Appendix — Wherehouse Entertainment, Inc. v. McMahan & Co.
Supreme Court brief1996
Ask Donna
What actually matters in this document.
Text
la
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
No. 1707—August Term, 1994
(Argued: June 8, 1995 Decided: September 13, 1995)
Docket No. 95-7008
MCMAHAN & COMPANY; FROLEY, REVY INVESTMENT
Co., INC.; WECHSLER & KRUMHOLZ, INC.; and DON
THOMPSON, on behalf of himself and all others sim-
ilarly situated,
Plaintiffs-Appellees,
WHEREHOUSE ENTERTAINMENT, INC.; LOUIS A.
KWIKER; GEORGE A. SMITH; MICHAEL T. O’ KANE;
LAWRENCE K. HARRIS; DONALD E. MARTIN; JOEL
D. TAUBER; FURMAN SELZ MAGER DIETZ & BIR-
NEY, INC.; WEI ACQUISITION CORP.; WEI HOLD-
INGS, INC.; and ADLER & SHAYKIN,
Defendants-Appellants.
la
Before:
OAKES, MINER, and LEVAL,
Circuit Judges.
Appeal by permission from an order entered in the
United States District Court for the Southern District of
New York (Lowe, J.) denying, in part, defendants’
motion for summary judgment, the court having ruled
that plaintiffs may be entitled to recover benefit-of-the-
bargain damages for alleged securities law violations and
that a no-action clause in the underlying indenture did
not bar plaintiffs’ federal securities law claims.
Affirmed in part, reversed in part.
PHILIP K. HOWARD, New York, NY (Linda
C. Goldstein, Howard, Darby & Levin,
New York, NY, Judith L. Spanier, Abbey
& Ellis, New York, NY, of counsel), for
Plaintiffs-Appellees.
DENNIS J. BLOCK, New York, NY (Joseph S.
Allerhand, Miranda S. Schiller, Howard
L. Kneller, Weil, Gotshal & Manges,
New York, NY, of counsel), for Defen-
dants-Appellants.
(Simon M. Lorne, General Counsel, Jacob H.
Stillman, Assoc. Gen. Counsel, Susan S.
McDonald, Special Counsel, Diane V.
3a
White, Senior Counsel, and Paul Gon-
son, Solicitor, Securities and Exchange
Commission, Washington, DC) submit-
ted a brief as amicus curiae for the
Securities & Exchange Commission.
MINER, Circuit Judge:
Defendants-appellants appeal from an order entered on
August 12, 1994 in the United States District Court for
the Southern District of New York (Lowe, J.) denying, in
part, defendants’ motion for summary judgment, the
court having determined, inter alia, that benefit-of-the-
bargain damages are available to plaintiffs under section
11 of the Securities Act of 1933 (the “1933 Act”) and
under section 10 of the Securities Exchange Act of 1934
(the “1934 Act”), and that the no-action clause in the
underlying indenture did not bar plaintiffs’ federal secu-
rities law claims. The district court identified these
issues as warranting interlocutory review and certified
its order, pursuant to 28 U.S.C. § 1292(b). A panel of
this Court granted defendants’ motion for leave to
appeal on January 3, 1995.!
For the following reasons, we affirm so much of the
district court’s order as allows plaintiffs to recover ben-
efit-of-the-bargain damages under section 10 of the 1934
Act and as holds that the no-action clause in the under-
lying indenture does not bar plaintiffs’ federal securities
law claims. We reverse the district court’s order to the
: Plaintiffs’ cross-motion for leave to appeal the remaining issues
decided by the district court in its August 12, 1994 order was denied by
the panel, and we will not consider those issues.
4a
extent that it allowed benefit-of-the-bargain damages
under section 11 and refused to consider defendants’
statutorily prescribed affirmative defense.
BACKGROUND
In July of 1986, defendant-appellant Wherehouse
Entertainment, Inc. (“Wherehouse”) issued 6.25% Con-
vertible Subordinated Debentures (the “Debentures” at
$1,000 par value. Plaintiffs allege that one of the key
selling features of the Debentures was the right of hold-
ers to tender the Debentures to Wherehouse in the case
of certain triggering events that might endanger the
value of the Debentures. One such triggering event
would occur if Wherehouse “consolidate[d] or merge[d]
. . unless approved by a majority of the Independent
Directors.” “Independent Director” was defined in the
offering materials as a director of the company who was
not a recent employee but who either was a member of
the board of directors on the date of the offering, or who
subsequently was elected to the board by the then-Inde-
pendent Directors.
On November 19, 1987, Shamrock Holdings, Inc.
announced that it planned to commence a tender offer
for Wherehouse’s common stock. Subsequently, defen-
dant Adler & Shaykin, an investment partnership,
formed defendants WEI Acquisition Corp. and WEI
Holdings, Inc., and submitted a bid for the Wherehouse
stock. On December 20, 1987, the Board of Directors of
Wherehouse unanimously approved, with one abstention,
a merger with WEI Acquisition Corp. and WEI Hold-
ings, Inc. The Board’s approval of the merger was
announced the following day, December 21, 1987. This
news seemed to have a positive effect on the Debentures,
5a
which traded on the open market. The price of the
Debentures went from 47% of par on the previous trad-
ing day, December 18, to 49% of par on the announce-
ment date, December 21. On December 23, 1987,
Wherehouse filed a Schedule 14D-9 with the Securities
and Exchange Commission in which the company
advised that the right to tender would not be triggered by
the merger.
Despite the company’s announcement, plaintiffs
attempted to tender their Debentures to Wherehouse fol-
lowing the merger, seeking a redemption price of
106.25% of par, pursuant to the right to tender. Where-
house refused to redeem the Debentures at this price,
claiming that the right to tender had not been triggered
because the Board had approved the merger. Instead, all
debentureholders were given the opportunity to tender
their securities at 50.72% of par, which represented the
Debentures’ conversion value on the date preceding the
merger. Also, pursuant to a “Supplemental Indenture,”
the debentureholders no longer had a right to convert the
Debentures into common stock.
Based on the foregoing, plaintiffs commenced two
separate actions (the “McMahan” action and the
“Thompson” action), which ultimately were consoli-
dated. Plaintiffs claim that they were misinformed about
the true nature of the right to tender, that the right was
illusory, and that the registration statements and the
prospectus, as well as oral representations made in con-
nection therewith, were materially misleading. They
contend that the right was portrayed as valuable to
debentureholders, creating a duty on the part of the
“Independent Directors” to act in the debentureholders’
interest. They allege federal securities claims arising
under, inter ali section 11 of the 1933 Act, 15 U.S.C.
6a
§ 77k, for a misleading registration statement and under
section 10 of the 1934 Act, 15 U.S.C. § 78), for fraud in
connection with a sale of securities.
In the McMahan action, defendants made a motion to
dismiss, which later was converted into a motion for
summary judgment. The district court, adopting the rec-
ommendation of the magistrate judge, granted summary
judgment in favor of defendants and dismissed the com-
plaint. We reversed that decision, finding that there was
a genuine issue of material fact as to whether a reason-
able investor could have been misled by the offering
materials. See McMahan & Co. v. Wherehouse Enter-
tainment, Inc., 900 F.2d 576, 578 (2d Cir. 1990)
(“McMahan I’), cert. denied, 501 U.S. 1249 (1991).
On remand, the defendants again moved for summary
judgment. It is this second motion that gives rise to this
appeal. As to the issues raised in this appeal, the district
court denied defendants’ motion, ruling, inter alia, that
(1) the no-action clause in the indenture did not operate
to bar plaintiffs’ federal securities law claims; (2) plain-
tiffs may recover benefit-of-the-bargain damages under
section 11 of the 1933 Act and section 10 of the 1934
Act. See McMahan & Co. v. Wherehouse Entertainment,
Inc., 859 F. Supp. 743 (S.D.N.Y. 1994). Subsequently,
the court certified an order delineating these two rulings
for an interlocutory appeal, pursuant to 28 U.S.C.
§ 1292(b). A panel of this court granted leave to appeal
on January 3, 1995.
7a
DISCUSSION
I. Benefit-Of-The-Bargain Damages
Defendants contend that the district court erred in rul-
ing that plaintiffs could recover benefit-of-the-bargain
damages under section 11 of the 1933 Act and under sec-
tion 10 of the 1934 Act. “Summary judgment may be
granted if, upon reviewing the evidence in the light most
favorable to the nonmovant, the court determines that
there is no genuine issue of material fact and that the
movant is entitled to judgment as a matter of law.”
Richardson v. Selsky, 5 F.3d 616, 621 (2d Cir. 1993).
“We review a grant of summary judgment de novo.”
Peoples Westchester Sav. Bank v. FDIC, 961 F.2d 327,
330 (2d Cir. 1992). Each of defendants’ claims will be
discussed in turn.
A. Section I] of the 1933 Act
Section 11(a) of the 1933 Act imposes civil liability
on issuers and other signatories of a registration state-
ment if the registration statement contains material mis-
statements or omissions and the plaintiffs acquired the
securities without knowledge of such misrepresentations.
See 15 U.S.C. § 77k(a); Akerman v. Oryx Communica-
tions, Inc., 810 F.2d 336, 340 (2d Cir. 1987); see also
Greenapple v. Detroit Edison Co., 618 F.2d 198, 203 n.9
(2d Cir. 1980). Section 11(e) of the 1933 Act specificaily
provides the measure of damages in such suits:
The suit. . . may be to recover such damages as
shall represent the difference between the amount
paid for the security (not exceeding the price at
which the security was offered to the public) and (1)
the value thereof as of the time such suit was
oC
8a
brought, or (2) the price at which such security shall
have been disposed of in the market before suit, or
(3) the price at which such security shall have been
disposed of after suit but before judgment if such
damages shall be less than the damages [as calcu-
lated under subsection (1), above]... .
15 U.S.C. § 77k(e). While any decline in value is pre-
sumed to be caused by the misrepresentation in the reg-
istration statement, see Greenapple, 618 F.2d at 203 n.9,
section 11(e) provides the following affirmative defense:
[I]f the defendant proves that any portion or all of
such damages represents other than the depreciation
in value of such security resulting from [the] part of
the registration statement. . . [that contains the
material misstatement or omission], such portion of
or all such damages shall not be recoverable.
15 U.S.C. § 77k(e) (emphasis added). This defense is
known as the defense of “negative causation.” See Aker-
man, 810 F.2d at 340. Accordingly, where a defendant
proves that the decline in the value of the security in
question was not caused by the material omissions or
misstatements in the registration statement, plaintiff is
not entitled to recover any damages. See id.
Here, the district court erred in ruling that plaintiffs
may recover benefit-of-the-bargain damages under sec-
tion 11 and that the market value was “irrelevant to
Plaintiffs’ claimed economic losses.” 859 F. Supp. at
751. “It is axiomatic that [t]he starting point in every
case involving construction of a statute is the language
itself.” Landreth Timber Co. v. Landreth, 471 U.S. 681,
685 (1985) (internal quotations omitted). The plain lan-
guage of section 11(e) prescribes the method of calcu-
lating damages, see 15 U.S.C. § 77k(e), and the court
oS eg Oe te ee © eee
= 2 oe
9a
must apply that method in every case. Cf. Versyss Inc. v.
Coopers & Lybrand, 982 F.2d 653, 657 (1st Cir. 1992)
(recognizing that, in general, section 11 should not be
“extended beyond its normal reading”), cert. denied, 113
S. Ct. 2965 (1993). Plaintiffs’ claim that section 11(e),
like section 11(g),? only provides a “cap” on damages,
rather than the “measure” of damages, is belied by the
plain language of the statute. Indeed, section 11(e) is
entitled “Measure of damages,” and the statutory scheme
requires courts to apply the prescribed formula in every
section 11 case. The record indicates that there was a
substantial decline in the market price of the Debentures
between the date plaintiffs purchased the Debentures and
the date of the merger. This decline in market value per-
mits plaintiffs to recover damages under the statutory
scheme.
Defendants argue that the claim for damages under
section 11 should be dismissed because they have estab-
lished the defense of negative causation. The district
court, however, ruled that negative causation was irrel-
evant to plaintiffs’ section 11 claim in view of its deter-
mination that benefit-of-the-bargain damages were
available and therefore failed to consider the defense.
Because the plain language of section 11 allows this
defense, the district court, on remand, must allow defen-
dants the opportunity to prove that the decline in value
was not caused by the alleged misstatements in the reg-
istration statements. See Akerman, 810 F.2d at 342.
When considering defendants’ defense, the district court
should apply the following principles.
Section 11(g) provides that “[iJn no case shall the amount recoverable
under [section 11} exceed the price at which the security was offered to
the public.” 15 U.S.C. § 77k(g).
10a
First, the term “value” in section 11(e) was intended to
mean the security’s true value after the alleged misrep-
resentations are made public. Even plaintiffs have sug-
gested that damages be measured by the difference
between the amount paid and the amount that defendants
were willing to redeem the Debentures for after the
merger was announced, i.e., the value of the Debentures
after the alleged misrepresentations were disclosed.
Accordingly, the district court’s reference to “promised
value” was misplaced because promised value is irrele-
vant to this calculation.
Second, the value of a security may not be equivalent
to its market price. Congress’ use of the term “value,” as
distinguished from the terms “amount paid” and “price”
indicates that, under certain circumstances, the market
price may not adequately reflect the security’s value. See
Beecher v. Able, 435 F. Supp. 397, 404-05 (S.D.N.Y.
1977) (adjusting the market price to account for panic
selling in the market that was unrelated to the misrep-
resentations in the registration statements); Grossman v.
Waste Management, Inc., 589 F. Supp. 395, 415-16
(N.D. Ill. 1984) (holding that subsequent fraud on the
market may make market price an unreliable indication
of the security’s value). However, instances where the
market price of a security will be different from its value
are “unusual and rare” situations. Jn re Fortune Sys. Sec.
Litig., 680 F. Supp. 1360, 1370 (N.D. Cal. 1987).
Indeed, in a market economy, when market value is
available and reliable, “market vaiue will always be the
primary gauge of an enterprise’s worth.” Mills v. Electric
Auto-Lite Co., 552 F.2d 1239, 1247 (7th Cir.), cert.
denied, 434 U.S. 922 (1977). Moreover, even where mar-
ket price is not completely reliable, it serves as a good
Starting point in determining value. See Beecher, 435
lla
F. Supp. at 406. In this case, market price appears to be
the most reliable gauge of the Debentures’ true value
and, at the very least, an excellent starting point. Thus,
the district court, in applying the statutory damages for-
mula, should begin with the market price to determine
the true value of the Debentures.
Finally, as a general rule, a “price decline before dis-
closure may not be charged to defendants.” Akerman,
810 F.2d at 342; see also Feit v. Leasco Data Processing
Equip. Corp., 332 F. Supp. 544, 586-88 (E.D.N.Y. 1971).
The defendant, however, bears the burden of proving
that the price decline was not related to the misrepre-
sentations in the registration statement. See 15 U.S.C.
§ 77k(e); see also Akerman, 810 F.2d at 340.
The district court should address these issues in the
first instance, being most familiar with the circum-
stances of this case.
B. Section 10 of the 1934 Act
Plaintiffs’ section 10 claim for damages stands on a
different footing. Section 28(a) of the 1934 Act provides
that “no person permitted to maintain a suit for damages
under the provisions of this chapter shall recover. . . a
total amount in excess of his actual damages on account
of the act complained of.” 15 U.S.C. § 78bb. The statute
does not prescribe a particular method of calculating
damages, and, in fact, we have allowed benefit-of-the-
bargain damages under section 10, id. § 78j(b), and Rule
10b-5, 17 C.F.R. § 240.10b-5, promulgated thereunder.
In Osofsky v. Zipf, 645 F.2d 107 (2d Cir. 1981), the
plaintiffs were offered a specific price if they tendered
their common stock in connection with a tender offer.
Plaintiffs tendered their stock, but received a lesser
12a
amount than they originally had been offered. Jd. at 109-
10. We held that benefit-of-the-bargain damages, under
Rule 10b-5, were particularly appropriate in the context
of tender offers where, despite the fraud, the share-
holders normally will receive an amount in excess of
market value. Jd. at 114. We noted that the key to award-
ing benefit-of-the-bargain damages is the degree of cer-
tainty to which they can be established. Jd.
In Levine v. Seilon, Inc., 439 F.2d 328, 334 (2d Cir.
1971) (Friendly, J.), the court stated that, under Rule
10b-5, a defrauded buyer of securities was “entitled to
recover only the excess of what he paid over the value of
what he got, not, as some other courts had held, the dif-
ference between the value of what he got and what it was
represented he would be getting.” In Osofsky, we noted
that this language in Levine was dicta, and we distin-
guished Levine on the ground that damages sustained by
a defrauded buyer of securities are more speculative and
thus different from the damages of a defrauded seller
who does not get what he was promised. Osofsky, 645
F.2d at 112. In cases following Osofsky, we have focused
on the plaintiff’s ability to establish benefit-of-the-bar-
gain damages with some reasonable degree of certainty.
For example, in Barrows v. Forest Labs., Inc., 742 F.2d
54, 59-60 (2d Cir. 1984), we refused to allow benefit-of-
the-bargain damages where such damages were based on
the speculation of what plaintiff’s securities would have
been worth if the company had disclosed its true finan-
cial forecast. More recently, in Commercial Union
Assurance Co. v. Milken, 17 F.3d 608, 614-15 (2d Cir.),
cert. denied, 115 S. Ct. 198 (1994), we acknowledged
the possibility of awarding benefit-of-the-bargain dam-
ages in a Rule 10b-5 case, but declined to do so because
the plaintiff’s claims were speculative.
13a
In this case, we believe that plaintiffs could establish
benefit-of-the-bargain damages with reasonable cer-
tainty. We acknowledge, however, that this is not a case
like Osofsky, where plaintiffs were offered a certain
price during a tender offer and then received some lesser
amount. In this case, plaintiffs purchased debentures,
allegedly relying in part on the possibility that a merger
that was not approved by the Independent Directors
might occur and thus trigger the right to tender. This
possibility, we have previously held, could reasonably be
considered a “valuable right” to plaintiffs. See McMahan
I, 900 F.2d at 579. Whether plaintiffs can establish, with
a reasonable degree of certainty, the amount of that
value is a different question.
