source: Caselaw Access Project

author: KRAM, District Judge.

license: Public Domain

text:
    HANSON TRUST PLC, HSCM Industries Inc., Hanson Holdings Netherlands B.V., and HMAC Investments Inc. directly on behalf of themselves as shareholders of SCM Corporation, and derivatively on behalf of SCM Corporation, Plaintiffs, v. SCM CORPORATION, Paul H. Elicker, D. George Harris, Robert O. Bass, Robert B. Bauman, John T. Booth, George E. Hall, Crocker Nevin, Charles W. Parry, Thomas G. Pownall, E. Everett Smith, David W. Wallace, Richard R. West, Manufacturers Hanover Trust Company, ML SCM Acquisition Inc., ML L.B.O. Holdings Inc., Merrill Lynch Capital Markets, Merrill Lynch & Co., Inc. and Merrill Lynch, Pierce, Fenner & Smith, Incorporated, Defendants.
    Nos. 85 Civ. 7433 (SWK), 85 Civ. 7971 (SWK) and 85 Civ. 8095 (SWK).
    United States District Court, S.D. New York.
    Nov. 26, 1985.

      Weil Gotschal & Manges, Shea & Gould, New York City by Dennis J. Block, Milton Gould, for plaintiffs.
    Wachtell Lipton Rosen & Katz, Shearson & Sterling, New York City by Bernard W. Nussbaum, Jeremy G. Epstein, for defendants.
   MEMORANDUM OPINION AND ORDER

KRAM, District Judge.

I. Introduction

This is a case in which each of the relevant actors asserts that it is truly concerned with furthering the interests of a takeover target’s shareholders. The hostile tender offeror argues that it is concerned with giving the target’s shareholders the highest price for their equity. The “white-knight” argues that it has secured, for its own benefit, a lock-up option for two of the target’s most valuable divisions in order to create additional value for the target’s shareholders. For their part, the senior members of the target’s management, some of whom may be equity participants in the surviving entity of a leveraged buy-out transaction, argue that they were also concerned with securing the greatest value for the target’s shareholders. Similarly, the financial and legal advisors on all sides, who have already received or will receive substantial fees, assert that they too acted to secure the highest value for the target’s shareholders. Finally, members of the target’s board of directors, who authorized the payment of enormous fees and granted certain lock-up options, assert that they acted to secure the highest possible price for the target’s shareholders. Apparently, the target’s shareholders disagree with at least some of the foregoing. Some would consider this scenario to be the free market place and the forces of competition operating at their best; others take serious issue with this state of affairs.

The current state of affairs, and the appropriate role for this Court to play in the instant drama, was recently aptly summarized by the Second Circuit, which stated:

Contests for corporate control have become ever more frequent phenomena on the American business scene. Waged with the intensity of military campaigns and the weaponry of seemingly bottomless bankrolls, these battles determine the destinies of large and small corporations alike. Elaborate strategies and ingenious tactics have been developed both to facilitate takeover attempts and to defend against them. Skirmishes are fought in company boardrooms, in shareholders’ meetings, and with increasing regularity, in the courts.
The efforts of targeted management to resist acquisitive moves, and the means they employ, have been alternatively praised and damned. Proponents of corporate “free trade” argue that defensive techniques permit managers to entrench themselves and thus avoid accountability for their performance, at the expense of shareholders who are denied the opportunity to maximize their investment in sought-after corporations. Opponents contend that takeover struggles squander enormous capital resources which could better be spent to improve industrial productivity and to develop and commercialize new technologies.
When these battles for corporate dominance spawn legal controversies, the judicial role is neither to displace the judgment of the participants nor to predetermine the outcome. Rather, the responsibility of the court is to insure that rules designed to safeguard the fairness of the takeover process be enforced. Our most important duty is to protect the fundamental structure of corporate governance. While the day-to-day affairs of a company are to be managed by its officers under the supervision of directors, decisions affecting a corporation’s ultimate destiny are for the shareholders to make in accordance with democratic procedures.

Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 258 (2d Cir.1984) (footnotes omitted).

Amid the unfolding drama outlined above, plaintiffs in the instant consolidated actions seek a preliminary injunction pursuant to Fed.R.Civ.P. 65(a). The following constitutes the Court’s findings of fact and conclusions of law.

II. Findings of Fact

A. The Actors

Hanson Trust PLC is a corporation organized under the laws of the United Kingdom. HSCM Industries Inc. is a Delaware corporation and an indirect wholly owned subsidiary of Hanson Trust PLC. Hanson Holdings Netherland, B.V. is a limited liability company incorporated under the laws of the Kingdom of the Netherlands, and is an indirect wholly owned subsidiary of Hanson Trust PLC. HMAC Investments Inc. is also a Delaware corporation and is a wholly owned subsidiary of Hanson Trust PLC. Hanson Trust PLC, HSCM Industries Inc., Hanson Holdings Netherlands B.V. and HMAC Investments Inc. (hereinafter collectively referred to as “Hanson”) are the plaintiffs in three separate actions which have been consolidated for the purposes of the instant preliminary injunction motion.

Hanson filed its initial complaint on September 20, 1985. That complaint named SCM Corporation (“SCM”) and its twelve directors as defendants. Subsequently, Hanson commenced a second action against Manufacturers Hanover Trust Company (“Manufacturers Hanover”). Manufacturers Hanover is the escrow agent for certain agreements to which SCM is a party. Hanson commenced a third action against various entities which are all related to Merrill Lynch, Pierce, Fenner & Smith Incorporated in some manner. These entities are hereinafter collectively referred to as “Merrill Lynch”. The Prudential Insurance Company of America was Merrill Lynch’s partner in the LBO offers made to SCM, and in certain “lock-up” options granted to Merrill Lynch.

In its initial complaint, Hanson alleged that SCM and its twelve directors had committed several violations of the federal securities laws, and that the directors had breached their fiduciary duties to SCM and SCM shareholders. This complaint also alleged that the SCM directors had committed a “waste” of corporate assets. In addition, the complaint alleged violations of N.Y.Bus.Corp.Law §§ 717, 720 and 909. Hanson alleges that Merrill Lynch aided and abetted SCM and its directors in the foregoing violations of law, and that Merrill Lynch conspired with SCM and its directors to commit the foregoing violations. As for Manufacturers Hanover, Hanson seeks to enjoin it from executing various allegedly unlawful escrow agreements for which it is the escrow agent.

B. The Competing Offers

The instant dispute arises out of a battle for control of SCM between Hanson and Merrill Lynch. On August 21, 1985, Hanson announced that it would commence an all cash tender offer for any and all shares of SCM’s common stock. This offer was for any and all shares of SCM’s common stock at a price of $60.00 per share.

On September 3, 1985, the SCM Board of Directors and Merrill Lynch reached a merger agreement. This agreement provided for Merrill Lynch to acquire SCM through a leveraged buy-out (“LBO”) transaction. This agreement provided, inter alia, that Merrill Lynch would make a cash tender offer for up to 85.7 percent (10,500,000 shares) of SCM’s common stock at a price of $70.00 per share. This tender offer would be followed by a merger in which each share of the remaining 14.3 percent of SCM’s common stock would be exchanged for a high risk, high yield “junk bond” valued at $70.00. This agreement provided for the payment of certain fees to Merrill Lynch and also contemplated participation by some members of SCM’s management in the surviving LBO company. The current SCM management could ultimately own up to 15 percent of the surviving LBO company. This agreement was contingent upon Merrill Lynch acquiring at least 66% percent (8,254,000 shares) of SCM’s common stock through the tender offer. The SCM board recommended to the shareholders that they accept this offer.

In response to this agreement, Hanson announced, on September 3, 1985, that it would raise the price of its tender offer to $72.00 per share. This $72.00 offer was an all cash offer for any and all shares of SCM’s common stock. The $72.00 offer was contingent upon SCM not granting any “lock-up” options to any other party. Neither Hanson’s $60.00 offer nor its $72.00 offer were conditioned on a minimum number of shares being tendered.

In response to Hanson’s $72.00 offer, Merrill Lynch made a new offer to SCM. This offer, which was unanimously accepted and approved by nine of SCM’s directors (three directors abstained) on September 10, 1985, was also an LBO in which SCM management would participate on the same terms as in the $70.00 LBO offer. Merrill Lynch would commence a cash tender offer for up to 80 percent of SCM’s common stock at a cash price of $74.00 per share. This would be followed by a merger in-which each remaining share of SCM’s common stock would be exchanged for a high risk, high yield “junk bond” valued at $74.00. This tender offer was also contingent on Merrill Lynch acquiring a minimum of 8,254,000 shares of SCM’s common stock. This figure represents 66% percent of SCM’s common stock on a fully diluted basis. The SCM board recommended to the shareholders that they accept this offer. This agreement also granted to Merrill Lynch certain lock-up options. The options permitted Merrill Lynch to purchase SCM’s pigments business at a price of $350,000,-000.00 and SCM’s Durkee Famous Foods business (also known as the consumer foods business) at a price of $80,000,000.00 if a certain triggering event occurred. The right to exercise the option would be triggered if any person or group, other than Merrill Lynch, acquired more than one-third of SCM’s common stock.

