Sanford BRASS; Joyce Mericle Brass; Gustave E. Chew; Fred
Suther; John Tomaszewski; Stephen D.E. Mitchell, as
Trustee for Giles David Edwin Mitchell and Neville Arthur
Thomas Mitchell, Plaintiffs-Appellants,
v.
AMERICAN FILM TECHNOLOGIES, INCORPORATED, Defendant-Appellee.
No. 37, Docket 92-7328.
United States Court of Appeals, Second Circuit.
Argued Sept. 4, 1992.
Decided March 8, 1993.
Raymond A. Connell, New York City (Connell Losquadro & Zerbo, of counsel), for plaintiffs-appellants.
Robert Knuts, New York City (Darrell K. Fennell, Fennell & Minkoff, of counsel), for defendant-appellee.
Before: FEINBERG, NEWMAN and CARDAMONE, Circuit Judges.
CARDAMONE, Circuit Judge:
This securities law action was brought against a defendant-corporation that was selling warrants for the purchase of its common stock. Plaintiff's suit alleging conversion, breach of contract and fraud arose when he met with defendant's chief executive officer to inquire about the business and ended up purchasing 65,000 of the warrants transferable into the company's common stock. Unknown to plaintiff, and untold by defendant's CEO, was the existence of a two-year holding period in which public trading of the common stock was prohibited. Despite the obvious effectiveness of defendant's sales pitch, the district court ruled in dismissing plaintiff's complaint that defendant had no duty to explain the restriction to plaintiff because of the absence of a fiduciary or other type of relationship between the parties that should have induced the plaintiff to rely on the CEO's investment advice.
Whatever validity the aphorism "speech is silver, silence is golden" may have in general, in this securities fraud action it should be restated to "speech is golden" because the CEO's silence broadcasted a misleading impression to plaintiff. To remain silent when one might have been supposed to speak is sufficiently alleged in the present complaint for plaintiff's suit to escаpe dismissal.
BACKGROUND
Defendant, American Film Technologies, Incorporated (AFT), is a modern-day business that has developed a special process for adding color to black-and-white films. The plaintiff, Sanford Brass, was attracted to the company as an investment, though he had no prior knowledge of it, its plans, or the prospects for the colorizing industry in general. To learn something about the company he attended a meeting in April 1987 with George Jensen, AFT's chairman and chief executive, and with Dennis Abert, a consultant to the same firm. Jensen laid out the company's business plans and told plaintiff that AFT had warrants available that could be used to purchase AFT common stock, which was expected soon to rise in value. The warrants Jensen referred to were the 65,000 warrants that had been allocated to Abert, who was in need of cash.
Following this April meeting Brass agreed to buy 10,000 of Abert's warrants for $1 per warrant. Jensen confirmed the purchase in a letter dated May 7, 1987 that set out the material elements of the transaction, stating that the warrants were exercisable for a five-year period at $2 per share. According to plaintiff, neither the seller, Abert, nor Jensen told him that the warrants and the underlying common stock were part of a private placement and thus for two years were not freely transferrable. See Sеcurities and Exchange Commission (S.E.C.) Rule 144, 17 C.F.R. § 230.144 (1992). Brass declares that had he known of the restriction he would not have purchased $10,000 worth of warrants.
Jensen continued to solicit Brass with respect to AFT securities. In July 1987 plaintiff received a Red Herring Preliminary Prospectus regarding the impending public offering of AFT common stock. The prospectus identified certain shares of common stock derived from the exchange of outstanding warrants as subject to a two-year resale limitation, without identifying precisely which shares were so restricted. Two years later plaintiff purchased the remaining 55,000 warrants allocated to Abert on the same basis as the original 10,000 warrants. In the summer of 1989 Abert faxed evidence to Brass of his entitlement to the warrants and included in the transmission a "Stock Purchase Right" certificate. Although this certificate did not disclose the restrictions on the common stock, it did state that the warrants were transferable only with AFT's approval, which AFT gave to allow Abert to sell his warrants.
In September 1989 AFT faxed at plaintiff's request a new Stock Purchase Right--similar to the one Brass received during the summer--certifying that Brass had the right to buy 65,000 shares of "unissued common stock." AFT insists that a letter accompanying the certificate disclosed the S.E.C. Rule 144 limitation on the sale of the common stock. Brass denies receiving the letter.