Plaintiffs contend that determining damages in this
case is a simple task—upon a merger, they are entitled to
106.25% of par for each Debenture. In reality, the mat-
ter is more complex than plaintiffs’ contention would
indicate. Because the value of plaintiffs’ right to tender
was contingent on the occurrence of certain events, the
value of this right is somewhat speculative. Neverthe-
less, if plaintiffs could establish, under their theory of
the case, that independent directors, acting on behalf of
the debentureholders, would not have approved this
merger, then damages could be assessed at the promised
redemption of par plus 6.25%.
Il. The No-Action Clause
Defendants contend that the district court erred in rul-
ing, as a matter of law, that the no-action clause found in
the Indenture cannot operate to waive plaintiffs’ rights
under the 1933 and 1934 Acts. The no-action clause is
contained in section 8.06 of the Indenture and provides
as follows:
l4a
Limitation on Suits. A Securityholder may pursue
any remedy with respect to this Indenture or the
Securities only if:
(1) the Holder gives to the [Indenture] Trustee
written notice of a continuing Event of Default;?
(2) the Holders of at least 25% in principal
amount of the Securities make a written request to
the Trustee to pursue the remedy;
(3) such Holder or Holders offer to the Trustee
indemnity satisfactory to the Trustee against any
loss, liability or expense;
(4) the Trustee does not comply with the request
within 60 days after receipt of the request and the
offer of indemnity; and
(5) during such 60-day period the Holders of a
majority in principal amount of the Securities do not
give the Trustee a direction inconsistent with the
request.
Section 14 of the Debentures states in relevant part:
“Securityholders may not enforce the Indenture or the
Securities except as provided in the Indenture.”
Section 8.01 of the Indenture states that an event of default occurs if,
inter alia, “the Company defaults in the payment of the principal of any
Security when the same becomes due and payable, whether at maturity,
upon redemption or otherwise[, or] the Company fails to comply with
any of its other agreements in the Securities or this Indenture.”
Section 8.07 of the Indenture provides that debentureholders are
excused from complying with the No-Action clause in suits based on
nonpayment of principal and interest on or after the due dates expressed
in the Debenture and in suits based on the right to convert a Debenture
to common stock. This is a requirement of section 316(b) of the Trust
Indenture Act, 15 U.S.C. § 77ppp(b).
15a
Such no-action clauses frequently are included in
indentures to limit suits arising from those agreements.
See UPIC & Co. v. Kinder-Care Learning Ctrs., Inc.,
793 F. Supp. 448, 454 (S.D.N.Y. 1992) (citing American
Bar Foundation, Commentaries on Model Debenture
Indenture Provisions, 232-34 (1971)). “These clauses are
strictly construed,” Cruden v. Bank of New York, 957
F.2d 961, 968 (2d Cir 1992), and have been enforced in
a variety of contexts in both federal and state courts, see,
e.g., Friedman v. Chesapeake and Ohio Ry. Co., 261 F.
Supp. 728, 729-31 (S.D.N.Y. 1966) (action to accelerate
the time of payment on bonds), aff'd, 395 F.2d 663 (2d
Cir. 1968), cert. denied, 393 U.S. 1016 (1969); Greene
v. New York United Hotels, Inc., 260 N.Y.S. 405, 406-07
(Ist Dep’t 1932) (action based on non-payment of
coupons on debenture bonds), aff’d, 261 N.Y. 698
(1933).
In this case, plaintiffs failed to comply with the no-
action clause, and, as a result, the district court ruled
that their state-law claims were barred. In regard to the
federal securities law claims, however, the district court
ruled that the no-action clause was inoperable because it
infringed on plaintiffs’ substantive rights under the secu-
rities laws. The court based its conclusion on the anti-
waiver provisions of both the 1933 and 1934 Acts, which
provide, in pertinent part, that “[a]ny condition, stipu-
lation, or provision binding any person acquiring any
security to waive compliance with any provision of [the
Acts or any rule or regulation of the Commission or an
exchange] . . . shall be void.” 15 U.S.C. §§ 77n; id.
§ 78cc(a).
Defendants argue that the no-action clause does not
constitute a “waiver,” but, rather, establishes a procedure
that must be followed before an action may be brought.
16a
They attempt to analogize the no-action clause to an
arbitration clause, and claim that both merely are pro-
cedural limitations. We disagree.
Arbitration clauses are enforceable under federal secu-
rities laws because they are procedural in nature and do
not serve to waive compliance with the provisions of
substantive law. See Shearsen/American Express, Inc. v.
McMahon, 482 U.S. 220, 238 (1987) (stating that “the
SEC has sufficient statutory authority to ensure that arbi-
tration is adequate to vindicate Exchange Act rights”).
The no-action clause in this case can operate to bar a
minority plaintiff class from exercising its substantive
rights under federal securities law upon the vote of a
majority of the debentureholders. Further, a plaintiff’s
inability to indemnify the Trustee, as required by the no-
action clause here, would bar that plaintiff from com-
mencing a securities law claim. The statutory framework
of the 1933 and 1934 Acts compels the conclusion that
individual securityholders may not be forced to forego
their rights under the federal securities laws due to a
contract provision. See Kusner v. First Pa. Corp., 531
F.2d 1234, 1239 (3rd Cir. 1976) (finding no “authority
for the proposition that a “no action’ provision in an
indenture effectively bars a direct action based upon the
federal securities laws”). Thus, the district court prop-
erly found that actions based on federal securities laws
may not be precluded by the no-action clause.
CONCLUSION
We affirm so much of the district court’s order as
determined that benefit-of-the-bargain damages are
available under section 10 of the 1934 Act and as deter-
mined that the no-action provision in the Indenture could
4
s
4
17a
not bar plaintiffs’ securities law claims. We reverse the
district court’s order to the extent that the court ruled
that benefit-of-the-bargain damages were available under
section 11 of the 1933 Act. On remand, the district court
is to apply the measure of damages specifically provided
under section 11(e) of the 1933 Act in accordance with
this opinion.
18a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
Filed December 21, 1995
McMahan & Company et al. v.
Wherehouse Entertainment, Inc. et al.
88 Civ. 0321 (MIL);
Don Thompson v. Wherehouse Entertainment, Inc. et al.
88 Civ. 9040 (MJL)
ORDER
Before the Court is Defendants’ motion for summary
judgment, on which this Court previously ruled in its August
10, 1994 opinion and order (“August 1994 Opinion”), and
on which the Second Circuit ruled in a September 13, 1995
decision. Still at issue are Plaintiffs’ claims under Section 11
of the Securities Act of 1933 (“Section 11”).
The background of this action is set forth in this Court’s
August 1994 Opinion and the Second Circuit’s September 13,
1995 decision and need only be briefly summarized here.
Plaintiffs are holders of debentures (“Debentures”) issued by
Defendant Wherehouse Entertainment, Inc. (“Wherehouse”).
Plaintiffs claim that a key selling feature of the Debentures
was the right of holders to tender (“Right to Tender”) the
Debentures to Wherehouse at 106.25% of par in the event of
certain triggering events including Wherehouse’s merger with
another company, unless that merger was approved by a
majority of “Independent Directors.” On December 20, 1987,
the Board of Directors of Wherehouse approved a merger
19a
(“Merger”) with WEI Acquisition Corp. and WEI Holdings,
Inc. Following the Merger, Plaintiffs attempted to exercise the
Right to Tender, but Wherehouse refused to redeem the
Debentures at 106.25% of par because the Board had
approved of the Merger. Subsequently, Plaintiffs initiated this
suit, claiming, inter alia, that they were misinformed about
the true nature of the Right to Tender, that the right was illu-
sory, and that they were not informed that the right would not
be triggered by a friendly acquisition of Wherehouse. Plain-
tiffs allege a variety of claims including claims under Section
11.
In June 1993, Defendants moved for summary judgment on
Plaintiffs’ claims. With respect to Plaintiffs’ Section 11
claims, Defendants argued that the decline in the market price
of Plaintiffs’ securities was not attributable to their alleged
misrepresentations because that decline occurred prior to the
December 21, 1987 disclosure that Wherehouse’s Board of
Directors had approved the Merger. Defs.’ Mem. at 15-19.
Plaintiffs did not dispute Defendants’ showing of negative
causation regarding a decline in market value,' Pls.’ Mem. at
40-43, but argued that “[t}he ‘negative causation’ proviso”
was inapplicable to their case. Jd. at 43. Instead, Plaintiffs
claimed entitlement to benefit-of-the-bargain damages, i.e.,
damages “measured against the promised value” of Plaintiff’s
debentures. /d.
In its August 1994 Opinion, this Court agreed with Plain-
tiffs’ argument and concluded that Plaintiffs could seek dam-
ages based on the “promised value” of their securities that
was lost due to fraud. Aug. 1994 Op. at 18-19. Defendants
appealed this portion of the August 1994 Opinion to the Sec-
ond Circuit, which, on September 13, 1995, ruled in Defen-
dants’ favor.” The Court of Appeals held that Plaintiffs may
While Plaintiffs argued that “the depreciation in value resuits from
defendants’ failure to honor the terms of the Holder’s Right to Tender,”
Plaintiffs referred to a depreciation from the promised value of the Deben-
tures, not from the price they paid for those securities. Pls.” Mem. at 42 (“the
loss is not market loss, but the loss of a promised benefit”).
. Defendants also raised other grounds for appeal which the Second
Circuit overruled.
20a
not recover benefit-of-the-bargain damages under Section 11]
and that the concept of “promised value” is irrelevant to a cal-
culation of Section 11 damages. McMahan & Co. v. Where-
house Entertainment, Inc., No. 95 Civ. 7008, slip op. at 6-8
(2d Cir. Sept. 13, 1995). The Court of Appeals remanded
Defendants’ motion to this Court for consideration of Defen-
dants’ “negative causation” defense. /d. at 7.
After careful review of the parties’ summary judgment
submissions, the Court concludes that Defendants have suc-
cessfully established a negative causation defense to Plain-
tiffs’ Section 11 claims. Defendants’ submissions demonstrate
that: (1) Plaintiffs’ debentures, which traded at close to 100%
of par when first issued in July 1986, were trading at about
60% of par by October 1987, at about 50% of par by Novem-
ber 1987, Defs.’ and Pls.’ Stmts. Pursuant to Local Rule 3(g)
at 45, and at about 47% of par on December 18, the last trad-
ing day before Wherehouse approved the Merger, Defs.’
Mem. at 9-10; Defs.’ Ex. 3 (list of daily closing prices); (2)
Defendants first publicly disclosed that the Right to Tender
would not be triggered by the Merger shortly after the occur-
rence of the Merger in late December 1987, Defs.” Mem. at 17
and submissions cited therein; Pls. Mem. at 17 and submis-
sions cited therein; and (3) pursuant to a supplemental inden-
ture issued after the Merger agreement was approved,
debenture holders were, subsequent to the Merger, allowed to
cash in their debentures at 50.72% of par, Defs.’ Stmt. Pur-
suant to Local Rule 3(g) at 4 6; Defs.” Mem. at 17.
Thus, the “true value” (as opposed to “promised value”) of
Plaintiffs’ securities at the time of suit—i.e., the value at
which Defendants were willing to redeem those securities
after the December 1987 disclosure’—was no less than the
value of those Debentures prior to the disclosure which
allegedly revealed Defendants’ misrepresentations. Defen-
3
As noted by the Second Circuit, “[e]ven plaintiffs have suggested
that damages be measured by the difference between the amount paid and the
amount that defendants were willing to redeem the Debentures for after the
merger was announced, i.e., the value of the Debentures after the alleged
misrepresentations were disclosed.” McMahan, supra, slip op. at 8 (empha-
sis added).
Pe RAN alt ah ae
reer, Mle th adr 6 ot")
Se
Se
2la
dants cannot, of course, be held liable under Section 11 for a
price decline occurring prior to such disclosure. See Akerman
v. Oryx Communications, Inc., 810 F.2d 336, 342 (2d Cir.
1987). Thus, Defendants have demonstrated that their alleged
misrepresentations did not cause the decline in the price of
Plaintiffs’ Debentures.‘ Accordingly, Defendants are entitled
to summary judgment on Plaintiffs’ Section 11 claims, which
do not seek legally congnizable damages. See 15 U.S.C.
7-Lk(e) (measure of damages and negative causation defense
under Section 11); Fed. R. Civ. P. 56(c) (summary judgment
standard). The parties are to submit a Joint Pre-Trial Order on
or before February 19, 1996.
It is So Ordered.
Dated: New York, New York
December 19, 1995
MARY JOHNSON LOWE
United States District Judge
° As already indicated, Plaintiffs’ opposition papers do not dispute
that Defendants have established negative causation with respect to the
decline in the market value of the Debentures. Instead, Plaintiffs raise argu-
ments, subsequently rejected by the Second Circuit, that they are entitled to
benefit-of-the-bargain damages based on promised value.
22a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
Filed August 12, 1994
88 Civ. 0321 (MJL)
MCMAHAN & COMPANY, FROLEY, REVY INVESTMENT
Co., INC. and WECHSLER & KRUMHOLZ, INC.,
Plaintiffs,
—-against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWIKER,
GEORGE A. SMITH, MICHAEL T. O’ KANE, LAWRENCE K.
HARRIS, DONALD E. MARTIN, JOEL D. TAUBER, FUR-
MAN SELZ MAGER DIETZ & BIRNEY INCORPORATED,
WEI ACQUISITION CORP., WEI HOLDINGS, INC. and
ADLER & SHAYKIN,
Defendants.
88 Civ. 9040 (MJL)
DON THOMPSON, on behalf of himself
and all others similarly situated,
Plaintiff,
—against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWIKER,
GEORGE A. SMITH, MICHAEL T. O’ KANE, LAWRENCE K.
HARRIS, DONALD E. MARTIN, JOEL D. TAUBER, and
FURMAN SELZ MAGER DIETZ & BIRNEY INCORPORATED,
Defendants.
AIS wet
? atari 6 SpeB abe Bi
pA 21 his A ele lag Cea.
wt Dd eter ae
Dee CRO Ree ote ie
APPEARANCES:
ABBEY & ELLIS
Attorneys for Plaintiff Thompson and Class
22 East 39th Street
New York, NY 10016
By: ARTHUR N. ABBEY, Eso.
HOWARD, DARBY & LEVIN
Attorneys for McMahan Plaintiffs
1330 Avenue of the Americas
New York, NY 10019
By: PHILIP K. HOWARD, Eso.
WEIL, GOTSHAL & MANGES
Attorneys for Defendants
767 Fifth Avenue
New York, NY 10153
By: DENNIS J. BLockK, Eso
OPINION AND ORDER
MARY JOHNSON LOweE, D.J.
Before the Court are motions for partial summary judgment
and summary judgment filed by plaintiffs and defendants
respectively, and a report and recommendation (“R & R”) by
a United States Magistrate Judge addressing these motions in
part. The motions were referred to Magistrate Judge Kathleen
A. Roberts who recommends that this Court grant defendants’
motion for summary judgment and dismiss the actions against
it. For the reasons below, this Court adopts in part and
declines to adopt in part this recommendation. Defendants’
motion for summary judgment is granted in part and denied in
part. Plaintiffs’ motion for partial summary judgment is dis-
missed as moot.
24a
BACKGROUND
The background of this action is also set forth in the R & R,
in prior opinions of this Court, and in an opinion by the Court
of Appeals.' The plaintiffs in the McMahan action, composed
of financial institutions, and individual plaintiff Don Thomp-
son in the Thompson action (collectively, “Plaintiffs”) are
holders of 6 1/4% convertible subordinated debentures (the
“Debentures”) issued in July of 1986 by Wherehouse Enter-
tainment, Inc. (“Wherehouse”), a retailer of home entertain-
ment and information software. The Debentures are due July
1, 2006. The governing indenture (the “Indenture”), between
Wherehouse and Trustee Bank of America, provides deben-
tureholders with a right to tender their debentures at 106.25%
of par to Wherehouse upon the occurrence of certain “trig-
gering events” listed therein. Indenture, § 5.01. One such
event occurs when Wherehouse consolidates or merges with
another company, unless that merger was approved by a
majority of “Independent Directors,” a term described in the
Indenture. Indenture, § 5.02. This “right to tender” is also
described in the prospectus through which the debentures
were advertised.
On November 19, 1987, Shamrock Holdings, Inc. (“Sham-
rock”) announced that it would commence a tender offer for
Wherehouse’s common stock. Subsequently, defendant Adler
& Shaykin, an investment partnership, formed defendants
WEI Acquisition Corp. and WEI Holdings, Inc., and bid for
the Wherehouse stock. On December 20, 1987, the Board of
Directors of Wherehouse unanimously approved, with one
abstention, a merger with WEI Acquisition Corp. and WEI
, The defendants to the McMahan action made a prior motion to
dismiss pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules of
Civil Procedure. This motion was treated by Magistrate Judge Roberts as
one for summary judgment. On May 22, 1989, this Court adopted the
recommendation of the Magistrate Judge, granted summary judgment in
favor of the defendants in the McMahan action, and dismissed the com-
plaint. On April 10, 1990, the Court of Appeals reversed this decision.
See McMahan & Co. v. Wherehouse Entertainment, Inc., 900 F.2d 576
(2d Cir. 1990), cert. denied, 111 S. Ct. 2887 (1991).
25a
Holdings, Inc. The merger was announced the following day.
Debentureholders were given the opportunity to tender their
securities at 50.72% of par.
Plaintiffs attempted to tender their Debentures to Where-
house following this merger, seeking a redemption price of
106.25% pursuant to the “right to tender.” Wherehouse
refused to permit Plaintiffs to exercise this right because the
board had approved the merger. Plaintiffs commenced their
respective suits against the various defendants, including:
Wherehouse, various officers of Wherehouse, Furman Selz
Mager Dietz & Birney (“Furman Selz”) as the underwriter of
the Debentures, the merging companies, and the bank financ-
ing the offer (collectively, “Defendants”).?
Plaintiffs claim that they were misinformed about the true
nature of the right to tender debentures, that the right was
illusory, and that the registration statements and the prospec-
tus, as well as oral representations, were materially mis-
leading. They allege that the right was portrayed as valuable
to debentureholders, creating a duty to them on the part of the
“Independent Directors,” but that they were not informed that
the right to tender would not be triggered by a friendly acqui-
sition of Wherehouse. They allege federal securities claims
arising under the following: Section 11 of the Securities Act
‘f 1933, 15 U.S.C. § 77k, for a misleading registration state-
ment; Section 12(2) of the Securities Act of 1933, 15 U.S.C.