In response to this agreement Hanson announced, on October 8, 1985, that it would increase its tender offer to $75.00, all cash, for any and all shares of SCM’s common stock. This offer was not contingent upon the tender of a minimum number of shares, but was contingent upon the termination or injunction of the lock-up options granted to Merrill Lynch.

On October 10, 1985, the SCM Board of Directors approved an exchange offer or “self-tender” offer. This offer provides that each share of SCM common stock could be exchanged for $10.00 in cash and one share of a new series of SCM preferred stock with an effective stated value of $64.00. This offer is for up to two-thirds, or 8,254,000 shares, of SCM’s common stock, and is not conditioned on the tender of a minimum number of shares. It is undisputed, and the Court so finds, that this offer was made in an attempt to protect SCM shareholders in the event that neither Merrill Lynch’s $74.00 tender offer nor Hanson’s $75.00 tender offer is successful.

C. Additional Findings of Fact

SCM’s Board of Directors (hereinafter referred to as “the board”) consists of twelve members. Three members of the board, Messrs. Elicker, Hall, and Harris, are also senior members of SCM’s management. Elicker is the chairman of the board and SCM’s chief executive officer. Harris is SCM’s president and chief operating officer. Hall is a senior vice president of SCM. The remaining nine members of SCM’s board are independent directors. None of them hold a position in SCM’s management and none own significant amounts of SCM common stock. Moreover, these nine directors receive no remuneration from SCM other than standard director’s fees, and none of these nine directors, including Mr. West, are affiliated with any entity which does business with SCM. Mr. West’s position as an independent director for certain mutual funds managed by Merrill Lynch did not present any conflict of interest for him in his position as an SCM director. These nine directors, Messrs. Booth, Nevin, West, Bass, Bauman, Parry, Pownall, Smith and Wallace, are hereinafter collectively referred to as the “outside” or “independent” directors.

Wachtell, Lipton, Rosen & Katz (“Wachtell Lipton”) served as the legal advisor to SCM and the SCM board. Goldman Sachs, an investment banking firm, served as the financial advisor to SCM and the SCM board. Both Wachtell Lipton and Goldman Sachs had previously represented SCM. SCM’s board approved of Wachtell Lipton and Goldman Sachs as its advisors in the present matter at a board meeting held on August 25, 1985. At all relevant times during the events of the instant battle for control of SCM, Wachtell Lipton and Goldman Sachs represented SCM and the SCM board. Wachtell Lipton and Goldman Sachs did not represent SCM’s management in any manner during the relevant time of this dispute.

Neither the nine independent directors nor Wachtell Lipton and Goldman Sachs were dominated or improperly influenced by SCM’s management. Likewise, none of the independent directors had any conflict of interest with their fiduciary obligations during any of the relevant negotiations or in any of the approved merger agreements with Merrill Lynch. The same is true for Wachtell Lipton and Goldman Sachs.

Martin Lipton of Wachtell Lipton advised SCM’s board about the business judgment rule and a director's fiduciary obligations at the August 25, 1985 board meeting. Moreover, Wachtell Lipton and Goldman Sachs advised the SCM board extensively from August 25, 1985 to the present. This advice included presentations made at SCM board meetings which were held on August 25, August 30, September 3 and September 10, 1985. Each of these meetings was attended by all twelve board members except for the September 3 meeting. Two independent directors were not present and did not participate in this meeting.

The nine independent directors relied, at least in part, on the advice of Wachtell Lipton and Goldman Sachs throughout this contest for control of SCM. The independent directors also relied on their financial and legal advisors to negotiate with Merrill Lynch. Each of the nine independent directors had extensive business experience as well as a thorough working knowledge of SCM, its operations and its financial condition.

At the August 25 board meeting, the directors concluded that Hanson’s $60.00 price was inadequate and resolved to find a superior alternative. The board, Wachtell Lipton, and Goldman Sachs agreed on a strategy which involved seeking either a “white knight” to make a competing, but superior tender offer, or to find a superior leveraged buy-out offer. The board, Wachtell Lipton, and Goldman Sachs also agreed on a strategy which involved refraining from any direct negotiations with Hanson. The board decided on this strategy so that potential superior competing bids would not be “scared off.” At all times the independent directors acted with a motivation to secure offers for SCM which would be superior to Hanson’s offers. The independent directors at no time acted to “entrench” either themselves or SCM’s management.

After the August 25 meeting, Goldman Sachs attempted to find a “white knight” and/or an LBO group. The only concrete offer Goldman Sachs was able to generate was the $70.00 Merrill Lynch offer.

Goldman Sachs’ efforts on behalf of SCM led to the $70.00 Merrill Lynch LBO merger agreement. This agreement was unanimously authorized by SCM’s independent directors on August 30 and unanimously approved by the seven independent directors who were present at the September 3 meeting. See footnote 6. The three management directors did not participate either in authorizing or approving the $70.00 LBO merger agreement. The management directors were absent during the portion of the meeting when the independent directors approved the $70.00 LBO. Moreover, in negotiating the $70.00 LBO, the board’s advisors, Goldman Sachs and Wachtell Lipton, specifically refused to grant to Merrill Lynch any lock-up options for assets or SCM common stock.

The result of the $70.00 offer was Hanson’s $72.00 offer. Hanson’s $72.00 offer would not have been forthcoming without the Merrill Lynch $70.00 offer.

After Hanson’s $72.00 offer, Wachtell Lipton and Goldman Sachs resumed negotiations on behalf of SCM with Merrill Lynch. The board, Goldman Sachs and Wachtell Lipton continued their strategy of not negotiating directly with Hanson. They did not want to “scare off” a superior competing offer by creating the appearance of using Merrill Lynch as a “stalking horse.”

On September 10, 1985, the nine independent directors unanimously approved a $74.00 LBO merger agreement with Merrill Lynch. The independent directors also approved lock-up options which granted to Merrill Lynch the right to purchase SCM’s pigments and consumer foods businesses. SCM’s pigments business was a “core business” for SCM. These two businesses had previously generated approximately 50 percent of SCM’s earnings.

In approving the $74.00 LBO and granting the lock-up options the independent directors relied, in part, on the advice of Wachtell Lipton and Goldman Sachs. They also relied on their own business experience and their knowledge of SCM’s operations and financial condition. The $74.00 LBO, the lock-up options and the price of the optioned assets were the result of arm’s length negotiations between Goldman Sachs and Merrill Lynch. Moreover, on September 10, Goldman Sachs, Wachtell Lipton, and Merrill Lynch each advised the independent directors that Merrill Lynch would not offer the $74.00 LBO without the lock-up options. Goldman Sachs further advised the independent directors that the prices for the optioned assets were “fair” and that a higher price might be secured if there was more time to seek other buyers for these two assets. Goldman Sachs did not define the range of fair values for the optioned assets, nor did it offer a fair value or range of fair values for SCM as a whole.

The independent directors approved the lock-up options even though there was no consideration for these options other than the potential additional value the $74.00 LBO offer created for SCM’s shareholders. They approved the lock-up options after concluding that they could not secure the $74.00 LBO offer without the options.

There has been a considerable dispute among the parties as to whether the trigger event for the lock-up options has been met. First, the Court concludes that this is an issue which it must resolve before it can decide Hanson’s preliminary injunction motion. Second, the Court concludes, based on the entire record before it, that the options are triggered when a party or group, other than Merrill Lynch, acquires more than one-third of SCM’s outstanding common stock. That is, the options are triggered on a primary basis, and not on a fully-diluted basis as Hanson contends. Thus, Hanson triggered the options as a result of purchases of SCM stock which it completed on September 11, 1985. The language of the asset-option agreement supports this conclusion. Moreover, all of the witnesses from SCM, Merrill Lynch and Goldman Sachs testified to that effect. Hanson has simply failed to adduce sufficient credible proof to refute this conclusion. Thus, because of Hanson’s failure to adduce sufficient credible proof on this issue the Court is constrained to conclude, on the basis of the record before it, that the lock-up options are triggered when any party or group (other than Merrill Lynch) acquires more than one-third of SCM’s outstanding common stock. Accordingly, the trigger condition has been satisfied.

The Court also concludes that Hanson’s $75.00 offer would not have been forthcoming without Merrill Lynch’s $74.00 offer. Moreover, in approving the $74.00 LBO and the lock-up options, the independent directors were aware that they would no longer continue to serve on SCM’s board, regardless of who prevailed in the contest between Hanson and Merrill Lynch. They were also aware that they would have no role in the optioned businesses if Merrill Lynch successfully purchased them pursuant to the lock-up agreement. The independent directors were aware that some members of SCM’s management would participate in the LBO company which would emerge if Merrill Lynch’s $74.00 offer was successful. The independent directors were also aware that members of SCM’s management would be invited to participate in the LBO company as equity holders. There is no evidence, however, to suggest that the independent directors approved the $74.00 LBO offer in order to entrench SCM’s management, nor indeed even to secure management’s participation in the LBO. The independent directors approved the $74.00 offer and the lock-up options in an attempt to secure additional value for SCM shareholders.

