Smith International, Inc. v. Texas Commerce BankSmith International, Inc. v. Texas Commerce Bank
Fed. Sec. L. Rep. P 93,770,
SMITH INTERNATIONAL, INC., Etc., Plaintiff,
Ajax Magnethermic Corp., Baird Corp., Motion Industries,
Inc., John R. Peterson, Inc., Marvin Howard Peck,
Newage Industries, Inc., and Production
Tool Sales, Inc., Plaintiffs-Appellants,
v.
TEXAS COMMERCE BANK, National Association, et al.,
Defendants-Appellees.
No. 86-2841.
United States Court of Appeals,
Fifth Circuit.
May 18, 1988.
Stephen D. Susman, Barbara Lowe, Susman, Godfrey & McGowan, Houston, Tex., for Baird Corp., Ajax Magnathermic Corp., et al.
Joe M. Kirkham, Wendy Siceloff, Kirkham & Siceloff, Carole R. Riggs, Campbell & Riggs, Houston, Tex., for Marvin Howard Peck.
Douglas S. Johnston, Houston, Tex., for John R. Peterson, Inc.
Van E. McFarland, Houston, Tex., for Production Tool Sales, Inc.
Christopher B. Allen, Liddell, Sapp, Zively, Brown & LaBoon, Houston, Tex., for Texas Commerce Bank.
Michael P. Graham, David P. King, Houston, Tex., for John F. Carter, II, et al.
Appeals from the United States District Court for the Southern District of Texas.
Before THORNBERRY, GARWOOD, and HIGGINBOTHAM, Circuit Judges.
GARWOOD, Circuit Judge:
Plaintiffs-appellants and their attorney appeal the district court's grant of defendants-appellees' motions for sanctions pursuant to
Facts and Proceedings Below
The underlying action consists of consolidated suits by plaintiffs-appellants, who are some of the trade creditors of Tubulars Unlimited (Tubulars), against Tubulars and its president, Tublars' attorneys, Texas Commerce Bank (TCB), which had made Tubulars a construction loan, a TCB officer and certain others, under the Securities Act of 1933, the Securities Exchange Act of 1934, and the Racketeer Influenced and Corrupt Organizations Act (RICO). The district court granted defendants' motion for summary judgment and dismissed the suits. No appeal has been taken from that ruling. Subsequently, the court granted defendants' motion for sanctions, and it is this action which the present appeal challenges.
In July 1981, Tubulars began construction on a pipe threading and heat treating facility in Brookshire, Texas. To finance this construction, Tubulars borrowed over $13,000,000 from defendant-appellee TCB. As part of this transaction, TCB acquired a first lien on all of Tubulars' real and personal property. Defendant-appellee John McGee, one of TCB's vice presidents, was given the task of overseeing this loan.
While the facility was still under construction, plaintiffs sold certain equipment to Tubulars on open account. However, because of the general downturn in the oil industry in early 1982 and the consequent reduction in demand for Tubulars' services, Tubulars was unable to pay these accounts as they became due. In response to Tubulars' rapidly deteriorating financial situation, Tubulars' management developed a four-point financial plan pursuant to which the company's smaller trade creditors (those with claims below $10,000) would be paid in full and its larger trade creditors (those with claims above $10,000) would be offered Tubulars one-year promissory notes. Before attempting to implement this plan, defendant-appellee Robert Donaldson, Tubulars' president, called defendant-appellee John F. Carter, II, an attorney at defendant-appellee Hutcheson & Grundy, to discuss the legal aspects of the plan. Subsequent to this discussion, Donaldson sent Hutcheson & Grundy the draft of a letter that he proposed to send to Tubulars' larger creditors, which another Hutcheson & Grundy attorney reviewed. Donaldson also requested that Hutcheson & Grundy prepare a draft of the promissory note that Tubulars planned to submit to its larger creditors, which a third Hutcheson & Grundy attorney did.
Between July and October 1982, Tubulars offered its one-year, unsecured promissory notes to each of its larger trade creditors in the amount of each creditor's trade debt plus interest at one point above the prevailing prime rate. Hoping that they would help Tubulars regain financial health and thereby recover the amounts they were owed, plaintiffs accepted these notes. Throughout this period, McGee was monitoring Tubulars' financial situation fairly closely, at one point holding weekly breakfast meetings with Tubulars' management. Despite the efforts of Tubulars' management, Tubulars' four-point financial plan did not prove to be a success. As a result, on April 5, 1983, TCB foreclosed on Tubulars' realty and fixtures. Two months later, TCB foreclosed on Tubulars' machinery, equipment, and other personal property.
Because Tubulars had failed to pay its promissory notes, in July 1983, plaintiff-appellant Smith International asked attorney Gerald Burleson to take action to recover on Smith International's $166,000 promissory note. Appellant Burleson talked with someone at Smith International who had knowledge of the transaction involving the promissory note; he also talked with Tubulars' president, Donaldson. On the basis of the information thus acquired, Burleson filed suit on August 9, 1983, on behalf of Smith International against Tubulars, Donaldson, and TCB.