During early 1990 AFT warrants and common stock rose substantially in value on the Philadelphia Stock Exchange, prompting AFT to effect a two-for-one reverse stock split. This meant that plaintiff's warrants entitled him now to buy 32,500 shares of common stock. In April 1990 when AFT stock was selling at $9 per share and the warrants were trading at $5.50, Brass decided to distribute his warrants to his wife and several valued business colleagues (the transferees), who are now named plaintiffs. The transferees paid Brass the $65,000 he had paid Abert to acquire the warrants.
AFT consented to the transfer and sent Brass a revised Stock Purchase Right for 32,500 warrants, requesting him to list his transferees. In a letter accompanying this new Stock Purchase Right AFT informed Brass that "the warrants are now exercisable at four dollars ($4.00) per share," to reflect the reverse stock split, "and the common stock will remain restricted for two years after the date of exercise of the purchase rights." This, Brass avers, was the first notice he had that the warrants covered restricted shares of stock. On April 26, 1990 plaintiff signed the new Stock Purchase Right certificate and on the following day, AFT returned his old certificate marked "cancelled," and forwarded new certificates to the seven designated plaintiff transferees. On May 3, 1990 AFT sent a clarification letter to the transferees, disclosing that both the Stock Purchase Rights and the underlying common stock were issued as pаrt of an AFT private placement. Thus, neither was freely tradeable.
On July 18, 1991 Brass and the transferees commenced the instant action against AFT in New York State Supreme Court alleging that defendant's actions constituted a wrongful conversion of the warrants, and of the right of Brass and his distributees to exercise the purchase option evidenced by those warrants. Plaintiffs demanded $290,550 damages. AFT removed the case to the United States District Court for the Southern District of New York on diversity grounds and made a Fed.R.Civ.P. 12(b)(6) motion to dismiss. The district court, Louis J. Freeh, Judge, converted that motion sua sponte to one for summary judgment. See Brass v. American Film Technologies, Inc.,
In opposing summary judgment, plaintiffs asserted that AFT's conduct constituted conversion, breach of contract, securities fraud and common law fraud. To make out a conversion claim, Brass contended that he was entitled to receive unrestricted AFT common stock. He based this argument on U.C.C. § 8-204 and a Tenth Circuit case interpreting it. See Edina State Bank v. Mr. Steak, Inc.,
In an order dated December 18, 1991, the district court rejected Brass' conversion claims. It disagreed with the holding in Edina State Bank and did not think § 8-204 required issuers of securities to include notices regarding limitations on transfer arising under the federal securities laws. See Brass,
Later plaintiffs filed an amended complaint pursuing only a claim for common law fraud, which AFT moved to dismiss. On February 28, 1992 the district court granted this motion because plaintiffs had failed to state a claim upon which relief could be granted under Rule 12(b)(6) and to plead fraud with sufficient particularity under Fed.R.Civ.P. 9(b). The trial court observed that plaintiffs had two fraud claims: fraudulent misrepresentation and fraudulent concealment. As to thе Brass transferees, these plaintiffs had dealt only with Brass and not with AFT. Hence, they had no claim under either theory. With respect to Brass, there was no misrepresentation because the complaint never alleged that Jensen made false statements, and there was no case for concealment because AFT and Jensen were not in a fiduciary relationship with Brass and therefore had no duty to disclose restrictions. Following a motion by the plaintiffs, the district court reconsidered its December 18 decision with respect to plaintiffs' contract claim, and reaffirmed its prior ruling. Although it now agreed with Brass that the Stock Purchase Rights constituted a continuing offer by AFT to sell securities, it concluded that these rights created no contractual obligation to provide unrestricted stock to any party.
On March 6, 1992 judgment was entered dismissing the plaintiffs' amended complaint and all their claims against AFT. Plaintiffs appeal from the grant of summary judgment in favor of AFT on the conversion and contract claims and from the Rule 12(b)(6) dismissal of their fraud claims. We affirm as to the conversion claim, but reverse the contract and fraud rulings and remand the matter to the district court.