§ 771, for a misleading prospectus or oral communication:
and Section 10(b) of the Securities Exchange Act of 1934, 15
U.S.C. §78j, for fraud in connection with a sale of securities.
In addition, they assert state-law claims based on breach of
contract, interference with contract, breach of the implied
duty of good faith, and fraudulent conveyance.
. The defendant bank was dismissed without prejudice by stipu-
lation and order filed July 29, 1991.
26a
DISCUSSION
The Court will conduct a de novo review of the R & R
and the parties’ motions addressed therein. See 28 U.S.C.
§ 636(b)(1)(B); Fed. R. Civ. P. 72(b). A motion for summary
judgment must be granted “if the pleadings, depositions,
answers to interrogatories, and admissions on file, together
with the affidavits, if any, show that there is no genuine issue
as to any material fact and that the moving party is entitled to
a judgment as a matter of law.” Fed. R. Civ. P. 56(c). The
facts are to be viewed favorably to the nonmoving party.
Adickes v. S. H. Kress & Co., 398 U.S. 144, 158-59 (1970).
The moving party bears the burden of initially demonstrating
the absence of a genuine issue of material fact. Jd. at 159.
This burden may be discharged as to issues on which the non-
moving party bears the ultimate burden by showing an
absence of evidence in support of essential elements of that
party’s case. Celotex Corp. v. Catrett, 477 U.S. 317, 323-25
(1986). The nonmoving party must then come forward with
“specific facts showing that there is a genuine issue for trial.”
Fed. R. Civ. P. 56(e); Anderson v. Liberty Lobby, Inc., 477
U.S. 242, 256 (1986); Celotex, 477 U.S. at 324.
I TheR&R.
At the heart of Defendants’ motion and the conclusion of
the R & R is § 8.06 (the “No Action Clause”) of the Inden-
ture. The No Action Clause provides as follows:
Limitation on Suits. A Securityholder may pursue any
remedy with respect to this Indenture or the Securities
only if:
(1) the Holder gives to the [Indenture] Trustee written
notice of a continuing Event of Default;°
3
Section 8.01 of the Indenture states that an event of default
occurs if, inter alia, “the Company defaults in the payment of the prin-
cipal of any Security when the same becomes due and payable, whether
at maturity, upon redemption or otherwise[, or] the Company fails
to comply with any of its other agreements in the Securities or this
Indenture.”
27a
(2) the Holders of at least 25% in principal amount of the
Securities make a written request to the Trustee to pur-
sue the remedy;
(3) such Holder or Holders offer to the Trustee indem-
nity satisfactory to the Trustee against any loss, liability
or expense;
(4) the Trustee does not comply with the request within
60 days after receipt of the request and the offer of
indemnity; and
(5) during such 60-day period the Holders of a majority
in principal amount of the Securities do not give the
Trustee a direction inconsistent with the request.
Indenture, § 8.06. Section 14 of the Debentures states in rel-
evant part. “Securityholders may not enforce the Indenture or
the Securities except as provided in the Indenture.”4
In a well-reasoned and thorough report, Magistrate Judge
Roberts analyzed the law pertaining to “no action” provisions
and applied this law to the instant No Action Clause. Magis-
trate Judge Roberts found the No Action Clause valid and
enforceable as to both Plaintiffs’ securities and non-securities
claims. Because Plaintiffs failed to comply with the No
Action Clause, she recommends that summary judgment be
granted in Defendants’ favor and that Plaintiffs’ entire com-
plaint be dismissed.
A. Plaintiffs’ Non-securities Claims.
No action clauses are frequently included in indentures to
limit the types of suits arising from those agreements. See
Upic & Co. v. Kinder-Care Learning Ctrs., Inc., 793 F. Supp.
: As stated in § 8.07 of the Indenture, debentureholders are
excused from complying with the No Action Clause in suits based on
nonpayment of principal and interest on or after the due dates expressed
in the Debenture and in suits based on the right to convert to Debenture
to common stock. This is a requirement of § 316(b) of the Trust Inden-
ture Act, 15 U.S.C. § 77ppp(b).
28a
448, 454 (S.D.N.Y. 1992) (citing the American Bar Founda-
tion, Commentaries on Model Debenture Indenture Provi-
sions, 232-34 (1971)). “These clauses are strictly construed,”
Cruden v. Bank of New York, 957 F.2d 961, 968 (2d Cir.
1992), and have been enforced in a variety of contexts in both
federal and state courts.
No action clauses have been used as a defense to the fol-
lowing types of debenture-related claims: civil claims brought
under the Racketeer Influenced and Corrupt Organizations
Act and fraudulent conveyance claims, see Victor v. Riklis, 91
Civ. 2897, 1992 WL 122911, at *6 (S.D.N.Y. May 15, 1992)
(containing a “no action” clause identical in scope to the
instant clause)*; actions to accelerate the time of payment on
bonds, see Friedman v. Chesapeake and Ohio Ry. Co., 261 F.
Supp. 728, 730 (S.D.N.Y. 1966), aff'd, 395 F.2d 663 (2d Cir
1968), cert. denied, 393 U.S. 1016 (1969); actions to set aside
transfers as violative of a trust indenture, see Relmar Holding
Co. v. Paramount Publix Corp., 263 N.Y.S. 776, 778 (1932),
aff'd, 261 N.Y.S. 959 (1933); and actions based on non-
payment of coupons on debenture bonds, see Greene v. New
York United Hotels, 260 N.Y.S 405, 407 (App. Div. 1 Dept.
1932), aff'd, 261 N.Y. 698 (1933) (securities held subject to
the underlying trust agreement, which contained a no action
clause). The Court will first determine whether the instant No
Action Clause is a successful defense to Plaintiffs’ state-law
claims.
Plaintiffs contend that the No Action Clause does not apply
to their situation because an absolute right to payment arose
upon the occurrence of the merger. A no action clause, as
stated in § 316(b) of the Trust Indenture Act, may not bar
debentureholders from suing to enforce the payment of prin-
cipal or interest “on or after the respective due dates
expressed in [the debenture].” 15 U.S.C. § 77ppp(b); see foot-
note 4. Section 316(b) pertains to events of payment default
where a company has failed to pay out on an indenture secu-
The “no action” clauses in Victor and the instant case are broad.
They pertain to any remedy with respect to the Indenture or Debentures
See Victor, at *7,n. 7.
29a
rity after its maturity date or after an explicit date on which
it has come due—in other words, when the right to payment
becomes absolute and unconditional. See Upic, 793 F. Supp.
at 455 (discussing legislative history of § 316(b)).°
The only date of payment explicitly stated in the Debenture
on which the right to payment becomes unconditional is the
maturity date, July 1, 2006. Plaintiffs do not seek to enforce
payment on the Debentures on or after this date: therefore,
§ 316(b) is not applicable to the instant situation. Plaintiffs’
right to tender prior to the due date expressed in the Deben-
ture is analogous to an acceleration of payment of principal
and interest, the time of which is not certain and, indeed, may
never come. “[A]cceleration is a collection remedy provided
in the Indenture and may not properly be considered a ‘pay-
ment default.’ ” Jackson Nat’! Life Ins. Co. v. Ladish Co., 92
Civ. 9358, 1993 WL 43373, at *6 (S.D.N_Y. 1993). This rea-
soning holds true for the conditional right to tender, which is
subject to a decision by the “Independent Directors,” prior to
the Debentures’ due date. The No Action Clause is not made
inapplicable to this situation by means of § 316(b).
Plaintiffs contend that, even if it does pertain to their
claims, the No Action Clause is unenforceable because it does
not appear on the face of the Debentures. Magistrate Judge
Roberts found no merit to this contention. This Court agrees.
A restriction or condition upon security holders, such as the
No Action Clause in the instant case, is enforceable when that
restriction is “definite and fairly places the [securityholder]
on notice that his [or her] rights to sue before the stated matu-
rity date are restricted and conditioned by the indenture.”
Friedman, 261 F. Supp. at 730 n.1 (S.D.N.Y. 1966) (empha-
sis included) (citing Dunham v. Omaha & Council Bluffs St.
Ry. Co., 106 F.2d 1, 2 (24 Cir 1939), cert. denied, 309 U.S.
661 (1940)).
Friedman involved bonds which referred their holders to
the underlying indenture for information on collection reme-
6
The securities in Upic became due and owing within a specific
time period after a date certain and specified in the securities. See Upic.
793 F. Supp. at 450. Thus, § 316(b) applied in that situation /d. at 456.
30a
dies prior to the bonds’ maturity. Section 14 of the instant
Debentures states that “[s]ecurityholders may not enforce
. the Securities except as provided in the Indenture.”
Debenture, § 14. Just as in Friedman, Plaintiffs here, by the
plain terms of the Debentures, are forced to rely on the Inden-
ture to enforce their securities. The Indenture contains the No
Action Clause which, in turn, refers back to the securities.
The Debentures put the Plaintiffs on notice of the No Action
Clause, a clause which limits suits for payment of principal
and interest prior to maturity only, by referring Plaintiffs to
the Indenture.’
Plaintiffs next argue that the “right to tender” is an indi-
vidual right, and that the No Action Clause applies to the
enforcement of “collective” rather than “individual” rights.
This distinction is of no avail to Plaintiffs. Just as the “right
to tender” refers to “The Holder” and “Each Holder,” so too
does the No Action Clause refer to “A securityholder[’s]” pur-
suit of a remedy. See supra. Regardless of whether the lan-
guage of these clauses refers to individuai rights, the right to
relief for a breach of an Indenture provision is limited by the
broad No Action Clause. The Indenture states that a holder
may pursue “any remedy with respect to [the] Indenture or the
Securities only if: . . . (2) the Holders of at least 25% in
principal amount of the Securities make a written request to
the Trustee to pursue the remedy.” Indenture, § 8.06(2),
supra. Indentures contain such provisions
to deter individual debentureholders from bringing inde-
pendent law suits for unworthy or unjustifiable reasons,
causing expense to the Company and diminishing its
assets. The theory is that if the suit is worthwhile, 25%
of the debentureholders would be willing to join in spon-
soring it. The 25% figure is standard.
>
Magistrate Judge Roberts appropriately distinguished Friedman
v. Airlift Int'l, Inc., 355 N.Y.S 2d 613 (App. Div. 1 Dept. 1974), and Cun-
ningham v. Pressed Steel Car Co., 265 N.Y.S. 256 (App. Div. 1 Dept.
1933), aff'd, 263 N.Y. 671 (1934). While both cases addressed the effec-
tiveness of restrictive language on the face of securities, both cases also
involved the obligation to pay principal and interest at maturity.
3la
Upic, 793 F. Supp. at 454 (citing American Bar Foundation,
Commentaries on Model Debenture Indenture Provisions,
supra). Regardless of whether the “right to tender” is char-
acterized as a collective or individual right, it is does not
escape application of the No Action Clause.*
As a last resort in objecting to the R & R, Plaintiffs seize
upon the doctrines of laches and estoppel. They argue that
Defendants should be precluded from using the No Action
Clause as a defense because it was not raised in their original
Rule 12(b)(6) motion to dismiss. See footnote 1, supra. Rule
12(h) of the Federal Rules of Civil Procedure addresses the
“Waiver or Preservation of Certain Defenses.” It is true that
it may be more efficient to raise all defenses in one motion
rather than in successive motions. However, while some
defenses are waived if not raised at the first opportunity, such
defenses do not include the defense of failure to state a claim
upon which relief can be granted. See Fed. R. Civ. P. 12(g),
(h)(2). The No Action Clause defense is such a defense and
cannot be waived.
Finally, Magistrate Judge Roberts rejected Plaintiffs’ argu-
ment “that they should not be bound by the no action provi-
sion because the McMahan plaintiffs held over 34 percent of
the debentures when their complaint was filed. . . . Plaintiffs
cite no authority for the novel proposition that a party to a
contract should be excused from complying with a condition
precedent merely because it was capable of compliance.”
R & R, pp. 14-15 Plaintiffs do not object to this conclusion.
. Plaintiffs object to Magistrate Judge Roberts’ finding that the
right to tender appears to be a “collective right” since it effects all deben-
tureholders in an identical manner. Plaintiffs argue that “the same could
be said of non-payment of principal and interest.” Objections to Mag-
istrate’s Report and Memorandum in Support of Summary Judgment, p.
17. This analogy is irrelevant to the finding of the Magistrate Judge.
Because of a statutory exception to the No Action Clause, suits to enforce
the payment of principal and interest after a debenture’s maturity may be
brought notwithstanding their characterization as “collective” or “indi-
vidual.” This very specific right was created not by this Court or by Mag-
istrate Judge Roberts, but by the United States Congress. See footnote 4,
supra.
32a
Where no objections have been filed, the Court need only sat-
isfy itself that there is no clear error on the face of the record
before accepting the recommendation. See Walker v. Hood,
679 F. Supp. 372, 374 (S.D.N.Y. 1988); Fed. R. Civ. P. 72
advisory committee’s note. The Court finds no clear error in
this recommendation and adopts this portion of the R & R.
The Court has addressed all of Plaintiffs’ objections to the
R & R with regard to the state-based claims, and the Court
agrees with Magistrate Judge Roberts’ recommendations. The
No Action Clause is broad and applies to “any remedy with
respect to [the] Indenture or the Securities.” Indenture, § 8.06.
Plaintiffs did not comply with the No Action Clause, and thus
are precluded from suing Defendants on the state-law claims.
Summary judgment for Defendants is granted on these claims,
and these claims are dismissed.
B. Plaintiffs’ Securities Claims.
Magistrate Judge Roberts recommends not only that the
state-law claims be dismissed, but that Plaintiffs’ entire action
be dismissed for failure to comply with the No Action Clause.
Plaintiffs submit that clauses of this type cannot prevent fed-
eral securities claims. This Court agrees.
Plaintiffs rely heavily upon a statement by the Court of
Appeals for the Third Circuit in Kusner v. First Pennsylvania
Corp., 531 F.2d 1234 (3d Cir 1976). That court found that the
defendants there cited “no authority for the proposition that
a ‘no action’ provision in an indenture effectively bars a
direct action based upon the federal securities laws.” /d. at
1239. However, unlike the broad clause in the instant case,
the “no action” clause in that case prohibited only suits aris-
ing under the indenture. Jd. While the impact of Kusner on
the facts of the instant case is unclear, this Court does find
that actions based on federal securities laws may not be pre-
cluded by a “no action” clause of any breadth.
Both the Securities Act of 1933 and the Securities
Exchange Act of 1934 contain anti-waiver provisions. See
Section 14 of the Securities Act, 15 U.S.C. § 77n; Section
29(a) of the Securities Exchange Act, 15 U.S.C. § 78cc. Both
q
iS.
+o
oa
“3
sg
coi
&
33a
Acts provide that “[a]ny condition, stipulation, or provision
binding any person. . . to waive compliance” with the Acts
“shall be void.”
The No Action Clause here requires that holders of 25% of
the Debentures must request initiation of a lawsuit by the
Indenture Trustee; even then, that action is barred if a major-
ity of the debentureholders instruct the Trustee not to sue. It
is possible that a debentureholder could be forced to forego
federal securities claims under the language of the No Action
Clause. Indeed, this is what Defendants ask the Court to find.
However, Sections 14 and 29(a) of the Securities Acts void
provisions binding any person to waive compliance with the
substantive protections of those Acts. They do not merely
void provisions binding plaintiffs to a securities lawsuit to
waive compliance with those protections. It is irrelevant that
Plaintiffs did not attempt compliance with the No Action
Clause prior to bringing federal securities Suits, as the No
Action Clause is void in this regard.
Defendants argue that the No Action Clause does not con-
stitute a “waiver,” but rather establishes a procedure which
must be followed before an action may be brought. They
attempt to analogize the No Action Clause to an arbitration
clause, reaching the conclusion that both are “mere proce-
dural limitation[s].” Defendants’ Response to Plaintiffs’
Objections to Magistrate Judge’s Report and Recommenda-
tion, p. 8. Defendants argue that a securities action by Plain-
tiffs was not precluded by the No Action Clause because they
held over 25% of the Debentures at the time this action was
commenced. Notwithstanding the truth of this statement, the
No Action Clause is impotent with regard to any federai secu-
rities claims. If any securityholder is forced to forego his or
her rights under the federal securities laws due to a contract
provision, then that provision is void. Plaintiffs appropriately
9 Arbitration clauses are enforceable under federal securities laws.
See Rodriguez de Quijas v. Shearson/American Express, Inc., 490 U.S.
477, 485-86 (1989); Shearson/American Express, Inc. v. McMahon, 482
U.S. 220, 238 (1987). Arbitration clauses were held to be procedural pro-
visions, and not within the ambit of $§ 14 and 29(a).
34a
reject Defendants® analogy, arguing that “[i]t is difficult to
imagine a starker distinction than that between a forum
clause, which only controls where a claim is brought, and a
clause which actually bars many claims.” Plaintiffs’ Objec-
tions, p. 20.
This Court holds that, as a matter of law, “no action”
clauses in indentures or securities may not be used as a
defense to federal securities claims. The No Action Clause in
question does not preclude Plaintiffs’ federal claims. Defen-
dants’ motion for summary judgment on this issue is denied.
Il. Alternative Grounds for Summary Judgment.'°
A. Plaintiffs’ Motion for Summary Judgment.
Plaintiffs have moved for summary judgment on the breach
of contract and breach of the implied covenant of good faith
claims. As stated in Section I(A) of this Opinion, supra, these
claims are dismissed due to Plaintiffs’ failure to comply with
the No Action Clause. Plaintiffs’ motion for summary judg-
ment is dismissed as moot.
B. Defendants’ Motion for Summary Judgment.
Defendants contend that several more grounds exist which
warrant the entry of summary judgment in their favor. Before
addressing these contentions, the Court stresses that there are
numerous issues of material fact potentially making summary
judgment inappropriate. Many of these issues are genuine and
in need of resolution by the finders-of-fact. See McMahan
& Co. v. Wherehouse Entertainment Inc., 900 F.2d 576 (2d
Cir. 1990), cert. denied, 111 S. Ct. 2887 (1991).
10
The remaining issues were not addressed in the R & R, which
relied on the No Action Clause in reaching its conclusion.