In the spring of 1984, Burleson attended a meeting of Tubulars' creditors at which he met other trade creditors who had not been paid on their one-year Tubulars notes. Following this meeting, some of these creditors (but not including any who were or became parties to this suit) decided to file an involuntary petition against Tubulars under Chapter Seven of the Bankruptcy Code,
Between October 1984 and May 1985, Burleson deposed defendants and conducted other discovery. On June 12, 1985, after discovery had ended, the complaint was amended to add a claim against TCB under RICO,
On October 30, 1985, defendants filed a motion for summary judgment. On May 14, 1986, the district court granted defendants' motion for summary judgment on the grounds that the promissory notes were not securities as a matter of law and the evidence did not support a showing of a pattern of racketeering activity. On June 18, 1986, TCB and McGee filed a motion for sanctions against plaintiffs and Burleson pursuant to
Discussion
We recently gave thorough consideration to
Thomas also teaches that in fixing the character and extent of sanctions district courts are to be guided by "the principle that the sanction imposed should be the least severe sanction adequate to the purpose of
By its terms,
In its May 14, 1986 memorandum and order granting defendants summary judgment, the district court focused almost entirely on a legal and factual analysis supporting its ultimate conclusion "that the promissory notes were not of the required investment character which would enable the Plaintiffs to bring a cause of action under the securities laws." The only other matter addressed in that memorandum was the RICO claim, which the court dealt with merely by saying that "the undisputed facts do not support a showing of a RICO claim. The evidence does not support a showing of a pattern of racketeering activity required pursuant to the statute or the case law. See Sedima v. Imrex Co., [
"The Court expressed concern to Plaintiffs' counsel at the outset of the litigation about the viability of Plaintiff's allegations in their Complaint. At the first pretrial conference in January of 1984, the Court expressed at some length its concern how the Plaintiffs could make a federal securities act allegation out of what appeared to be a straight commercial transaction. The case involved the giving of promissory notes by a company to its trade creditors in acknowledgement of its existing trade debts. Later in the litigation when Mr. Burleson sought leave to amend the Plaintiffs' Complaint to allege a violation of the Racketeer Influenced and Corrupt Organizations Act ('RICO') solely against the Bank, the Court instructed him to consider
"Based upon the facts and the law set forth in the Court's Order dated May 14, 1986 granting Defendants' Motion for Summary Judgment, the Court is of the opinion that the Plaintiffs and Mr. Burleson at the time of the filing of this litigation had no factual or legal support for their position that the promissory notes in question were securities pursuant to the federal securities laws. The applicable law cited in the Order was well established for some time prior to the filing of the litigation."
While the court went on to say that it "is further of the opinion that the Plaintiffs could never have established that they suffered any loss in view of the fact that they exchanged a worthless debt for a worthless promissory note," this was not a ground mentioned in the summary judgment order and the sanctions order does not further elaborate on it. Given its relatively brief mention following the court's explicit reliance on the conclusion that the notes were not securities, and the fact that the court did not expressly indicate that the total worthlessness of the debts at the time the notes were issued should have been known to plaintiffs or their counsel when suit was filed, or at any other particular time thereafter, we are unable to conclude from the court's order that it would have imposed the same sanctions on this ground alone. Moreover, such a brief recitation is simply not sufficient to authorize meaningful review of these rather sizable across-the-board sanctions if they are to rest only on this basis.
With respect to the RICO claim, the district court's sanctions order merely states:
"Finally, late in the litigation, the Plaintiffs amended their Complaint alleging that the Bank had violated the RICO Act. These allegations were made after discovery had occurred which reflected a total absence of evidence to support such allegations. This action by Plaintiffs and Mr. Burleson compounded the injury done by the original filing by injecting the allegation of 'racketeering' into the case."
We are similarly unable to conclude that the district court would have imposed the same sanctions as it did on the basis of the RICO claim alone. To begin with, the RICO claim was only against TCB, and hence would not have justified the sanctions in favor of Hutcheson & Grundy. Moreover, as to TCB, the sanctions awarded were apparently for its full litigation expenses, while the RICO claim was not added until very late in the proceedings below. Further, neither the district court's summary judgment order nor its sanctions order clearly identifies the particular deficiency or deficiencies which the court found in the RICO claim, although the former order refers generally to an absence of evidence of a pattern of racketeering activity. Since the RICO claim relied, in significant part, on alleged securities violations as predicate acts, it may well be that the district court's holding that the notes were not securities and that suit was hence frivolous when instituted, influenced its apparent determination that inclusion of the RICO claim was also a violation of
Accordingly, as we must address the case, the central issue is whether the district court "abused its discretion" in determining that plaintiffs' claim that the notes were securities was sanctionable under
But, of course, this is not the end of the inquiry. Merely because plaintiffs and their counsel were mistaken as to the law does not mean that the mistake was unreasonable.