The record also demonstrates, however, that the independent directors did not give extensive consideration to whether, as of September 10, 1985, any party had already triggered the lock-up options. Nor did the independent directors extensively scrutinize whether the additional value created by. the $74.00 LBO offer justified granting the lock-up options with the possible result that, if exercised, SCM would be a company without two of its most significant businesses. The independent directors apparently concluded that the $74.00 offer created additional value which justified the risks concomitant with the lock-up options, including the risk of not knowing how close to the trigger event Hanson or any other third party was. As the Court will explain in its conclusions of law, the current state of the law apparently permits the directors to do this and precludes this Court from second-guessing or modifying their conduct.

In conclusion, the Court finds that prior to Hanson’s $60.00 offer Elicker had discussions with parties other than Merrill Lynch about a possible leveraged buy-out of SCM in which Elicker and other members of SCM management might participate as equity holders. This fact, however, in no way affected the independent directors’ decision to approve the $74.00 LBO offer and grant the lock-up options. The Court also concludes that in granting the lock-up options the independent directors knew or should have known that the bidding for SCM would come to an end. Hanson, the only other interested bidder, had specifically conditioned its $72.00 offer on no lock-up options being granted. It was highly unlikely, therefore, that Hanson would top the $74.00 offer without the same condition. The foregoing constitutes this Court’s findings of fact.

III. Conclusions of Law

The following constitutes the Court’s conclusions of law. Hanson seeks a preliminary injunction to prevent the defendants from executing certain lock-up option agreements. Specifically, Hanson seeks to prevent Merrill Lynch from acquiring SCM’s pigments and consumer foods businesses through the asset-option (lock-up option) agreement. Hanson seeks this relief in its dual role as an SCM shareholder and as a competing tender offeror seeking to acquire control of SCM.

In order to obtain a preliminary injunction Hanson must meet the following standard:

Preliminary injunctive relief in this Circuit calls for a showing of “(a) irreparable harm and (b) either (1) likelihood of success on the merits or (2) sufficiently serious questions going to the merits to make them a fair ground for litigation and a balance of hardships tipping decidedly toward the party requesting the preliminary relief.”

Jack Kahn Music Co. v. Baldwin Piano & Organ Co., 604 F.2d 755, 758 (2d Cir.1979) (citations omitted). The Second Circuit has recently reaffirmed the extraordinary and drastic nature of this remedy, particularly in the context of a takeover battle. The Court noted:

... the preliminary injunction, which is one of the most drastic tools in the arsenal of judicial remedies, Medical Soc. of State of N.Y. v. Toia, 560 F.2d 535, 537 (2d Cir.1977) (“an extraordinary and drastic remedy which should not be routinely granted”), must be used with great care, lest the forces of the free market place, which in the end should determine the merits of takeover disputes, are nullified.

Hanson Trust PLC v. SCM Corp., 774 F.2d 47, 60 (2d Cir.1985), petition for reh’g en banc filed, (2d Cir. October 11, 1985) (No. 85-7745).

In order to obtain a preliminary injunction, Hanson must demonstrate either a likelihood of success on the merits or a sufficiently serious question going to the merits and a balance of hardships tipping decidedly in its favor on at least one of the many claims in its complaint. For the reasons which follow, the Court concludes that Hanson has failed to make the required showing.

In order to obtain the injunction it seeks, Hanson must demonstrate a likelihood of success on the merits or the existence of a sufficiently serious question going to the merits of its claim that SCM’s board breached its fiduciary duty to SCM and SCM shareholders by entering into the lock-up option agreement. A careful review of the current state of the law in this area compels the conclusion that Hanson has failed to make the requisite showing under either prong of the preliminary injunction standard.

The Second Circuit recently explained a board member’s obligations as follows:

A board member’s obligation to a corporation and its shareholders has two prongs, generally characterized as the duty of care and the duty of loyalty. The duty of care refers to the responsibility of a corporate fiduciary to exercise, in the performance of his tasks, the care that a reasonably prudent person in a similar position would use under similar circumstances. See NYBCL § 717. In evaluating a manager’s compliance with the duty of care, New York courts adhere to the business judgment rule, which “bars judicial inquiry into actions of corporate directors taken in good faith and in the exercise of honest judgment in the lawful and legitimate furtherance of corporate purposes.”
The second restriction traditionally imposed, the duty of loyalty, derives from the prohibition against self-dealing that inheres in the fiduciary relationship. Once a prima facie showing is made that directors have a self-interest in a particular corporate transaction, the burden shifts to them to demonstrate that the transaction is fair and serves the best interests of the corporation and its shareholders. See NYBCL § 713(a)(3).

Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 264 (2d Cir.1984) (citations omitted).

The Court also observed that the business judgment rule gives directors wide latitude to resist unfriendly advances and applies unless the directors are shown to have acted out of self-interest in some manner. Norlin at 264-265. Even where the business judgment rule applies, however, the board is required “to analyze carefully any perceived threat to the corporation, and to act appropriately when it decides that the interests of the company and its shareholders might be jeopardized.” Id. at 266. When the actions of SCM’s directors in granting the lock-up options are measured against the foregoing, it is clear that Hanson is not entitled to the injunction it seeks.

The Court’s findings of fact indicate that the nine independent directors did not grant the lock-up options (or indeed take any action) out of self-interest, or bad faith, or fraud, or for any other improper purpose (such as attempting to entrench themselves or SCM’s management in control). The three management directors did not vote on, and did not unduly influence the remaining directors in approving, either the Merrill Lynch $70.00 offer or the $74.00 offer and the lock-up options. The independent directors were precisely that: independent. They had no position in SCM’s management, they did not own significant amounts of SCM stock,- they received no significant remuneration from SCM and they had no other meaningful business contact with SCM. Moreover, the independent directors did not act to perpetuate their positions on the SCM board, nor did they attempt to perpetuate the position of current SCM management. Thus, there has been no showing that the independent directors breached their duty of loyalty to SCM and its shareholders in any manner. Accordingly, the burden of proof to prove the fairness of the challenged transactions has not shifted to the SCM board.

Similarly, there has been no showing that the board breached its duty of care. The board retained financial and legal advisors. Those' advisors served the SCM board and did not act on behalf of SCM’s management. There has been no showing of any impropriety in the relationship between the board and its financial and legal advisors, nor has there been any showing that the independent directors acted improperly in relying upon the advice of Goldman Sachs and Wachtell Lipton. In short, the nine disinterested directors exercised independent judgment. They were entitled to engage these advisors and to rely upon the advice of their independent legal and financial advisors. See Treadway Companies, Inc. v. Care Corp., 638 F.2d 357, 384 (2d Cir.1980).

The independent directors granted the lock-up option to secure a $74.00 offer from Merrill Lynch. Thus, the option was granted to secure additional value for the SCM shareholders. This was entirely consistent with the directors’ duty of care, even if the lock-up option served to end the bidding for SCM. The granting of the option was not motivated by a desire on the part of the independent directors to end the bidding for SCM. Hanson’s $75.00 offer would not have been forthcoming without the $74.00 offer. The independent directors were advised by Merrill Lynch, Wachtell Lipton, and Goldman Sachs that they could not obtain the $74.00 offer without the lock-up option. Moreover, the board had previously refused to grant lock-up options in securing the Merrill Lynch $70.00 offer. This supports the conclusion that the board did not act out of a desire to end the bidding for SCM.

Granting lock-up options is not a per se violation of a board’s fiduciary obligation. See Buffalo Forge Co. v. Ogden Corp., 717 F.2d 757 (2d Cir.), cert. denied, 464 U.S. 1018, 104 S.Ct. 550, 78 L.Ed.2d 724 (1983). Indeed, all of the factors found to exist by the district court in that case exist in the instant case as well. See Id. at 759. Moreover, the Second Circuit noted:

... it would have been a mistake for the district court to substitute its judgment for the business judgment of the directors, the exercise of which brought about an increase in Ampco’s tender offer from $25.00 a share to $37.50 a share.

Id. (citations omitted). See also CrouseHinds Co. v. Internorth, Inc., 634 F.2d 690, 701-702 (2d Cir.1980). The foregoing applies with equal vigor to the instant case.

In its moving papers, and at the evidentiary hearing, Hanson attempted to challenge the lock-up option, in part, on the ground that the option prices were far below the fair value of the optioned assets. Indeed, the Court heard extensive, albeit conflicting testimony on this point. Questions involving valuation of particular segments of large companies are precisely the type of questions into which the business judgment rule is designed to preclude courts from inquiring. Courts cannot become mired in valuation issues and should not second-guess directors’ decisions on such issues absent a strong showing that the directors’ somehow breached their fiduciary duties.

