

In evaluating the plaintiffs’ contentions that the Royal

defendants had violated 10b-5, Judge Huyett held that ‘‘to

establish the element of scienter in an action brought under

section 10(b) and Rule 10b-5, a party must prove injury

resulting from a conscious deception or from a misrepre-

sentation so recklessly made that the culpability attaching

to such reckless conduct closely approaches that which at-

taches to conscious deception.’’ (423 F. Supp. at 796).

The Supreme Court has recently announced, in Ernst

& Ernst v. Hochfelder, that ‘‘scienter’’ is a necessary

element of a violation of Rule 10-b(5).5 We agree with the

trial judge, and the majority of the courts which have

passed on the question since Hochfelder, that plaintiff may

recover under Rule 10b-5 for misrepresentations that are

recklessly made as well as those made with conscious

4. Coleco’s brief suggests that if damages are recomputed, then attorney's

fees should also be re-examined. Since the court does not disturb the final

damage award, we need not discuss the contention regarding counsel fees.

5. 425 U.S. 185 (1976).

a ee eee

fraudulent intent. We need not precisely define the na-

ture of the recklessness which might give rise to 10(b) (5)

liability, however, for the finding by the trial court that the

actions of the Royal defendants were not reckless is amply

supported by the record under any of the standards which

other courts have suggested.

The trial court specifically determined that the Royal

defendants represented to Coleco the condition of Royal

as they believed it to be, and that they were ‘forthright in

their dealings with . . . Coleco and did not deliberately

misrepresent any aspect of Royal’s status or operation.’’*

Judge Huyett found as a fact that Rubin ‘‘expected Zel-

nick, Sobelman & Co. to be totally responsible for Royal’s

accounting, including the costing of the various pool

models.’’* He held that the proven errors in the April 30

financial statement could be traced to Zelnick’s failure

properly to examine the statement, and that the Royal

defendants were entitled to recover damages suffered as a

result of their reliance on Zelnick in this regard.°

Coleco has adduced no evidence which indicates that

the reliance on Zelnick’s expertise by the Royal defendants

was outside the bounds of commercial prudence. Indeed,

the only information suggested which might have alerted

Royal to inaccuracies was equally available to Coleco.’

7 . Heiser Corp., (slip op. No. 76-1140, June 30, 1977, 7th Cir.);

Bollty v. Meister Brow Inc. $36 F2d 982 (th Cir. 1977) ; Hersfeld .

Laventhol, Krekstein, Horwath and Horwath, $40 F.2d 27 (2d Cir. 1 6);

cf. Arthur Lipper Corp. v. SEC, $47 F.2d 171 (2d Cir. ~~ Ben J.)

(subjective intent or knowledge not necessary to sustain plinary

proceeding).

7. 423 F. Supp. at 285, 289.

8. Id. at 281.

9. Id. at 308-310. ates idle ss oa

immediate ore an “examining

to checked Royals books, aod found tat costs had been underestimated

per pool. 423 F. Supp. at 286-87. This circumstance differentiates

“face-to-face

10a

Under these circumstances, we do not believe the trial court

erred in finding no ‘‘reckless’’ behavior on the part of the

Royal defendants.

B. Common-Law Fraud and Breach of Warranty

As alternative claims, the plaintiff maintained that it

should be able to recover for defendants’ misrepresenta-

tions on two state law theories: (1) that the representa-

tions of profitability and competent design, particularly

those contained in the contract, constituted common-law

fraud under New Jersey law; and (2) that the failure of

the April 30th financial statement and of the pool design

to be in accord with the contractual representations of ac-

curacy and soundness, respectively, were breaches of war-

ranty.

The trial court held that no actionable fraud had ac-

curred inasmuch as the standard of scienter for common

law fraud was identical with that necessary for 10b-5. On

the warranty claim, the court found that the admitted

$49,992 underestimation of inventory cost in the April 30

statement breached the financial warranty, and it awarded

$49,992 as damages. However, it rejected plaintiffs’ claim

for a recovery of all monies expended in buying and re-

financing Royal. Judge Huyett also concluded that, assum-

ing the design defects, if any, breached warranties, no

damages had been proven as a result of such breaches.

Plaintiff challenges the failure to find liability on the

fraud count as well as the court’s calculation of damages

on the warranty claim.

(1) Liability

As a matter of general common law, Judge Huyett’s

findings of good faith and lack of recklessness negative the

assertion of fraud on the part of the Royal defendants.

And while common law standards in New Jersey may be

read to extend the rubric of fraud beyond the bounds of

commercial recklessness, Judge Huyett’s failure to recog-

nize such a cause of action is not ultimately at issue here.

There is no question but that the allegedly fraudulent

assertions in the April 30 statement also constituted a

breach of warranty. As we understand the law of New

Jersey, on this record, the damages recoverable for fraud

are identical to those recoverable for breach of warranty.

A potential finding of fraud is, therefore, superfluous, and

the only issue before us regarding the misrepresentations

is the correctness of the damage calculations.

(2) Damages

(a) Proof

It is necessary to review an evidentiary ruling made by

Judge Huyett regarding evidence proffered by the plaintiff

on the issue of proof of damages.

In its pretrial memorandum, Coleco indicated that it

intended to prove under-costing by comparing the cost

sheets prepared for the June, 1973 inventory with cost

figures contained in the financial statement for the quarter

ending in April, 1973, the financial statement that the de-

1. The discussion of the parties focuses on the doctrine of Plimpton v.

Friedberg. 110 N.J. 427, 166 A.2d 295 (1933) (mirsepresentation put

as made on basis of personal knowledge is fraudulent, when in fact based on

opinion of others). In our judgment, Zelif v. Sabbatino, 15 N.J. 70, 104 A.2d

54 (1954) and Palmiere v. Forte, 56 N.J. 155, 265 A.2d 539 (1970), are more

In Zeliff the court upheld a finding of fraud grounded on the defendant

realty sellers’ misrepresentation, in the contract of sale, ing the cost of

oil used to heat a property. The trial court held, and Supreme Court

affirmed the holding, that representation was false, and since defendants

ithin their own know , it was actionable.”

ee 3 Fh, gp - the defendants based on a

ion in

s produce. Although —_ Ty repre-

based isrepresentation to a company

bed them a8 innocent, they were held 10 be lable

12a

fendants had warranted as accurate. The differential came

to $80,272.00 more than the $49,992 by which the defendants

admitted erring. At the hearing on the plaintiff’s summary

judgment motion, which occurred before trial, defendants

challenged the June, 1973 figures, on the ground that such

figures could not be taken to represent the true costs as of

the time of the April 30 statement. Defendants maintained

that under Royal’s first-in-first-out accounting, the proper

invoices to examine for costing would have been those for

materials bought in 1972, and used in the first quarter of

1973. Since the price of aluminum, the material used to

construct the pools, was rising rapidly during 1972-73, de-

fendants argued, costing based on 1973 invoices could be

used as neither proof of inaccuracy nor proof of damages.

Without amending their pretrial statement, or notify-

ing defendants’ counsel, Coleco thereupon commissioned a

Philadelphia accounting firm to study 1972 supply invoices

with regard to their similarity to 1973 prices. When Coleco

attempted to introduce the findings of the new study by an

expert witness, the defendants objected. The trial judge

ruled that in light of the failure of plaintiff’s pretrial filings

to disclose the study or its prospective use, to admit it

would subject defendants to unfair surprise and prejudice.

In view of the fact that plaintiff had been specifically

ordered to notify counsel and the court of the substance of

testimony by witnesses,"* and that no excuse was presented

by Coleco’s counsel for its failure to advise the court earlier

— Plaintiff argues that since no pretrial order was issued explicitly bind-

ing them to reliance on 1973 invoices “in accordance with Local Rule 7(f),”

became effective in July 1976, while the case was tried during the winter and

ior Rule 7 made no explicit provision for a pretrial

order, and indeed contemplated the required pretrial memorandum as having

tnesses

order requiring the plaintiff to file a pretrial memorandum including “plain-

tiffs’ contentions as to disputed facts,” and “Plaintiffs’ final designation of

witnesses to be called at trial. . . briefly identifying each witness and specify-

ing the evidence which the witnesses will give. iven this order, it is not

an abuse of discretion to prevent the plaintiffs from introducing a study of

1972 invoices which they neglected to mention before its introduction at trial.

OAR he te ET ow ee ee

13a

that the evidence would be offered, we do not believe it was

an abuse of discretion to refuse to receive the plaintiff’s

proffered proof."*

We therefore must accept as correct the trial court’s

conclusion that costs were underestimated in the April 30th

statement by only $49,992.

(b) Calculation

At trial and before this Court, plaintiff’s counsel

focused on the contention that the underestimation of costs

struck at the heart of the bargain which Coleco had been

led to expect; instead of buying a potential gross profit of

36%, plaintiff argues, under the facts as Judge Huyett

found them gross profits were closer to 20%. Increased

costs and lowered profits, Coleco asserts, meant that Royal

was commercially worthless. Therefore, according to

Coleco, it is entitled to the full $1.3 million in out-of-pocket

expenditures which represents the costs of obtaining and

operating Royal.

“2 While = recognize that under New Jersey law dam-

ages for fraud or breach of warranty seek to compensate a

ili that to cure the prejudice; (3) the extent to which waiver

~ A A A * unlisted witnesses would disrupt the orderly and

—y- FRG, A

- in faili

14a

plaintiff for his ‘‘loss of the bargain’’—the difference be-

tween the worth of the article as represented and that as

actually delivered **“—the record does not contain evidence

which satisfactorily establishes the worth of Royal either

as represented or as delivered. We agree with Judge

Huyett’s conclusion that the allegation that Royal was

worthless is insufficiently supported by the record.” Nor

can we say that it was error to hold that the plaintiff failed

to prove by a preponderance of evidence the degree to

which Royal’s worth as delivered was less than as repre-

sented. Indeed, we find little testimony in the record which

bears on such a calculation. The only loss of the bargain

actually proven was that which the trial court in fact

awarded : the $49,992 by which the April 30 statement over-

estimated the inventory.

Likewise, we do not believe the trial court erred in

rejecting Coleco’s demand for reimbursement for the out-

of-pocket expenditures made on behalf of Royal. J udge

Huyett held that Coleco had not proven by a preponderance

of the evidence that the misrepresentation of the April 30

statement resulted in the $1.3 million out-of-pocket expendi-

tures. We cannot say that this conclusion was reversible

error, particularly in light of the fact that over $600,000

of the amount claimed was expended after Royal learned

of the inaccuracies in the April 30 statement.’”

Judge Huyett held that any recoveries due from the

Royal defendants to Coleco should be offset by Coleco’s

15. Zeliff v. Sabbatino, 15 N.J. 70, 75, 104 A.2d 54, 56 (1954). Sce note

12 supra.

16. Judge Huyett chose not to credit the testimony of Edward Fialkowski,

's treasurer, that had Royal’s balance sheet showed a deficit, Royal

would have had no value. 423 F. Supp. 366 at 52.

We cannot say that Judge Huyett erred in finding that this testimony is

unpersuasive. Indeed, the testimony of Coleco’s president, Arnold Greenburg,

is that even had the costs been underestimated by $100,000 (rather than the

$49,992 actually proved), he would still have purchased Royal, albeit at a

lower price. (Transcript 250-251).

17. See Plaintiff's brief pp. 15-25.

15a

$350,000 recovery from Zelnick."* That conclusion is not

erroneous. The fact that the compensation from Zelnick

was obtained on a different theory from that which Coleco

asserts against Royal is not controlling under New Jersey

law, so long as the damages recovered are the same. Like-

wise, we believe that the trial court’s conclusion that the

policy of the New Jersey courts of applying the ‘‘one satis-

faction’’ rule only to obtain a ‘‘just result,’’ and not on

behalf of wrongdoers,’” presents no bar to its use in the

present action.

C. Purchase Price and Loan Repayment Counter-

claims, Future Profits

The Royal defendants counterclaimed against Coleco

for the balance of the $500,000 non-contingent purchase

price which they had not yet received, as well as for cer-

tain sums of money which they had loaned to Royal. Plain-

tiff asserted as a defense to this counterclaim a clause in

the purchase agreement that ‘‘obligations of Coleco under

the agreement shall at all times be subject to the condi-

tion precedent .. . [that] representations and warranties

... contained .. . shall be true on and as of the closing

date.’’ 20 Ba

Judge Huyett construed this condition precedent to

apply only to the obligations under the purchase agree-

ment to close the contemplated arrangement, and concluded

that if a $49,992 inaccuracy could excuse payment of a

$500,000 purchase price after the closing had occurred and

Coleco had taken possession of Royal, such a clause would

be unenforceable as a penalty. .

While this ruling may not necessarily be compelled

by the record, Judge Huyett’s decision is not without sub-

stantial evidentiary support. The other paragraphs in the

, 671 (1958); Dailey v.

Sombery, BING. ee a2 “66 ea 1958). - —

19. Theobald v. Angelos, 44 N.J. 228, 208 A.2d 129 (1965).

20. Joint appendix at 231.

l6a

agreement concerning conditions precedent all refer clearly

to conditions precedent to closing. In view of the refusal

by the New Jersey courts to enforce contractual provisions

which act as penalties, Judge Huyett’s interpretation will

be affirmed.”