35a
1. Summary Judgment As to All Plaintiffs.
Defendants contend that they have not, as a matter of law,
caused Plaintiffs to suffer damages under §§ 11 and 10 of the
Securities Acts because losses in the value of the Debentures
were not caused by the alleged misrepresentations in the
Prospectus. Defendants state that the market value per Deben-
ture was $1,000 when issued in July of 1986 and only $470 on
the business day prior to December 21, 1987—the day the
Wherehouse board of directors announced approval of the
merger. Plaintiffs counter that they do not seek damages based
on decline in market value, but upon their inability to exercise
their right to tender at the time of Wherehouse’s merger.
a. Section 1] Damages.
Damages under § 11 are measured by the difference
between the amount paid for the security and the value of that
security at the time suit is brought. 15 U.S.C. § 77k(e). Dam-
ages under § 11 are capped at the price at which the security
was offered to the public. 15 U.S.C. § 77k(g). Defendants
may prove that any portion of a plaintiff’s losses are due to a
depreciation in value not resulting from the alleged misrep-
resentation. 15 U.S.C. § 77k(e). Thus, Defendants may show
“negative causation” in order to escape liability, while Plain-
tiffs must show a decrease in value due to fraud.
Plaintiffs claim that Defendants misrepresented in the reg-
istration materials the true nature of the debentureholders’
right to tender. “[N]otwithstanding the broad discretion which
issuers have in assembling and organizing their data, where
the method of presentation obscures or distorts the signifi-
cance of material facts, a violation of Section 11 will be
found.” Greenapple v. Detroit Edison Co., 618 F.2d 198, 205
(2d Cir. 1980) (citing cases). Defendants argue that any
alleged § 11 violations did not impact upon the low market
value of the Debentures at the time of merger, and that they
therefore cannot be held responsible for this depreciation.
Under the very specific facts of this case, a showing of
“negative causation” based upon market value is of no
defense to Defendants. It is true that a “price decline before
36a
disclosure may not be charged to defendants.” Akerman v.
Oryx Communications, Inc., 810 F.2d 336, 342 (2d Cir. 1987)
(citing cases). However, Plaintiffs do not seek to hold Defen-
dants liable for this market-decline. Acceptance of Defen-
dants’ argument would make § 11 toothless: misrepresentation
as to value to be received would be proscribed, but security-
holders would be powerless to enforce this prescription.
Plaintiffs seek damages based on the promised value that
was lost due to alleged fraud. Plaintiffs attempted to redeem
the Debentures at a premium pursuant to the “right to tender.”
Instead, Plaintiffs received a reduced amount due to the
alleged fraud of Defendants with respect to this right. The
market is irrelevant to Plaintiffs’ claimed economic losses.
Obviously, the real market value of the Debentures is less
than the premium to which Plaintiffs claim entitlement. Plain-
tiffs are permitted to seek damages based upon the alleged
violation of § 11 of the Securities Act.
b. Section 10 Damages.
Defendants argue that Plaintiffs have suffered no legally
cognizable damages under § 10 of the Securities Exchange
Act. Section 10(b) requires that plaintiffs prove “loss causa-
tion”—a loss in the value of an investment caused by defen-
dants’ fraud. Manufacturers Hanover Trust Co. v. Drysdale
Securities Corp., 801 F.2d 13, 20 (2d Cir. 1986), cert. denied,
479 U.S. 1066 (1987). Again, Defendants argue that any loss
in the value of the Debentures is attributable to the market,
and that Plaintiffs are not entitled to “benefit-of-the-bargain
damages” based upon the value the Debentures were allegedly
represented to have.
Plaintiffs correctly argue that they may be compensated
“for economic loss suffered as a result of wrongs committed
in violation of the 1934 Act, whether the measure of those
compensatory damages be out-of-pocket loss, the benefit of
the bargain, or some other appropriate standard.” Osofsky v.
Zipf, 645 F.2d 107, 111 (2d Cir. 1981). Osofsky involved mis-
representations in a tender offer to shareholders as to the
value of consideration they would receive in a merger. The
‘
>
4
ni
:
¥
at)
7
37a
Court of Appeals found that the shareholders should receive
the amount which they were told they would receive. /d. at
113. The Court established the proper rule to be as follows:
[T]he benefit-of-the-bargain rule should be applied under
the 1934 Act to the limited situation involved in [that]
case, where misrepresentation is made in the tender offer
and proxy solicitation materials as to the consideration
to be forthcoming upon an intended merger. . .
[Giving the plaintiff benefit-of-the-bargain damages is
appropriate only when they can be established with rea-
sonable certainty.
Id. at 114.
The situation in Osofsky is not unlike the Situation in the
instant action. Plaintiffs allege that Defendants made mis-
representations involving their right to tender back Deben-
tures to Wherehouse upon the occurrence of a merger. Under
this alleged scenario, Plaintiffs are tantamount to “sellers” of
securities who have been promised a specific consideration
for their holdings. They claim that they were promised a sum
certain upon tendering their securities, but instead they
received a lesser amount than promised. Plaintiffs, if they
prove their case, are entitled to benefit-of-the-bargain dam-
ages, which here can be established with certainty. In other
words, Plaintiffs are entitled to the difference between what
they were told they would receive and what they actually
received, independent of market value. Defendants argue that
the rule of Osofsky is one of limited application which should
not be applied to “buyers” of securities. They further argue
that damages do not become awardable simply because they
can be calculated with precision. In support they cite to
Levine v. Seilon, Inc., 439 F.2d 328 (2d Cir. 1971), and Zeller
v. Bogue Elec. Mfg. Corp., 476 F.2d 795 (2d Cir.), cert.
denied, 414 U.S. 908 (1973), for the proposition that benefit-
of-the-bargain damages are available only to defrauded sell-
ers, and not to buyers." While it is true that these two cases
i Defendants also cite Freschi v. Grand Coal Venture, 767 F.2d
1041, 1051 (2d Cir. 1985), vacated, 478 U.S. 1015 (1986), as a recent
38a
do state this, the court in Osofsky points out that this was
stated in dictum. 645 F.2d at 112, 113.
The distinction between buyers, whose gain is “specula-
tive,” and sellers, who are promised a specific price, “lies in
the ability to determine the amount of damages with cer-
tainty.” Osofsky, 645 F.2d at 112. See also Commercial Union
Assurance Co. v. Milken, 17 F.3d 608, 614-15 (2d Cir. 1994)
(denying benefit-of-the-bargain damages to buyers of part-
nership interests only because of the absence of a “reasonable
certainty” as to what they “would have earned”); Barrows v.
Forest Lab., Inc., 742 F.2d 54, 59 (2d Cir. 1984) (reading
Osofsky for the proposition that benefit-of-the-bargain dam-
ages are unavailable to buyers only where their determination
is “unduly” speculative). Plaintiffs, like sellers, were
allegedly falsely promised specific consideration for their
holdings upon the occurrence of a merger. The rule of Osof-
sky applies perfectly to this situation.
Court of Appeals opinion standing for the proposition that “a Rule 10b-
5 plaintiff can be compensated only for actual damages.” The plaintiff in
that case was promised tax deductions arising from a tax shelter. When
deductions were disallowed, the plaintiff sued under Rule 10b-5. The
District Court denied benefit-of-the-bargain damages. 588 F. Supp. 1257,
1259. The Court of Appeals affirmed finding that “any award in com-
pensation for hoped-for tax savings would be an impermissible award of
damages arising from an expectation interest.” 767 F.2d at 1051. The
Supreme Court vacated and remanded that decision in light of Randall v.
Loftsgaarden, 478 U.S. 647 (1986) and Sedima S.P.R.L. v. Imrex Co.,
Inc., 473 U.S. 479 (1985). The Court in Randall found that Congress did
not define the extent of the “actual damage” which may be recovered
under the 1934 Act, 15 U.S.C. § 78bb(a), and that these “flexible” dam-
ages are not limited to the net economic harm suffered by a plaintiff. 478
U.S. at 663. The plaintiff in Randall was permitted to receive damages
unreduced by tax benefits received.
On remand of Freschi, the Court of Appeals did not expressly reverse
its decision that “hoped-for” value is not recoverable. 800 F.2d 305.
However, the earlier decision by the Court of Appeals was vacated by the
Supreme Court and is of no value to Defendants. The entire rule and rea-
soning of Freschi is in doubt. Randall teaches that “actual damages”
greater than those permitted in Freschi may be recovered.
39a
c. Scienter under § 10-b.
Defendants next contend that they cannot be held liable
under § 10(b) because there is no evidence of scienter on their
part. Scienter is one of the requirements for liability under
§ 10(b) and can be established by a showing of intent or reck-
lessness by a defendant. Royal Am. Managers, Inc. v. IRC
Holding Corp., 885 F.2d 1011, 1015 (2d Cir. 1989). “Issues of
motive and intent are usually inappropriate for disposition on
summary judgment. . . . Ina § 10(b) action, a court may not
grant such relief to the defendants on the ground of lack of
scienter unless the plaintiff has failed to present facts that can
support an inference of bad faith or an inference that defen-
dants acted with an intent to deceive.” Wechsler v. Steinberg,
733 F.2d 1054, 1058 (2d Cir. 1984).
Defendants put forth evidence, especially by way of depo-
sition testimony, to demonstrate this lack of scienter. They
submit evidence as to the good faith of Wherehouse’s direc-
tors and the lack of involvement of outside directors in the
issuance of the Debentures. While there is certainly evidence
in support of Defendants’ case, this Court finds that there is
also sufficient evidence in support of Plaintiffs’ case from
which a jury could infer scienter. The offering materials could
be found ambiguous with regard to the “right to tender” and
misleading with regard to the Debentures’ true value. See
McMahan v. Wherehouse Entertainment Inc., 900 F.2d 576,
581 (2d Cir. 1990), cert. denied, 111 S. Ct. 2887 (1991). This
could be found to be the result of intentional misconduct or
recklessness by Defendants. Plaintiffs have presented evi-
dence supportable of an inference of bad faith, and it will be
for a jury to decide this issue.
2. Summary Judgment As to Froley, Revy Investment
Co., Inc.
In their original motion, Defendants raise additional
grounds for the entry of summary judgment against plaintiff
Froley, Revy Investment Co., Inc. (“Froley, Revy”), a party to
the McMahan portion of this action. These grounds shall be
addressed separately.
40a
a. Section 10(b) “transaction causation.”
Defendants first contend that they should be granted sum-
mary judgment on Froley, Revy’s § 10(b) claim because
Froley, Revy cannot prove “transaction causation.” Like
“loss” causation, “transaction” causation must be established
before liability can be found under § 10(b). Burke v. Jacoby,
981 F.2d 1372, 1378 (2d Cir. 1992), cert. denied, 113 S. Ct.
2338 (1993). “Transaction causation focuses on whether the
alleged fraud induced the plaintiff to buy the security,” and
“can be thought of as ‘but for’ causation, or reliance.” Perez-
Rubio v. Wycoff, 718 F. Supp. 217, 238-39 (S.D.N.Y. 1989)
(emphasis added).
Again, both sides put forth evidence in their support.
Defendants give evidence that Froley, Revy based its invest-
ment decision on factors other than the “right to tender.”
However, Froley, Revy gives evidence that the right to tender
was “one of the inducements” in deciding to purchase the
Debentures and “of some value.” September 23, 1992 Depo-
sition of Thomas Revy, pp. 65, 110. Thomas Revy, of Froley,
Revy, has also described the right as “important” and stated
that he purchased the Debentures based on oral and written
representations, apparently regarding the right to tender.
March 7, 1988 Affidavit of Thomes Revy, p. 3. Sufficient evi-
dence exists for a jury to infer that Froley, Revy relied on the
alleged misrepresentation when purchasing the Debentures.
See Burke, 981 F.2d at 1378-79. Summary judgment on this
ground is denied.
b. Timeliness of Froley, Revy’s § 12(2) Claim.
Defendants next contend that the statute of limitations
under § 12(2) bars Froley, Revy’s claim. “No action shall be
maintained to enforce any liability created under [§ 12(2)]
unless brought within one year after the discovery of the
untrue statement or the omission, or after such discovery
should have been made by the exercise of reasonable dili-
gence.” 15 U.S.C. § 77m. Froley, Revy commenced this
action in January of 1988, the month following the Where-
house merger which allegedly should have triggered the “right
SE ee ee ne,
4la
to tender.” The § 12(2) claim was added approximately five
months later. Oral representations regarding the “right to ten-
der” were allegedly made by a representative of Furman Selz
Mager Dietz & Birney Inc. (“Furman Selz”), underwriter of
the Debentures, to Thomas Revy in the summer of 1986, eigh-
teen months before the commencement of this action. Defen-
dants maintain that the Prospectus, which was also read at
that time, contradicts these alleged statements. Therefore,
Defendants argue that Froley, Revy was placed on notice of
the alleged § 12(2) violation prior to one year before the
action was commenced.
Defendants admit that reasonable diligence is the standard
by which the commencement of the statute of limitations is
determined “[OJn a fair reading of the offering materials . . .
an investor could have reasonably believed that the tender
option was presented as a valuable right for debenturehold-
ers.” McMahan, 900 F.2d at 581. The alleged misstatements,
as Claimed by Froley, Revy in its Amended Complaint, are
consistent with this fair reading. Jd. A reasonable investor,
exercising “reasonable diligence,” cannot be deemed to be on
notice of a § 12(2) violation under these circumstances.
Froley, Revy’s § 12(2) claim was brought well within the time
it should have been discovered.
c. Defendants as “Sellers” of Debentures.
Wherehouse argues that it cannot be held liable as a
“seller” of the Debentures. Liability under § 12(2) is limited
to those who offer or sell securities by means of a materially
misleading prospectus or oral communication. 15 U.S.C.
§ 771(2). “[T]he term ‘seller’ must include the person ‘who
successfully solicits the purchase, motivated at least in part
by a desire to serve his [or her] own financial interests or
those of the securities owner.’ ” Capri v. Murphy, 856 F.2d
473, 478 (2d Cir. 1988) (quoting Pinter v. Dahl, 486 U.S. 622.
647 (1988)).'* Wherehouse claims that Furman Selz, as under-
ta Pinter is concerned with § 12(1) of the Securities Act. This case
has been held to be applicable to § 12(2), as well. See Capri, 856 F.2d at
478.
42a
writer, passed title to the holders of the securities and that
therefcre no other Defendant can be deemed the seller of the
Debentures for the purposes of § 12(2) liability. They argue
that no oral misrepresentations were made by anyone from
Wherehouse and that the “Independent Directors” played no
role in the marketing of the Debentures.
The Supreme Court stated in Pinter that despite the exis-
tence of courts and commentators who would restrict § 12 lia-
bility to those who transfer title of securities for value it does
not read that statute “so restrictively.” 486 U.S. at 644. Plain-
tiffs point out that when the promoter of securities acts at the
“behest” of another party and upon information “supplied” by
that party, then the second party may be found to be a “seller”
under § 12(2). See Capri, 856 F.2d at 478. Title to a security
does pass from the issuer to the underwriter, and then from
the underwriter to the buyer. Akerman, 810 F.2d at 344. Thus,
there is no privity between the issuer and the buyer. Jd. How-
ever, if the plaintiff-buyer puts forth proof of scienter, “a
person who makes a misrepresentation may be held liable as
a ‘participant’ even though he [or she] is not the immediate
and direct seller of the securities.” Jd. (citing Lanza v. Drexel
& Co., 479 F.2d 1277, 1298-99 (2d Cir. 1973)). “Liability
under section 12(2) is available to the buyer of securities
against his [or her] immediate seller, and against those who
‘substantially participated’ in the sale.” Jn re CitiSource, Inc.
Sec. Litig., 694 F. Supp. 1069, 1083 (S.D.N.Y. 1988) (post-
dating Pinter).
The position of the courts of this circuit and the Supreme
Court is contrary to Defendants’ position. There need be no
direct contact between a plaintiff and defendant, provided that
the defendant, with scienter, participated in the sale of secu-
rities. Froley, Revy has established a connection between
defendant Louis Kwiker, Chief Executive Officer and chair-
man of the board of Wherehouse, and Furman, Selz in the
solicitation of the Debentures. There is no dispute that “Mr.
Kwiker participated in the solicitation process.” Defendants’
Memorandum in Support of Summary Judgment, p. 35. Only
the extent of that participation is in dispute. Froley, Revy’s
43a
evidence is supportable of an inference that Wherehouse and
its directors, motivated by financial interests, participated,
with scienter, in the sale of the Debentures. While Plaintiffs’
evidence may not conclusively establish § 12(2) liability by
Wherehouse or Louis Kwiker, Defendants’ evidence does not
conclusively establish otherwise. Plaintiffs will be given the
opportunity to present a case that Furman, Selz acted at the
behest of Wherehouse in misrepresenting the value of Deben-
tures and the “right to tender” and in selling the Debentures.
Defendants may be found to be sellers of the Debentures
d. Application of § 12(2) to Froley, Revy’s
Aftermarket Purchase.
Defendants contend that Froley, Revy’s debenture pur-
chases which occurred after the initial public offering (and
after the market price of the Debentures had falien) should be
excluded from the § 12(2) claim as a matter of law. In sup-
port, they cite to Ballay v. Legg Mason Wood Walker. Inc.,
925 F.2d 682, 693 (3d Cir.), cert. denied, 112 S. Ct. 79
(1991), in which the Court of Appeals for the Third Circuit
held that § 12(2) applies only to initial offerings of securities
and not to aftermarket trading. This rule has had support in
this circuit. See, e.g., Strong v. Paine Webber. Inc., 700 F.
Supp. 4, 5 (S.D.N.Y. 1988); SSH Co., Ltd. v. Shearson
Lehman Bros. Inc., 678 F. Supp. 1055, 1059 (S.D.N.Y. 1987).
However, there is a contrary view that § 12(2) does apply to
aftermarket transactions. See, e.g., Pacific Dunlop Holdings
Inc. v. Allen & Co. Inc., 993 F.2d 578, 582 (7th Cir. 1993);
Farley v. Baird, Patrick & Co. Inc., 750 F. Supp. 1209, 1221
(S.D.N.Y. 1990).
Plaintiffs argue that the Court should accept the more
expansive view of the applicability of § 12(2). However. it
also argues that the Court need not reach this decision at all,
and that the Court instead may apply § 12(2) to aftermarket
purchases bearing a close relationship to the initial offering.
This Court agrees. To establish liability under § 12(2), a
plaintiff must have purchased securities pursuant to a false or
misleading prospectus. Jn re AES Corp. Sec. Litig., 825 F.