No such showing has been made in the instant case. The board’s financial advisors indicated that the asset prices were fair. Goldman Sachs informed the board that no pigments business had ever been sold for a price in excess of $1,000.00 per ton of capacity. Goldman Sachs also discussed the price-earnings ratio for the consumer foods business. Goldman Sachs discussed the book-value of these assets and the earnings of these divisions. Moreover, Goldman Sachs stated that a higher price could possibly be obtained for them if more time existed to seek alternative buyers. Goldman Sachs negotiated in good faith and at arm’s length with Merrill Lynch over the asset prices and whether a lock-up should even be granted. In view of the current state of the law, the Court sees no basis upon which it can or should second-guess the independent business judgment of the independent directors on this point.

Hanson further argues that the board hastily gave away the two optioned assets. This argument ignores the realities of a heated takeover battle. The directors did not have the luxury of unlimited time; unlimited time either to consider the Merrill Lynch $74.00 offer or to find an alternative buyer for the two optioned assets. See Joy v. North., 692 F.2d 880, 886 (2d Cir.1982), cert. denied, 460 U.S. 1051, 103 S.Ct. 1498, 75 L.Ed.2d 930 (1983) (... business imperatives often call for quick decisions).

Hanson also argues that Merrill Lynch and The Prudential Insurance Company of America (“Prudential”) “stole” these assets, and “stole” them for nothing. This argument is flawed in two respects. Whether Merrill Lynch thought it was making a profitable deal is irrelevant in determining whether SCM’s board acted improperly. Moreover, neither Merrill Lynch nor Prudential owe a fiduciary duty to SCM and its shareholders.

Hanson challenges SCM’s decision not to negotiate directly with it. The directors were entitled to utilize this strategy particularly where there was concern about “scaring off” superior competing bids.

In view of the foregoing, the Court concludes that Hanson has failed to show a likelihood of success on the merits or a sufficiently serious question going to the merits of its claim that the SCM board breached its fiduciary obligation. This conclusion is by no means intended to convey the impression that this Court condones or approves of the actions taken by SCM’s board in granting the lock-up options. Rather, the Court simply concludes that the business judgment rule insulates the directors’ actions from intrusion by this Court. There are several aspects of the independent directors’ actions which trouble the Court, but these actions do not rise to the level of a breach of the board’s fiduciary obligation as the law currently defines it.

The board appears to have given little or no consideration to whether the trigger event for the lock-up option was already satisfied when the option was granted, or how quickly thereafter it might be satisfied. As it turns out, Hanson triggered the lock-up option on September 11, 1985—one day after it was granted. Similarly, the board appears not to have carefully and closely scrutinized the actual superiority of the $74.00 offer (which involved a cash purchase for up to 80 percent of SCM’s common stock with the remaining 20 percent being exchanged for “junk bonds”), particularly when coupled with the risk that if the option was triggered and exercised, SCM would be a company without two of its most valuable divisions. The board also failed to read and review carefully Merrill Lynch’s offers, Hanson’s various offers, and the lock-up option agreement. They relied instead primarily on their advisors’ description of the terms of these agreements and offers. Finally, the board accepted Goldman Sachs’ conclusion that the prices of the optioned assets were fair without ever inquiring about the range of fair values. The foregoing is not condoned by this Court. Rather, based on the record before this Court and the current state of the law, these actions do not rise to the level of a breach of the fiduciary obligation owed to SCM and its shareholders by the board.

Hanson also challenges the payment of certain fees to Merrill Lynch. Of particular concern to Hanson is the so-called $9,000,000.00 “good-bye” or “break-up” fee and the $6,000,000.00 “hello-again fee.” Such fees are not unusual in transactions of this type. See MacAndrews & Forbes Holdings, Inc. v. Revlon, Inc., 501 A.2d 1239 (Del. Ch.1985), aff'd, Revlon, Inc. v. MacAndrews & Forbes Holdings, Inc., No. 353 & 354, 1985, slip op. (Del. November 1, 1985) (hereinafter cited as “Revlon”).

Hanson attempts to rely on Revlon to support its position in the instant case. Revlon is distinguishable in several significant respects, however. First, the Revlon board was not disinterested. It was composed of 14 members, six of whom held “prominent positions in Revlon’s management”, two of whom held significant blocks of Revlon’s stock, with most of the remaining non-management directors having an association with entities which did business with Revlon. Id. at 1243, n. 2. Second, in Revlon the hostile tender offeror (Pantry Pride, Inc.) had clearly stated that it intended to top every offer which the “white knight” (Forstmann Little & Co.) would make. Id. at 1245-1246. Third, the Court in Revlon noted that the price for the optioned asset was $75,000,000.00 below the lowest fair value placed upon it by Revlon’s own investment banker (Goldman Sachs). Id. at 1249. Finally, the court concluded that the Revlon board acted to protect the interests of Revlon’s note or debtholders instead of the shareholders. Id. at 1249-1250. Thus, Revlon is significantly distinguishable to render it inapplicable to the instant case.

IV. Conclusion

Based on the foregoing' findings of fact and conclusions of law Hanson’s motion for a preliminary injunction is denied. Hanson has challenged, albeit unsuccessfully, the phenomena of the management leveraged buy-out, “crown jewel” lock-up options, and a transaction where both are combined in an attempt to defeat a hostile tender offer. The current state of the law relating to a board’s fiduciary obligation and the transfer of corporate control, however, permits a management leveraged buy-out as well as an LBO where management is an equity participant although not the dominant equity participant. This type of transaction poses serious questions about management’s conflicting interests and the protection of the shareholders’ interests. Hanson raised those questions in the instant case, but ultimately failed to adduce sufficient credible proof on those questions.

Similarly, the use of lock-up options poses problematic questions. Nonetheless, they are not per se improper, have frequently been utilized, and have been upheld by courts.

In the instant ease, both phenomena were present. To date, this has not occurred frequently. The problematic questions which are posed by a lock-up option standing alone, or by an LBO in which members of management are or may be significant equity participants standing alone, are infused with a synergistic quality when these two phenomena are combined in a single transaction. In the instant case, Hanson simply failed to produce sufficient credible evidence to prove the existence of the dangers potentially inherent in such a transaction. In view of this failure of proof, this Court is unable to issue the injunction Hanson seeks. The current state of the New York Business Corporation Law permits the type of conduct present in the instant case. The federal courts may not modify this law. That is a matter for the New York Legislature and the New York Court of Appeals.

A group of learned commentators recently correctly summarized the current state of the business judgment rule as follows:

In sum, while the reasoning in the cases to date has not been consistent, one important theme seems to be a judicial willingness to uphold reasonable defensive measures which are part of a viable business strategy and which are likely to facilitate a favorable result for shareholders. Courts seem to struggle —and, where appropriate, have not hestiated [sic] to overturn transactions—in circumstances where defensive strategies do not further such a result and/or alter the basic decision-making structure between management and shareholders. Thus, the business judgment rule, though strained by the unique facts and circumstances arising from the exigencies of hostile takeovers, remains the flexible doctrine required by the courts to protect the good faith conduct of directors.

Block, Barton and Radin, Business Judgment Rule Changes, New York Law Journal, May 28, 1985, at 25, 31. The instant case is one in which reasonable measures were deployed as part of a viable business strategy, as the law currently defines those terms. Hanson failed to adduce sufficient credible proof to the contrary. Accordingly, its motion for a preliminary injunction is denied.

SO ORDERED.

      . An SCM shareholder has commenced a shareholder’s derivative suit. That suit, Weiss v. SCM, No. 85 Civ. 7569, is currently pending before Judge Keenan of this Court.

      . The parties to the instant actions have, in effect, stipulated to maintain the status quo while the Court considered plaintiff's preliminary injunction motion. They have also stipulated to maintain the status quo in all respects for a period of time beyond the date of this opinion so that the unsuccessful litigant can seek relief in the Court of Appeals.

      . The Court's findings of fact and conclusions of law are based upon an evidentiary hearing which continued for eight days, as well as the exhibits submitted by the parties and their moving papers. The parties have been given great latitude to present their positions with supporting material to the Court.

      . As the caption of this opinion reflects, the three actions have been consolidated for pre-trial purposes and for purposes of this preliminary injunction motion.

      . This is the initial complaint in the instant three consolidated actions. This Court currently has two additional (earlier filed) actions arising from this takeover battle: Hanson v. SCM, 85 Civ. 6632 (SWK) and Hanson v. SCM, 85 Civ. 6667 (SWK). The latter two actions are not before the Court in the context of the instant preliminary injunction motion.

      . One of the independent directors, Mr. Nevin, was engaged in a sailing trip. Tr. at 550. When first questioned, Nevin could not recall whether he was at the September 3 meeting. Upon reflection, he was able to recall that he was sailing on September 3. Id.