Similarly, the trial court’s finding that the breaches

of the contract were not so material as to entitle Coleco to

retain Royal without tendering the contractual payments is

not reversible error. Had Coleco attempted to rescind im-

mediately upon learning of the misrepresentations, a dif-

ferent situation might be presented. After Coleco ab-

sorbed Royal into its subsidiary, however, we cannot say

that Judge Huyett erred in holding that Coleco is required

to pay the purchase price set forth in the contract less the

damages that it established.

We also uphold the trial court’s determination that

the Royal defendants were not entitled to that portion of

the purchase price which was made contingent upon profits.

Royal was a fledgling business enterprise, and its future

profits were not sufficiently certain so as to be susceptible of

accurate determination.

D. Salary Claims

(1) Berman

Mr. Berman counterclaims against Coleco for the sal-

ary which he was to receive as president of Royal under

the purchase and employment agreements. Coleco main-

tains that the contractual breach was Berman’s, and that

he was discharged for cause. In view of the evidence that

‘‘Berman’s office work was a disaster,’’*? and that Ber-

man had at one point gone on vacation for several weeks

without leave, Judge Huyett’s conclusion that Berman

21. See Barr & Sons, Inc. v. Cherry Hill Ctr. Inc., 217 A.2d 631, 90

N.J. Super. 358 (1966) (rebate of all rental paid triggered by breach of

restrictive covenant) ; Westmount Country Club v. Kaceny, 197 A.2d 379, 82

N.J. Super. 200 (1964); Keller v. Architects Display Bldg. Inc., 148 A.2d

634, 54 N.J. Super. 205 (1959) (unconscionably high interest is penalty).

22. 423 F. Supp. at 314.

23. Id.

17a

was dismissed for cause and therefore had no claim for

future salary was neither factually or legally erroneous.

(2) Rubm

Similarly, we cannot overturn Judge Huyett’s conclu-

sions regarding Mr. Rubin. Judge Huyett found that by

making arrangements to move the bulk of Royal’s opera-

tions out of New Jersey, in violation of a contractual pro-

vision, as well as by making Rubin’s situation as vice-

president of Royal untenable, Coleco breached its contract

with Rubin. He further found that Rubin’s subsequent

resignation was a mere acknowledgment of a contractual

breach. We do not view these determinations to be er-

roneous. The New Jersey cases in which resignation has

been held to bar an action for breach of an employment

ontract are factually distinguishable.

° At oral heme A counsel for Rubin admitted that his

recovery should be reduced by any earnings which Rubin

in fact received between the close of trial and the end of

the contractual period. We suggested that counsel for Mr.

Rubin submit a statement of these earnings to counsel for

Coleco, and that the attorneys attempt to reach an agree-

ment on the appropriate set-off. On this issue, the case

will be remanded to the district court, and should no agree-

ment eventuate, the district court is directed to offset Mr.

Rubin’s recovery by the amount which he actually earned

through November 1, 1976.

E. Liability of Zelnick

Since we hold that the district court did not err in its

computation of damages, recovery by Coleco against the

Royal defendants is offset entirely by the $350,000 settle-

ment between Zelnick and Coleco. Since Zelnick is thus

exposed to no liability as a result of the judgment against

it, Zelnick ’s appeal becomes moot and must be dismissed.

18a

ITI. Conrcivusion

The judgment of the trial court will be affirmed except

as it bears on Rubin’s wage claim. On the issue of Rubin’s

wages, the case will be remanded for action in accordance

with this opinion.

A True Copy:

Teste:

Clerk of the United States Court of Appeals

for the Third Circuit.

(A.0.—U. S. Courts, International Printing Co., Phila., Pa.)

19a

APPENDIX B

COLECO INDUSTRIES, INC. v. BERMAN

Cite as 423 F Supp. 275 (1976)

- ablishing (0

COLECO INDUSTRIES, IN¢., Plaintiff,

Abe BERMAN et al., Defendants,

ZELNICK, SOBELMAN & COMPANY,

Third-Party Defendants.

Civ. A. No. 73-2790.

United States District Court,

E. D. Pennsylvania.

Aug. 9, 1976.

As Amended Dec. 1, and Dec. 21, 1976.

Litigation arose out of a contract for

the purchase of a business by plaintiff from

defendants. The District Court, Huyett, J.,

held that defendants breached a contract

provision whereby they warranted certain

financial statements. Under evidence, the

more probable cause of immediate postac-

qitisition difficulties of such business and its

eventual disintegration was not problems

arising from breaches of contract by de-

fendants but from plaintiff’s miscalculation

of kind and amount of assistance needed to

enhance chances of success. Plaintiff failed

to establish damages under its enterprise

theory of liability. Notwithstanding lack of

strict privity, accountants are liable in neg-

ligence for careless financial misrepresenta-

tions relied upon by actually foreseen and

limited classes of persons. There was a

breach by the plaintiff of its employment

contract with one defendant but another

20a

defendant breached his employment con-

tract with the plaintiff. Though the con-

tract provided for recovery of attorneys’

fees by the plaintiff the award would be

limited to $15,000.

Judgment for plaintiff against all de-

fendants in amount of $15,000; judgme «<s

for each of two defendants against plain-

tiff, on counterclaims; judgment for other

defendants and against plaintiff.

OPINION AND ORDER

HUYETT, District Judge.

INTRODUCTION

This dispute arose, we have concluded

after months of considering the legal and

factual convolutions of this case, out of the

frustration and need to assign fault engen-

dered when an important business deal

went sour. On June 4, 1973, after two and

one-half months of negotiation, plaintizr

Coleco Industries, Inc. (Coleco), a Connecti-

cut manufacturer of recreational products,

including toys, swimming pools, and swim-

ming pool accessories, purchased Royal All-

Aluminum Swimming Pool Corp. (Royal), a

smaller New Jersey corporation specializing

in the design, packaging, and distribution of

above-ground aluminum pools. The pur-

chase was effected by the transfer to Coleco

of all shares of outstanding Royal capital

stock by the five Royal stockholders—Abe

Berman, Royal’s president, and Joseph Ru-

bin, Royal’s secretary-treasurer, both of

whom managed Royal’s daily operations,

and Irvin, Lewis, and Frederick Cohen,

2la

brothers and outside shareholders.'! Subse-

quent to the purchase date in June 1973,

Royal’s fortunes went quickly and steadily

downhill and by 1975 Royal All-Aluminum

Swimming Pool Corp. was inoperational.

Plaintiff Coleco did not wait until 1975 to

bring suit, however. Under the terms of

the 1973 Purchase Agreement (Ex. 1),

which contemplated both contingent and

non-contingent payments to Berman, Ru-

bin, and the Cohens,? Coleco, at closing, paid

to the Royal shareholders $135,000 of the

$500,000 non-contingent purchase price plus

6% interest. The second non-contingent

payment of $57,500 plus interest was due in

January 1974. Coleco initiated suit against

all five Royal shareholders and Royal’s ac-

countants in December 1973, however, and

made no payment beyond the amount paid

at closing.

Under the complaint filed in December

1973, which is jurisdictionally grounded

both in the federal securities laws and di-

versity of citizenship, Coleco demands dam-

1. Of the total of 180 Royal shares outstanding

prior to purchase, Berman held sixty, Rubin

sixty, Irvin Cohen thirty, Lewis Cohen fifteen,

and Frederick Cohen fifteen. (Purchase Agree-

ment, Ex. 1, { 1.1)

2. The non-contingent payment amounted to

$500,000 plus interest payable in four install-

ments; the contingent payment geared to Roy-

al’s profits over three years amounted to a

maximum of another $500,000. (Purchase

Agreement, Ex. 1, ‘* 1.2-1.4)

3. Plaintiff invokes jurisdiction pursuant to 15

U.S.C. § 78aa of the Securities Exchange Act of

1934 and 28 U.S.C. §§ 1331 and 1337 and

brings its federal securities claim pursuant to

22a

ages of nearly one and one-half million dol-

lars against the five Royal shareholders,

Berman, Rubin, and the Cohens,‘ for securi-

ties fraud, common law fraud, and breach

of contract. The complaint also named as a

defendant, Zelnick, Sobelman, & Co. (Zel-

nick), Royal’s accountant from its inception

in 1971 through the June 1973 purchase

date. Just prior to trial, however, Coleco

and defendant Zelnick reached a settlement

which shifted Zelnick’s posture in the case

from that of defendant to that of third-par-

ty defendant since there remained claims

against Zelnick by defendants Rubin and

the Cohens. All defendants filed counter-

claims demanding the remainder of the pur-

chase price as well as repayment of their

personal loans to Royal, another part of the

contract consideration.’ In addition, Ber-

man and Rubin counterclaimed for breach

of their employment contracts with Coleco

executed at the same time as the Purchase

15 U.S.C. § 78j(b) and Rule 10b-—5. Its claims

based on common law fraud and breach of

contract are brought under 28 U.S.C. § 1332.

4. During the pendency of this litigation defend-

ant Frederick Cohen was lost and presumed

dead in an airplane accident. His estate has

been substituted as defendant. (Tr. at

31:3946-47)

5. Under the terms of the Purchase Agreement

(Ex. 1, © 12.1), plaintiff was not to begin repay-

ing defendants’ personal loans to Royal until

January 2, 1974. Thus, when Coleco filed suit

in December 1973 and stopped all future pay-

ment under the Purchase Agreement, it

stopped repayment on defendants’ loans.

23a

Agreement and related to it.6 Finally, the

Cohen defendants crossclaimed against Ber-

man and Rubin on the basis of a side agree-

ment entered into at the June 1978 closing

between Berman and Rubin on one hand

and the Cohens on the other (Ex. 397),

under the terms of which any breach dam-

ages due Coleco out of the non-contingent

purchase price would come first out of Ru-

bin’s and Berman’s shares.

FINDINGS OF FACT

Following almost two years of discovery

and other pretrial activity, we tried this

case non-jury’ beginning November 10,

1975, and continuing, with a few interrup-

tions, to January 29, 1976; the trial record

exceeds 4000 pages. Now, having reviewed

with care the notes of testimony, the docu-

mentary evidence submitted, and the post-

trial briefs and proposed findings of fact

and conclusions of law, we find the case

ripe for decision.

6. As part of the total transaction by which

Coleco acquired Royal, Coleco hired Berman

and Rubin as president and vice-president re-

spectively of Royal. Moreover, a large amount

of the purchase price contingent on Royal's

profitability was also contingent on Berman's

and Rubin's fulfilling their employment con-

tracts. (Purchase Agreement Ex. 1, © 1.4(d)(ii))

7. We began trial with a jury. On the joint

motion of all parties, we agreed in the interest

of fairness and judicial economy to dismiss the

jury and proceed non-jury. (Tr. at 18:2074-

78c)

24a

For ease of understanding, we choose to

document our findings of fact and conclu-

sions of law in narrative form rather than

in separately numbered paragraphs.’ The

narration that follows shortly, then, consti-

tutes our findings of fact required under

Fed.R.Civ.P. 52(a). In making our findings,

we reply perhaps most heavily upon the

lengthy testimony of Joseph Rubin, one of

the defendants. His demeanor and the sub-

stance of his testimony impressed us great-

ly; he was a straightforward, conscientious,

and intelligent witness. In crucial areas

where his testimony contradicts that of

plaintiff’s witnesses, we credit Mr. Rubin’s

testimony. We also credit substantially the

testimony of Abe Berman, especially that

testimony dealing with information about

Royal that he revealed to Coleco’s officers,

agents, and representatives prior to June 4,

1973.

A. 1971 Through March 1978

Joseph Rubin, a mechanical engineer with

a B.S. in engineering, met Abe Berman in

1968 while they were both working for

Esther Williams Swimming Pool Co. Ber-

man is a high school graduate who has

worked in sales all his adult life. At Esther

Williams, Rubin was responsible for the de-

sign of a new line of pools, and Berman was

the company’s national sales manager.

Sometime in 1971, Berman and Rubin, now

8. Where the facts are substantially undisputed,

we will not refer to the notes of testimony;

where they are disputed, we will cite to the

notes of testimony.

25a

vice-president of Gindy Manufacturing Co.,

discussed seriously the prospect of their go-

ing into the swimming pool business togeth-

er. As Berman explained the situation:

I don’t know who brought it up or what,

but the fact remained that he [Rubin] in

his experience and knowledge of produc-

tion and design and my experience in

promotion and sales, we just felt that it

would be a real good combination for

starting our own company, if we could

acquire capital.

Tr. at 28:3609. To acquire capital, Rubin

contacted Irvin Cohen, a Reading, Pa., busi-

nessman, with whom he had had business

dealings and interested Cohen and through

Cohen his two brothers, Lewis and Freder-

ick, in investing in the proposed company.

In addition to investing his own money,

Irvin Cohen could aid Rubin and Berman in

their enterprise through his contacts with

Reading banks which made likely the pros-

pect of the new company’s obtaining a loan.

As a result of this activity, then, Royal

All-Aluminum Swimming Pool Corp. was

formed in late Summer or early Fall 1971

with an initial capitalization of $84,000—

$12,000 each from Rubin and Berman and

$60,000 from the Cohens together. Because

Irvin Cohen wanted Royal to use as its

accountant the accounting firm that he em-

ployed for his other enterprises, Royal hired

the firm, Zelnick, Sobelman, & Co., in the

Fall of 1971 for a retainer of $300 a month.