DISCUSSION
I Summary Judgment
To defeat AFT's motion for summary judgment dismissing the conversion and contract claims, plaintiffs must do more than demonstrate the existence of some metaphysical doubt as to the material fаcts, they are required to produce "specific facts showing that there is a genuine issue for trial." Matsushita Elec. Indus. Co. v. Zenith Radio Corp.,
A. Conversion Claim
Plaintiffs contend that AFT's failure to provide them with Stock Purchase Rights covering unrestricted common stock constitutes a conversion under New York law of both the rights acquired from Abert and the common stock obtainable from AFT by the exercise of those rights. They believe they were entitled to have Stock Purchase Rights going to unrestricted stock because AFT failed to disclose those restrictions applicable to the common stock as required by U.C.C. § 8-204. That section provides: "[a] restriction on transfer of a security imposed by the issuer ... is ineffective against any person without actual knowledge of it unless ... the security is certificated and the restriction is noted conspicuously thereon." N.Y.U.C.C. § 8-204 (McKinney 1993). It imposes а "strict rule as to notice" to protect purchasers of securities, id. official uniform cmt. 2. The consequences of failure to give notice fall on the issuer because § 8-204 applies only to transfer restrictions imposed by the issuer. In contrast, S.E.C. Rule 144 may be read to imply that securities issued under a private placement not be publicly traded for two years from the date of acquisition from the issuer. See 17 C.F.R. § 230.144(d)(1) (1992); id. § 230.142. The Commercial Code makes no reference to restrictions imposed by any other law. A reading of § 8-204 as not including any possible restrictions arising out of SEC regulations is supported by its Official Commentary, which states that "[t]his section deals only with restrictions imposed by the issuer and restrictions imposed by statute are not affected." N.Y.U.C.C. § 8-204 official uniform cmt. 6.
Plaintiffs naturally take a contrary position. They rely primarily upon the Tenth Circuit's broad interpretation of the U.C.C. phrase "imposed by the issuer" to include as well restrictions arising out of the Securities Act of 1933. See Edina State Bank,
When the holding in Edina State Bank was cited to a Southern District judge in DeWitt v. American Stock Transfer Co.,
Plaintiffs urge us to adopt Edina State Bank, which they think consistent with the S.E.C. policy of encouraging issuers of privately placed securities to make full disclosure of re-sale restrictions. See 17 C.F.R. § 230.502(d)(3) (1992); 3 Louis Loss & Joel Seligman, Securities Regulation 1491-99 (3d ed. 1989). Continuing, plaintiffs point out that even were we to embrace the limitations imposed by DeWitt, their conversion claim would still stand because it falls squarely within the factual context of Edina State Bank, that is, the stock in this case, like Mr. Steak's stock in that case, was issued as part of a private placement, and AFT, like Mr. Steak, had the exclusive opportunity to legend its own securities before issuing them.
In our view the instаnt case is distinguishable from Edina State Bank. Hence, we need not decide whether to adopt its reading of the "imposed by the issuer" language in U.C.C. § 8-204. Edina State Bank is inapt because there the bank received Mr. Steak common stock certificates without notice on their face of the restrictions. In the present case plaintiffs never exercised their Stock Purchase Rights and therefore never received any AFT common stock certificates. Thus, unlike Mr. Steak, AFT had no opportunity to legend its stock certificates and accordingly had no responsibility under § 8-204 to notify Brass--assuming such is a requirement--of the S.E.C. Rule 144 restrictions concerning its privately placed common stock.