      . These findings of fact are based in large part on the testimony which the Court heard during eight days of hearings. During this time the Court had an opportunity to view and assess the credibility and demeanor of all of the witnesses who testified.

      . Hanson also challenges the payment of a $9,000,000.00 fee to Merrill Lynch. It does not seek an injunction with regard to this fee at this point because Merrill Lynch has already received this fee. Even if Hanson were to seek to enjoin this fee, such a motion would be denied as moot because Merrill Lynch has already received the $9,000,000.00 fee.

      . The Court will not address the issue of irreparable harm because it concludes that Hanson has failed to satisfy the second prong of the preliminary injunction test.

      . Hanson alleges several causes of action in its three complaints. As the hearing progressed, however, it was clear that for purposes of the preliminary injunction motion Hanson was relying upon its claim that the directors breached their fiduciary duty. In any event, Hanson has failed to show a likelihood of success on the merits or a sufficiently serious question going to the merits of any of its other claims, including its claim of waste of corporate assets.

      . Although the parties failed to brief the specific issue they apparently assumed that the Court would apply New York law. In any event, the Court concludes that because SCM is incorporated under New York law and has its principal place of business in New York, the correct law to be applied is the New York corporate fiduciary law. The relevant statutory law is codified in N.Y.Bus.Corp.Law §§ 717, 720 and 909.


author: BARKER, District Judge.

text:
    Ali COULIBALY, Plaintiff, v. T.G.I. FRIDAY’S, INC., John Carroll and Rick Wolf, Defendants.
    United States District Court, S.D. Indiana, Indianpolis Division.
    Nov. 26, 1985.
    Daniel R. Carroll, Indianapolis, Ind., for plaintiff.
    James E. Hugh, Karen D. Scanlon, Sommer & Barnard, Indianapolis, Ind., for defendants.
   ENTRY

BARKER, District Judge.

This matter comes before the Court on the July 27, 1984 motion of defendants T.G.I. Friday’s, Inc., John Carroll, and Richard Wolf (“Defendants”) to dismiss Count I of plaintiff Ali Coulibaly’s (“Coulibaly”) amended complaint. Coulibaly filed a brief in opposition to the motion to dismiss on September 17, 1984. This matter became fully briefed with the filing of defendants’ reply brief on September 28, 1984.

The Court, being duly advised in the premises, now GRANTS defendants’ motion to dismiss Count I of Coulibaly’s amended complaint for the reasons set forth below.

Background

Coulibaly was employed by defendant T.G.I. Friday’s as a prep cook from April 30, 1980, until his discharge on July 18, 1983. On October 5, 1983, Coulibaly filed a charge with the Equal Employment Opportunity Commission pursuant to Title VII of the Civil Rights Act of 1964, 42 U.S.C. § 2000e et seq. Coulibaly received his right to sue letter from the EEOC on January 3, 1984.

Coulibaly alleges that upon receipt of the right-to-sue letter he requested legal assistance from the offices of Legal Services Organization of Indiana, Inc., but that his request was denied by a letter dated March 28, 1984. On March 29, 1984, eighty-six days after he received the right-to-sue letter, Coulibaly filed with this Court the right-to-sue letter, including the determinations of the EEOC, along with an application to proceed in forma pauperis. The Court granted Coulibaly’s motion to proceed in forma pauperis on April 16, 1984. On April 27, 1984, Coulibaly, by his attorney, filed his complaint against T.G.I. Friday’s. Subsequently, on May 17, 1984, Coulibaly filed a three-count amended complaint, adding defendants Carroll and Wolf.

In Count I, Coulibaly alleges that he was discharged by defendants because of his race and national origin. Count II is brought under 42 U.S.C. §§ 1981 and 1985 and alleges that defendants maintained a policy, custom, usage, or practice of intentional discrimination. In Count III, Coulibaly alleges that defendants conspired to perform discriminatory acts against him in violation of 42 U.S.C. § 1985(3). Defendants have moved to dismiss Count I only.

Discussion

Defendants argue that the filing of Coulibaly’s initial complaint with this Court one hundred and fifty (150) days after receiving the right-to-sue letter is not timely. Defendants contend that even assuming that the time period during which the petition to proceed in forma pauperis was under consideration by the Court is tolled, the complaint was still filed ninety-seven (97) days after Coulibaly received the right-to-sue letter, which is not within the ninety-day filing period set forth in 42 U.S.C. § 2000e-5(f)(1)-

Coulibaly, on the other hand, contends that the application to proceed in forma pauperis and the right-to-sue letter filed on March 29, 1984, constitute an initial complaint, and that these filings were made within the ninety-day statutory filing period. Coulibaly alternatively argues that the filing period should be equitably tolled.

Under the 1972 Amendments, Title VII requires that a person claiming to be aggrieved commence any civil action within ninety (90) days after receipt of the EEOC’s notification of their right to sue. See 42 U.S.C. § 2000e-5(f)(1). This filing period is tolled where a plaintiff files an application to proceed in forma pauperis. However, this period is tolled only during the time the motion is pending; once the Court rules on the application to proceed in forma pauperis, the limitation period begins to run again. Harris v. National Tea Company, 454 F.2d 307 (7th Cir.1971) (limitation period tolled with filing of application for appointment of counsel and leave to proceed without payment of fees until court makes a decision on application); Ortiz v. Clarence H. Hackett, Inc., 581 F.Supp. 1258, 1261 (N.D.Ind.1984).

Thus, in the present case the ninety-day limitation period began to run on January 3, 1984, when Coulibaly received the right-to-sue letter, and was not tolled until the filing of the in forma pauperis application on March 29, 1984, eighty-six (86) days later. The statutory period began to run again on April 16, 1984, the day this Court granted Colibaly’s motion to proceed in forma pauperis. It would appear, then, that the filing of the complaint on April 27, 1984, ninety-seven (97) days after Coulibaly received the right-to-sue letter, was untimely and that his Title VII claim should be dismissed for lack of subject matter jurisdiction, unless the Court accepts Coulibaly’s argument that the filing of the in forma pauperis application and the right-to-sue letter on March 29, 1984, were sufficient to satisfy the formal pleading requirements of Rule 8 of the Federal Rules of Civil Procedure. If this Court finds that these filings are not a “complaint” within the meaning of Rule 8, the filing of Coulibaly’s complaint on April 27, 1984, would be untimely and subject to dismissal.

The United States Supreme Court in Baldwin County Welcome Center v. Brown, 466 U.S. 147, 104 S.Ct. 1723, 80 L.Ed.2d 196 (1984), addressed the very issue presented by the case at bar. In Baldwin County, respondent Brown (“Brown”) filed her claim with the EEOC on November 6, 1979, alleging that her former employer, Baldwin County Welcome Center (“Welcome Center”) had discriminated against her. 104 S.Ct. at 1724. The EEOC issued Brown a notice of right to sue on January 27, 1981. Brown subsequently mailed the notice to the United States District Court along with a request for the appointment of counsel. These documents were received by the Court on March 27, 1981. On April 15, 1981, a United States Magistrate ordered Brown to make application for court appointed counsel on a form supplied by the District Court; at this time Brown was reminded that she had a statutory obligation to file a complaint within ninety (90) days of the issuance of the right-to-sue letter. The application for appointment of counsel was not returned by Brown until May 6, 1981, ninety-six (96) days after receipt of the right-to-sue letter. The Magistrate denied her request for appointment of counsel on the ground that it was not timely made per his order; he deferred a ruling on the issue of whether the filing of the right-to-sue letter constituted commencement of a civil action within the meaning of Rule 3 of the Federal Rules of Civil Procedure. On June 9, 1981, one hundred thirty (130) days after Brown received the right-to-sue letter, she filed an “Amended Complaint” with the Court. Id.

On December 24, 1981, the District Court ruled that Brown had forfeited her right to pursue the Title VII claim because she failed to file a complaint meeting the pleading requirements of Rule 8 of the Federal Rules of Civil Procedure within the statutory limitation period. Id. The District Court held that the right-to-sue letter failed the requirements of Rule 8 because it did not contain a factual basis for the discrimination claim. On appeal of this ruling, the Eleventh Circuit Court of Appeals reversed this dismissal, holding that the filing of the right-to-sue letter tolled the time period provided by Title VII. The Supreme Court granted the Welcome Center’s petition for certiorari, and reversed the judgment of the Court of Appeals. Id.

In reversing the Court of Appeals, the Supreme Court held that in Title VII cases a plaintiff must satisfy the requirements of the general rules of pleading as set forth in the Federal Rules of Civil Procedure. The Court noted that Rule 3 states that “[a] civil action is commenced by filing a complaint with the court,” and that Rule 8 requires that a complaint contain “a short and plain statement of the claim showing that the pleader is entitled to relief.” Id. at 1724-25. The Court held that the filing of the right-to-sue letter with the District Court did not meet these general rules of pleading and that there was no persuasive reason to relax these rules in Title VII cases. Id. at 1725, n. 4.