Rubin told Norman Zelnick that because he

had no significant accounting knowiedge

(Tr. at 20:2412-18) and because both he and

26a

Berman would be constantly occupied with

design, production, and sales (Tr. at

20:2412), he expected Zelnick, Sobelman, &

Co. to be totally responsible for Royal’s

accounting including the costing of the var-

ious pool models which Royal would market.

Zelnick agreed to this undertaking. Tr. at

20:2417 & 2418. Rubin designed three pools

in Fall 1971, the Crest pool, which came in

two sizes, the Crown pool, in two sizes, and

the Jewel pool, which came in four sizes.

Royal went into production in December

1971 and shipped its first pools in March

1972, Rubin and Berman projecting a sales

total of 900 pools for the 1972 season.

In January 1972 Royal obtained a $100,-

000 loan from the National Central Bank in

Reading. Also, in January 1972, Rubin and

Berman met Leonard Greenberg, Coleco’s

then president,? at a National Swimming

Pool Association trade show. Greenberg

was apparently impressed with Royal’s

products and suggested to Berman the pos-

sibility of Coleco’s acquiring Royal. Tr. at

28:3619. Berman responded that since Roy-

al had not yet done a year’s business, he

thought the suggestion premature. Tr. at

28:3619. Leonard Greenberg followed up

this conversation with a letter dated Febru-

ary 4, 1972 (Ex. 7), in which he reiterated

his interest in discussing Coleco’s acquisi-

tion of Royal.

Royal was to sell only 600 of the 900 pools

projected in 1972, at least in part because

9. Leonard Greenberg is now Coleco’s Chairman

of the Board of Directors; his brother, Arnold

Greenberg, is Coleco’s present president.

27a

June 1972, one of the key months for pool

sales, was an inordinately rainy month and

pool sales suffered accordingly. By Fall

1972, because of this discrepancy between

the number of pools sold and the number

projected, Royal had a substantial amount

of inventory on hand for which it couldn’t

pay its suppliers. Its financial condition

was poor, and in late 1972 and early 1973 its

five shareholders made it various personal

loans; some of which were repaid. The

balance of the loans, $43,333.44, remained

outstanding on June 4, 1973, the purchase

date. Tr. at 31:3950. In addition to the

loans, in early 1973 Rubin and Berman

stopped drawing salaries. In spite of these

financial problems, or perhaps because of

them, Rubin began designing in Fall 1972

two new pools, a low cost, above-ground

pool in two sizes, named the Castle, and

another above-ground pool, the Camelot.

The Castle design was never completed,

however, because of technical difficulties

encountered by Royal’s suppliers of alumi-

num extrusions in executing parts of the

designs (Tr. at 20:2448-49) and because the

unpaid suppliers were reluctant to cooper-

ate with Royal. Tr. at 20:2461. In Novem-

ber 1972 Leonard Greenberg again ap-

proached Abe Berman at a swimming pool

trade show and expressed interest in ac-

quiring Royal. Berman promised to talk to

him about the matter at a pool show they

would both attend in January 1973. Tr. at

28:3621. At year end 1972 Royal was

struggling. Rubin made the following as-

sessment of Royal’s financial condition as of

December 31, 1972:

28a

We were not in good condition. We had

an unbalanced inventory. We had suppli-

ers that we owed a substantial amount of

money to that were pushing us to get

them money and at the same time, we

were trying to work up ourselves differ-

ent methods of trying to obtain capital.

Tr. at 20:2465.

January 1973 brought some relief in the

forms of a $220,000 Small Business Admin-

istration loan and a $20,000 increase in Roy-

al’s loan from National Central Bank. Al-

though this new capital was not sufficient

to pay all of Royal’s debts, it did start

supplies flowing more freely to Royal from

its main extrusion suppliers. Berman and

Rubin projected total! sales for 1973 as 1200

pools. In February and March, however,

Royal’s financial condition again worsened.

Its inventory was high but out of balance.

The imbalance was caused partly when Ru-

bin was forced to substitute parts from

other pool models for the parts of the Cas-

tle pool he could not, for one reason or

another, get from his suppliers. Nor could

Royal balance its inventory because its lack

of capital discouraged suppliers from pro-

viding it with the parts it needed. This

state of affairs is memorialized in the

“Whereas” clauses of the Purchase Agree-

ment:

WHEREAS, ROYAL’S operations have

produced a deficit for the twelve (12)

month period ended January 1, 1973 of

over One Hundred Seventy Five Thou-

sand (175,000) Dollars; and

29a

WHEREAS, ROYAL’S operations have

produced an additional deficit for the pe-

riod ended March 31, 1973; and

WHEREAS, ROYAL is in immediate

need of additional working capital to con-

tinue its operations; and

WHEREAS ROYAL is not presently able

to obtain said additional working capital

from any source;

Meanwhile Leonard Greenberg and Abe

Berman had met at the pool show in Janu-

ary 1978. Greenberg told Berman that he

thought it was time to sit down and talk

about Coleco’s acquiring Royal—‘“that he

[could] make rich men out of us.” Tr. at

28:3624. Rubin and Berman, exploring dif-

ferent avenues for providing Royal with

much needed capital, agreed; eventually a

meeting between Rubin and Berman and

Leonard Greenberg was set to take place at

the Royal plant in New Jersey on April 18,

1973.

B. April 18, 1973 Through June 4, 1973

On April 18, 1978, Leonard Greenberg

did, in fact, spend the day at Royal in

Pennsauken. He talked to Rubin and Ber-

man both separately and together. He col-

lected information on Rubin’s and Berman’s

backgrounds, and Rubin showed him around

the Royal plant where Greenberg was im-

pressed with the efficiency and orderliness

of the packaging and shipping operation as

well as the general design of the pool mod-

els. He noticed an apparently obvious dis-

crepancy between the large amount of

stock on some pool parts and the relatively

smal! amount on others, and this observa-

30a

tion triggered a discussion between Rubin

and Greenberg on the problem of Royal’s

inventory imbalance. Tr. at 20:2510. Ru-

bin and Berman discussed with Greenberg

their increasing difficulty in getting parts

because of lack of capital, and Rubin told

Greenberg that in addition to any purchase

price which Coleco paid for Royal it would

have to pay out a substantial amount al-

most immediately to pay suppliers. Tr. at

20:2514. Berman told Greenberg that the

crux of Royal’s problem was that although

the orders were coming in, Royal lacked the

capital necessary to start a strong flow of

pools from Royal to fill the orders. Tr. at

28:3625-26. Greenberg asked if Royal

could produce and sell 2500 pools in 1973.

Rubin said such production would be possi-

ble with a substantial infusion of capital,’

operating two 10-hour shifts six days a

week, and if Coleco provided Royal with

production foremen. Tr. at 20:2514—15.

Greenberg said money and personnel would

be available and suggested further that Co-

leco could ease Royal’s burden by providing

Royal with certain Coleco-manufactured

pool parts and with trucking services. Tr.

at 20:2515-16. He also pointed out that

should Coleco acquire Royal, suppliers

would not press as hard for payment, be-

cause of the Coleco name. Tr. at 20:2515.

Rubin told Greenberg that he believed Roy-

al to be making an average $500 gross

10. Berman and Rubin both testified that Rubin

told Greenberg that in order for Royal to pro-

duce 2500 pools in 1973, Coleco would have to

invest $200,000 immediately and up to $500,-

000 within a few months to pay suppliers. Tr.

at 20:2515 & 28:3629.

3la

profit on each pool sale which would result

in $4 million total sales for 2500 pools and a

gross profit of $1,250,000. See Ex. U-14 at

4. There was also discussion among the

three men of Royal’s inroads and potential

inroads on the dealer/customers of Abco

Swimming Pool Co., a subsidiary of Coleco.

Greenberg pointed out that one advantage

of the acquisition would be the elimination

of competition between Abco and Royal.

Tr. at 20:2507. Greenberg testified on

cross-examination that on April 18, 1973, he

was aware that Abco and Royal shared

some of the same customers and that Royal

was courting one of Abco’s larger custom-

ers. Tr. at 8:872-73. Finally, Greenberg

told Rubin and Berman that Coleco wanted

to acquire Royal because

It would be an extension of the swim-

ming pool—their participation in the

swimming pool field on a high quality

pool which they had not made before and

he said that they had the choice of either

designing it themselves from scratch or

buying someone that was in the industry

and it looked like we had been doing

fairly well.

He mentioned that he had been im-

pressed the first—back in San Antonio a

year ago with Abe’s presentation of the

booth and he watched us in the year in

between and it looked like that we had

done rather well for our limited capital,

which was generally pretty well known in

the field.

Tr. at 20:2511. The three men then dis-

cussed a purchase price of approximately $1

million (Tr. at 20:2512), and Greenberg con-

32a

ditioned his tentative offer on Royal's al-

lowing Coleco personnel to visit Royal and

examine its books and records. Tr. at

20:2513.

The substance of this April 18th meeting

is corroborated by exhibit U-14, a memo-

randum, dated April 20, 1973, from Leonard

Greenberg to Arnold Greenberg and Mel

Gershman; the two Greenbergs and Gersh-

man formed Coleco’s executive committee.

Some of the more salient portions of the

memorandum document Coleco’s motiva-

tion, as expressed by its then president, in

acquiring Royal and Coleco’s recognition

that the acquisition was a speculative one.

Greenberg begins the memo:

Remembering, of course, that this compa-

ny has yet to make a profit, the question

really gets down to what management

capability are we buying, and how is this

evidenced by their product line, and what

would it take for us to duplicate this type

of product line and sell it.

He also suggests that Coleco could, upon

acquisition, raise the price of each Royal

pool about $200 since “they [Rubin and Ber-

man] entered the market a little nervous

this year, and let their pants down with

regard to prices.” Near the end of the

memo Greenberg states, in discussing a pur-

chase price,

At this point I’m holding out for a million

dollars and I have a hunch that they

would be willing to sell for a million, and

I stress, of course, in these notes, that

they have still to show their first profit.

Everything is conjecture.

33a

In addition to Leonard Greenberg’s April

20th memorandum, the record contains a

memo, dated April 19, 1973, from Gershman

to the Greenbergs. This memo (Ex. U-304)

contains information which Gershman had

collected at Leonard Greenberg’s request in

order to verify Royal’s reputation and sta-

tus in the swimming pool industry.

Through discussions with the principals at

Esther Williams Swimming Pool Co., Gersh-

man did indeed verify that Royal was “un-

dercapitalized and, therefore, couldn't really

move in the marketplace because it takes so

much money to build the inventory and

carry the accounts” but that Hank Green-

berg of Esther Williams (no relation to

Leonard and Arnold Greenberg) said

that Royal pool was coming up very

strong, with apparently a good product

copied after Esther Williams, and was in

his second year. He indicated that both

Berman and Rubin seemed to know what

they were doing and that because of their

limited finances he had to work carefully

with them but indicated an estimated

sale of 2500 filters this season.

Gershman also notes the “drastic material

costs increases” in the pool industry in 1973

and that aluminum prices, in particular,

were “increasing very rapidly.” ™

Before moving on in our narrative of the

events of April and May 1973, we note that

11. Gershman testified in deposition, parts of

which were read into the record at trial, that,

as Coleco’s overseer of purchasing, he was in a

position to follow price fluctuation in the sup-

plies market. Tr. at 19:2307.

Bia ay

34a

plaintiff at trial and in its brief made much

of two letters (Exs. 33 & 37), dated April

17, 1973, and written by Joe Rubin to his

two major suppliers of aluminum extru-

sions, Howmet Corp. and Capital Products,

Corp. Rubin admits that he did not men-

tion these letters to Leonard Greenberg

during their April 18th meeting. Based on

this omission, plaintiff contends that Rubin

deliberately concealed from Greenberg the

facts to which Rubin attests in the letters.

In both letters, but especially in the letter

to Howmet, Rubin invokes the imminency

of Armageddon if both suppliers do not

deliver as promised. He mentions various

“disasters” and “catastrophes,” including lost

customers, damaged reputation, and threat-

ened law suits, all resulting in no small part

from the dereliction of Howmet and Capi-

tal. Rubin explains these letters and his

failure to show them to Greenberg as at-

tributable to the inflated rhetoric and fac-

tual exaggeration necessary in “a business

letter that was sent out trying to shake

them up into manufacturing parts for us

correctly.” Tr. at 24:3057. We accept Ru-

bin’s explanation and find that on April 18,

1973, Rubin and Berman represented to

Leonard Greenberg the condition of Royal

as they believed it to be.

On April 21, 1973, the Greenbergs and

12. Both exhibits were admitted as to defend-

ants Rubin and Berman; we took under advise-

ment the objection of the Cohen defendants

that the letters, relevant only to the 10b-5

claim, were irrelevant as to them since we had

already directed a verdict in their favor on the

10b-5 claim. We now sustain their objection.