The question here then becomes whether plaintiffs' legal theory that the notes were securities, though erroneous, can fairly be said to be unreasonable from the point of view both of existing law and of its possible extension, modification, or reversal. We think not.
Plaintiffs in this connection relied primarily on our decision in Securities and Exchange Commission v. Continental Commodities Corp.,
The opinion in Continental Commodities is somewhat unclear as to certain aspects of the operative facts there. The notes are described variously as being "partial reimbursement to customers who held open accounts with Continental" and as a forty percent "return ... of the investors' original investments," with the remaining sixty percent thereof being refunded in cash.
Another aspect of Continental Commodities bears mention. In part II of that opinion, we held that the discretionary accounts for trading in options on commodities futures contracts which Continental maintained were securities. Id. at 520-23. In part III of the opinion, we turned to consider the notes, id. at 523-27, which we had earlier indicated were given to these same customers either for forty percent of their then account balances or of all they invested in this manner through Continental. Id. at 519. These noteholders, then, achieved their status as such by virtue of having been securities investors with Continental. Their relationship with Continental, and its notes, accordingly arose out of their investment in Continental's securities. While, as previously observed, the portion of our opinion there dealing with the notes states that the "recipients accepted the notes with the hope of realizing a greater return on their investments," id. at 527, it nevertheless nowhere either expressly attaches significance to the investment character of the transaction giving rise to the indebtedness represented by the notes or predicates the holding in part III on that in part II.
In the present case, plaintiffs argue that they, like the noteholders in Continental Commodities, accepted Tubulars' promissory notes in the hope of resuscitating the company and that, therefore, the promissory notes they received from Tubulars are securities under the federal securities laws. We disagree, believing that the better reading of Continental Commodities does not extend so far, and that the result there is dependent on the investment nature of the transaction giving rise to the preexisting debt which the notes represented and/or on the creditor's otherwise having an investment interest in the debtor apart from the debtor's unconditional obligation to pay the specified note principal and interest. We have, however, been cited to no decision expressly determining whether or not Continental Commodities is so limited. In the district court's opinion, the distinction between the present case and Continental Commodities was patent. In our view, however, the distinction between the two cases is less apparent. Hence, although we agree with the district court's conclusion that the notes in question were not securities, we do not believe that the reasoning of Continental Commodities was so clear or its facts so plainly inapposite as to prevent a reasonable attorney from contending on the basis of it that the present notes were securities. On the contrary, we view the facts of the two cases as arguably sufficiently similar and the reasoning of Continental Commodities as sufficiently unclear to permit an attorney to make a plausible, though ultimately flawed, argument that Continental Commodities should apply in a case such as this.
Accordingly, although we agree with the district court's resolution of the securities law issue on the merits, we disagree with its determination that the law in this respect was so clear and well fixed that the plaintiffs' legal theory was unreasonable both as a matter of existing law and as a request for its modification or extension. We hold that the district court exceeded the scope of its discretion in determining that the plaintiffs' legal theory that the notes were securities was unreasonable for purposes of
Finally, even if the district court's reasons for awarding sanctions against appellants were both clear and correct, we would nonetheless be forced to remand this order because of the court's failure to apportion this award among the individual appellants.
Conclusion
Because we find the district court's order awarding sanctions against appellants was premised at least in significant part on an erroneous view of the law respecting the reasonableness of plaintiffs' claim that the notes were securities, we vacate the sanctions order and remand the matter of sanctions to the district court for reconsideration in light of this holding. Moreover, as the district court did not have the benefit of our en banc opinion in Thomas, it should reconsider not only whether and in what respect or respects the various plaintiffs (and Burleson) violated
VACATED and REMANDED.
Notes
Until the complaint was amended for the final time, Peck had asserted a section 12(2) claim against defendants
Again, until final amendment of the complaint, Peck had asserted a claim under section 10(b) and Rule 10b-5
We observe again, as we have before, that "abuse of discretion" is a phrase which "sounds worse than it really is." See, e.g., United States v. Walker,
See, e.g., Bellah v. First National Bank,
While both the Securities Exchange Act of 1934, 15 U.S.C. Sec. 78c(a)(10), and the Securities Act of 1933, 15 U.S.C. Sec. 77b(1), define a security as including "any note," it is nevertheless well settled that these definitional sections are not read literally because "Congress intended the application of these statutes to turn on the economic realities underlying a transaction, and not on the name appended thereto," United Housing Foundation, Inc. v. Forman,
Given the foregoing decisions, it is simply too late in the day to successfully contend that the literal statutory definitions of themselves mean that it can always be reasonably argued that any note (or any for more than nine months) is a security no matter what the circumstances.
We recognize that
We do not pass on the other points raised by appellants, and we leave to the district court in the first instance to determine on remand whether there were (except as we have herein held otherwise) any