The Supreme Court in Baldwin County has made it clear that in Title VII cases such as the one before the Court the rules of pleading shall be strictly applied. Taking into account the fact that Coulibaly filed the right-to-sue letter pro se and liberally construing these filings, the Court finds that Coulibaly failed to file a document containing a “short and plain statement” within the meaning of Rule 8 showing that he was entitled to relief. Although this case is somewhat different factually than the Baldwin County case, in that Coulibaly filed the right-to-sue letter and an application to proceed in forma pauperis, there is nothing about these facts which warrants a departure from the result reached by the Supreme Court in Baldwin County. In Archie v. Chicago Truck Drivers, Etc., 585 F.2d 210, 217 (7th Cir.1978), the Seventh Circuit Court of Appeals stated that although the Court must construe layman-initiated proceedings liberally, the pleading nonetheless must contain “a short statement of the grounds upon which the Court’s jurisdiction depends, a short statement of the claim showing that the pleader is entitled to relief, and a demand for judgment for the relief to which he deems himself entitled.” Although in the application to proceed in forma pauperis Coulibaly indicated that the nature of his action was “[r]ace and [njational [ojrigin [discrimination in [violation of Tptle] VII of the Civil Rights Act of 1964 for terminating [his] employment on July 18, 1983,” this statement does not meet the pleading requirements of Rule 8. There is no jurisdictional assertion or demand for judgment. Also, although there is a statement that the alleged discriminatory act occurred on July 18, 1983, there is no statement of the facts showing Coulibaly’s entitlement to relief.

Because Coulibaly did not commence this action within ninety (90) days after receiving the right-to-sue letter, defendant’s motion to dismiss Count I of the amended complaint is GRANTED and the same is hereby DISMISSED.

      . The record reflects that Coulibaly’s attorney entered an appearance on April 23, 1985.

      . The Eleventh Circuit Court of Appeals alternatively held that the 90-day filing period was "tolled” with the filing of the right-to-sue letter. The Supreme Court reversed this ruling as well, holding that these facts did not warrant the application of the doctrine of equitable tolling. Id. at 1725. The Court did note, however, that there were circumstances where tolling might be justified, such as where a motion for appointment of counsel accompanies the right to sue letter. Id. at 1725-26. See Brown v. I.I. Case Co., 756 F.2d 48 (7th Cir.1985) (filing of right-to-sue letter and request for appointment of counsel tolls the 90-day filing period). This Court has already held that the 90-day filing period was tolled during the time the motion to proceed in forma pauperis was pending before the Court, thus finding that the doctrine of equitable tolling should be applied in the present case.

      . In layman-initiated proceedings under Title VII, the Court is to construe liberally the procedural requirements. Archie v. Chicago Drivers, Etc., 585 F.2d 210, 217 (7th Cir.1978).


author: EDWARD C. REED, Jr., District Judge.

text:
    Robert L. BLEVINS, Plaintiff, v. Kendall R. BOYD, Security Bank of Nevada, a Nevada corporation, State of Nevada, Employment Security Department, a governmental agency, and also all other persons unknown claiming any right, title, estate, lien or interest in the real property described in Plaintiffs Complaint adverse to Plaintiffs ownership, or any cloud upon Plaintiffs title thereto, Defendants.
    No. CV-R-85-42-ECR.
    United States District Court, D. Nevada.
    Nov. 27, 1985.

      Richard S. Henderson, San Diego, Cal., and Douglas R. Hill, Reno', Nev., for plaintiff.
    Terrance Shea, Reno, Nev., for Kendall R. Boyd.
    J. Thomas Susich, Carson City, Nev., for Employment Security.
    Paul C. Giese, Reno, Nev., for Security Bank.
   ORDER

EDWARD C. REED, Jr., District Judge.

Plaintiff in this action is a California citizen, and has brought a case to quiet title to a parcel of land in Washoe County to which he claims title. Jurisdiction for the suit is premised on diversity of citizenship, in that all defendants are citizens of the State of Nevada, and the parcel in question is valued at more than $10,000. The two elements for diversity jurisdiction set out in 28 U.S.C. § 1332 having been satisfied, the Court may consider the substance of the present motion. Because this is a diversity case, this Court must apply State law on substantive issues. Erie Railroad Co. v. Tompkins, 304 U.S. 64, 58 S.Ct. 817, 82 L.Ed. 1188 (1938).

At issue in this suit is whether defendant Boyd will be charged with notice of certain documents which purport to restrict the use of this parcel of land. Prior to October 5, 1982, Owen H. Cooper owned the parcel in fee. On that date, Owen Cooper executed and recorded a quitclaim deed for this property in favor of O.H.C. Batteries and Car Sales, Inc. (O.H.C.). At this time, Owen Cooper was also the sole shareholder in O.H.C. On October 6, Owen Cooper and Bruce Cooper, Owen’s father, both acting as individuals, entered into and recorded an agreement which encumbered the parcel in various degrees. This document essentially recognized that Bruce Cooper had paid the entire purchase price of the parcel, and that he therefore held a constructive trust over the land. The agreement further provided that if the property or Owen Cooper’s shares of O.H.C. should ever come into default under any deed of trust, the property and the shares would revert to Bruce Cooper. From the face of the agreement, however, it is clear that O.H.C. as a corporate body was not a party to the agreement.

In August of 1983, Bruce Cooper and O.H.C. became indebted to the plaintiff for $90,000 and executed a series of promissory notes and mortgages which secured the debt with this parcel. These instruments were recorded on the 10th of that month. On December 14, 1983, O.H.C., through Owen Cooper, executed a $30,000 promissory note in favor of defendant Boyd. This note was secured by a trust deed, which was also executed and recorded on December 14. The latter agreement was apparently made in violation of the agreement between Owen and Bruce Cooper of October 6, 1982.

In October of 1983, Bruce Cooper had become aware that Owen Cooper was in breach of that agreement, and filed notice of default with the county recorder on February 11, 1985. On that date, Bruce Cooper apparently physically occupied the parcel, and asserted 100% ownership of the outstanding stock in O.H.C. Although the record is very inartfully drafted, it appears that Bruce Cooper had been in actual physical possession of the parcel well before this date. On his behalf and on that of O.H.C., Bruce Cooper then executed a deed for this parcel to the plaintiff, in lieu of a foreclosure of the mortgage which the plaintiff held on the parcel.

In his complaint, plaintiff argues that all subsequent purchasers had notice of the October 6 agreement between Owen and Bruce Cooper. Boyd, contends plaintiff, executed the promissory note and trust deed with Owen Cooper in constructive knowledge of the reverter contained in that document. Therefore, Boyd cannot claim to be a bona fide purchaser and his trust deed cannot be superior to the later agreement with the plaintiff.

Defendant Boyd has filed a motion to dismiss this complaint pursuant to Fed.R.Civ.P. 12(b)(6). In essence the defendant argues that the October 6th agreement is a “wild” document, in that it lies outside of the chain of title. Because of this, contends defendant, the agreement imparts no constructive notice, and he cannot be bound by its provisions.

A motion to dismiss may not be granted unless it appears to a certainty that the plaintiff would not be entitled to relief under any state of facts that could be proved. On a motion to dismiss, the court presumes that the facts alleged by the plaintiff are true. Halet v. Wend Inv. Co., 672 F.2d 1305, 1309 (9th Cir.1982). In the present case, the Court cannot say that plaintiff will never be able to establish a set of facts which would entitle him to relief, and must therefore deny the motion to dismiss.

Boyd’s basic argument in requesting dismissal of this suit is that the October 6th agreement lies outside the chain of title, and that it cannot give constructive notice of the restrictions contained therein. Nevada law supports his statement. In Snow v. Pioneer Title Inc. Co., 84 Nev. 480, 444 P.2d 125 (1968), the Supreme Court of Nevada stated that “[a]ny instrument executed by ... an owner which is recorded before his acquisition or after his relinquishment of title is considered outside the ‘chain of title.’ ” Id. at 485, 444 P.2d 125 (iciting 6 Powell, Real Property 293; 8A Thompson, Real Property (1963) Replacement section 4340)). If a document is outside the chain of title, the court concluded, it imparts no constructive notice to subsequent bona fide purchasers. Id. See Ryczkowski v. Chelsea Title and Guaranty Co., 85 Nev. 37, 449 P.2d 261 (1969).

There is no question that the agreement between Owen and Bruce Cooper of October 6, 1982, lies outside the chain of title. Owen had conveyed the parcel to O.H.C. just the day before, on October 5th, and that deed was recorded before the later agreement. Thus, the agreement was recorded after the owner had relinquished his title in the property. According to Nevada law, therefore, it lies outside of the chain of title, and imparts no constructive notice.