35a

Gershman met among themselves in Hart-

ford to discuss the details of a possible

acquisition of Royal. Although they were

aware that Rubin and Berman wanted to

effect any acquisition as rapidly as possible

because of Royal’s need for working capital,

the Coleco principals, especially Arnold

Greenberg, wanted a full audit as of June

30, 1973, to verify the $500 per pool gross

profit figure Rubin had given to Leonard

Greenberg. Tr. at 2B:26—-28. This, in Ar-

noid Greenberg’s estimation, would delay

closing until August 1973. Tr. at 2B:30.

Should this take place, however, the Green-

bergs and Gershman agreed they would pay

$1 million for Royal over a three-year, pay-

out period. Tr. at 2B:30.

One week later, April 28, 1973, Rubin and

Berman came to Hartford and met there

with Arnold and Leonard Greenberg, Mel

Gershman, Michael Schwefel, Coleco’s gen-

eral counsel, James Hubert, Coleco’s corpo-

rate controller, and Edward Fialkowsky,

Coleco’s treasurer. The meeting was a

lengthy one beginning with a discussion of

Rubin’s and Berman’s backgrounds and the

nature and status of the Royal operation.

Although Rubin and Berman were enthusi-

astic about Royal’s potential, they told the

group at the meeting, as they had told

Leonard Greenberg on April 18th, that Roy-

al had to have an immediate infusion of

several hundred thousand dollars of work-

ing capital for suppliers. Tr. at 21:2527-

13. Rubin’s and Berman’s testimony that they

talked, in the early discussions with Coleco,

about Royal’s need for an immediate few hun-

36a

28. The conversation also covered the

availability of Coleco foremen, pool parts,

and trucking (Tr. at 21:2532 & 2535-36), as

well as joint Abco/Royal customers and

customers that Royal would bring to Coleco.

Tr. at 21:2529. Rubin discussed the prob-

lems he was having with his newest pool

model, the Castle. He told the Coleco rep-

resentatives that he was having technical

problems with the aluminum extruders be-

cause of their difficulty in executing his

designs and that he had no final costing

figures on the Castle. Tr. at 21:2531. He

also told them that because of difficulties

with suppliers he was shipping pools to

dealers short parts when the dealers were

willing to accept incomplete pools tempo-

rarily and wait for missing parts. Tr. at

22:2708-11. The Coleco representatives

then told Rubin and Berman that before

closing they wanted a June 30, 1973, audit.

Rubin and Berman responded that Royal

dred thousand dollars for suppliers and up to

$500,000 within a month or so appears corrob-

orated by exhibit U-302, notes taken by Arnold

Greenberg during the April 28th meeting in

Hartford. The exhibit shows the following no-

tation:

Suppliers: 300,000 now

will go to 400-500,000—by end of May

Although Arnold Greenberg testified that these

figures represented Royal's total indebtedness

to suppliers (Tr. at 3:166), the congruence be-

tween Greenberg’s figures and the ones testi-

fied to by Berman and Rubin coupled with the

presence in Greenberg’s notes of the word

“now” underscored persuades us that Green-

berg was recording statements by Rubin and

Berman that Royal would need several hundred

thousand dollars by June to pay suppliers.

a ae

37a

could not wait that long for relief. This

seeming impasse was resolved when the

parties tentatively agreed that the non-con-

tingent $1 million purchase price originally

contemplated would be reduced to $500,000

with another $500,000 contingent upon the

profitability of Royal over a three-year pe-

riod. As Arnold Greenberg put it: “In

other words, if we were to be persuaded to

go forward without a June 30 audit, they

ought to wait for their money.” Tr. at

2B:58. The parties also agreed that the

Royal shareholders would warrant Royal’s

financial and operational status in the pur-

chase agreement and that Royal’s account-

ant, Zelnick, Sobelman, & Co., would pre-

pare an unaudited April 30, 1973, financial

statement also to be warranted in the Pur-

chase Agreement. Finally, since Berman

was reluctant to open fully his customer

files to Coleco without some assurance that

the acquisition was being seriously con-

sidered, the parties agreed that Coleco

would provide Royal with a letter of intent

to purchase, and plans were then made to

send a team from Coleco to Royal

to take a look around, to get some com-

fort, to take a look at certain books and

records te see if they backed up the rec-

ommendations we heard.

Tr. at 2B:77 (Arnold Greenberg).

The examining team, consisting of

Schwefel, Hubert, and Gerald Glassman,

Coleco’s then director of costing," subse-

14. Although Glassman is no longer in the em-

ploy of Coleco, we consider his deposition testi-

mony, read into the trial record, to be crucial

38a

quently visited Royal on May 2, 1973.

Schwefel, who brought with him the letter

of intent, spent a good deal of time with

Berman going over the status of Royal’s

individual dealer/customers. Tr. at 21:2599

and 28:3642-45. Berman told Schwefel

about Royal’s practice of giving customers

so-called “protected ‘erritories,” that is,

making informal, usually oral agreements

that Royal would not sell pools to other

dealers in a certain geographical area. Ber-

man considered these agreements a com-

mon practice in the swimming pool indus-

try, terminable at will, and without any

legal force. Tr. at 28:3616-18. Schwefel

told Berman he was familiar with the con-

cept of “protected territories” through

Abco, Coleco’s subsidiary, which also en-

gaged in the practice. Tr. at 29:3738—40.

Berman also discussed with Schwefel spe-

cial problems with Regency, Carib, and

Style, all pool companies." Tr. at 28:3643-

for a few reasons. First, he was, both during

1973 and at the time of his deposition, plain-

tiff's own man, one of its higher ranking man-

agement employees. Tr. at 3:242. Second, as

Coleco’s director of costing, he was its expert

in the area in which Coleco claims perhaps the

most serious breach of the Purchase Agree-

ment. We also note that despite Glassman’s

significant role in pre-acquisition activity,

plaintiff did not call him as a witness.

15. Regency was an apparently abortive enter-

prise Rubin and Berman launched in 1972 to

distribute Royal pools in Canada. Tr. at

28:3643. Regency was to be operated in Cana-

da by a Mr. Gascoigne and a Mr. Mitchell who

were to receive a commission on each Royal

pool sold in Canada whether or not they sold it.

Tr. at 27:3529-30. Rubin showed the contract

with Gascoigne and Mitchell to Schwefel, and

39a

47. In addition Schwefel sat in on a discus-

sion between Berman and Royal’s attorneys

concerning litigation with Carib Pool Co. in

which Royal was involved and went over

the Royal shareholder and bank loan agree-

ments. He asked to see customer service

files, and Rubin told him that no files exist-

ed since service complaints were minor, usu-

ally having to do with faulty liners and

were dealt with informally.“ Tr. at 4:304-

Regency was discussed with Schwefel on more

than one occasion. Tr. at 27:3531-32.

Carib was the pool company involved in litiga-

tion with Royal in the Spring of 1973. The

lawsuit was settled in May 1973.

Style Pool Company was one of Royal's 1972

dealer/customers in Chicago. Style had pur-

chased about 25% of Royal's production in

1972, but Rubin and Berman had had a great

deal of difficulty in collecting their money from

Style, nearly $100,000 owing to Royal near the

end of 1972. In order for Royal to collect its

money, Rubin and Berman were pressured into

entering into a written agreement with Style in

October 1972 giving it an exclusive distributor-

ship. When they finally collected all money

owing from Style, they notified Style that Roy-

al would no longer deal with it. All this infor-

mation was revealed to Schwefel on May @

1973. Tr. at 28:3644-47.

16. We have not overlooked exhibit U-77, a

letter from Style to Coleco dated June 6, 1973,

and exhibit P-82, a memorandum from Tony

Gaeta to Abe Berman dated June 18, 1973, in

finding that Royal had had no major customer

complaints prior to June 4, 1973, and that

whatever complaints it had received were han-

died informally. Both U-77 and P-82 are, of

course, dated post June 4, 1973. As to the

substance of the problems cited in U-77 and

P82 and relevant to the inferences one might

draw regarding the kinds and number of cus-

40a

5. Hubert spent his time with two of Roy-

al’s accountants, Norman Zelnick and Ste-

ven Savett, going over their work papers

for a January 31, 1973, financial statement

they had prepared for Royal.'7 Based on

information given to him, Hubert then pre-

pared an estimate of Royai’s profits for

1973. Glassman spent his time either with

Rubin or alone going over invoice files and

tomer complaints Royal might have received

prior to acquisition, we note first that com-

plaints from Style to Coleco are suspect given

the difficulties it had created for Royal in 1972.

Rubin believed Style to be capable of commer-

cial blackmail, and, although Style no longer

dealt directly with Royal, it was still a custom-

er of Coleco’s. Second, while Gaeta’s asser-

tions in P-82 are not suspect, most of the

complaints he lists go not to the quality of the

Royal pools but to Royal's failure to deliver

promptly on the orders it took. This, of course,

is the problem, revealed to Coleco prior to

acquisition, that prompted defendants’ decision

to sell Royal. Gaeta also mentions the related

problem, also revealed to plaintiff prior to ac-

quisition, of Royal’s shipping incomplete pools

to dealers who were willing to accept them that

way temporarily. Finally, Gaeta cites com-

plaints for faulty liners and Royal's failure to

deliver a pool feature called “Roman Steps.”

Rubin told Schwefel prior to acquisition that

most of the complaints he had received had to

do with faulty liners. As for the missing “Ro-

man Steps,”’ whatever the explanation for the

problem to which Gaeta refers, his memoran-

dum reference does not move us to change our

finding that Rubin spoke the truth when he told

Schwefel that he kept no formal customer com-

plaint files and that he dealt with occasional

minor complaints on an ad hoc basis.

17. Hubert found a $16,000 error in the state-

ment which was corrected in the April 30,

1973, statement. Tr. at 10:1107-09.

4la

a cost sheet and bills of material on the

different pool models made available to

him."® Glassman toured the factory with

Rubin and noted that the Royal inventory

was “very much out of balance,” (Tr. at

19:2255) and he and Rubin discussed the

problem. Rubin then showed him the cost

sheet ® on the 15 by 30 foot Crest pool,

Royal’s largest seller for 1972. Eventually,

Glassman found that $70 worth of materials

had been left off this cost sheet.” Tr. at

19:2259 and 2283. Although Rubin did not

show him cost sheets on other pools, he

showed him the bills of material *" for sev-

eral other pools but not the Castle and

Camelot models, and Glassman found the

same items missing on these bills of materi-

al as he had found on the Crest cost sheet.

Tr. at 19:2267. Rubin and Glassman also

discussed the fact that Royal’s cost sheets

had not been updated from 1972 and that

aluminum prices were rising. Tr. at

19:2284. Rubin estimated the price rise

18. Glassman’s account of his visit to Royal on

May 2, 1973, and Rubin's account of the same

visit are highly corroborative.

19. A cost sheet consists of a listing of the

various parts comprising a given pool model

along with the prices of the parts.

20. Hubert testified that after Glassman in-

formed him of the $70 discrepancy, he as-

certained from Rubin that $20 of the $70, the

cost of a crate, was accounted for since it was

included in factory expenses rather than in the

cost of the pool. Tr. at 10:1112.

21. A bill of material differs from a cost sheet in

that it omits prices.

42a

would affect the price of a pool by $50. Tr.

at 19:2284. Finally, near the end of the

day, Rubin discussed with Schwefel, Hu-

bert, and Glassman together the problems

caused by inventory imbalance, particularly

the problem of shipping out Castle pools

with heavier and more expensive Crown

and Crest parts substituting for the missing

Castle parts. Tr. at 21:2567-68. After this

meeting at Royal, Glassman discussed his

findings at Royal with Hubert and Schwe-

fel. He summarized those discussions this

way:

Only to the effect that I was satisfied

that the items listed on the Bills of Mate-

rial or the Bill of Material, if you will,

were costed properly according to invoic-

es, but that I did have a concern that

perhaps there might be other items that I

didn’t find inasmuch as I had found some

$70 of items already just by probing that

were not contained on the Bill of Materi-

als.

Tr. at 19:2283. Back at Coleco, Glassman

told Mr. Gershman about the discrepancies

he had found:

I iniormed him of the missing items on

the Bill of Materials. I told him that I

had been satisfied that the pricing that

had been listed on the costed Bill of Ma-

terials appeared to be correct, and I ex-

pressed a concern about perhaps some

other items that I didn’t find listed that

perhaps might also be missing from the

costing.

Tr. at 19:2294. Glassman and Gershman

discussed Roya!’s inventory imbalance. Tr.

at 19:2300-01. Glassman also reported his

43a

May 2nd findings directly to Arnold Green-

berg.” Tr. at 19:2296. Stangely enough,

although Schwefel visited Royal again and

Hubert twice more prior to acquisition,

Glassman was not again instructed to con-

cern himself with Roya! until September

1973. Tr. at 19:2296-97.

Sometime after May 2, 1973, Schwefel

called Royal to say that Coleco was willing

to go ahead with the acquisition and that he

was sending to New Jersey a copy of a

draft agreement. The upshot of this call

was the next meeting between Royal and

Coleco in Hartford on May 14, 1973. This

time, however, Rubin and Berman met only

with Schwefel and Hubert, Arnold Green-

berg coming into the room only a few times

to engage in a quick exchange and then

leave. Beginning a pattern of practice fol-

lowed by Coleco through the critical Sum-

mer of 1978, Schwefel conducted the direct

communications between Rubin and Ber-

man and Coleco. The parties once again

discussed joint Abco/Royal customers (Tr.

at 24:3094), Royal’s need for a large infu-

sion of capital (Tr. at 21:2618), its inventory

imbalance (Tr. at 21:2618), and its special

relationships and problems with Regency,

Style, Carib, and Apex pool companies (Tr.

at 21:2602-03).% Berman and Rubin were

22. Greenberg does not dispute that Glassman

reported to him; he tes‘ified only that he has

no recollection of such a report. Tr. at 3:249.