Plaintiffs state further that AFT should have noted on the Stock Purchase Rights certificate that S.E.C. restrictions applied to the underlying stock. But neither the plain meaning of § 8-204--nor for that matter the Edina State Bank interpretation of it--provides that a disclosure of transfer restrictions that must appear on the face of one security must also appear on the face of another security, which a purchaser might acquire. Rather, § 8-204 applies only to the restricted security actually acquired by the purchaser, and requires that restrictions be "noted conspicuously thereon " or in an initial transaction statement. N.Y.U.C.C. § 8-204 (emphasis supplied); accord id. official uniform cmt. 2; see also Allen v. Biltmore Tissue Corp.,
AFT noted on the face of each of the Stock Purchase certificates that "[t]his stock purchase right is transferable only with the consent of the Company." We need not address on this appeal whether this disclosure of the restrictions applicable to the warrants themselves--as opposed to restrictions applicable to the underlying common stock--was adequate under N.Y.U.C.C. § 8-204 and federal securities laws because the Brass conversion claim is based solely upon "the failure of AFT to provide warrants covering unrestrictеd shares " of AFT common stock, and the district court did not directly decide any other conversion issues. See Brass,
B. Contract Claim
1. Rules of Interpretation. Plaintiffs maintain this case involves two contracts: one between Brass and Dennis Abert to purchase 65,000 warrants, and another between AFT and the holders of the Stock Purchase Rights, now the Brass transferees, to receive unrestricted AFT common stock. They contend AFT breached the second contract. They assert that because the languаge of the Stock Purchase Right is consistent with Brass' claim that he thought he was purchasing warrants for unrestricted shares, which AFT now refuses to issue, a breach of contract has been alleged. The trial court's grant of summary judgment to AFT on this claim was in error, plaintiffs believe, because at best this second contract is ambiguous. See Burger King Corp. v. Horn & Hardart Co.,
Contracts are interpreted under well-settled rules that aid in determining the intent of the parties drawn from the language they chose to use. See Hartford Accident,
Whether an ambiguity exists in a contract is a threshold question of law to be resolved by the court. See Curry Rd. Ltd. v. K Mart Corp.,
2. Rules Applied. Plaintiffs correctly note that the Stock Purchase Rights--the rights representing warrants--constitute a contract between them and AFT. Warrants are simply "a contract by which the corporation gives an irrevocable option to the holder to purchase authorized corporate stock within a period of time at a price and upon terms specified in the contract." Tribble v. J.W. Greer Co.,
We agree that there is nothing said in the contract about restricted or unrestricted common stock. Yet this lack, we think, makes its language not so clear and definite as to be susceptible only to one reasonable reading. The key language is AFT's covenant to reserve from its "authorized and unissued common stock" adequate shares to satisfy the Stock Purchase Rights. In its February 28 opinion, the district court read this phrase аnd concluded that nothing in it "indicates that the stock at issue will be unrestricted and freely transferable." At the same time it seems equally true that nothing in this phrase indicates that the stock will be encumbered. In fact, given the general assumption that securities are free of adverse claims, see N.Y.U.C.C. § 8-204 uniform official cmt. 2, a reasonable person reading this phrase would not know that the stock being purchased, to which this language refers, is restricted.
For that reason we think there is an ambiguity in this phraseology that cannot be resolved without reference to extrinsic evidence. When what the parties intended cannot be "definitely and precisely gleaned" from a reading оf the contract, Seiden Assocs.,
II Motion to Dismiss
We review de novo the grant of AFT's motion to dismiss plaintiffs' fraud claim. See Allen v. WestPoint-Pepperell, Inc.,
A. Duty to Disclose
The basis for dismissal of the instant complaint was its failure to state a claim for either fraudulent misrepresentation or fraudulent concealment with respect to either Brass or his transferees. On appeal plaintiffs do not appear to contend that the district court erred in dismissing the claims of the transferees, nor do they argue that there was any affirmative misrepresentation by AFT to Brass. Rather, they assert that AFT, through its chief executive Jensen, had an affirmative duty to disclose to Brass that the warrants and the underlying stock involved in his transaction with Abert were restricted and that Jensen's silence when he had a duty to speak was tantamount to fraud.
A duty to speak cannot arise simply because two parties may have been on opposite sides of a bargaining table when a deal was struck between them, for under New York law the ancient rule of caveat emptor is still alive and well. See, e.g., Moser v. Spizzirro,
1. Informal Trust Relationship. Brass asserts that Jensen owed him a duty of full disclosure with respect to the warrant transaction because there existed an "informal" relationship of trust between Jensen and him. We previously have observed in looking to New York law that a fiduciary relationship embraces not only those the law has long adopted--such as trustee and beneficiary--but also more informal relationships where it can be readily seen that one party reasonably trusted another. Examples of such informal fiduciary relationships found in the writings of scholarly commentators include priest and parishioner, bank and depositor, majority and minority stockholder, and close friends or family members. See W. Prosser, Handbook of the Law of Torts § 106, at 697 (4th ed. 1971) (citing cases); Restatement (Second) of Torts § 551 cmt. f (1977). Employing this broad definition, we held a fiduciary relationship might well have existed between executives of a subsidiary of WestPoint-Pepperell and the corporate entity. See Allen,
But Brass does not point to and we are unable to find any cases in New York or other jurisdictions that have found an informal relationship of trust in a situation like the one at hand, where a sophisticated prospective investor attends a sales meeting with a herеtofore unknown corporate officer. There is no reason to expand the class of informal fiduciary relationships to include these parties participating in such an arms-length transaction. Hence, Jensen had no informal fiduciary duty towards Brass that would have required him to make full disclosure of the stock restrictions.