Supp. 578, 592 (S.D.N_Y. 1993) (citing cases). While this pur-
44a
chase is often during the initial offering, claims “may be
brought by persons who purchased shares ‘traceable’ to the
public offering.” Jd. (relying upon Barnes vy. Osofsky, 373
F.2d 269, 272 (2d Cir. 1967) (stating in dictum that applica-
tion of § 12(2) is not limited to newly registered securities)).
Where there is no nexus between the aftermarket transac-
tions and a public offering, the weight of authority is clearly
that § 12(2) should not be applied to the aftermarket pur-
chases. This is not the instant case. Here, Froley, Revy pur-
chased approximately one-half of its Debentures in the initial
securities offering. It can be reasonably inferred that the deci-
sion to purchase in the aftermarket was based on information
received at the time of the initial purchase, such as from a
prospectus or an oral communication. Froley, Revy claims to
have made the secondary purchases to reduce the average cost
of the initial investment. Defendants do not refute this con-
nection, but instead urge the Court to adopt the blanket-rule
that § 12(2) does not apply to aftermarket transactions. The
Court rejects this argument and follows the reasoning of /n re
AES Corp. Given the nexus between the initial purchases and
the aftermarket purchases, § 12(2) will be applied to all of
Froley, Revy’s Debentures."
3. As to the Thompson Class.
Finally, Defendants argue that the claims brought pursuant
to § 11 of the Securities Act by Don Thompson (“Thompson”)
are barred as untimely. The statute of limitations on § 11
claims is the same as that for § 12(2) claims. See Section
I1(2)(b) of this Opinion, supra. Section 13 of the Securities
Act provides in relevant part: “No action shall be maintained
to enforce any liability created under [§ 11] unless brought
- Defendants make a final argument in their reply papers that nei-
ther Wherehouse nor Furman Selz were the sellers of the securities pur-
chased in the aftermarket. While the defense that Wherehouse is not a
“seller” was addressed in section II(2)(c) of this Opinion, supra, this spe-
cific argument relating to after-market purchases was not raised earlier.
Tue Court expresses no opinion as to the merit of this argument. Instead,
the Court declines to address the issue as it is inappropriately raised at
this juncture. See In re AES, 825 F. Supp. at 593, n. 20.
45a
within one year after the discovery of the untrue statement or
the omission, or after such discovery should have been made
by the exercise of reasonable diligence.” 15 U.S.C. § 77m.
Suit must be filed within one year after the time a plaintiff is
in possession of facts objectively sufficient to have placed
that plaintiff on inquiry notice of a potential claim. Bresson
v. Thomson McKinnon Sec., Inc., 641 F. Supp. 338, 344
(S.D.N.Y. 1986) (citing Ingenite v. Bermec Corp., 441
F. Supp. 525, 554 (S.D.N.Y. 1977)). Defendants contend that
Thompson was on inquiry notice of the facts surrounding his
claim more than one year prior to the commencement of his
action.
Defendants must meet an extraordinary burden in con-
vincing the Court that summary judgment based on inquiry
notice is appropriate. Whether reasonable diligence was exer-
cised by a party is a ordinarily a question of fact for a jury. In
re Integrated Resources Real Estate Ltd Partnerships Sec.
Litig., 815 F. Supp. 620, 638 (S.D.N_Y. 1993). “ ‘When con-
flicting inferences can be drawn from the facts, . . . sum-
mary judgment is inappropriate.’ ” Jd. (quoting Robertson v.
Seidman & Seidman, 609 F.2d 583, 591 (2d Cir. 1979)). “(ijt
is only in ‘extreme circumstances’ that summary judgment is
appropriate when the defendants assert that the action was
untimely commenced because inquiry notice was triggered
more than a year before the action was brought by the plain-
tiff.” Integrated Resources, 815 F. Supp. at 638 (quoting Fres-
chi v. Grand Coal Venture, 583 F. Supp. 780, 785 (S.D.N.Y.
1984)). The Court will examine Defendants’ motion with
these considerations.
Thompson filed this action on December 21, 1988, just
within the one year limitations period which began to run
upon the announcement by Wherehouse of the merger. Defen-
dants contend that Thompson was on notice of the nature of
the “right to tender” on November 19, 1987, when Shamrock
announced in a press release that it would make a tender offer
for Wherehouse."* In that release, Shamrock’s president and
14
The merger which allegedly triggered the right to tender fol-
lowed this offer by Shamrock. See Background, supra.
46a
chief executive officer announced that in the absence of a
merger agreement debentureholders would have the right to
redeem their debentures at a premium, but if a proposed
merger agreement were executed, this right of redemption
would not be triggered. The information contained in the
release was published on November 20, 1987 in the Wail
Street Journal, Los Angeles Times, Business Wire, and
Reuters. Defendants contend that this announcement should
have put Thompson on inquiry notice that his understanding
of the nature of the “right to tender,” as it relates to friendly
acquisitions, might not be accurate.'°
Again, § 11 provides for civil liability on account of a false
registration statement. Plaintiffs contend that the registration
statement misstated the right to tender. The Court of Appeals
found that a rational trier of fact could view the registration
materials as misleading. McMahan, 900 F.2d at 581. On a
“fair reading” of the registration materials, a reasonable
investor could have believed that “Independent Directors
were to render independent votes on the right to tender based
on the impact of a merger and on the interests of debenture-
holders.” Jd. Clearly, reasonable minds can differ as to the
nature of the “right to tender.”
Shamrock’s conclusions regarding this right were made
independently of any specific information provided by
Wherehouse other than in the registration materials and
Prospectus. It would be unfair to deem Thompson on inquiry
notice based upon the subjective conclusions of a third party
about the effect of a potentially ambiguous right.'® This Court
se Publication of information in the media gives plaintiffs con-
structive knowledge of that information. Jn re Integrated Resources, 815
F. Supp. at 639. Additionally, Shamrock filed a lawsuit in California
State Court on November 19, 1987, alleging that the Debentures con-
stituted “poison debt” giving the Independent Directors “unbridled dis-
cretion” in determining whether the right to tender has been triggered.
Defendants argue that this lawsuit also put Thompson on notice. See /d.;
Korwek v. Hunt, 646 F. Supp. 953, 958 (S.D.N.Y. 1986), aff'd, 827 F.2d
874 (2d Cir. 1987) (citing Berry Petroleum Co. v. Adams & Peck, 518
F.2d 402, 410 (2d Cir. 1975)).
16
Shamrock’s press release does indicate a view of the right to
tender different from that expressed by Plaintiffs, it appears that
veo.
oe =
hal deat cnt picattnnl
ott —
47a
is reluctant to deem Thompson on notice of the true nature of
the “right to tender” when that notice would have come from
the subjective views of a third party. Defendants’ motion for
summary judgment against Thompson based on the statute of
limitations is denied.
CONCLUSION
For the reasons stated above, the Court adopts in part and
declines to adopt in part the Magistrate Judge’s Report and
Recommendation. Plaintiffs’ motion for partial summary
judgment is dismissed as moot. Defendants’ motion for sum-
mary judgment on the claims arising under state law is
granted. Defendants’ motion for summary judgment on the
federal securities claims is denied. A Joint Pre-trial Order is
due on or before October 14, 1994.
It is SO ORDERED.
Dated: New York, New York
August __, 1994
MARY JOHNSON LOWE
United States District Judge
Shamrock too was unsure of the effect of that right to tender. On Novem-
ber 19, 1987, Shamrock sued Wherehouse and its directors in California
State court alleging that the Debentures constitute “poison debt.” Defen-
dants’ Memorandum in Support, p. 42 n. 87. Shamrock alleged that “[t}he
Indenture leaves unbridled discretion to the Independent Directors in
determining whether a Triggering Event is to be approved.” Jd.
48a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
88 Civ. 0321 (MJL) (KAR)
MCMAHAN & COMPANY, FROLEY, REVY INVESTMENT Co.
INC. and WECHSLER & KRUMHOLZ, INC.,
Plaintiffs,
—against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWIKER,
GEORGE A. SMITH, MICHAEL T. O’ KANE, LAWRENCE K.
HARRIS, DONALD E. MARTIN, JOEL D. TAUBER, FUR-
MAN SELZ MAGER DIETZ & BIRNEY INCORPORATED
WEI ACQUISITION CorRP., WEI HOLDINGS, INC. and
ADLER & SHAYKIN,
Defendants.
88 Civ. 9040 (MJL) (KAR)
DON THOMPSON, on behalf of himself and
all others similarly situated,
Plaintiff,
—against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWIKER,
GEORGE A. SMITH, MICHAEL T. O’ KANE, LAWRENCE K.
HARRIS, DONALD E. MARTIN, JOEL D. TAUBER, and
FURMAN SELZ MAGER DIETZ & BIRNEY INCORPO-
RATED,
Defendants.
49a
REPORT & RECOMMENDATION
TO THE HONORABLE MARY JOHNSON LOWE:
This Report and Recommendation addresses a motion for
partial summary judgment filed by plaintiffs in McMahan and
Thompson on June 17, 1993, and defendants’ motion for
summary judgment dismissing both complaints, also filed on
June 17, 1993. For the reasons set forth below, I recommend
that the defendants’ motion for summary judgment be granted
and the above-captioned complaints be dismissed.
BACKGROUND
Plaintiffs commenced these actions on January 15, 1988
(McMahan),' and December 21, 1988 (Thompson), alleging
breach of contract and violations of the federal securities laws
in connection with the sale of convertible subordinated deben-
tures (the “Debentures”) issued in July 1986 by defendant
Wherehouse Entertainment, Inc. (“Wherehouse”).? Defendant
Furman Selz Mager Dietz & Birney, Inc. (“Furman Selz”)
served as underwriter for the Debentures. At issue in both
cases is a provision contained on the face of the Debentures.
in the governing Indenture and in the Prospectus,? which pro-
vided that if a “triggering event” occurred, the debenture-
holders would have the right to sell their debentures back to
Wherehouse at the set redemption price of 106.25% of par
value:
Holder's Right to Tender. The Holder of any Security or
Securities shall have the right, at his option, upon giving
An amended complaint was filed by the McMahan plaintiffs on
January 22, 1988, and a “Revised Amended Complaint” was filed on
June 14, 1988.
. The McMahan Plaintiffs are financial institutions that purchased
the Debentures; the Thompson plaintiffs are individual investors who pur-
chased the Debentures. Thompson has been certified as a class action.
; Defendants’ Appendix (“Def. App.”) contains a copy of the
Indenture (Ex. 1), and a copy of the Prospectus (Ex. 2). The Debenture
is annexed to the Indenture as Exhibit A.
50a
of notice of the occurrence of any event described in
Section 5.02 * * * to tender for redemption any such
Security or Securities * * *.
Indenture § 5.01.
Section 5.02 of the Indenture sets forth the events referred
to in § 5.01:
(a) A person or group * * * shall attain the beneficial
ownership * * * of an equity interest representing
at least 80% of the voting power for election of the
Board of Directors of the Company unless such
attainment has been approved by a majority of the
Independent Directors;
(b) The Company * * * consolidates or merges with
any other person * * * unless approved by a major-
ity of the Independent Directors;
(c) The Company or any Subsidiary incurs, issues,
assumes, guarantees or creates any Debt, or pledges
any Company or Subsidiary assets to secure repay-
ment of any Debt, excluding Debt existing on July
9, 1986 and Debt which is authorized or ratified by
a majority of the Independent Directors * * *.
Indenture § 5.02
On December 20, 1987, Wherehouse entered in a merger
agreement with defendant WEI Holdings, Inc. (“WEI”),‘
owned by defendant Adler & Shaykin, a New York Partner-
ship.° The Independent Directors® of Wherehouse (defendants
. WEI Holdings, Inc., is a Delaware corporation with its princi-
pal place of business in New York City. Defendant WEI Acquisition
Corp., a Delaware corporation with its principal place of business in New
York City, is a subsidiary of WEI Holdings, Inc. Louis A. Kwiker was
Wherehouse’s Chief Executive Officer, President and Director.
; This merger was in response to a hostile takeover effort by
Shamrock Holding, Inc.
6
The term Independent Directors is defined in § 5.02 of the
Indenture as a director who had not been an employee of the company
during the preceding 5 years.
S5la
George Smith, Michael O’Kane, Lawrence Harris, Donald
Martin, and Joel Tauber) unanimously voted in favor of the
merger; Wherehouse and WEI therefore took the position that
there was no “triggering event” under § 5.02.’
Plaintiffs contend that the Indenture prohibits the Inde-
pendent Directors from approving any merger that is not in
the debentureholders’ interest, and that the Independent
Directors breached the Indenture contract by unanimously
approving the merger with WEI. Alternatively, plaintiffs con-
tend that if the Indenture did not protect debentureholders in
this manner, defendants violated federal securities laws by
issuing debentures pursuant to a materially misleading reg-
istration statement and prospectus and by omitting to state in
the registration statement and prospectus that the “holder’s
right to tender” was not for the benefit of the debenture-
holders. Defendants contend that the Indenture provides for
redemption of the Debentures at a premium only in the event
of a merger that was not approved by a majority of the Inde-
pendent Directors, i.e., a hostile takeover. Accordingly, defen-
dants contend that since the merger with WEI was
unanimously approved by the Independent Directors, the
“holder’s right to tender” was not activated.
PROCEDURAL HISTORY
The McMahan case was referred to me for supervision of
pretrial discovery on February 2, 1988 and for all substantive
motions on March 21, 1988. On February 23, 1988, defen-
dants moved to dismiss the McMahan amended complaint
pursuant to Rules 12(b)(1) and 12(b)(6) of the Federal Rules
of Civil Procedure. On August 10, 1988, after having advised
the parties in McMahan of my intention to treat defendants’
motion to dismiss as a summary judgment motion, I recom-
mended that the complaint be dismissed, on the ground that
there were no genuine issues of material fact with respect to
, The debentureholders were given an opportunity to redeem their
debentures at 50.72% of par value. The most recent closing price had
been 47% of par.
52a
plaintiffs federal securities claims, and that defendants were
entitled to judgment as a matter of law on those claims. I fur-
ther recommended that the pendent state law claims be dis-
missed. Your Honor adopted my Report and Recommendation
by Opinion and Order dated May, 25, 1989.
Plaintiffs appealed, and on April 10, 1989, the Court of
Appeals reversed and remanded for further proceedings, on
the ground that summary judgment on plaintiffs’ securities
claims was precluded by the existence of material issues of
fact as to whether written and oral representations about the
right to tender provision were material and misleading to a
reasonable investor. McMahan & Company v. Wherehouse
Entertainment, Inc., 900 F.2d 576 (2d Cir. 1990), cert. denied,
__. U.S. ___, 111 S.Ct. 2887 (1991). The Thompson case was
referred to me on June 20, 1991.
DEFENDANTS’ MOTION FOR SUMMARY JUDGMENT
“No Action” Clause
Defendants move to dismiss the McMahan and Thompson
complaints, inter alia, on the ground that plaintiffs have
failed to comply with § 8.06 of the Indenture (the “no action”
provision).® Section 8.06 provides:
Limitation on Suits. A Securityholder may pursue any
remedy with respect to this Indenture of the Securities
only if:
(1) the Holder gives to the Trustee written notice of a
continuing Event of Default;[*]
: Because I find that these actions are barred by plaintiffs’ failure
to comply with the no action provision, I do not address the other
grounds for dismissal asserted by defendants or plaintiffs’ motion for
summary judgment.
9
Under § 8.01(3) of the Indenture an “event of default” occurs,
inter alia, if “the Company fails to comply with any of its other agree-
ments in the Securities or this Indenture * * *.”
53a
(2) the Holders of at least 25% in principal amount of
the Securities make a written request to the Trustee
to pursue the remedy;
(3) such Holder or Holders offer to the Trustee indem-
nity satisfactory to the Trustee against any loss, lia-
bility or expense;
(4) the Trustee does not comply with the request within
60 days after receipt of the request and the offer of
indemnity; and
(5S) during such 60-day period the Holders of a major-
ity in principal amount of the Securities do not give
the Trustee a direction inconsistent with the request.
Indenture § 8.06. This provision does not appear on the face
of the Debentures. However, § 14 of the Debenture states that
Securityholders may not enforce the Indenture or the
Securities except as provided in the Indenture. The
Trustee may require indemnity satisfactory to it before it
enforces the Indenture or the Securities.
Debenture § 14.
Under § 8.07 of the Indenture, debentureholders are
excused from complying with the no action provision 1) with
respect to suit based upon the nonpayment of principal and
interest “on or after the respective due dates expressed in the
[Debenture],”'° and 2) with respect to suit based on the
debentureholder’s right to convert the Debenture to common
stock.
The Second Circuit has held that no action clauses are to be
“strictly construed.” Cruden v. Bank of New York, 957 F.2d
961, 968 (2d Cir. 1992),"! and provisions comparable to § 806
10 This provision is required by § 316(b) of the Trust Indenture
Act, 15 U.S.C. § 77ppp(b). See Cruden v. Bank of New York, 957 F.2d
961, 968 (2d Cir. 1992).
“ The Cruden court observed that permitting circumvention of no
action clauses would “upset{ ] settled indenture law and the expectations
of countless parties to proposed or existing indenture agreements.”
Cruden, 957 F.2d at 969.
54a
of the Wherehouse Indenture have been enforced by both fed-
eral and state courts. See, e.g., Victor v. Riklis, 91 Civ. 2897
(LJF), 1992 WL 122911 *6 (S.D.N.Y. May 15, 1992) (dis-
missing RICO and fraudulent conveyance claims based upon
plaintiff's failure to comply with no action clause in inden-
ture); Friedman v. Chesapeake & Ohio Ry. Co., 261 F. Supp.
728, 730-31 and n.1 (S.D.N.Y. 1966) (granting summary judg-
ment to defendants in action by bondholders to recover prin-
cipal and interest on bonds issued under an indenture based
upon plaintiff's failure to comply with no action provision in
indenture), aff'd, 395 F.2d 663 (2d Cir. 1968), cert. denied,
393 U.S. 1016 (1969); Greene v. New York United Hotels,
Inc., 260 N.Y.S. 405, 407 (ist Dep’t 1932) (complaint based
upon non-payment of coupons on debenture bonds secured by
a trust mortgage should have been dismissed because plain-
tiff failed to comply with no action clause contained in trust
agreement),"* aff'd, 261 N.Y. 698 (1933); see also Relmar
Holding Co., Inc. v. Paramount Publix Corporation et. al.,
263 N.Y.S. 776, 778 (Sup. Ct. N.Y. Cty. 1932) (denying
motion to strike defense of plaintiff's non-compliance with no
action provision in underlying indenture), aff'd 237 A.D.2d
870, 261 N.Y.S. 959 (ist Dep’t 1993); cf. Jackson National
Life Ins. Co. v. Ladish Co., Inc., 92 Civ. 9358 (PKL), 1993
WL 43373 *5-6 (S.D.N.Y. Feb. 18, 1993) (denying summary
judgment to plaintiff based upon disputed material facts with
respect to whether no action clause prohibited action to accel-
erate notes).