23. Apex was a New England pool company

connected with Carib pools. Berman con-

sidered Apex to be Carib’s dealer and that any

exclusivity afforded Apex came though Royal's

relationship with Carib. As Berman put it,

44a

unhappy about unilateral changes they felt

Coleco had made from their original under-

standing to the draft agreement and were

offended by the Greenbergs’ seeming refus-

al to deal with them directly. Before leav-

ing Hartford, however, Rubin did telex

banks and certain of Royal’s suppliers au-

thorizing them to release to Coleco’s repre-

sentatives financial information they had

on Royal. Tr. at 21:2618-19. In addition,

before they left, Arnold Greenberg stopped

in the meeting room to say that the litiga-

tion with Carib pools must be resolved be-

fore closing. Tr. at 21:2623. Within sever-

al days after this May 14th meeting, Schwe-

fel called Royal to inquire into the status of

the acquisition, and Rubin and Berman told

him that they had decided against going

ahead because of the discourteous treat-

ment they had received in Hartford on May

14th. This announcement precipitated a

phone discussion between the Greenbergs in

Hartford and Rubin and Berman in Penn-

sauken during which agreement was again

reached. Thereafter, Hubert visited Royal

twice more on May 25, and June 1, 1973, to

work with Royal’s accountants on the April

30, 1973, statement which was to be war-

“Carib had an exclusive and Apex had an ex-

clusive with Carib and | honored that and let

Apex know about that.” Tr. at 29:3746. The

Apex situation was discussed with Schwefel

more than once. Tr. at 21:2605-07 and

28:3664. On May 14, 1973, in Hartford, when

Berman explained Royal's relationship to Apex

to Schwefel, he told Rubin and Berman that, in

his opinion, Apex was Carib’s dealer and not

Royal's. Tr. at 21:2606.

a ere

45a

ranted as part of the Purchase Agreement,

and reported back to Hartford. Although

Hubert had, over his several visits to Royal,

discovered more than one error made by

Zelnick, Sobelman, and Co., he missed two

others that defendants concede render the

April 30, 1978, statement erroneous in the

amount of $49,922.88.% At last, on June 4,

1973, the Carib litigation having been set-

tled, the acquisition was effected and clos-

ing took place in Pennsauken and Philadel-

phia. The Royal shareholders received

$135,000 plus interest as the first of three

non-contingent payments, and Coleco took

Royal.

To summarize, then, and to make explicit

our assessment of the character of Rubin’s

and Berman’s negotiations with Coleco

which culminated in the June 1973 acquisi-

tion of Royal by Coleco, we find that during

the whole of the pre-acquisition negotia-

tions, both Rubin and Berman were forth-

right in their dealings with the principals

and representatives of Coleco and did not

deliberately misrepresent any aspect of

Royal’s status or operation. Any factual

misrepresentation made through the vehicle

of the warranties in the Purchase Agree-

ment, especially through the warranty of

the April 30, 1973, financial statement, was

not studied.

24. Post-trial brief of the Cohen defendants at 2.

Zelnick, Sobelman, & Co. admits these errors

were accountants’ errors. Tr. at 31:4072-76

and 4085.

46a

C. June 4, 1973 Through November 1973.

Immediately upon closing and continually

thereafter Berman, and especially Rubin,

applied to Coleco, through Michael Schwe-

fel, for the heavy infusion of capital to

suppliers they had been led to expect would

be forthcoming. Tr. at 21:2657-67. It sim-

ply never came. In June Coleco advanced

$155,000, in July $45,000, and in August

$9,000 to pay suppliers. Tr. at 3:226. The

continuing shortage of working capital had

three immediate effects. It left suppliers

unsatisfied so that they withheld materials

from Royal. Tr. at 21:2659-70 and

28:3673-74. This, in turn, precluded Royal

from delivering on its orders and from bal-

ancing its inventory. Id. Finally, it made

Royal's accounts receivable difficult to col-

lect for reasons on which Berman and An-

thony Gaeta, a Royal salesman, agreed. Tr.

at 28:3674-75 and 30:3844-45. As Gaeta

explained the problem:

The reason I was having a problem is

that at that time of year, the manufac-

turer is in a very critical position. The

25. The situation with suppliers was exacerbat-

ed because, just prior to closing, Rubin had

released to suppliers news of the acquisition

and had thereby raised their expectations of

payment, as the Greenbergs had predicated.

Tr. at 21:2657-58. When payment was not

forthcoming, suppliers took a hard line toward

Royal. Rubin told Hubert:

We have no answer for suppliers. Coleco

came on like a big company and said they

were going to pay everyone and the suppliers

want money and now they refuse to give us

anything.

Tr. at 21:2665.

47a

dealer has sold his pool. If he does not

receive delivery, the customer is going to

cancel, so the dealer will go somewhere

else. In order for the dealer to go some-

where else at that time of the season, he

had to pay cash or certified before deliv-

ery so he would hold up the monies that

he owed me to pay another manufactur-

er.

Tr. at 30:3844—45. This situation left Rubin

contending daily with suppliers to obtain

what parts he could (Tr. at 21:2673) and

Berman contending daily with dealer/cus-

tomers on whose previously obtained orders

he could not deliver. Tr. at 21:2668-69.

Nor did Rubin ever get any Coleco person-

nel to help him in the factory, and for seven

weeks during the summer of 1973 he

worked seven days a week, 13 and 14 hours

a day. Tr. at 22:2698 and 2702. Moreover

Berman and Rubin were relegated to deal-

ing with Schwefel, Coleco’s general counsel,

in trying to work out Royal's operational

problems. Schwefel told Rubin to deal

through him (Tr. at 21:2646-47), and, when

Rubin attempted to contact directly Mel

Gershman, Coleco’s overseer of purchasing,

he was unsuccessful. Tr. at 21:2666.

Aside from preventing Royal from pro-

ducing the number of pools Coleco wanted

it to produce, the frustrating state of af-

fairs in Pennsauken had a second debilita-

ting effect. Berman and Rubin were fast

alienating each other. Berman obtained

many more orders than Rubin could fill so

Berman was constantly importuning Rubin

for more finished pools. Rubin, in turn,

48a

without the foremen Coleco had promised

and instructed by Schwefel to use Berman

in the factory (Tr. at 22:2698), attempted to

draft Berman into production. At this Ber-

man balked saying to Rubin:

What am I going to do out there? I don’t

know how to drive a fork lift. I don’t

know how to pack a pool. I wouldn't

know if parts were short and what parts

weren't short. I am a salesman. I am

selling pools. I’ve got the pools sold and

now it is up to you to ship them.

Tr. at 26:3442. Berman also left the office

work and supervision of the office workers

to Rubin. Tr. at 26:3428, Ex. R-35. For

instance, in a letter to his counsel that

Rubin wrote in September 1973, he made

the following statement which we credit:

Berman never Credited dealers on re-

turns. He never Debited suppliers on

returns. Generally the office work was a

disaster.

Ex. R-35 at 4 (admitted without objection).

By July Rubin was keeping a diary of Ber-

man’s comings and goings and reporting

them to Coleco (Ex. 18). Berman told Ru-

bin that “he will do what he wants and let

Coleco fire him then he will sue.” Ex. 18,

Tr. at 26:3439. This statement was part of

the information that Rubin relayed to Cole-

co. Tr. at 26:3489. In addition, Rubin tes-

tified at trial that Berman spent less and

less time at Royal in July but that he didn’t

know whether Berman spent his time away

from Royal on personal matters or on Roy-

al’s business. Tr. at 26:3429. According to

Berman and Gaeta, whose testimony we

accept, the bulk of the time away from

49a

Royal was spent on telephones with and at

the premises of dealers/customers trying to

placate those whose orders were overdue.

Tr. at 22:3689-92 and 30:3845-46. Also in

July Coleco made known to Rubin and Ber-

man that it was considering adding Al Katz

to Royal’s sales staff. Berman objected

strongly, first, because he disapproved of

Katz’s sales techniques, and, second, be-

cause he felt that Royal, heavy on orders

and light on production, needed no addition

to its sales staff. Tr. at 28:3679-80-81. In

spite of Berman’s strong objections, Leon-

ard Greenberg announced to Berman at a

meeting in Hartford on July 14, 1973, that

Coleco had hired Al Katz as Royal’s sales

manager. At the same meeting Berman

presented a 1974 sales projection considered

unrealistic by the Coleco personnel and by

Rubin, whose opinion we accept. Tr. at

26:3434-36. Shortly thereafter Schwefel

instructed Rubin to inform Berman that he

was no longer President of Royal, and Ru-

bin transmitted the message. Tr. at .

28:3698-99. Next, Coleco informed Berman

he would no longer have authority to sign

checks for Royal. Tr. at 28:3700. Then

sometime at the end of July or the begin-

ning of August, Rubin told Berman that

Leonard Greenberg had requested Rubin to

keep a log on Berman and to tell Berman

he was doing so. Tr. at 27:3466 and

28:3704. At this point Berman left Royal

and was gone a few weeks. He described

his reaction when Rubin told him about the

log this way:

The fact that the money—we didn’t

have the money to buy materials, that we

50a

couldn’t supply pools, that they took the

presidency away from me, that they took

the check signing authority away, the

way I was treated up in Hartford, this

{Rubin’s telling him about the log] was

more or less the straw that broke the

camel’s back. I just felt my heart palpi-

tating, my stomach turning over and my

face turning red, and I said to Joe, “Joe,

I’m sorry; because of what’s going on

here, I must get out of here.”

I left and sat down with my wife and

told her what happened and she immedi-

ately called the doctor and we went over

to see him and as a result of this I called

Joe and told him that I must have time

off, I did go to see a doctor; I must have

time off. Otherwise, it is going to result

in a nervous breakdown and that I was

going away to the seashore for a few

days; that I will be in touch with him

and as soon as | am able to return, |

certainly will, which should be approxi-

mately two weeks.

Tr. at 28:3705-06. During the time Ber-

man was away from Royal, he missed an

executive meeting in Hartford which he

was supposed to attend. Shortly after he

returned Arnold Greenberg informed him

by phone that he was discharged. Coleco

also notified him formally by letter (Ex.

146).

Meanwhile Royal was struggling through

the Summer with suppliers dunning them

for payment and dealers clamoring for

pools. An inventory was taken * at the end

26. The taking of the inventory produced added

difficulty between Rubin and Berman. Rubin

Sla

of July, badly taken according to Rubin (Tr.

at 22:2732-36) whose opinion we credit, and

Coleco personnel contended that based on

the figures Royal had given them at clos-

ing, they had come up short. At approxi-

mately the same time as the taking of the

inventory Gershman issued a memorandum

(Ex. R-49) cancelling all orders with suppli-

ers and authorizing new purchase orders

only for materials “to balance off and com-

plete 320 pools.” According to Rubin’s tes-

timony, which we credit, this directive in-

creased the chaos at Royal:

With regard to paragraph 3, I asked,

“What model 320 pools are we supposed

to build?” With regard to paragraph 2, I

asked, “Why are we cancelling orders

that were placed in an effort to balance

out the inventory and then issue new

orders for 320 pools that I didn’t know

what models they were referring to?” It

just didn’t seem to make any sense.

In some cases, it didn’t make any differ-

ence because vendors had refused to ship

us for lack of payment, so cancelling was

a futile gesture and in other cases when

we cancelled it threw out of balance what

we were trying to balance out.

Tr. at 22:2730-31. Yet, in spite of the

results of the inventory and the directive

from Gershman, on August 16, 1973, Leon-

ard Greenberg wrote to Rubin after an

A, gust 13th meeting in Hartford:

tried to involve Berman in the invento’. Ber-

man at first demurred on the ground that he

must deal with anxious customers and then, on

the next day at Schwefel’s or Hubert’s request,

lent some assistance.

52a

Let’s all put our shoulders to the market-

ing wheel now. I think we know what

we have to do for next year, and I think

we have an excellent opportunity to grow

successfully.

Exhibit U-83 at 4. Also in August Royal

received a handful of complaints (less than

10) that Castle pools had pulled apart or

“blown” in the field. As a result Rubin

designed a “retrofit kit” (Tr. at 22:2760), an

assembly to be added to the structure of the

pool to prevent any further problems.

