567 F.2d 209 (2d Cir. 1977)
David Goldberg, a stockholder of Universal Gas & Oil Company, Inc. (UGO), a Panama corporation with its principal place of business in New York City, brought a derivative action in the District Court for the Southern District of New York against UGO’s controlling parent Maritimecor, S.A., Maritimecor’s parent Maritime Fruit Carriers Company Ltd., several individuals who were directors of one or more of these companies, the investment firm of Hornblower & Weeks, Hemphill, Noyes, Inc., and the accounting firm of Laventhal & Horwath.1
The suit concerned an agreement under which UGO issued up to 4,200,000 shares of its stock to Maritimecor and assumed all of Maritimecor’s liabilities, including a $7,000,000 debt owed to UGO, in exchange for the transfer of Maritimecor’s assets excluding 2,800,000 UGO shares already held by Maritimecor.2 In May 1972, defendants caused UGO to issue a prospectus offering 11,000 units of common stock and debentures, stating proceeds would finance construction of tankers for liquified gas transportation.3 In 1974, UGO sold contracts for two vessels for $25,000,000, realizing $14,000,000 profit, and made loans to Maritimecor resulting in a $7,000,000 debt.4 In August 1975, defendants caused UGO to enter the agreement with Maritimecor, which was carried out at least in part, and issued press releases on August 1 and December 19, 1975, describing the transaction in positive terms as making UGO the principal operating subsidiary engaged in diversified shipping activities.5
Goldberg filed his original complaint on February 3, 1976, alleging violations of section 10(b) and Rule 10b-5 along with state law claims.6 UGO moved for a stay under New York Business Corporation Law section 627 requiring security for expenses.7 On July 30, 1976, the district court ordered Goldberg to post security or amend the complaint to eliminate state law claims.8 Goldberg filed an amended complaint on August 27, 1976, omitting state claims but alleging a conspiracy to dissipate UGO assets for the benefit of the parent companies through the transactions.9
In opposing motions to dismiss, Goldberg’s counsel submitted an affidavit asserting lack of disclosure to him as a minority shareholder of the fraudulent nature of the transfer and attached the press releases, claiming they failed to disclose Maritimecor’s over $42.5 million current liabilities, the forgiveness of the $7 million debt, conflicts of interest, and that the net value of Maritimecor’s assets was far less than the UGO shares issued.10 An additional affidavit detailed that after the transfer UGO’s financial position deteriorated from approximately $39 million net current assets to a deficit of about $3.6 million, leading to defaults and seizure of ships by creditors.11 On February 11, 1977, Judge Lasker dismissed the amended complaint, and Goldberg appealed to the Second Circuit.12
Whether the district court abused its discretion in denying leave to amend the complaint to include allegations of deception based on the press releases and other discovered facts?13
Federal courts should exercise liberality in allowing amendment of complaints in stockholder derivative suits to reflect facts already discovered before answers are filed, particularly to avoid granting summary judgment to defendants without full discovery.14
Yes. Goldberg had amended the complaint once solely to eliminate state law claims.15 This was ordered by the district court under New York Business Corporation Law section 627.16 At that time, no ruling on the federal claim's sufficiency had been made.17 Thus the requested amendment was a second opportunity rather than a third.18 The press releases and information about director Martin Siem's lack of full information had surfaced in discovery.19 The considerations from Schoenbaum dictate allowing such amendments.20
The district court's refusal to permit amendment of the complaint was an abuse of discretion.21
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Circuit Judge Meskill concurred in the majority's holding that the district court abused its discretion by denying leave to amend.22 He agreed that the allegation of deception was insufficient under Federal Rule of Civil Procedure 9(b), which requires specificity in pleading fraud.23 This deficiency arose because Goldberg had insisted in the district court that Rule 10b-5 did not require an allegation of deception.24
After the Supreme Court's reversal in Green, Goldberg recast his case on appeal to focus on the alleged deception.25 Meskill nonetheless joined the conclusion that leave to amend should be granted to allow inclusion of the press releases and other facts.26
Whether the amended complaint states a claim under section 10(b) and Rule 10b-5 based on misleading disclosures to minority shareholders regarding a transaction between the corporation and its controlling parent?27
Rule 10b-5 reaches a controlling parent's misleading disclosure or nondisclosure of material facts in causing a partly owned subsidiary to engage in a securities transaction adverse to the subsidiary's interests.28 The deception is practiced on the corporation in effect its minority shareholders.29 The omitted facts must have assumed actual significance in the deliberations of reasonable directors or created a substantial likelihood that such directors would have viewed the total mix of information as significantly altered.30 State law must provide injunctive remedies that full disclosure would have enabled.31
Yes. The August 1 and December 19, 1975 press releases held out an inviting picture of UGO becoming the principal operating subsidiary engaged in diversified shipping activities.32 The truth was that the transaction would ensure UGO's doom by saddling it with Maritimecor's over $42.5 million in current liabilities and forgiving the $7 million debt owed to UGO.33 If reasonable directors of UGO had known the grim actualities rather than the barebones of the press releases, there is a significant likelihood they would not have voted for the transaction.34
New York law under Business Corporation Law section 720 provided for injunctive relief against unlawful conveyance of corporate assets that full disclosure would have allowed minority shareholders to pursue.35
The amended complaint, with the amendment treated as allowed, states a claim under section 10(b) and Rule 10b-5.36
Related opinions on this issue
Circuit Judge Meskill dissented from the holding that the complaint states a cause of action.37 He contended that the claimed deception was not material.38 Under Panamanian law no shareholder action was necessary to effect the transaction.39
The plaintiff also failed to allege what course of action he contemplated.40 Meskill found the majority's reliance on state injunctive remedies unpersuasive and noted that it raised difficult choice of law issues.41