Plaintiffs concede that they did not comply with § 8.06 of
the Indenture. They argue, however, that they are exempt
under § 8.07 of the Indenture because this action is based
upon the nonpayment of principal and interest on or after the
due dates expressed in the security. This argument is based on
the theory that the principal of the Wherehouse debentures
became due and owing in 1988 when the merger events
allegedly triggered the “holder's right to tender.” Plaintiffs’
‘2 The Greene court held that “[t}he plaintiff as a bondholder holds
his securities subject to the condition of this underlying trust agreement
and can maintain an action only upon the conditions specified in the trust
agreement.” /d. at 407.
55a
Memorandum in Opposition to Defendants’ Motion for Sum-
mary Judgment (“Pl. Opp. Memo”) at 28-29. I disagree. Even
if the events surrounding the merger triggered the “holder’s
right to tender,” the due date “expressed in” the Debenture
would remain July 1, 2006. I therefore find that this is not a
Suit to receive principal due and owing.
Plaintiffs next argue that § 8.06 is unenforceable because
the limitations on suit do not appear on the face of the Deben-
tures. Pl. Opp. Memo at 30-32. This argument is based upon
Friedman v. Airlift International, Inc., 355 N.Y.S.2d 613 (Ist
Dep't 1974) and Cunningham v. Pressed Steel Car Co., 265
N.Y.S. 256 (1st Dep’t 1933), aff’d, 263 N.Y. 671 (1934).
In Airlift, the court reversed the dismissal of a debenture-
holder's suit to recover interest in default, based upon a no
action provision in the underlying indenture. The court held
that the provision was ineffective because the bond itself did
not give adequate notice of the restriction. Airlift, 355
N.Y.S.2d at 614-15. The text of the bond, “including the
designedly almost illegible small print on the back of the
bond,” contained two reference pertinent to payment of prin-
cipal or interest at maturity: 1) that “the interest payable
hereon” is “subject to certain exceptions provided in the
Indenture”; and 2) a “reference to the indenture for a descrip-
tion of the rights, limitations of rights, obligations, duties and
immunities thereunder of the Trustee, the Company and the
holders of the Debentures.” Jd. at 614 (internal quotations
omitted). The court found that neither of these clauses
affected the obligation to pay principal or interest on maturity,
and that “[a] reference to another document cannot contradict
the promise to pay unless the exception is stated specifically.”
Id. at 614-15. The court emphasized that “[t}he bond itself is
intended to be a negotiable instrument. Any limitation on the
obligation to pay at maturity appearing on its face would ren-
der it non-negotiable. It would appear that defendant has cir-
culated its negotiable promises to pay and now seeks to deny
their negotiability. As a matter of law the references in the
bond to the indenture do not accomplish this.” Jd. at 615.
In Cunningham, the court reversed the denial of summary
judgment to plaintiff in a suit for non-payment of principal on
S6a
convertible bonds, based upon a no action provision in the
underlying trust indenture. The bond itself stated that the it
had been “issued under and * * * equally secured by an
Indenture dated December 30, 1922, * * * to which Inden-
ture reference is hereby made for a statement of the rights of
the holders of said bonds.” 265 N.Y.S. at 258 (internal quo-
tations omitted). The court held that the reference to the
indenture did not fairly place the bondholder on notice of any
restriction upon defendant's obligation to pay at maturity and
therefore did not constitute a bar to maintenance of the action
for nonpayment. Observing that “the construction defendant
now seeks to place upon these bearer bonds would render
them nonnegotiable,” the court held that “[t}here being no
definite restrictive language in the bond which inhibits the
bondholder’s right to enforcement of the obligation at matu-
rity, any inconsistency between the bond and the indenture
must be construed in favor of the bondholder.” /d. at 260-61.
Accordingly, the court granted summary judgment to plaintiff.
In other cases, however, language similar to that appearing
on the Wherehouse Debentures has been held to provide suf-
ficient notice of restrictions on suit contained in the under-
lying debenture. For example, in Friedman v. Chesapeake,
(cited with approval in Cruden) the court held that the fol-
lowing statement on the face of the debenture provided suf-
ficient notice of restrictions in the Indenture to bind the
plaintiff:
in case an event of default, as defined in the Indenture,
shall occur, the principal of the Bonds may be declared,
or may become, due and payable, in the manner and with
the effect provided in the Indenture.
261 F. Supp. at 730. As noted above, the Wherehouse Deben-
tures contain the following provision:
Securityholders may not enforce the Indenture or the
Securities except as provided in the Indenture. The
Trustee may require indemnity satisfactory to it before it
enforces the Indenture or the Securities.
Sia
Debenture § 14. I find that this statement is sufficiently spe-
cific to bind the debentureholder to the no action provisions
of the Indenture." See Defendants’ Reply Memorandum in
Support of their Motion for Summary Judgment (“Def. Reply
Memo”) at 21-22.
Plaintiffs next contend that the § 8.06 limitations on suit do
not apply to this action because § 8.06 governs only “col-
lective rights,” and the holder's right to tender is an indi-
vidual right. Pl. Opp. Memo at 27-29. I disagree. Section 8.06
makes no distinction between cellective and individual rights,
and § 8.07, which sets forth the exceptions to § 8.06, provides
no exception for a suit for breaca of the “holder’s right to ten-
der” provision. Moreover, plaintiffs’ claim that the merger
triggered the “holder's right totender” would appear to be a
“collective right” since it affects all debentureholder in an
identical manner. See Def. Repy Memo at 17-18.
Plaintiffs next contend that the no action provision applies
solely to their contract claims ind not to their federal secu-
rities claims." Pl. Opp. Memo at 32-33. Plaintiffs rely on
Kusner v. First Pennsylvania Corp., 531 F.2d 1234, 1239 (3d
‘> Defendants also argue that tle notice requirements outlined in
Airlift and Cunningham apply solely v actions seeking payment of prin-
cipal and interest due under the deenture, where such restrictions
“impact upon negotiability.” Def. Rely Memo at 20-21. In light of my
finding that the language on the face ¢ the Wherchouse Debentures was
sufficient to bind plaintiffs to the terns of the Indenture, it is unneces-
sary to address this argument.
‘* Defendants’ answer, filed in Jily 1990 in the McMahan case and
58a
Cir. 1976), which held that the following no action clause did
not bar plaintiff's § 10(b) action:
No holder of any Debenture shall have the right to
institute any suit, action or proceeding, in equity or at
law, for the execution of any trust or power hereof, or for
the enforcement of any other remedy under or upon this
Indenture, unless * * *.
Id. at 1239 n.6. The Kusner court held that “[t)he right which
Kusner seeks to vindicate * * * derives not from the Inden-
ture, but from federal law.” /d. at 1239. The court noted that
the defendants had cited “no authority for the proposition that
a ‘no action’ provision in an indenture effectively bars a
direct action based upon tne federal securities laws. More-
over, the indenture provision * * * does not in terms apply
to any action arising other than under the agreement.” /d.; see
also Cruden v. Bank of New York, 85 Civ. 4170 (JFK), 1990
WL 131350 *12 (S.D.N.Y. Sept. 4, 1990) (no action clause
does not bar RICO and fraud claims, which did not arise
“under the indenture”), aff'd in part and rev'd in part, 957
F.2d 961 (2d Cir. 1992).
Relying upon Victor v. Riklis, 91 Civ. 2897 (LIF), 1992 WL
122911 (S.D.N.Y. May 15, 1992), defendants argue that Kus-
ner may be distinguished because the no action provision at
issue in that case only barred suits arising under the Indenture
itself, whereas the Wherehouse no action provision pertains
more broadly to “any remedy with respect to this Indenture or
the Securities.” Indenture § 8.06 (emphasis added). In Victor,
the court held that the failure to comply with a no action pro-
vision required dismissal of both the fraudulent conveyance
claims and federal statutory claims arising under RICO. The
court reached this holding because, unlike the no action pro-
vision in Kusner, the no action clause at issue in Victor
applied to any action seeking “any remedy with respect to
[the] Indenture or the Securities.” Id. at *6 (emphasis added)
(internal quotations omitted). Victor similarly distinguished
Cruden, 1990 WL 131350 *12 (S.D.N.Y. May 15, 1992),
which held that a no action clause did not bar RICO and fraud
59a
claims because they did not arise “under the indenture.” Vic-
tor, at *7 n.7.'5
I find that § 8.06 is broader than the Kusner and Cruden no
action provisions and applies to all claims asserted in these
actions. I also reject plaintiffs’ argument that application of
the no action provision to federal securities claims “would
violate public policy because contract limitations purporting
to waive compliance with the securities laws are unenforce-
able.” Pl. Opp. Memo at 33. As defendants point out, the no
action provision is analogous to an arbitration clause, which
the courts have held to be enforceable. Def. Reply Memo at
23, citing Shearson/American Express, Inc. v. McMahon, 482
U.S. 220, 238 (1987).
Finally, plaintiffs argue that they should not be bound by
the no action provision because the McMahan plaintiffs held
over 34 percent of the debentures when their complaint was
filed. Pl. Opp. Memo at 29-30. I disagree. Plaintiffs cite no
authority for the novel proposition that a party to a contract
should be excused from complying with a condition precedent
merely because it was capable of compliance. Plaintiff essen-
tially asks the court to create a new exception to § 8.06, a
request that I find must be rejected.
CONCLUSION
For the reasons set forth above, I find that these actions are
barred by plaintiffs’ failure to comply with § 8.06 of the
Indenture and recommend that defendants’ motion for sum-
mary judgment dismissing the complaints be granted.
'S The Cruden no action provision states:
No holder of any Debenture shal! have any right by virtue of
or by availing himself of any provision of this Indenture to
institute any action or proceedings at law or inequity or in
bankruptcy or otherwise, upon or under or with respect to this
Indenture, or for the appointment of a receiver or trustee. or for
any other remedy hereunder, unless * * *.
Cruden, 1990 WL 13150 *12.
60a
Pursuant to 28 U.S.C. § 636(b)(1)(c) and Rule 72(b) of the
Federal Rules of Civil Procedure, the parties shall have ten
(10) days from receipt of this Report to file written objec-
tions. See also Fed. R. Civ. P. 6. Such objections shall be filed
with the Clerk of the Court, with extra copies delivered to the
chambers of the Honorable Mary Johnson Lowe, Room 803,
and to the chambers of the undersigned, Room 631. Any
requests for an extension of time for filing objections must be
directed to Judge Lowe. Failure to file objections may result
in a waiver of those objections for purposes of appeal.
Thomas v. Arn, 474 U.S. 140 (1985); Wesolek v. Canadair
Ltd., 838 F.2d 55, 57-59 (2d Cir. 1988); McCarthy v. Manson,
714 F.2d 234, 237-38 (2d Cir. 1983).
DATED: New York, New York
March 11, 1994
Respectfully submitted,
KATHLEEN A. ROBERTS
KATHLEEN A. ROBERTS
UNITED STATES MAGISTRATE JUDGE
6la
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
Dkt No: 95-7008
Filed December 15, 1995
At a stated term of the United States Court of Appeals for
the Second Circuit, held at the United States Courthouse,
Foley Square, in the City of New York, on the 15th day of
December one thousand nine hundred and ninety-five.
MCMAHAN & COMPANY
Plaintiffs-Appellees,
—_vVv,.—
WHEREHOUSE
Defendants-Appellants.
A petition for rehearing containing a suggestion that the
action be reheard in banc having been filed herein by the
appellants McMahan & Company, et al.
Upon consideration by the panel that decided the appeal,
it is Ordered that said petition for rehearing is DENIED.
It is further noted that the suggestion for rehearing in banc
has been transmitted to the judges for the court in regular
62a
active service and to any other judge that heard the appeal and
that no such judge has requested that a vote be taken thereon.
FOR THE COURT
GEORGE LANGE III, Clerk
By: BETH J. MEADOR
Beth J. Meador,
Administrative Attorney
63a
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
88 Civ. 0321]
88 Civ. 9040
Filed November 4, 1994
MCMAHAN & Co., et al.,
ee
WHEREHOUSE ENTERTAINMENT INC. et al.
DON THOMPSON,
tee “fared
WHEREHOUSE ENTERTAINMENT INC. et al.
Notice of motion for leave to appeal pursuant to 28 U.S.C.
§ 1292(b).
Motion by:
Dennis J. Block, Esq.
Weil, Gotshal & Manges
767 Fifth Avenue,
New York, New York 10153
(212) 310-8000
Opposing Counsel:
Philip Howard, Esq.
Howard, Darby & Levine
1330 Ave. of the Americas
New York, New York
(212) 841-1000
Judith Spanier, Esq.
Abbey & Ellis
212 E. 39th Street
New York, New York
(212) 889-3700
Has consent of opposing counsel:
A. been sought? ClYes GIJNo
B. been obtained? ClYes GINo
Has service been effected? GlYes (CIJNo
Is oral argument desired? [lYes GINo
(Substantive motions only)
Requested return date:
(See Second Circuit Rule 27(b))
Has argument date of appeal been set:
A. by scheduling order?
B. by firm date of argument notice?
C. If Yes, enter date:
Judge or agency whose order is being appealed:
Judge Mary Johnson Lowe, U.S. District Court, S.D.N.Y.
Brief statement of the relief requested:
Petition for leave to appeal pursuant to 28 U.S.C.
§ 1292(b).
By: (Signature of attorney)
/s/ DENNIS J. BLOCK
Dennis J. Block
Signed name must be printed beneath
/s/ DENNIS J. BLOCK
Date 1]-4-94
65a
Appearing for: (Name of party)
WHEREHOUSE ENTERTAINMENT INC. et al.
Appellant or Petitioner:
C)Plaintiff G)Defendant
Appellee or Respondent:
CPlaintiff [Defendant
ORDER
Before: WINTER, MAHONEY and JACOBS, C.JJ.
IT Is HEREBY ORDERED that the motion be and it hereby
is granted and the cross-petition is denied.
GEORGE LANGE JJI, Clerk __
By: ARTHUR HELLER
Arthur Heller,
Administrative Attorney
1/3/95
66a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
88 Civ. 9040 (MJL)
88 Civ. 0321 (MJL)
November 30, 1994
MCMAHAN & COMPANY et al. v.
WHEREHOUSE ENTERTAINMENT INC. et al.
ORDER
Before the Court is Defendants’ motion requesting the
Court to amend its Order of October 21, 1994, certifying for
an interlocutory appeal, pursuant to 28 U.S.C. § 1292(b), this
Court’s Opinion and Order dated August 12, 1994. Defen-
dants request that the Court identify the specific rulings being
certified and the reasons why certification under § 1292 is
proper.
Plaintiffs oppose the motion to amend on the grounds that
Defendants’ proposed order incompletely and incorrectly
describes the issues to be certified. Plaintiffs also submit a
proposed order.
Upon consideration of the parties’ proposed orders and the
Second Circuit’s preference that District Judges certifying
orders for appeal state more than their bare finding that the
statutory requirements of § 1292(b) have been met, /sra Fruit
Ltd. v. Agrexco Agr. Export Co. Ltd., 804 F.2d 24, 25 (2d Cir.
1986), Defendants’ motion is granted in the following
respects.
This Court believes that two controlling questions of law
contained in its August 12, 1994 decision are of such a nature
that their immediate resolution by the Court of Appeals might
67a
materially advance the ultimate termination of this litigation.
These questions are:
(1) Whether the “no waiver” provisions of the federal
securities laws preclude the assertion of a “no action”
clause in an indenture as a defense to Plaintiffs’ federal
securities claims.
(2) Whether Plaintiffs are entitled to recover damages
under Section 11 of the Securities Act of 1933 and Sec-
tion 10(b) of the Securities Exchange Act of 1934 under
a “benefit of the bargain” theory of damages regardless
of whether the misrepresentations alleged affected the
market value of the Plaintiffs’ securities.
Because only the Plaintiffs’ federal securities claims
remain in this suit, a reversal of this Court’s decisions on the
aforementioned controlling questions could materially
advance the final and full disposition of all of Plaintiffs’
claims.
Further, both the substantial grounds for differences of
opinion and the absence of clear legal precedent in this Cir-
cuit on the two controlling questions are reflected in the opin-
ions of this Court and the Magistrate Judge in this case.
For the foregoing reasons, the Court has certified for imme-
diate appeal pursuant to 28 U.S.C. § 1292(b) its Opinion and
Order of August 12, 1994.
It is SO ORDERED.
DATED: New York, New York
November 14, 1994
MARY JOHNSON LOWE
United States District Judge
68a
Copies to:
WEIL, GOTSHAL & MANGES
Attorneys for Defendants
767 Fifth Avenue
New York, NY 10153-0119
ATTN: Dennis J. Block, Esq.
ABBEY & ELLIS
Attorneys for Plaintiff Thompson and Class
22 East 39th Street
New York, NY 10016
ATTN: Judith L. Spanier, Esq.
HOWARD, DARBY & LEVIN
Attorneys for the McMahan Plaintiffs
1330 Avenue of the Americas
New York, NY 10019
ATTN: Philip K. Howard, Esq.
Be re
69a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
88 Civ. 9040 (MJL)
88 Civ. 0321 (MJL)
October 13, 1994
MCMAHAN & COMPANY et al. v.
W HEREHOUSE ENTERTAINMENT INC. et al.
ORDER
Before the Court is Defendants’ Motion for Certification
Pursuant to 28 U.S.C. § 1292(b) of this Court’s August 12,
1994 Opinion and Order (“Order”).!
The Court is of the opinion that the Order involves con-
trolling questions of law as to which there is substantial
ground for difference of cpinion. The Court also believes that
an immediate appeal from the Order may materially advance
the ultimate termination of this litigation. Therefore, Defen-
F: dants’ Motion for Certification Pursuant to 28 U.S.C.
: § 1292(b) is granted. Further proceedings on this action are
3 stayed pending outcome of the interlocutory appeal.
It is SO ORDERED.