In September Abco, Coleco’s subsidiary

pool company, began to take over the Royal

sales functions. The situation with suppli-

ers was as bad or worse than ever. Rubin

told Schwefel and Hubert “that they will

not open for business in 1974 unless they

pay suppliers.” Tr. at 22:2772. A letter

dated September 25, 1973, from Rubin to

Leonard Greenberg (Ex. U-94) records Ru-

bin’s assessment of Royal’s problems with

its accounts payable. After noting that

relations with Howmet were excellent, that

Howmet was willing to wait for its money,

and that he did not intend to deal with

Capital, Rubin went on to say:

On the balance of suppliers we are having

major problems. These are small opera-

tors that require money immediately. I

have not been able to find anyone at

Coleco that will give me a clear financial

picture at this time and it has placed me

and Royal in a very poor position as far

as negotiating with these suppliers. I

had hoped that when I sent my Aug. 27th

letter to Ed Fialkowsky that the picture

53a

would clarify itself since it covered in

total, our fourth quarter budget plus cash

flow plus receivables plus expenses.

However, neither Hubert nor Fialkowsky

have at this point been able to give me

information as to when monies would be

available. I have been told on an unoffi-

cial basis that everyone would be paid by

Dec. 15th, but this was not definitive

enough for me to clearly negotiate with

the suppliers. As a result, our credibility

factor has been questioned and probably

some of the suppliers will not be willing

to do business with us next year. If the

target date is Dec. 15th and I definitely

know about it, at least I know where and

how to act. However some monies must

be paid prior to that date as some suppli-

ers absolutely cannot wait.”

27. Exhibit R-6, a portion of which was admit-

ted in evidence over objection (Tr. at 22:2780-

84), offers some corroboration for Rubin's

statement to Leonard Greenberg. In exhibit

R-6, a September 6, 1973, letter to Rubin, the

president of Jard Engineering Co., one of Roy-

al’s suppliers, wrote:

Like all our other customers, we value the

Royal account, but upon a closer examina-

tion, we find that even though your account

represents a large dollar volume, it has not

been profitable for one apparent reason.

During the month of August alone, we paid

$774.05 in interest charges to borrow money

to equal the amount that Royal currently

owes us.

In as much as Jard is not a large company,

we can not afford to continue to finance

Royal or Coleco. We, therefore, have no

alternative but to charge a 1'2% per month

service charge for all invoices over thirty (30)

days old.

54a

Exhibit U-94. He received no response

from Coleco to his letter. Tr. at 22:2779.

In September the communications lines be-

tween Rubin and Coleco remained down.

Tr. at 22:2785. On September 27, 1973,

however, Rubin attended a meeting in

Hartford with the Greenbergs, Gershman,

and Schwefel. During the course of the

meeting, Leonard Greenberg told Rubin

that the manufacturing of Royal’s above-

ground models was to be moved to West

Haven, Connecticut. Tr. at 22:2797. Since

most models of Royal pools were above-

ground models, such a change would, in

Rubin’s words, render the Pennsauken facil-

ity a “hollow operation.” Tr. at 22:2798.

When the Coleco men asked Rubin if he

wanted to move to West Haven, he re-

sponded negatively and invoked the clause

in his employment contract which stipulat-

ed that Royal’s operation would not be

moved more than 30 miles absent an agree-

ment of the parties. Tr. at 22:2798. He

then asked what would comprise his duties

at Royal in New Jersey after the move but

received no answer before the meeting ad-

journed. Tr. at 22:2798. Just before ad-

journing Arnold Greenberg told Rubin that

Coleco was “going [to go] after the Cohens

. and Abe Berman” if necessary by

a lawsuit. Tr. at 22:2799. He told Rubin

he was satisfied with his work and would

As of the writing of this letter Royal owed Jard

$62,943.01, of which $51,088.25 was owing

more than thirty days. Although plaintiff

raised hearsay objections to exhibit R-6, plain-

tiff does not contend that the facts represented

by Jard are inaccurate. Tr. at 22:2782.

55a

like to retain and protect him; Greenberg

asked Rubin if he would testify for Coleco

in a lawsuit. Tr. at 22:2800. Rubin re-

sponded that he would simply testify to the

truth. Tr. at 22:2800. Back in Pennsauk-

en, Royal employees were being given their

working instructions directly by Coleco rep-

resentatives, a method of operation that

bypassed Rubin. Tr. at 22:2810.

In October Rubin received a memoran-

dum, dated October 17, 1973, from Gersh-

man (Ex. R-135) in which Gershman in-

formed Rubin that he was to complete

packaging the 150-200 pools for which he

had parts on hand. Gershman went on to

say:

We would suggest that you, Joe, then

personally sell off these Royal pools so

that Abco will not get involved in clean-

ing up the pools from your stock.

Following receipt of this memorandum Ru-

bin procured an order from a pool dealer,

Eugene Margolis, for 300-400 Castle pools.

Tr. at 22:2820. When Rubin notified Coleco

of the sale, however, Schwefel told him not

to contact Margolis again, and Hubert later

told him Coleco never sold the pools to

Margolis. Tr. at 22:2821. Sometime in No-

vember Rubin came upon an advertisement

in a trade journal (Ex. R-152) that, for the

first time, informed him of the use to which

Coleco was putting the Royal name and

reputation. The advertisement is headed:

This year ABCO is also ROYAL

the Famous Line of

ALL ALUMINUM SWIMMING POOLS

56a

A portion of the text of the advertisement

states:

Royal pools have always had a great con-

cept. Now, this outstanding line will

have Coleco for manufacturing and in-

ventory control and ABCO’s management

and distribution experience . . |. an

outstanding combination.

The company name is printed as

“ABCO/ROYAL (a subsidiary of Coleco In-

dustries, Inc.),” and the pools pictured in

the advertisement are called the Crest, the

Jewel, and the Crown. Up to the time he

saw the advertisement, Rubin was unaware

of any connection between Royal and Abco

except for Abco’s acting as Royal’s sales

department; nor was he informed that the

Royal Crest and Crown names were to be

appended to Coleco’s apparently newly-de-

signed versions of above-ground aluminum

pools.% Tr. at 22:2823-29.

28. On direct examinaticn Rubin testified that

the Abco/Royal Crown and Crest were con-

structed of sheet aluminum rather than the

extruded aluminum used in Rubin's designs.

Tr. at 22:2827. His answers to questions also

implied that he believed the new Crown and

Crest to be redesigns of the old Crown and

Crest. Tr. at 22:2828-29. On cross-examina-

tion Rubin further testified that the technical

design and construction of the new Crown and

Crest appeared different from that of the old

ones. Tr. at 27:3594-97. When counsel for

plaintiff attempted to elicit Rubin’s agreement

that there was no redesign involved. Rubin

answered:

It may be partially correct or incorrect. |!

don’t know. Maybe the fencing is the same.

Certainly the balance of it is not. It was just

a partaking of the name.

‘..

57a

By November 1973, then, Rubin found his

professional! situation totally unworkable.

His relationship with Coleco personnel was

“absolutely terrible;” “there was not even

a pretense on their part of attempting to

work with me.” Tr. at 22:2830. Rubin had

one last meeting with Arnold Greenberg,

who reassured him that any slights or fail-

ure to transmit information was inadver-

tent on Coijeco’s part; he also asked Rubin

to meet him at a trade show in New York

near the end of November. Tr. at 22:2834—

35. Rubin went to the show but never saw

Greenberg. Tr. at 22:2836. He then came

back to New Jersey and typed and mailed

his resignation. (Ex. R-154).

Having concluded our chronological fac-

tual findings, we now come to the question

of what happened to Royal All-Aluminum

Swimming Pool Corp. during the Summer

and Fall of 1973. According to plaintiff,

Royal was doomed to failure before it pur-

chased the company; the misrepresentation

of Royal’s financial status, the presence of

exclusive dealerships, and the defective de-

sign of the Castle pool, all of which consti-

tuted breaches of the Purchase Agreement,

I can’t answer that. I would really have to

think considerably, because | think it may be

misleading and a play on words, with no

disrespect meant.

Tr. at 27:3595. We agree with Rubin that the

problem appears semantic. Whether or not

Coleco was attempting to bolster Abco’s sales

through the Royal name, the Royal design, or a

combination of the two is not material. The

point is that without informing Rubin, Coleco

appropriated for Abco what it obviously per-

ceived as Royal strengths.

58a

precluded profitability, destroyed Royal’s

reputation and customer goodwill, and

drove away customers. We simply cannot

accept this contention. Assuming, for the

moment, the breaches of the Purchase

Agreement, which plaintiff alleges, we

note, that with the exception of a breach of

the financial warranty, Coleco offered no

persuasive proof of money damages flowing

from the existence of exclusive dealerships

or from the problems with the Castle pool

in August 1973. Neither did plaintiff prove

loss of customers or reputation resulting

from these breaches. In fact, in view of

Coleco’s obvious attempt to use the Royal

name in trade journal advertising for the

1974 pool season to attract customers for

Abco (Ex. R-152), it defies logic to find

that Coleco believed Royal’s reputation to

be in ashes. Plaintiff in its post-trial brief

states that what it was bargaining for in

acquiring Royal was “a potentially profita-

ble company producing and marketing a

high quality product, with an established

clientele and goodwill and having experi-

enced and qualified executives to manage

day-to-day operations.” Plaintiff’s post-tri-

al brief at-113 (emphasis added). This, we

find, is su} stantially what Coleco got. Roy-

al failed, we find it much more probable

than not, because Coleco mismanaged it

after the acquisition.

To begin, it becomes clear, in retrospect,

that Coleco did not invest in Royal the

amount of working capital necessary to

start the free flow of material that would

have thrown Royal into high gear. This

probably resulted from lack of planning on

59a

one hand and miscalculation on the other.

Gershman, one of the three Coleco princi-

pals and its overseer of purchases, admit-

tedly made no projections or forecasts of

the amount of working capital Royal would

need in 1973 nor did he instruct anyone on

his staff or in the accounting department to

do so. Tr. at 19:2329-30. Nor did Gersh-

man do any forecasting for the 1974 pool

season. Tr. at 19:2330. In addition to

problems caused by lack of planning, it

appears likely that Arnold Greenberg’s the-

ory on how to handle suppliers backfired.

Greenberg explained at trial that

Our desire was to get as much suppli-

er/company operation, obviously, without

putting in—without putting in too much

money and I think that was.a significant

piece of financial assistance. It was our

goal to put in as much money as was

required to meet the sales needs of Royal

A supplier relationship is very often a

continuous bit of dialogue, whereby the

supplier would like more and the manu-

facturer of a seasonal product who has

great needs and big receivables for part

of the year says “yes, I know, wut I need

another 30 days.”

The part of the skill of a good business-

man is to negotiate that and ease the

need for cash input and yet allow the

supplier to live. It is a delicate piece of

business. I think we have generally been

successful at it.

Tr. at 3:230-31. We do not believe Coleco

was successful in the present case. There is

also scattered but persuasive evidence in

60a

the trial record that Coleco was having

financial problems of its own during the

summer of 1973 which diverted both Cole-

co’s attention and money away from Royal.

In June 1973, after acquisition, when Rubin

questioned Schwefel about his reporting to

Schwefel instead of directly to the Coleco

principals, Schwefel told Rubin:

Look, don’t rock the boat. We have prob-

lems up there; we have problems in the

Coleco organization. They are losing a

lot of money in Canada. Just stay with it

and don’t rock the boat.

Tr. at 21:2672. In addition, Schwefel in-

structed Rubin to include in his report of

June pool sales the pool sales from the first

two weeks in July so that June, Coleco’s

quarterly closing, would “look like a big

month.” Tr. at 21:2677. Rubin complied.”

Tr. at 21:2679. In September, responding

to Rubin’s requests for money to pay suppli-

ers, Schwefel and Hubert said that “they

were having major financial problems of

their own and that they had no money to

give us.” Tr. at 22:2772. Finally, Arnold

Greenberg testified upon cross-examination

that Coleco did not show a profit in 1973

“by virtue of discontinuing an operation.”

Tr. at 3:274.

Furthermore, the Coleco principals, Ar-

nold and Leonard Greenberg and Mel

Gershman, apparently preoccupied else-

29. Rubin’s compliance is corroborated by ex-

hibit R-96, a tally sheet Rubin kept, which

shows the tota! pool sales for the month of

June as including the sales for the first two

weeks in July.

6la

where, insulated themselves from direct

contact with Royal and especially from di-

rect contact with Rubin, the man closest to

Royal’s problems. As we noted earlier,

strange though it now seems, the Coleco

representative to whom Rubin reported and

answered was Michael Schwefel, Coleco’s

atvorney, who made no pretense of having

any working knowledge of the pool busi-

ness. Tr. at 4:303. Thus, we will never

know whether the decisions to limit supplier

payments to a total of $210,000 for the pool

season months of June, July and August

and not to provide Royal with production

foremen to aid Rubin were a product of

studied consideration by the Greenbergs

and Gershman, of hasty denial, or of the

incompleteness or imprecision of the infor-

mation filtered to them through Schwefel.

Coleco’s inattention to Royal in Summer

and Fall 1973 is also evidenced by its failure

to effect the price rise for each pool model

obviously contemplated as early as Leonard

Greenberg’s memorandum of April 20, 1973

(Ex. U-14). Rubin advised Schwefel as

early as June 1973 that a price rise was in

order to “give ys more working capital and

at the same time slow down the influx of

orders.” Tr. at 22:2723. Yet by October

1973 the prices had not been changed. Tr.

at 22:2797. The slowness of Coleco’s mov-

ing to raise prices is even more curibus

when one recalls the testimony of Gersh-

man and Glassman and Gershman’s memo-

randum of April 19, 1973 (Ex. U-304),

which record Coleco’s awareness of the ris-

ing costs of pool materials, especially of

aluminum. Finally, we note that although

62a

Arnold and Leonard Greenberg believed in

April 1973 that one of Royal’s greatest

strengths was the two men who ran it,

Rubin and Berman, they handled both men

badly insisting that Berman, the salesman,

work in the factory, and allowing Rubin to

work killing hours unaided for weeks. In-

deed, both men were gone by the end of

1973.