The fact that an agreement is defectively recorded does not necessarily mean that a purchaser may never have notice of its contents, however. In Berge v. Fredericks, 95 Nev. 183, 591 P.2d 246 (1979), for example, Fredericks sought to transfer a parcel to Valdez in accordance with an oral ante-nuptial agreement between them. Fredericks had previously executed a deed to Berge, the plaintiff in this action, but Berge did not record the instrument until after Valdez recorded hers. Because the plaintiff’s deed was absent from the record, Valdez argued, she took the property as a bona fide purchaser for value without notice of the previous transfer.

The Nevada Supreme Court disagreed with this argument. The exact timing of the recording of the two deeds notwithstanding, the court found that a party may not qualify as a bona fide purchaser if the party is under a duty of inquiry prior to the payment of consideration and transfer of legal title. This duty arises

when the circumstances are such that a purchaser is in possession of facts which would lead a reasonable man in his position to make an investigation that would advise him of the existence of prior unrecorded rights. He is said to have constructive notice of their existence whether he does or does not make the investigation. The authorities are unanimous in holding that he has notice of whatever the search would disclose.

Id. 591 P.2d at 249 (quoting Allison Steel Mfg. Co. v. Bentonite, Inc., 86 Nev. 494, 498, 471 P.2d 666, 668 (1970).)

The court noted further that open, notorious, and exclusive possession of lands by a stranger to the owner’s title of record, at the time of a purchase from the owner of record is sufficient to put a purchaser upon inquiry as to the legal and equitable rights of the party in possession. In this situation, the vendee takes the conveyance from the vendor with full notice of the rights of the possessor, and of his subordination to these rights. This fact can only be overcome by clear and explicit proof that the vendee made a diligent, but unavailing, effort to discover or obtain actual notice of the rights of the party in possession, the court concluded. Id. (quoting Brophy M. Co. v. B. & DM. Co., 15 Nev. 101, 109 (1880)). In that the plaintiff had been in such possession of the property well before the transfer to Valdez, the court concluded that Valdez was put on inquiry notice by this possession. See Snow, supra; see also Pellisier v. Title Guarantee and Trust Co., 208 Cal. 172, 280 P. 947 (1929); Farmer’s Mutual Royalty Syndicate v. Issacks, 138 S.W.2d 228 (Tex.Civ.App.1940). Because there were no facts in the record to indicate that Valdez had made even the most rudimentary inquiry into the plaintiff’s possession, the court reversed the summary judgment given in Valdez’ favor by the trial court.

In light of this case, it is clear that the present plaintiff may be able to prove that the defendant had some duty to inquire into Bruce Cooper’s rights in the parcel. Plaintiff has alleged that the elder Cooper was in open and notorious possession of the property before and after the time at which the note and trust deed between Owen Cooper and the defendant were signed. This Court is required to treat this allegation of the plaintiff as true when considering a motion to dismiss. Halet, supra. With this in mind, plaintiff has alleged facts which indicate that the defendant had notice of the agreement of October 6, 1982. Defendant, therefore, is not entitled to judgment as a matter of law.

Of course, once the case comes to trial, plaintiff will actually have to prove that Bruce Cooper was in possession of the property at the time the note between Owen Cooper and the defendant was signed. In order to survive a motion to dismiss, however, he must only allege this fact, and he has done so.

The Court emphasizes, however, that its decision is strictly limited to the chain of title question and to the defendant’s knowledge of the October 6th agreement between Bruce and Owen Cooper. The Court does not now decide what information would be imparted to the defendants by this agreement, as it appears that Bruce Cooper may never have held any interest in the property. Although he claims to hold a “constructive trust” over the property by virtue of having paid its entire purchase price, the Court is not aware of any Nevada law which actually creates such an interest. In addition, the Court notes that Owen Cooper had conveyed away any interest which he held in the property on the day before he and Bruce Cooper signed this restrictive agreement. Any interest which Bruce Cooper claims to the property probably cannot come through this conveyance from Owen, therefore, as he no longer held title to the property when he signed the agreement. The Court only decides that Boyd cannot claim that he took his interest free and clear of Bruce Cooper’s interest because of the doctrine of implied actual notice. The Court does not, however, indicate what the nature, quality, and extent of that interest may be.

IT IS, THEREFORE, HEREBY ORDERED that defendants’ motion to dismiss is DENIED.

       In addition to his opposition to the defendants’ motion, the plaintiff has filed a “Rebuttal” to the defendants’ reply brief. There is no authority for the filing of such a document in this Court. In fact, the local rules of practice expressly forbid this. See Local Rule 16- (D.Nev.). In accordance with this rule, the Court has not considered this "Rebuttal” in deciding this motion.


author: WARREN, District Judge.

text:
    LEE BEVERAGE COMPANY, INC., a Wisconsin corporation, Plaintiff, v. I.S.C. WINES OF CALIFORNIA, INC., a foreign corporation, and United Vintners, Inc., a foreign corporation, Defendants.
    No. 83-C-1882.
    United States District Court, E.D. Wisconsin.
    Nov. 27, 1985.

      James J. Williamson, Dempsey, Magnusen, Williamson & Lampe, Oshkosh, Wis., for plaintiff.
    Carol S. Josten, Godfrey & Kahn, S.C., Milwaukee, Wis., for I.S.C. Wines.
    Charles P. Graupner, Michael, Best & Friedrich, Milwaukee, Wis., for Vintners, Inc.
   ORDER

WARREN, District Judge.

This action involves alleged violations of the Wisconsin Fair Dealership Law (“WFDL”), Chapter 135, Wisconsin Statutes. The plaintiff, Lee Beverage Company, Inc. (“Lee”), has claimed that the defendants, I.S.C. Wines of California, Inc. (“I.S.C. Wines”) and United Vintners, Inc. (“United”), terminated, cancelled or substantially changed the plaintiff’s distributorship of wines and brandies without good cause in violation of Wis.Stat. § 135.03. The plaintiff has further alleged that the defendants violated the notice requirements set forth in Wis.Stat. § 135.04. As recompense, the plaintiff requests both damages and injunctive relief.

By stipulation of the parties and order of the Court dated November 16, 1984, all claims against I.S.C. Wines have been dismissed. Now pending before the Court is United’s motion for summary judgment as to the claims against it. The Court has reviewed the submissions of the parties with respect to this motion as well as other documents of record in this case, and finds that no material issues of fact are in dispute. Accordingly, the Court will proceed to resolve the legal issues presented.

BACKGROUND

This action arises out of a distributorship agreement entered into between Lee Beverage and United Vintners in April of 1980. United, a Connecticut corporation, is in the business of manufacturing, distributing and importing wine and other alcoholic beverages. Lee Beverage is a Wisconsin corporation that distributes wine, liquor, and beer. Their agreement granted Lee an exclusive distributorship of certain wines and brandies sold by United within a specified portion of Wisconsin. Lee proceeded to do so for approximately three and one-half years, during which time it expended time and money establishing and maintaining a market for the beverages it distributed.

In July, 1983, United agreed to sell some of its product lines to I.S.C. Wines of California, Inc. Among the product lines sold to I.S.C. Wines were some of those distributed by Lee in Wisconsin. On or about October 3, 1983, Lee received written notice from I.S.C. Wines that, as of September 28, 1983, I.S.C. Wines would select distributors for its new product lines and that Lee would not be among those selected. Lee did not receive any notice from United that its distributorship would be terminated. In fact, Lee continued to distribute certain product lines for United which had not been sold to I.S.C. Wines.

I. Was Lee’s Distributorship Terminated By United Without Good Cause?

Lee contends that United terminated or substantially changed its distributorship agreement with Lee without good cause in violation of Wis.Stat. § 135.03. United argues that the Wisconsin Fair Dealership Law does not apply to a non-discriminatory withdrawal from a product marketed in a large geographic area. United claims that its decision to sell certain of its product lines to I.S.C. Wines was based solely on economic considerations, and that the alteration of the distributorship agreement was a consequence of this sale.

There is no dispute between the parties that Chapter 135 governs the dealership agreement entered into between them. The parties do disagree as to whether Chapter 135 and, in particular, § 135.03 precludes the termination or alteration of a dealership agreement in the circumstances described above.

Section 135.03 provides that:
No grantor, directly or through any officer, agent or employe, may terminate, cancel, fail to renew or substantially change the competitive circumstances of a dealership agreement without good cause. The burden of proving good cause is on the grantor.

In St. Joseph Equipment v. Massey-Ferguson, Inc., 546 F.Supp. 1245 (W.D.Wis.1982), the question presented was whether the prohibition in § 135.03 applied where the defendant grantor had terminated the plaintiffs dealership of construction machinery by discontinuing, for economic reasons, its marketing of construction machinery in North America, the geographic area over which the plaintiff held dealership rights. The court held that § 135.03 did not apply “in cases where ... the grantor undertakes a non-discriminatory withdrawal from a product market on a large geographic scale.” 546 F.Supp. at 1247. In so holding, the court pointed out the absurdity of compelling a grantor to continue marketing an unprofitable product line in a geographic area simply to effectuate a dealership agreement. Such a result would frustrate the corporate grantor’s purpose in entering into a dealership arrangement in view of the ultimate objective of the corporation, which is to obtain a profit. The court concluded that “good cause” for the termination of a dealership could be found based upon the business motives of the grantor without reference to the performance of the dealer. 546 F.Supp. at 1247-1248.