2. Superior Knowledge. Plaintiffs next contend that Jensen had a duty to speak because of his superior knowledge with respect to AFT's securities. Superior knowledge standing alone, AFT tells us, imposes no duty to speak; such knowledge must also not have been readily available. See Aaron Ferer,
AFT reads the phrase "readily available" too broadly. In general where a buyer has an opportunity equal to that of a seller to obtain information, such information is "readily available," and the buyer is expected to protect himself in a business transaction. See Restatement, supra, § 551 cmt. k. Yet, in an increasing number of situations, a buyer is not required to conduct investigations to unearth facts and defects that are present, but not manifest. For example, a buyer is not expected to discover that a house is infested with termites, see Prosser, supra, at 698, a prospective investor is not required to uncover that an amusement center offered for sale will produce lower monthly income because it has been raided by the police for illicit activities on the premises, see Restatement, supra, § 551 cmt. 1, illus. 11, and a purchaser of a note from one who is not the maker is not expected to uncover facts showing the worthlessness of the paper on account of its maker's insolvеncy or because it has been paid. See Rothmiller v. Stein,
The case at hand is somewhat unusual, for it does not fit comfortably within the above examples, and the New York courts have not addressed it. In deciding, as we must, whether the state courts would require disclosure, we observe a tendency in New York to apply the rule of "superior knowledge" in an array of contexts in which silence would at one time have escaped criticism. See Minpeco, S.A. v. Conticommodity Servs., Inc.,
Taking the facts alleged in the amended complaint as true, we believe that AFT was duty bound under the superior knowledge rule to disclose to Brass the restrictions on alienability. Jensen, the statutory underwriter selling AFT securities to the public, met with Brass in April 1987 for the sole purpose of enticing him to purchase a substantial quantity of securities. To this end, Jensen emphasized the favorable prospects for film colorizing technology and informed Brass that AFT was selling warrants to purchase common stock that would rise in value. Over the course of the next two years, AFT through Jensen continued this solicitation, forwarding to Brass general literature and specific documentation regarding the warrants that Brass had acquired from Abert. None of these papers disclosed the restrictions on either the Brass warrants or the underlying common stock.
This case can be analogized to Donovan v. Aeolian Co.,
AFT distinguishes its case from Donovan because the piano manufacturer knew the buyer was acting under the belief that the instrument was new, while here plaintiffs have not alleged that AFT was similarly on notice about Brass' ignorance. AFT correctly states that a fraudulent concealment claim based on superior knowledge must allege that the defendant "knew that the plaintiff was acting under a mistaken belief with respect to a material fact." Frigitemp Corp. v. Financial Dynamics Fund, Inc.,
B. Scienter
As the district court stated, a claim of fraudulent concealment must allege not only (1) that the defendant failed to meet its duty to disclose, but also (2) that the defendant had an intent to defraud or scienter, (3) there was reliance on the part of the plaintiff, and (4) damages. See Leasing Serv. Corp. v. Broetje,
AFT argues on this appeal that plaintiffs failed to allege scienter. We have held that "a complaint need only aver intent generally" and that "[t]o satisfy the scienter requirement, a plaintiff need not allege facts which show the defendants had a motive for committing fraud, so long as the plaintiff ... adequately identifies circumstances indicating conscious behavior by the defendants." Cosmаs v. Hassett,
Accordingly, the grant of AFT's motion to dismiss plaintiffs' amended complaint alleging fraud must be reversed with respect to Brass.
CONCLUSION
The judgment of the district court is affirmed with respect to plaintiffs' conversion cause of action, and reversed with respect to plaintiffs' claims of breach of contract and Brass' claim of fraud. The matter is remanded to the district court for further proceedings on those claims in accordance with this opinion.