In summary, we believe that Royal’s

problems during 1973, which may have ren-

dered it inoperational by 1975, did not re-

sult from Royal’s inherent weaknesses but

from Coleco’s mismanagement of what it

recognized from the beginning was a specu-

lative venture into a fledgling business.

Recall Leonard Greenberg’s admonition in

his April 20, 1973, memo (Ex. U-14): “Re-

membering, of course, that this company

has yet to make a profit,” and his statement

in the same memo “Everything is conjec-

ture.” Furthermore, putting aside for the

moment the reasons why Royal no longer

operates, we note that Royal, in spite of its

severe problems, broke even for the five-

month period ending September 30, 1973

(Tr. at 12:1393), and that Abco, as distribu-

tor of Royal pools in 1974 and with its

advertising leaning heavily on the Royal

name, had a record year. Tr. at 9:990 (L.

Greenberg).

CONCLUSIONS OF LAW

Again, in the interest of palatability, we

will present our conclusions of law in essay

form rather than in separately numbered

63a

paragraphs. The following discussion, then,

comprises our conclusions of law required

under Fed.R.Civ.P. 52(a).

A. Liability of Defendants Rubin and Ber-

man Under Section 10(b) and Rule

10b-5"

[1] To make out a 10b—5 case a plaintiff

must prove that defendant made a misrep-

resentation either through affirmation or

omission, with the requisite scienter, of a

material fact upon which plaintiff relied.

Thomas v. Duralite Company, Inc., 524 F.2d

577 (3d Cir. 1975).8! Recently in Ernst &

Ernst v. Hochfelder, 425 U.S. 185, 96 S.Ct.

1375, 47 L.Ed.2d 668 (1976), the United

States Supreme Court clarified the concept

of scienter in the context of a 10b—5 action

by holding that it did not encompass mere

negligence. Relying on the language of

section 10(b) itself, on the legislative history

of the section, and on a comparative analy-

sis of the two major securities acts, the

Court stated that “[i]n this opinion the term

“scienter” refers to a mental state embrac-

ing intent to deceive, manipulate, or de-

fraud.” Id. at 194, 96 S.Ct. at 1381 n. 12.

The Court did go on to say:

In certain areas of the law recklessness is

30. At the close of plaintiff's case, we directed a

verdict on the 10b—5 claim for the Cohen de-

fendants. Tr. at 18:2069-73.

31. In Thomas, the Court of Appeals for the

Third Circuit holds, however, that in the case

of misrepresentation by omission, the burden

of proving non-reliance shifts to the defendant

because of the difficulty for plaintiff of proving

a negative. 524 F.2d at 585.

64a

considered to be a form of intentional

conduct for purposes of imposing liability

for some act. We need not address here

the question whether, in some circum-

stances, reckless behavior is sufficient for

civil liability under § 10(b) and Rule 10b-—

Id. Given the thrust of Ernst & Ernst,

however, with its emphasis on conscious

manipulation and trickery, we feel confi-

dent in continuing to apply to the 10b-5

issues in this action the test for scienter

which we applied in granting the Cohen

defendants’ motion for directed verdict be-

fore the Supreme Court handed down its

decision in Ernst & Ernst. Accordingly, we

hold that to establish the element of scien-

ter in an action brought under section 10(b)

and Rule 10b-5, a party must prove injury

resulting from a conscious deception or

from a misrepresentation so recklessly

made that the culpability attaching to such

reckless conduct closely approaches that

which attaches to conscious deception.

[2] Applying, then, the legal principles

articulated in Thomas v. Duralite Company,

Inc., and Ernst & Ernst v. Hochfelder to

the facts of this case, we conclude that

plaintiff has not proved that either defend-

ant Rubin or defendant Berman violated

section 10(b) and Rule 10b-5. Plaintiff

alleges that both defendants violated the

federal securities law in that they culpably

misrepresented or failed to reveal the fol-

lowing facts during pre-acquisition negotia-

tions:

1. That Roya! lost a substantial num-

65a

ber of customers from the 1972 to

the 1973 selling season.”

2. That Royal had received serious

complaints from customers.

3. That Royal was a party to territorial

or exclusive selling agreements.

4. The status of Royal’s relationship

with material suppliers.

5. That Royal’s inventory was out of

balance.

6. That the Castle had not been costed.

7. That Royal was shipping pools to

dealers short parts.

32. Plaintiff contends that any customer with

whom Royal did business in 1972 but not in

1973 is a “lost” customer about whom defend-

ants should have informed plaintiff. This defi-

nition strains our common sense, and we reject

it. A lost customer is one who, on its own

initiative, decides to buy from some other sell-

er. The only evidence which plaintiff placed in

the record on the factual issue of lost custom-

ers was a list of customers with whom Royal

dealt in 1972 but not in 1973. Although Rubin

testified on direct examination as to the rea-

sons why Royal no longer dealt with some of

these customers, the reasons he gave fell gener-

ally into one of two categories, either a particu-

lar customer no longer bought pools—some-

times because it was out of the pool business,

sometimes because it was starting to manufac-

ture its own pool line—or Royal, on its own

initiative, chose not to deal with a 1972 cus-

tomer because it had been delinquent in paying

Royal. Tr. at 20:2479-89. Style, with whom

Royal had done a substantial amount of busi-

ness in 1972, was in this latter category. Plain-

tiff never placed in the record any evidence of

the existence of a customer or customers who

chose to cease doing business with Royal and

go elsewhere for their supply of pools.

66a

8. The status of pending and threat-

ened litigation.

9. The average profit per pool.

10. The quality of the design of the Cas-

tle pool.

11. Royal’s financial status.

As to numbers one through eight, we con-

clude that no liability exists because, as we

found in Section I of this Opinion, there

was no misrepresentation or failure to re-

veal material facts about Royal relevant to

customer history, customer complaints, pro-

tected territories, supplier relationships, in-

ventory imbalance, the costing of the Castle

pool, the shipping of pools short parts, or

pending or threatened litigation. As to

numbers nine and ten, we will assume with-

out so finding that defendants Rubin and

Berman misrepresented the average profit

per pool to be $500 and misrepresented the

quality of the design of the Castle pool; as

to number 11, we have already found that

Royal’s financial state was misrepresented

through the medium of the April 30, 1973,

financial statement. We find no violation

of section 10(b) and Rule 10b—5, however,

since we believe that any misrepresentation

in these areas attributable to defendants

Rubin and Berman lacked the scienter nec-

essary for a finding of liability. The con-

duct of defendants Rubin and Berman was

neither intended to deceive nor was it so

reckless as to be virtually indistinguishable

in its culpability from deliberate fraud.

67a

B. Liability of Defendants Rubin and Ber-

man for Common Law Fraud

{3} Plaintiff also claims that the same

pre-acquisition conduct it alleges in making

its section 10(b) charge renders defendants

Rubin and Berman liable for common law

fraud. In directing a verdict for the Cohen

defendants on the section 10(b) claim, we

also directed a verdict for them on the

common law fraud claim saying:

I believe that my conclusion that the

record cannot support a jury finding of

scienter under Section 10(b) disposes as

well of the Common Law Fraud claim

against the Cohen defendants, since the

scienter requirement under Common Law

Fraud is as strict as, probably stricter

than, the requirement under Section

*Mb).

Tr. at 18:2073. Plaintiff contends in its

post-trial brief at 178-82 that this position

is erroneous and that under New Jersey

law, applicable here, “knowledge in a com-

mon law fraud action is even more relaxed

than the Sec. 10b standard adopted by this

Court.” Plaintiff's brief at 178. Plaintiff

has misread New Jersey law. After exam-

ining the New Jersey cases that plaintiff

cites, we find that they deal not with a

relaxed standard of knowledge but with a

particular species of knowing misrepresen-

tation. In New Jersey

[ljegal fraud or misrepresentation con-

sists of a material representation of a

presently existing or past fact, made with

knowledge of its falsity, with the inten-

tion that the other party rely thereon,

and he does so rely to his damage.

68a

Foont-Freendenfeld Corp. v. Electro Protec-

tive Corp., 126 N.J.Super. 254, 257, 314 A.2d

69, 71 (App.Div.1978), aff’d. 64 N.J. 197, 314

A.2d 68 (1974) (citation omitted). The par-

ticular species of knowing misrepresenta-

tion that plaintiff's cases examine is mis-

representation by a defendant that he

knows a fact to exist of his own knowledge

when, in fact, he has no personal knowledge

one way or the other and/or is relying on

someone else’s opinion. Thus, in Plimpton

v. Friedberg, 110 N.J.L. 427, 166 A. 295

(1933), defendant was held liable for com-

mon law fraud for representing to plaintiff

that he knew personally that the paintings

he was selling plaintiff were a Romney, a

Gainsborough, and a Reynolds when, in

fact, he had no such knowledge and was

simply transmitting the opinion of others.

The court said:

falsity may consist in making representa-

tion of a material fact knowing it to be

false, or in making a _ representation

which is untrue without knowledge

whether it is true or false and by cou-

pling with the representation an express

or implied affirmation that it is known to

be true of personal knowledge.

110 N.J.L. at 428-29, 166 A. at 296 (empha-

sis added). This is not a relaxing of any

knowledge requirement but merely an ap-

plication of the knowledge requirement to a

particular kind of deliberately fraudulent

conduct. We remain convinced, therefore,

that a finding that a party lacked scienter

under section 10(b) disposes of any common

law fraud claim against that party. Thus

we find that plaintiff fails in its common

69a

law fraud claim against defendant Rubin

and defendant Berman.

C. Liability of All Defendants for Breach

of Contract

1. Purchase Agreement, § 4.2(e): Finan-

cial Warranty

[4] By the terms of the 14.2(e) of the

Purchase Agreement, defendants warrant-

ed that both Royal’s January 31, 1973, au-

dited financial statement and its April 30,

1973, unaudited financial statement were

“accurate, correct and complete and fairly

present[ed] the financial position and opera-

tions of Royal as of said dates and for the

periods indicated.” Plaintiff asserts that

defendants breached this warranty since

the April 30, 1973, statement was inaccu-

rate. Defendants concede that the April

1973 statement was inaccurate although

they dispute with plaintiff the amount of

the inaccuracy. We conclude, therefore,

that defendants breached %4.2(e) of the

Purchase Agreement and are liable to plain-

tiff for any damages resulting from this

breach.

2. Purchase Agreement, { 4.2(qXii) and

4.1(d and f)

Paragraph 4.2(qXii) of the Purchase

Agreement warrants, among other things,

that

There are no contracts, agreements, in-

struments or commitments, written or

oral, to which Royal is, in any manner

whatsoever, subject to any prohibitions,

restrictions, or directions with respect to

70a

(a) The . . . selling or other-

wise disposing of or dealing with any

products or services of any kind what-

soever. . . ., including, but with-

out limiting the generality of the fore-

going, any restriction on the right of

Royal to . . .. sell or otherwise

dispose of or deal with any of the said

products or services in the United

States or Canada.

Paragraph 4.1(d and f) of the Purchase

Agreement warrants that none of the de-

fendants has any legal or equitable interest

in another business with which Royal has a

business relationship or which is engaged in

producing or selling any product produced

or sold by Royal. Plaintiff contends that

defendants breached the first warranty

both through Royal’s general practice of

giving dealers so-called “protected territo-

ries” and through more formal written

agreements with Style, Apex, and

Regency.* Plaintiff contends that defend-

ants breached the second warranty because

of Berman’s and Rubin’s stock ownership of

Regency.

(5) Before addressing the question of

the breaches themselves, we point out that

in this limited area of the contract breach

claim, we have considered parol evidence,

specifically the testimony of Berman relat-

ing his view of the nature of protected

territories and his discussions with Schwefel

on the subject. This testimony we credit

33. We reject the argument of the Cohen de-

fendants made at p. 8 of their post-trial brief

that the language of ° 4.2(q)(ii) cannot be read

to cover exclusive distribution contracts.

Tila

and have included in our findings of fact.

Whether we view Berman’s testimony as

aiding us in interpretation of the meaning

of 4 4.2(qXii) or in determining the intent of

the parties, we find that under New Jer-

sey’s version of the parol evidence rule,

Atlantic Northern Airlines, Inc. v. Schwim-

mer, 12 N.J. 298, 96 A.2d 652 (1953), we

may legitimately consider it.™ According

to Berman, then, a man experienced in the

selling practices of the pool industry, Roy-

al’s practice of granting its dealers protect-

ed territories was a common one in the

industry and the granting of such territo-

ries imposed no legal obligation upon Royal.