DATED: New York, New York
October 13, 1994
MARY JOHNSON LOWE
United States District Judge
: The Defendants move, in the alternative, for reconsideration of the
this Court’s ruling on the issue of damages. Because the Court finds certi-
fication appropriate, it does not address the motion for reconsideration.
70a
UNITED STATES DISTRICT COURT
SOUTHERN DISTRICT OF NEW YORK
88 Civ. 9040 (MJL)
Filed May 7, 1992
DON THOMPSON,
Plaintiff,
—against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWIKER,
GEORGE A. SMITH, MICHAEL T. O’KANE, LAWRENCE K.
HARRIS, DONALD E. MARTIN, JOEL D. TAUBER, and
FURMAN SELZ MAGER DIETZ & BIRNEY, INC.
Defendants.
APPEARANCES:
ABBEY & ELLIS
Attorneys for Plaintiff
212 East 39th Street
New York, New York 10016
By: JUDITH L. SPANIER, Esa.
WEIL, GOTSHAL & MANGES
Attorneys for Defendants
767 Fifth Avenue
New York, New York 10153
By: H. ADAM PRUSSIN, Esq.
HOWARD KNULER, ESQ.
Tla
HOWARD, DARBY & LEVIN’
1330 Avenue of the Americas
New York, New York 10019
By: PHILIP K. HOWARD, Esa.
LINDA C. GOLDSTEIN, Esq.
OPINION AND ORDER
MARY JOHNSON Lowe, D.J.
Before this Court is the motion of plaintiff Don Thompson
(“Thompson”) for an order, pursuant to Fed.R.Civ.P. 23,
certifying this case as a class action. This motion was referred
to Magistrate Judge Kathleen A. Roberts for a Report and
Recommendation, which was issued on February 11, 1992.
For the reasons stated below, the Report and Recommendation
is affirmed in full and the plaintiff’s motion for class certi-
fication is granted.
BACKGROUND
The relevant factual background is discussed at length in
the Report and Recommendation (“R & R”), familiarity with
which will be presumed. We will merely summarize the per-
tinent details herein.
Pursuant to a prospectus dated July 10, 1986, defendant
Wherehouse Entertainment, Inc. (“WEI”) issued $50 million
of convertible subordinated debentures (“the Debentures”) to
the public. The Debentures bore interest at a rate of 6-'/,%
The law firm of Howard, Darby & Levin represents the plaintiffs
in McMahan & Company, et al. v. Wherehouse Entertainment. Inc., et al.,
88 Civ. 0321, a companion case to the action currently before us. The two
cases have been consolidated for all pretrial purposes.
72a
and were due July 1, 2006. They were generally convertible
anytime prior to maturity into shares of WEI common stock
unless previously redeemed. The Debentures were sold in
increments of $1000 and traded on NASDAQ. Plaintiff Don
Thompson bought $71,000 in principal amount of the Deben-
tures between July 21, 1987 and December 21, 1987.
The prospectus contained a number of provisions to protect
the debenture holders in the event of a hostile takeover. How-
ever, it did not specify the consequences of a friendly
takeover. On December 20, 1987, WEI’s Board of Directors
unanimously approved, with one abstention, a merger agree-
ment with WEI Acquisition Corp. and WEI Holdings, Inc.
Because the merger was approved by a majority of WEI’s
independent directors, the debenture holders’ optional right
to tender, which arises in the event of a hostile takeover, was
not triggered.
Plaintiff filed this action on December 21, 1988, alleging
violations of § 11 of the Securities Act of 1933 and § 10(b) of
the Securities Exchange Act of 1934. Plaintiff claims these
violations were due to the defendant’s failure to state in the
Prospectus that the optional right to tender would not be trig-
gered in the event of a friendly acquisition. Plaintiff has also
asserted pendent state law claims.
The companion case to this action, McMahan v. Where-
house Entertainment, Inc., 88 Civ. 0321 (“McMahan
Action”), was filed on January 15, 1988. Plaintiffs in the
McMahan Action are financial institutions which purchased
34% of the Debentures. On February 23, 1988, defendants in
the McMahan Action moved to dismiss the complaint and for
a protective order staying discovery pending resolution of the
motion. During the pendency of the motion in the McMahan
Action, this action (the “Thompson Action”) was stayed. In
addition, during the pendency of an appeal of this Court’s
Opinion which granted the motion to dismiss in the McMahan
Action, the Thompson Action was placed on the Court’s sus-
pense docket. On April 10, 1990, the United States Court of
Appeals for the Second Circuit remanded the McMahan
I
a
73a
Action to this Court. See 900 F.2d 576 (2d Cir. 1990). The
Thompson Action was subsequently removed from the sus-
pense docket and plaintiff moved for class certification on
July 2, 1990. The motion for class certification was referred
to Magistrate Judge Roberts for a Report and Recommenda-
tion, which was issued on February 11, 1992.
DISCUSSION
Pursuant to 28 U.S.C. § 636(b)(1)(B) and Fed.R.Civ.P.
72(b), a decision by a magistrate judge on a dispositive mat-
ter shall be reviewed de novo by the District Court if any
objections to the decision are submitted. However, if no
objections are filed, the District Court need only satisfy itself
that there is no clear error on the face of the record in order to
accept the recommendation. Campbell v. United States Dist.
Court, 501 F.2d 196, 206 (9th Cir. 1974), cert. denied 419
U.S. 879; see also Fed.R.Civ.P. 72. Defendant’s have sub-
mitted objections only to that portion of the R & R which
found, pursuant to Fed.R.Civ.P. 23(b)(3), that “a class action
is superior to other available methods for the fair and efficient
adjudication of the controversy.” Jd. Thus, we will initially
discuss the other elements of the R & R, according to the
‘clear error’ standard, and then move on to a de novo deter-
mination of the question of superiority of a class action as the
method for resolving this and related actions.
Based on our review of the R & R, we find that the magis-
trate judge’s findings regarding the elements of Rule 23(a) are
wellgrounded in both the facts of the matter before us and the
law by which we are bound in evaluating those facts. Accord-
ing to Rule 23(a), in order to establish a class for certifica-
tion, plaintiff must establish the following:
(1) the class 1s so numerous that joinder of all members
is impracticable, (2) there are questions of law or fact
common to the class, (3) the claims or defenses of the
representative parties are typical of the claims or
74a
defenses of the class, and (4) the representative parties
will fairly and adequately protect the interests of the
class.
Fed.R.Civ.P. 23(a). The only dispute concerning Rule 23(a)
before the magistrate judge was with regard to the require-
ments of Rule 23(a)(3). This element of the rule requires that
the “claims or defenses of the representative parties are typ-
ical of the claims or defenses of the class.” Defendants
claimed before the magistrate judge that:
plaintiff’s claims are not based on the same legal theory
as that of other proposed class members because plain-
tiff cannot assert claims based upon the oral “roadshow”
misrepresentations, such as those asserted in McMahan
under § 12(2) of the Securities Act. . . . Defendants
claim that Thompson does not have standing to assert a
claim under § 12(2) based on alleged oral misrepresen-
tations because he bought his Debentures on the sec-
ondary market and claims not to have relied on oral
representations.
R & R, February 11, 1992, at 9. Thus, argued defendants,
plaintiff’s claims are not “typical” as required by Rule 23.
On this point, Magistrate Judge Roberts found that plain-
tiff’s claims are, in fact, typical to all members of the pro-
posed class because they “are based primarily on a single
document, the Prospectus, which was concededly provided to
all members of the proposed class.” Jd. at 10. Thus, it is clear
that there is a factual nucleus that is common to all proposed
class members and provides the required “typicality” element
of Rule 23. We, therefore, find no error in the magistrate
judge’s determination of this issue and adopt this portion of
her recommendation in full.
In addition to fulfilling the requirements of Rule 23(a),
plaintiff must further establish one element listed in Rule
23(b), which delineates the circumstances under which a class
action may be maintained. Plaintiff argues that Fed.R.Civ.P.
23(b)(3) is applicable here. Pursuant to Rule 23(b)(3), in
75a
order for a class to be maintained, the court must find that
there are common questions of law or fact which predominate
over any questions affecting only individual members, and
that a class action is superior to other available methods for
fair and efficient adjudication of the controversy. The defen-
dants argued before the magistrate judge that plaintiff had
failed to show both of the required elements of Rule 23(b)(3).
With regard to the issue of common questions of law or
fact, the magistrate judge found that,
the common factual and legal questions in this suit pre-
dominate over any individual questions, since liability
will depend upon a determination of whether defendants’
conduct in preparing and disseminating the Prospectus,
which was received by every person who purchased
Debentures, violated § 11 of the Securities Act of 1933
and § 10(b) of the Securities Exchange Act of 1934.
Report and Recommendation at 17. The defendants have not
objected to this finding in their submissions to this Court. In
evaluating the conclusions of the magistrate judge in light of
the ‘clear error’ standard, we fully agree with her determi-
nation regarding the core inquiry in this action. The alleged
acts which form the basis of the claims of plaintiff and other
prospective class members are essentially the same. In addi-
tion, the questions of law that must be determined in the
actions will involve analyses of identical legal guidelines,
those arising under the Securities Act of 1933 and the Secu-
rities Exchange Act of 1934. Thus, we adopt the magistrate
judge’s recommendation on this element, as well.
The final determination made by the magistrate judge was
that a class action would be the superior method of adjudi-
cation of this action. On this point, defendants have objected
to the magistrate judge’s recommendation. Specifically,
defendants argue that
{the] debentureholders have a strong interest in con-
trolling their own individual actions, and have enough at
stake to make individual actions economically feasible.
76a
Consequently, plaintiff has not established, as required
by Rule 23(b)(3), that a class action would be the supe-
rior method for resolving these claims.
Defendants’ Objections to Report and Recommendation,
March 9, 1992 (“Defendants Objections”), at 2. In her dis-
cussion of this point, tiie magistrate judge aptly articulated
that “private causes of actions for violations of the securities
laws constitute an essential tooi for enforcement of these
laws.” Id. at 14 (citing Basic Inc. v. Levinson, 485 U.S. 224,
230-231 (1988)). Furthermore, “the essential purpose of Rule
23 is ‘to encourage suits to redress rights where claims would
otherwise be too small to warrant individual litigation.’ ” /d.
(quoting Free World Foreign Car, Inc. v. Alfa Romeo, 55
F.R.D. 26, 30 (S.D.N.Y. 1972)). Pursuant to these guiding
principals, the magistrate judge found, inter alia, as follows.
Since the claims asserted all stem from the alleged mis-
representations and omissions in the Prospectus, it would
be in the interest of judicial economy to make factual
findings as to a class, and not to have a number of suits
seeking adjudications of the same factual issue. Further,
to deny class certification in the case at bar would likely
sound the “death knell” of the class claims, since class
members who did not intervene in plaintiff’s case within
a matter of hours would be barred by the statute of lim-
itations in commencing individual § 11 suits. Efficiency,
uniformity of decision, expense, and the likelihood that
many claims will not be pursued without the class action
all favor class certification.
Id. at 16.
Based on our de novo review of the record before us, we
find that Magistrate Judge Roberts’ recommendations on this
point are fully in line with the applicable law. Pursuant to
Rule 23(b)(3), the relevant issues to be considered in deter-
mining the issue of superiority are:
(A) the interest of members of the class in individually
controlling the prosecution or defense of separate
[Prt raat SES ie Lae Ee PT raib ces 2 Pe tre ee
T7a
actions; (B) the extent and nature of any litigation con-
cerning the controversy already commenced by or
against members of the class; (C) the desirability or
undesirability of concentrating the litigation of the
claims in the particular forum; (D) the difficulties likely
to be encountered in the management of a class action.
Fed.R.Civ.P. 23(b)(3). As quoted above, defendants arguments
against class certification consist of their claims that many
prospective class members have sufficiently large stakes that
they could proceed individually. In addition, plaintiff argues
that any inefficiencies or economic hardships that would
result in such individual actions can be overcome by co-
operation with the plaintiffs and counsel in this and the
McMahan actions and consolidation with these existing
actions. See Defendants’ Objections at 15, 22.
Defendants oppose the use of a class action for fear of a
“multimillion claim under the guise of protecting the rights of
others who have no need of this plaintiff’s protection.” Defen-
dants’ Objections at 17-18. They clearly fear less from what
they suggest as an alternative: the consolidated litigation of
multiple actions, which are so similar that joint litigation is
appropriate. See, e.g., Defendants’ Objections at 15, 16, 22.
Given the conceded factual and legal similarities among this
action and those of potential class members, presented in
sharp relief by defendants’ own arguments on these points, we
are lead to the conclusion that class certification is, indeed,
wholly appropriate to efficiently and economically join these
claims in a coordinated and manageable litigation. While it is
important to acknowledge the possible dangers of an abusive
use of the class action procedure, we do not find such abuse
indicated here. See Epifano v. Boardroom Business Products,
Inc., 130 F.R.D. 295, 299 (S.D.N.Y. 1990); Stoudt v. E.F. Hut-
ton & Co., Inc., 121 F.R.D. 36 (S.D.N.Y. 1988). Efficiency
and economy, for the Court and the litigants, will clearly be
best served by avoiding the multiplicity of actions that con-
solidation, as opposed to class certification, would create.
Further, class certification will avoid the possibility of incon-
78a
sistent factual determinations, a possibility that would be
greatly increased by separate trials of each action.
Defendants also argue that the “vast majority” of deben-
tureholders owned large enough amounts to give them finan-
cial incentive to litigate individually and, thus, a class action
is not a superior method by which to litigate these actions.
However, the fact that no debentureholders otlier than Thomp-
son and those in the McMahan Action had filed, by the eve of
the expiration of the statute of limitation, indicates that these
prospective class members do not have sufficient ability or
incentive to litigate individually.* Rather, it seems likely that
the costs of complicated federal securities litigation, even in
the face of a $60,000 or more claim, is a daunting task to take
on for any plaintiff. See Epifano v. Boardroom Business Prod-
ucts, Inc., 130 F.R.D. 295, 299 (S.D.N.Y. 1990) (Although the
damages claimed ranged from $50,000 to $285,000, given the
complexity of securities law cases and the high cost of liti-
gation, it was not clear that the cases would have been pur-
sued without the class action possibility); McMahon Books,
Inc. v. Willow Grove Associates, 108 F.R.D. 32 (E.D. Pa.
1985). Further, there are significant debentureholders who are
not the large stakeholders described by defendants and who
may be financially incapable of individually pursuing such a
litigation. See Plaintiff’s Reply to Defendants’ Objections to
Report and Recommendation, March 30, 1992, at 15.
In addition to the costs of litigation, the time in which other
potential plaintiffs could file suit if this motion were denied
is prohibitively short. When this motion was filed there was
one day left in which any other debentureholders could have
filed claims pursuant to § 11 of the Securities Act before the
expiration of the statute of limitations. Thus, if certification
2
Such failure to file suit cannot, as defendants suggest, be taken
as an indication of the weakness of plaintiff’s claims. Sirota v. Solitron
Devices, Inc., 673 F.2d 566, 572 (2d Cir. 1982), cert. denied, 459 U.S.
838 (1982) (It would be improper for a district court to resolve sub-
stantial questions of fact going to the merits when deciding the scope or
time limits of the class).
79a
were to be denied here, there would be a window of only one
day in which such claims could be filed. Fairness clearly dic-
tates that we may take into account the expiration of the § 11
claims of the prospective class members in making our deter-
mination here. While this consideration alone may not man-
date class certification, when it is evaluated in light of the
other circumstances of this action, we find it additionally per-
suasive.
Thus, in our evaluation of these issues, we find that the
guidelines of Rule 23 clearly contemplate class certification
in exactly the circumstances that are before us. See Korn v.
Franchard Corp., 456 F.2d 1206 (2d Cir. 1972); Epifano v.
Boardroom Business Products, Inc., 130 F.R.D. 295 (S.D.N.Y.
1990)(In spite of large damage claims, given the complexity
of securities law cases, and the high cost of litigation, it is not
clear that the cases would have been pursued without the class
certification possibility.); Tedesco v. Mishkin, 689 F.Supp.
1327 (S.D.N.Y. 1988); Esplin v. Hirschi, 402 F.2d 94, 101
(10th Cir. 1968), cert. denied, 394 U.S. 928 (Federal remedies
in the context of securities laws may depend on the applica-
bility of the class action device). For these reasons, we find
that class action is a superior method by which to adjudicate
this controversy and, therefore, affirm the Report and Rec-
ommendation on this point as well.
80a
CONCLUSION
For the reasons stated above, we adopt the Report and Rec-
ommendation of Magistrate Judge Kathleen A. Roberts, dated
February 11, 1992, in full. Plaintiff’s motion for class certi-
fication is granted. This action, as well as the companion
McMahan Action, shall remain with Magistrate Judge Roberts
for pretrial supervision.
It Is So Ordered.
Dated: New York, New York
April 24, 1992
/s/ MARY JOHNSON LOWE
United States District Judge
a
ie A Lal ee
8la
ORDER OF THE UNITED STATES SUPREME COURT
June 28, 1991
Certiorari Denied
No. 90-293. WHEREHOUSE ENTERTAINMENT, INC., ET. AL.
v. MCMAHAN & Co. ET. AL. C.A. 2d Cir. Certiorari denied
Reported below: 900 F.2d 576.
82a
Opinion of the United States Court of Appeals
For the Second Circuit
UNITED STATES COURT OF APPEALS
FOR THE SECOND CIRCUIT
—t-
No. 399—August Term 1989
Argued: December 19, 1989 Decided: April 10, 1990
Docket No. 89-7664
>
MCMAHAN & COMPANY, FROLEY, REVY INVESTMENT
Co., INC. and WECHSLER & KRUMHOLZ, INC.,
Plaintiffs-Appellants,
—against—
WHEREHOUSE ENTERTAINMENT, INC., LOUIS A. KWI-
KER, GEORGE A. SMITH, MICHAEL T. O’KANE,
LAWRENCE K. HARRIS, DONALD E. MARTIN, JOEL
D. TAUBER, FURMAN SELZ MAGER DIETZ & BIR-
NEY, INC., WEI ACQUISITION CORP., WEI HOLD-
INGS, INC., ADLER & SHAYKIN, and CHEMICAL
BANK,
Defendanis-Appellees.
Before:
OAKES, PRATT, Circuit Judges, and
LEONARD B. SAND, United States District Judge
for the Southern District of New York,
sitting by designation.