This Court fully agrees with the analysis and result in the St. Joseph case. The Wisconsin Fair Dealership Law was intended to protect dealers from unjustified, imperious acts on behalf of economically superior grantors. The law was not intended to compel the perpetuation of a business relationship when, for sound financial reasons, a grantor determines that the sales of its product over a wide geographic area are no longer a profitable venture.

The plaintiff’s argument that St. Joseph should be distinguished from the present case because the defendant here did not terminate or alter the dealership agreement due to economic necessity must be rejected. “Good cause” for a dealership termination need not be found only when the continuation of a dealership arrangement would mean financial ruin for the grantor. The reasoning expressed in St. Joseph applies equally well to a situation where the profitability of wide-scale sales of a product line has sunk to such a point that a sale or discontinuation of the product line is justified for the good of the corporation. A law which required otherwise would no doubt be subject to legitimate attack on the basis of constitutional principles.

On the other hand, the present situation is distinguishable from that in Kealey Pharmacy & Home Care Serv. v. Walgreen Co., 539 F.Supp. 1357 (W.D.Wis.1982), aff'd in part, 761 F.2d 345 (7th Cir.1985). In Kealey, the district court held and the Court of Appeals agreed that a grantor which terminated its dealership agreement with several independently owned pharmacies in favor of maintaining and increasing the number of its own stores in the same marketing area did so in violation of § 135.03. The grantor in Kealey continued to sell the same product line; albeit through a different network: its own stores as opposed to the pharmacies which had developed the market. In this case, there was no such shift of the product lines from one distributor to another. Rather, the grantor ceased selling the product lines at’ issue altogether.

Although the Court does not believe that such a discontinuation in the marketing of product lines is necessary in order to meet the good cause standard in § 135.03, the fact that the product lines in question in this case were not simply switched from some distributors to others is an important consideration in light of the purpose of the WFDL (discussed below). This fact also makes this case distinguishable from the situation in Kealey.

The Court is cognizant of the language in both the district court’s and circuit court’s decisions in Kealey concerning the limited meaning of the term “good cause” as it is used in the WFDL. The Court concedes that the definition of “good cause” in § 135.02(4) pertains exclusively to the performance or acts of the dealer without reference to the economic concerns of the grantor. However, such a literal reading of the statute would not comport with the intentions of the legislature as expressed in § 135.025 which reads, in part, as follows:

(1) This chapter shall be liberally construed and applied to promote its underlying remedial purposes and policies.
(2) The underlying purposes and policies of this chapter are:
(a) To promote the compelling interest of the public in fair business relations between dealers and grantors, and in the continuation of dealerships on a fair basis;
(b) To protect dealers against unfair treatment by grantors, who inherently have superior economic power and superior bargaining power in the negotiation of dealerships;
(c) To provide ’ dealers with rights and remedies in addition to those existing by contract or common law;
(d) To govern all dealerships, including any renewals or amendments, to the full extent consistent with the constitutions of this state and the United States ...

Apart from the constitutional concerns expressed above, a statute which required a grantor to maintain a dealership arrangement in spite of the economic consequences to itself could hardly be characterized as a law that promoted the “compelling interest of the public in fair business relations”, or one which promoted the “continuation of dealerships on a fair basis.” § 135.-025(2)(a). In order to effect the purpose of the legislature in enacting the WFDL, the term “good cause” must be interpreted more liberally in this situation than it was in Kealey Pharmacy. See Remus v. Amoco Oil Company, 611 F.Supp. 885 (E.D.Wis.1985).

The materials submitted to the Court, and in particular the affidavit of Christopher Mottern, Vice-President of Finance at Heublein Wines (formerly United Vintners, Inc.), establishes that the decision to sell the product lines at issue to I.S.C. Wines was based on sound financial considerations. The decision resulted in the cessation of sales and marketing efforts by United of several of its product lines over a wide geographic area, and was not intended to affect in a discriminatory or unfair manner its distributorship agreement with Lee.

Therefore, the Court finds that United’s alteration of the distributorship agreement with Lee was justified and done for good cause. Accordingly, the Court dismisses plaintiff’s claim that defendant’s actions violated § 135.03.

II. Notice

The second issue presented by United’s summary judgment motion is whether the defendant was required to give the plaintiff 90 days’ written notice prior to the termination or substantial alteration of the distributorship agreement, as required by Wis.Stat. § 135.04. Section 135.04 provides, in relevant part:

Except as provided in this section, a grantor shall provide a dealer at least 90 days’ prior written notice of termination, cancellation, nonrenewal or substantial change in competitive circumstances. The notice shall state all the reasons for termination, cancellation, nonrenewal or substantial change in competitive circumstances and shall provide that the dealer has 60 days in which to rectify any claimed deficiency.....

As was noted above, United never notified Lee that any alteration of the distributorship agreement was forthcoming. I.S.C. Wines notified Lee that the latter would not be selected as a distributor of I.S.C. Wines’ new product lines, but this notice was received by Lee after the alteration of the distributorship agreement had been effected.

United contends that it never terminated its distributorship agreement with Lee, and that no notice by it was therefore required. The Court cannot accept this argument. Although it’s true that Lee continued to distribute certain of United’s product lines after the sale of others to I.S.C. Wines, that sale of a substantial number of the products formerly distributed by Lee did significantly alter the competitive circumstances of their agreement. United had no basis for assuming that I.S.C. Wines would necessarily maintain Lee as its distributor of those products, for I.S.C. Wines was not bound by any distribution agreement between United and Lee. By selling those product lines, United drastically reduced the product lines distributed by Lee in Wisconsin. The failure to give Lee notice deprived it of an opportunity to cease its market development efforts and/or look for other distributorship opportunities. In accordance with the Act’s policy of insuring fairness in dealership relations, United was required to give notice to Lee as specified in § 135.04. St. Joseph, 546 F.Supp. at 1249.

Since no factual dispute exists as to whether United violated the notice provisions of § 135.04, the Court may award summary judgment to Lee with respect to its notice claim even though it has not moved for it. Kealey Pharmacy, 539 F.Supp. at 1370; 6 Moore’s Fed. Practice, ¶ 56.12, p. 56-331-339 (2d Ed.1982). The Court believes that the plaintiff is entitled to summary judgment on that issue. The defendant is liable to the plaintiff for any damages resulting from the defendant’s failure to give notice to the plaintiff of a substantial change in the competitive circumstances of their distributorship agreement as required by Wis.Stat. § 135.04.

CONCLUSION

The Court orders that:

(1) Defendant’s motion for summary judgment as to plaintiff’s claim under Wis. Stat. § 135.03 be GRANTED;

(2) the plaintiff be AWARDED summary-judgment with respect to its claim under Wis.Stat. § 135.04.

A subsequent proceeding will be held to determine the amount of damages to be awarded to the plaintiff.

      . The defendant argues in its reply brief that if § 135.03 is interpreted in such a way as to preclude a grantor from withdrawing its product from a wide-scale .geographic area in a nondiscriminatory manner for financial reasons, then the statute would violate the Commerce Clause of the United States Constitution. In addition to other constitutional infirmities which have been alleged in connection with the WFDL, this Commerce Clause argument has also been raised before. In C.A. May Marine Supply Co. v. Brunswick Corp., 557 F.2d 1163, 1167 (5th Cir.1977), the Fifth Circuit declared that this Commerce Clause argument, along with the other due process, Supremacy Clause and vagueness arguments raised, was "patently frivolous." The court reasoned that no Commerce Clause violation could occur when grantors became subject to the provisions of this law due only to their "contractual consent.” Id.

      While the Court does not intend to delve unnecessarily into this constitutional quagmire, and by no means wishes this footnote to be construed as its opinion on the constitutionality of § 135.03, it does believe that the Fifth Circuit's rather attenuated analysis leaves much to be desired. If it is assumed that a grantor that establishes a dealership arrangement in Wisconsin voluntarily submits itself to the constraints of the WFDL, then the obvious implication is that a reasonable alternative to that voluntary action must exist. The only alternative apparent to this Court is a decision not to market a product through dealers in Wisconsin, which in most cases would be tantamount to a decision not to sell that product in Wisconsin. This may appear to be a reasonable alternative to a Court that sits in another part of the country, but it does not appear to be too reasonable to one that sits in Wisconsin.

      . Section 135.02(4) defines "good cause” as:
      (a) Failure by a dealer to comply substantially with essential and reasonable requirements imposed upon him by the grantor, or sought to be imposed by the grantor, which requirements are not discriminatory as compared with requirements imposed on other similarly situated dealers either by their terms or in the manner of their enforcement; or
      (b) Bad faith by the dealer in carrying out the terms of the dealership.