Schwefel told Rubin he was familiar with

the practice through his contacts with Abco,

Coleco’s subsidiary. Under these circum-

stances, we conclude that the existence of

the various protected territories to which

Berman testified did not breach the Pur-

chase Agreement because the parties nei-

34. In Schwimmer the New Jersey Supreme

Court held:

Evidence of the circumstances is always ad-

missible in aid of the interpretation of an

integrated agreement. This is so even when

the contract on its face is free from ambigui-

ty. The polestar of construction is the inten-

tion of the parties to the contract as revealed

by the language used, taken as an entirety;

and, in the quest for the intention, the situa-

tion of the parties, the attendant circum-

stances, and the objects they were thereby

striving to attain are necessarily to be regard-

ed. The admission of evidence of extrinsic

facts is not for the purpose of changing the

writing, but to secure light by which to meas-

ure its actual significance.

12 N.J. at 301-02, 96 A.2d at 656.

72a

ther intended nor understood the warranty

given in 94.2(qXii) to cover the industry

practice of granting protected territories.

As to the questions surrounding Royal’s

more formal agreements with Apex, Style,

and Regency, we note first that we have

given plaintiff the benefit of an evidentiary

doubt and considered exhibits # # 383,

384, 385, 386, and 387, all correspondence

between Royal and Apex in the Winter and

Spring of 19738. Even considering these

exhibits, however, we can locate in the

record little evidence from which one could

find that any agreement was in force on

June 4, 1978, the critical date here. The

Style agreement is dated October 1972; the

Apex correspondence runs into April or

May 1973. Regency never really got off

the ground although Rubin testified that he

believed that the contract with Gascoigne

and Mitchell, the men operating Regency,

was in effect past the closing date. Tr. at

27:3537. Plaintiff argues that we can rea-

sonably assume that the Apex and Style

agreements continued through June 4, 1973.

The assumption is obviously more warrant-

ed in the case of Apex than in the case of

Style. Given this unsatisfactory state of

the record, we choose to assume without

formally concluding that Royal’s agreement

with Apex, Style, and Regency breached

the warranty contained in 1 4.2(q\ii). We

adopt such a procedure since, as we con-

clude below, the issue of whether or not any

damages flowed from breach of { 4.2(q\ii)

is one much more certainly and simply re-

solved than the issue of the breach itself.™

We will also follow this procedure, for the

73a

same reason, in assuming without formally

concluding that Rubin’s and Berman’s in-

terests in Regency violated 4 4.1(d and f) of

the Purchase Agreement.™*

3. Purchase Agreement, 74.2(qXiv and

v): Inventory Warranty

Paragraph 4.2(qXiv and v) of the Pur-

chase Agreement reads:

(iv) All of Royal’s finished inventory

will be as of the Closing, in first class

salable condition and suitable for the pur-

pose for which it is intended.

(v) All of Royal’s raw materials and

work in process will be in first class usa-

ble condition and suitable for the purpose

for which it is intended.

35. Our conclusion on damages also allows us

to sidestep the unpleasant question of whether

or not, given his knowledge about the relation-

ships between Royal and Apex, Style, and Re-

gency, Michael Schwefel’s conduct prior to ac-

quisition, as one of Coleco’s attorneys and ne-

gotiators, was of a nature requiring us to hold

plaintiff equitably estopped from claiming

breach.

36. Again we will sidestep the equitable issue

raised by Schwefel’s conduct in light of his

knowledge.

37. In its proposed finding of fact # 231, plain-

tiff also contends, for the first time we believe,

that the existence of Royal's inventory imba-

lance breached the inventory warranty. We

reject this position since we do not believe that

a standard inventory warranty such as that

found in {| 4.2(q)iv and v) can be stretched to

cover the problem of inventory imbalance. Al-

ternately, we find that given our finding that

plaintiff knew of the inventcry imbalance prior

to closing, the parties did not intend the inven-

tory warranty to cover inventery imbalance.

74a

Plaintiff contends that defendants breached

this warranty because one pool model, the

Castle pool, was defectively designed.”

Plaintiff further contends that the defec-

tive design caused several Castle pools to

“blow” or pull apart in August 1973 requir-

ing plaintiff to supply “retrofit kits” to cure

the problems on some 1973 pools and on

1974 pools. Although we had serious

doubts at trial, doubts that remain with us,

that a standard inventory warranty, such as

that contained in ¢4.2(qXiv and v), is in-

tended to cover design defect, we admitted

evidence on the alleged defect after counsel

stipulated that as of June 4, 1973, the clos-

ing date, there existed in Royal's inventory

at least one complete Castle pool. The evi-

dence on design defect consumed many

pages of transcript and was often high!y

technica!. Plaintiff's theory is that Rubin

designed the pool with defectively thin

walls and impossible welding requirements,

both problems contributing to the “blow-

ing” of Castle pools; defendants contend

that the Castles pulled apari because of

poor installation and shoddy welding. To

conserve the judicial energy it would take

to sort out any further than we already

have the record evidence on this issue, we

will again adopt the procedure of assuming

without so concluding that defendants

breached, in some highly technical way, the

inventory warranty in the Purchase Agree-

ment.™

38. Although plaintiff devotes pp. 127-132 of its

post-trial brief to its contention that defendants

breached ° 4.2(f(xi) of the Purchase Agree-

7Sa

D. Defenses to Breach of Contract Claim

1. Fraudulent Inducement:

[6] Defendant Rubin urges that we de-

clare the Purchase Agreement void or void-

able because plaintiff fraudulently induced

his entering into it by making various mis-

representations, primarily by misrepresent-

ing its intention to pay out to suppliers

several hundred thousand dollars upon clos-

ing.” Under New Jersey law, however, a

party claiming fraudulent inducement faces

the difficult task of proving by clear and

convincing evidence that the representa-

tions he attacks were not merely promises,

collateral to the contract, to do something

in the future but rather intentional misrep-

resentations of a present state of mind.

ment warranting that defendants had no

knowledge of present or future loss of a sub-

stantial number of customers, plaintiff, at trial,

represented explicitly that this particular war-

ranty was out of the case. So we consider it to

be. Tr. at 19:2234. Finally, an cat

plaintiff's post-trial brief (pp. |

lists eleven other sections of the Purchase

ed. Plaintiff does not discuss these sections,

however, stating “by their breach of the specif-

ic warranties . . ., defendants also

(sic). . . .™ Since this is plaintiff's posi-

tion, we remark only that while we doubt many

of the sections of the Purchase Agreement cit-

ed by the plaintiff are related to the so-called

specific warranties, we find nothing in these

contract sections that would lead us to alter

our findings and conclusions in this action.

39. Defendant Rubin also alleges that he was

fraudulently induced to enter into the Purchase

Agreement by promises of production foremen,

pool parts, and trucking services.

76a

Minter v. Bendix Aviation Corp., 26 N.J.Su-

per. 268, 274, 97 A.2d 715 (App.Div.1953);

Ocean Cape Hotel Corp. v. Masefild Corp.,

63 N.J.Super. 369, 164 A.2d 607 (App.Div.

1960). The court in Ocean Cape Hotel

Corp. explains the difficulty this way:

In order to form the basis for an action in

deceit, the alleged fraudulent representa-

tion must relate to some past or presently

existing fact and cannot ordinarily be

predicated upon matters in futuro. . .

An exception to this rule exists in the

case of a false representation of an exist-

ing intention, i. e, a “false state of

mind.”

If [a party's) alleged representation was a

mere promise collateral to the contract,

and not an affirmation of a present state

of mind, then fraud may not be found

because there has been no statement of

an existing fact.

63 N.J.Super. at 380, 164 A.2d at 612. The

court goes on to list some considerations

relevant to a finding vel non of fraudulent

inducement:

Misrepresentation of a present state of

mind, with respect to a future matter,

may be concluded from the utter reck-

lessness and implausibility of the state-

ment in light of subsequent acts and

events; from a showing that at the time

of the making of the promise, the promis-

or’s intention to perform was dependent

upon contingencies known to the promis-

or and unknown to the promisee; or from

77a

circumstances indicating that the promis-

or must have known at the time of his

promise that he could not or would not

fulfill it. (Citations omitted).

Id. at 381, 164 A.2d at 613. Guided by the

analysis of the Ocean Cape Hotel court,

then, we conclude that defendant Rubin has

not met his burden of establishing that

plaintiff fraudulently induced him to enter

into the Purchase Agreement. Although

we have found Coleco’s conduct in acquiring

Royal curious and even questionable, we are

not clearly and convincingly persuaded that

representations Coleco made as to how it

would run Royal after acquisition were any-

thing but “promise{s] collateral to the con-

tract.” After assessing the record before

us, we cannot find that plaintiff's promises

were reckless or implausible or contingent

upon some event known to plaintiff but

unknown to defendant Rubin; nor can we

locate circumstances from which to infer

that Coleco must have known at the time of

its promise that it could or would not per-

form.

2. Equitable Estoppel:

[7-9] The Cohen defendants contend

that Coleco’s knowledge, through Glass-

man’s revelations of costing inaccuracies, of

discrepancies in the financial statements es-

the Cohens for breach of the financial war-

ranty since Coleco knew the Cohens, as

non-managing shareholders, were unaware

of the discrepancies and failed to reveal

them. In urging their position defendants

78a

rely on Huck v. Gabriel Realty Co., 136

N.J.Super. 468, 346 A.2d 628 (1975) and on a

Louisiana case, Calhoun v. American Ma-

rine Corp., 159 So.2d 19 (App.Div.La.). In

Huck plaintiff was prevented from recover-

ing on an indemnity contract because, in

contracting with defendant broker for in-

demnity against any other broker who

claimed a commission from plaintiff on a

particular land transaction, plaintiff delib-

erately concealed from defendant broker

that he had been shown the property in

question by another broker prior to enlist-

ing defendant's services. Huck, then, is a

case involving active and intentional mis-

representation and, as such, is not particu-

larly helpful in this case. The facts in the

Calhoun case are admittedly much closer to

the facts here. Calhoun is, however, a Lou-

isiana and not a New Jersey case. More

significantly, the warranty considered by

the Calhoun court is much differently word-

ed than the warranty here. In Calhoun the

sellers warranted that

Sellers know of no material facts affect-

ing Louisiana Materials or Heartland

which have not been disclosed to Purchas-

In the case before us the financials are

unqualifiedly warranted as accurate and

#13 of the Purchase Agreement states

piainly:

Coleco shail not be deemed to have

waived the protection afforded it by any

representation, warranty or agreement

made by the Stockholders notwithstand-

ing the fact that Coleco may have or

79a

could have known at the time of Closing

that any such representation, warranty or

agreement was or might be inaccurate or

had been or could have been breached.

In Calhoun the court also relies heavily, in

holding the buyer remediless, on the

amount of time—a good week—during

which buyer’s accountant examined seller's

books pre-acquisjtion. Here the examina-

tion was more cursory.

Furthermore, as plaintiff points out, un-

der New Jersey case law on equitable estop-

a is no obligation to disclose matters

of which the other party has actual or

constructive knowledge or as to which

the information or means of acquiring

information of the two parties is equal.

Sanders v. Reid, 131 N.Y.Eq. 407, 25 A.2d

541 (1942). Certainly, under the facts of

this case, the Cohen defendants, as three of

the five Royal shareholders and in view of

Irvin Cohen’s direct ties with Royal’s ac-

countant, Zelnick, Sobelman, and Co., had

as much access to the financial information

in question as did plaintiff. Plaintiff also

cites Deerhurst Estates v. Meadow Homes,

Inc., 64 N.J.Super. 134, 165 A.2d 543 (App.

Div.1960), in support of its position that it is

not equitably estopped from claiming

breach of the financial warranty. In Deer-

40. In Sanders v. Reid, the defendant was held

not equitably estopped from exercising proper-

ty rights over her driveway even though she

had said nothing about such rights when plain-

tiff built a new garage to which access could be

had only by the driveway.

80a

hurst, plaintiff discovered between the time

of the execution of a land sales contract

and closing of title that two of the contract

warranties were breached but went ahead

with closing and then sued for breach of

warranty. The appellate court affirmed a

verdict for plaintiff holding:

Simply because he is informed by the

defaulting party that the latter cannot or

will not perform one of his obligations

under the contract, the injured party, by

choosing to proceed nonetheless, obvious-

ly does not manifest agreement that the

performance received is in full satisfac-

tion of all contractual obligations.

64 N.J.Super. at 145, 165 A.2d at 549. Al-

though we agree with defendants that

Deerhurst is significantly different from

this case because in Deerhurst plaintiff's

contractual rights had already vested when

it learned of the breach, we point out that

the Deerhurst court does have this to say on

the nature of estoppel:

Estoppel . . is a doctrine ground-

ed in equity, to the effect that one who

performs an act or takes a position upon

which it is intended that another rely

cannot repudiate the act or the position

where an unjust and unconscionable re-

sult would flow from such repudiations.

. . There was no repudiation on

the part of Deerhurst in the case at ber.

It took the position throughout that it

was entitled to the benefit of all of the

warranties included in the contract of

sale and preserved beyond the closing

date . . .. Meadow cannot claim

prejudice through goodfaith reliance on

any position which has subsequently been

discarded.

Id. at 147, 165 A.2d at 550. In this case, as

in Deerhurst, plaintiff has taken “the posi-

tion throughout that it was entitled to the

benefit of all of the warranties included in

the contract of sale and preserved beyond

the closing dat

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