>
83a
Plaintiffs appeal from summary judgment of United
States District Court for Southern District of New York,
Mary Johnson Lowe, Judge, dismissing complaint
charging securities violations based on misrepresentation
in debenture offering.
Reversed and remanded. Judge Sand dissents in a sep-
arate opinion.
>
PHILIP K. HOWARD, New York, NY
(Howard, Darby & Levin, Warren G.
Caywood, Jr., Bonnie Blacklock, of
Counsel), for Appellant McMahan.
DENNIS J. BLOCK, New York, NY (Weil,
Gotshal & Manges, H. Adam Prussin,
Richard B. Friedman, Miranda S. Schil-
ler, of Counsel), for Appellee Where-
house.
PRATT, Circuit Judge:
Plaintiffs appeal from a judgment of the United
States District Court for the Southern District of New
York, Mary Johnson Lowe, Judge, dismissing their
complaint that defendants made material misrepresenta-
tions and omissions in a debenture offering in violation
of § 10(b) of the Securities Exchange Act of 1934, 15
U.S.C. § 78j; § 11 of the Securities Act of 1933, 15
U.S.C. § 77k; and § 12(2) of the Securities Act of 1933,
15 U.S.C. § 77/. Finding that the complaint ‘‘fail[ed] to
84a
allege any omission or misstatement of fact—material or
otherwise—within the meaning of the securities laws’’,
the district court granted summary judgment to defen-
dants. The court also dismissed plaintiffs’ state-law
claims for lack of pendent jurisdiction. Since we con-
clude that plaintiffs presented sufficient evidence to cre-
ate a genuine issue as to whether the offering was
materially misleading, we reverse the summary judgment
and remand the case for further proceedings.
BACKGROUND
Defendant Wherehouse Entertainment, Inc. offered
6-1/4% convertible subordinated debentures whose key
selling feature was a right of holders to tender the
debentures to Wherehouse in the case of certain trigger-
ing events which might endanger the value of the deben-
tures. The tender right was to arise if:
(a) A person or group * * * shall attain the ben-
eficial ownership * * * of an equity interest repre-
senting at least 80% of the voting power * * *
unless such attainment has been approved by a
majority of the Independent Directors;
(b) The Company * * * consolidates or merges
* * * unless approved by a majority of the !nde-
pendent Directors;
(c) The Company * * * incurs * * * any Debt
* * * excluding * * * Debt which is authorized or
ratified by a majority of the Independent Directors,
immediately after the incurrence of which the ratio
of the Company’s Consolidated Total Debt to its
Consolidated Capitalization exceeds .65 to 1.0.
85a
Indenture § 5.02, 11-12 (June 15, 1986); see also Pro-
spectus Summary, ‘‘Optional Tender’’, 3 (July 10,
1986); id. Description of Debentures, ‘‘Optional Deben-
ture Tender’’ 5-26.
The offering materials defined an ‘‘Independent
Director’’ as ‘‘a director of the Company”’ who was not
a recent employee but who was a member of the board
of directors on the date of the offering or who was sub-
sequently elected to the board by the then-Independent
Directors. Indenture, § 5.02, 12; Prospectus Description
of Debentures, ‘‘Optional Debenture Tender’’, 26. The
reason offered for this unusual right to tender was that
it would be a protection against certain forms of take-
over attempts, including leveraged buy-outs. Prospectus
Description of Debentures, ‘‘Effect on Certain Take-
overs’’, 27. At the heart of this appeal is the meaning of
the limitation placed on the right to tender by the role
of ‘‘Independent Directors’’.
Plaintiffs are financial institutions that purchased
34% of the convertible debentures. Eighteen months
after the purchase, Wherehouse entered into a merger
agreement with defendants WEI Holdings, Inc. and its
subsidiary WEI Acquisition Corp. The practical effect
of the merger, accomplished through a leveraged buy-
out, left Wherehouse with a debt approaching 90% of
its capitalization and left plaintiffs’ debentures valued at
only approximately 50% of par. Plaintiffs attempted to
exercise their right to tender, but the company refused
to redeem the debentures on the ground that the ‘‘board
of directors’? had approved the merger. Plaintiffs then
commenced this suit for damages and an injunction to
prevent the merger. Named as defendants were Where-
house, various officers of Wherehouse, the underwriter
86a
of the debentures, WEI Holdings, Inc., WEI Acquisi-
tion Corp., and the bank that was financing the tender
offer. Plaintiffs claimed that the descriptions of the
debentures in the registration materials, as well as repre-
sentations made during conversations, were materially
misleading. Specifically, they claimed that, even though
the defendants knew that the right to tender was illu-
sory, their representations of the right as valuable and
protected had misled investors into buying the deben-
tures and therefore violated federal securities laws. In
the alternative, claiming that the representations created
a right to tender under the contract, plaintiffs asserted
state-law claims of breach of contract, interference with
contract, breach of implied duty of good faith, and
fraudulent conveyance.
Defendants argued that all the relevant provisions
were clear and unambiguous and that no false state-
ments were made; thus the offering was not materially
misleading or in violation of the securities laws.
The district court found nothing misleading. It
granted summary judgment to defendants and dismissed
plaintiffs’ state-law claims for lack of pendent jurisdic-
tion. The district court held that defendants were not
required to speculate about the likelihood of a waiver of
debentureholders’ rights by the Independent Directors
and that, even if the right were worthless, defendants
were not required to use pejorative terms describing it as
such. Moreover, it found the tender option was not illu-
sory, because it (was possible that it) might provide a
benefit to debentureholders in the case of a takeover
hostile to shareholders which management chose to
fight. Finally, according to the district court, the defini-
tion of ‘‘Independent Directors’’ was adequate because
87a
further description of their role, the extent of their dis-
cretion, their interests, or their intent would constitute
mere legal conclusions, characterizations, or descriptions
of underlying motives and were not required disclosures.
Thus, the district court found that the descriptions of
the right were not misstatements, and that the alleged
Omissions were not required to be disclosed under the
securities laws.
We disagree with the district court’s atomistic consid-
eration of the presentation of the debentureholders’
right to tender. The district court concluded that defen-
dants had not misled plaintiffs because the information
they included in the written and oral representations was
‘literally true’’. We think, however, that when read as a
whole, the defendants’ representations connoted a richer
message than that conveyed by a literal reading of the
statements. The central issue on all three claims is not
whether the particular statements, taken separately, were
literally true, but whether defendants’ representations,
taken togethey and in context, would have mislead a rea-
sonable investor about the nature of the debentures.
Some statements, although literally accurate, can
become, through their context and manner of presenta-
tion, devices which mislead investors. For that reason,
the disclosure required by the securities laws is measured
not by literal truth, but by the ability of the material to
accurately inform rather than mislead prospective buy-
ers. Greenapple v. Detroit Edison Co., 618 F.2d 198,
205 (2d Cir. 1980) (where method of presentation or
**gloss’’ placed on information obscures or distorts sig-
nificance of material facts, it is misleading). Even ‘‘ ‘a
statement which is literally true, if susceptible to quite
another interpretation by the reasonable investor * * *
88a
may properly * * * be considered a material misrepre-
sentation.’ ’’ Beecher v. Able, 374 F. Supp. 341, 347
(S.D.N.Y. 1974) quoting SEC v. First American Bank &
Trust Co., 481 F.2d 673 (8th Cir. 1973).
We hold that the district court erred in granting sum-
mary judgment to the defendants; because plaintiffs
have raised a triable issue as to whether the written and
oral representations about the right to tender these
debentures were materially misleading to a reasonable
investor in violation of § 11 and § 12 of the 1933 Securi-
ties Act and also of § 10(b) of the 1934 Securities
Exchange Act. Since the analysis for all three securities
claims is similar, we will first consider it in some detail
under § 11, and then review it only briefly under §§ 12
and 10(b).
A. Section 1] of the Securities Act of 1933
Section 11 states that any signer, officer of the issuer,
and underwriter may be held liable for a registration
Statement which “‘contained an untrue statement of a
material fact or omitted to state a material fact * * *
necessary to make the statements therein not mislead-
ing’’. Plaintiffs claim that these offering materials mis-
stated the right to tender and omitted important
information about it in violation of § 11. They argue
that a reasonable investor would have believed that the
right to tender was valuable because it was presented as
a right to be exercised at the holder’s option and as a
protection against takeovers that might affect the secu-
rity of the debentures. In truth, however, the right to
tender was illusory, they argue, because it was designed
to be exercised only at the option of management and
89a
therefore was intended to protect the interests of share-
holders, not of debentureholders.
Plaintiffs are correct that the offering materials can
reasonably be read to present the option to tender as a
valuable right. The language used was invariably lan-
guage of entitlement:
Holder’s Right to Tender. The Holder of any Secu-
rity or Securities shall have the right, at his option,
* * * to tender for redemption any such Security or
Securities.
Indenture § 5.01, 10 (emphasis added). The prospectus
summary provided that:
‘‘Each holder of Debentures has the option to
require the Company to redeem the holder’s Deben-
tures.”’
“‘Optional Tender’’, 3 (emphasis added). And the pro-
spectus itself stated:
‘Holders of the Debentures will have the option
* * * to require the Company to redeem such
Debentures.”’
Description of Debentures, ‘‘Optional Debenture Ten-
der’’, 25 (emphasis added).
Further, a jury could reasonably view the presentation
of the right to tender as a special feature to protect
investors, for the offering materials stressed the pur-
ported value of the right in any takeover transaction
which would threaten the value of the debentures.
Since the events which give rise to such right of
redemption could be expected to occur in connec-
tion with certain forms of takeover attempts, the
90a
optional tender provisions could deter takeovers
where the person attempting the takeover views
itself as unable to finance the redemption of the
principal amount of Debentures which may be ten-
dered * * * To the extent that Debentures may be
tendered * * * the Company would be unable to
use the financing provided by the sale of the Deben-
tures offered hereby. In addition, the ability of the
Company to obtain additional Senior Debt based
on the existence of the Debentures would be simi-
larly adversely affected.
Prospectus Description of Debentures, ‘‘Effect on Cer-
tain Takeovers’’, 27; see also id. ‘‘Optional Debenture
Tender’’, 26.
Finally, the right was restricted only in that it was
subject to action by ‘‘the Independent Directors’’. Simi-
lar language describing the restriction—the right to ten-
der occurs upon a triggering event, ‘‘un/ess [the event is]
approved by a majority of the Independent Directors’’
(emphasis added)—is found in the Indenture, § 5.02, 11-
12; in the prospectus summary, ‘‘Optional Tender’’, 3;
and again in the fuil prospectus, Description of Deben-
tures, ‘‘Optional Debenture Tender’’, 25-26. A jury
could reasonably find that this repeated use of the word
“‘unless’’ encouraged the inference that exercise of the
right would be the norm and that waiver would be the
exception.
Although the offering materials explain that the Inde-
pendent Directors would be chosen from the company’s
board of directors, the term ‘‘Independent Director’’
implies a special status, some distinction from an ‘‘ordi-
nary”’ director. The term suggests that these directors
would be ‘‘independent’’ of management and the nor-
9la
mal obligations of board members to act in the interests
of shareholders. Thus the restriction could reasonably be
understood to mean that in the case of a triggering
event, the right to tender would arise unless the Inde-
pendent Directors find the event to be in the interests of
the debentureholders. In short, as plaintiffs argue, a rea-
sonable investor could have regarded the right to tender
as a valuable right, protected by Independent Directors
who would, in situations endangering the security of the
debentures, consider debentureholders’ interests before
approving any waiver of their right.
By thus representing that in a takeover context the
Independent Directors would be considering the interests
of debentureholders, the defendants implied that the
Independent Directors had a duty to protect the deben-
tureholders’ interests. Defendants, however, have shown
nothing in their corporate charter or by-laws that would
have permitted, much less required, these Independent
Directors to favor debentureholders over shareholders.
Moreover, at the time of the approval of this merger,
the Independent Directors constituted all but one of the
“‘ordinary’’ directors on the board. As ordinary direc-
tors, they had a fiduciary duty to protect the interests of
shareholders in any takeover situation, regardless of
debentureholders’ interests or rights. It is inevitable,
then, that the so-called Independent Directors had no
independence; they would never protect the interests of
debentureholders except by coincidence because, as ordi-
nary directors, they were required by law to protect the
interests of the shareholders. From this perspective,
there is merit in plaintiffs’ contentions that the right to
tender was illusory and that the representations of it in
the offering materials were misleading.
92a
In sum, on a fair reading of the offering materials,
despite their literal meaning, an investor could have rea-
sonably believed that the tender option was presented as
a valuable right for debentureholders; that it provided a
special feature of protection for their interests; and that
Independent Directors were to render independent votes
on the right to tender based on the impact of a merger
and on the interests of debentureholders. But if, as
plaintiffs claim, the right to tender was illusory because
the Independent Directors were tied to management,
served its needs, protected shareholders’ interests, and
would inevitably waive the right in any merger beneficial
to management regardless of debentureholders’ interests,
then the offering materials could be found by a rational
trier of fact to be materially misleading in violation of
§ 11 of the Securities Act of 1933. Plaintiffs have there-
fore raised a genuine issue as to whether the written rep-
resentations could have misled a reasonable investor,
Greenapple, 618 F.2d at 205, and summary judgment
was therefore unwarranted.
B. Section 12 of the Securities Act of 1933
Section 12(2) of the Securities Act of 1933 presents a
problem similar to § 11, but it has the added factor of
oral representations made to the investors in order to
induce them to purchase. Section 12(2) states that any-
one who makes a securities offering ‘“‘by means of a
prospectus or oral communication, which includes an
untrue statement of a material fact or omits to state a
material fact necessary in order to make the statements
* * * not misleading * * * shall be liable’’ (emphasis
added). In an affidavit, Thomas Revy of plaintiff Fro-
ley, Revy, alleges that in a phone conversation and at a
‘‘due diligence’ lunch, officers of Wherehouse specifi-
93a
cally represented that the debentures included the right
to tender as a ‘‘protective covenant for the debenture-
holders’’ against takeovers. Plaintiffs claim these oral
communications were untrue and violated § 12(2).
Defendants argue that the statements were accurate
because they would protect holders in the event of a
takeover that was hostile to management. The district
court agreed, finding that ‘‘where the company might
find itself subjected to an hostile takeover, the right to
tender could, indeed, be ‘protective’ of the debenture-
holders’ interests.’’
However, the language used—‘‘protective covenant’’
and ‘‘special protection’’—is promissory and unre-
stricted. The statements clearly imply that the protection
to debentureholders would extend to the case of any
takeover hostile to the holders’ rights. It would be, to
say the least, a cramped interpretation to view the right
to tender as a ‘‘protective covenant for the debenture-
holders’’ if its protection were limited to a takeover that
was hostile only to management and the shareholders.
Finally, by representing that this special right to tender
was the key selling feature of other wise low-value
debentures, defendants could be found to have implied
that debentureholders would be protected against take-
overs hostile to their own interests, regardless of the
interests of shareholders, and thus to have misled plain-
tiffs as to the true nature of the right. Summary judg-
ment was therefore inappropriate on plaintiffs’ § 12(2)
claim.
C. Section 10(b) of the Securities Exchange Act of 1934
Section 10(b) of the Securities Exchange Act of 1934,
the general fraud provision of the act, prohibits any per-
94a
son from using or employing ‘‘any manipulative or
deceptive device’’ in connection with the sale of a secu-
rity. To state a claim under this section, plaintiffs ‘‘must
allege material misstatements or omissions indicating an
intent to deceive or defraud in connection with the pur-
chase or sale of a security.’’ Luce v. Edelstein, 802 F.2d
49, 55 (2d Cir. 1986); Ernst & Ernst v. Hochfelder, 425
U.S. 185 (1976). Plaintiffs claim that disclosure of the
true nature of the tender provision not oniy would have
altered a reasonable investor’s investment decision, but
would have dissuaded investment here by showing these
debentures to be a poor risk. They allege that Where-
house knew this and so deliberately misrepresented the
right-to-tender feature, thereby misleading investors in
violation of § 10(b).
The district court, having dismissed the claims under
§ 11, found it was therefore impossible to state a § 10(b)
claim. Since we have concluded that a question of fact is
presented as to whether the offering materials and the
oral communications, taken together, could have misled
a reasonable investor, it follows that a jury should also
determine whether the defendants violated of § 10(b).
D. Pendent Claims
Since the only reason for the district court’s dismiss-
ing plaintiff's pendent state-law claims was that the fed-
eral basis for jurisdiction had disappeared, now that we
have reinstated the federal claims, the pendent claims
are reinstated as well.
Reversed and remanded.
>
95a
SAND, District Judge:
The reasons why I am constrained to dissent may be
briefly stated.
The question whether an anti-takeover provision pro-
vides a ‘‘special protection’’ to debentureholders cannot
be answered in the negative merely because the ‘‘Inde-
pendent Directors’’ decided to waive its provisions and
approve a particular transaction. These directors were
explicitly empowered to act in this fashion by virtue of
the fully disclosed terms of the provision. A significant
function of an anti-takeover provision is to serve as a
deterrent to hostile takeovers, including takeovers which
would be contrary to the interests of both shareholders
and debenture-holders. One cannot, I believe, fairly
characterize such a provision as being ‘‘worthless’’ to
the debentureholders, even though as a matter of Dela-
ware law directors owe a fiduciary duty solely to share-
holders. The anti-takeover provision was therefore a
“*special protection’’ to debentureholders, albeit a lim-
ited one.
Federal securities laws do not impose an obligation to
advise investors of the fundamentals of corporate gov-
ernance. The disclosure required by the federal securities
laws is not a “‘rite of confession or exercise in common
law pleading. What is required is the disclosure of mate-
rial objective factual matters.’’ Data Probe Acquisition
Corp. v. Data Lab, Inc., 722 F.2d 1, 5-6 (2d Cir. 1983),
cert. denied, 415 U.S. 1052 (1984). Especially is this so
where, as here, the investor-complainants are sophisti-
cated financial institutions making major investments.
The role of the federal securities laws is not to remedy
all perceived injustices in securities transactions. Rather,
96a
as invoked in this case, it proscribes only the making of
false and misleading statements or material omissions.
Whether the Independent Directors breached an
implied duty of good faith or otherwise a
This text is long and has been trimmed here. Open the source document for the complete record.
This is a copy of a public record, reproduced as it was published. It is not legal advice, and it may not be the version a court would rely on. Check the official source before you cite it.