The opinion of the court was delivered by: MCCUNE
We have before us various motions for new trial and judgment n.o.v. in this complicated litigation which evolved from the complex personal, corporate and financial relationships of William J. Harnett and Edward M. Ryan.
Essentially, this suit involves alleged violations of § 10(b) of the Securities and Exchange Act of 1934 and alleged breaches of contract. Two suits, Civil Action No. 68-1383 and Civil Action No. 69-537 with various claims, alternate claims and counterclaims, were tried non jury before this court in May and June of 1972. Before discussing and deciding the motions now before us we will set forth again as background for this opinion, our findings of relevant fact distilled from three weeks of trial.
The pertinent facts of what has been referred to as the "10(b)-5" case (C.A. 68-1383) brought by plaintiff Harnett and the counterclaim of Edward Ryan are as follows:
The suit was brought in the fall of 1968 to recover 1000 shares of stock in Ryan Homes, Incorporated (hereafter Ryan Homes) shortly after Ryan Homes completed a successful sale of stock to the public (i.e., "going public") after some years of operation as a closely held corporation engaged in the home building business.
In short, the plaintiff alleged that he was induced by certain misrepresentations to sell his stock in Ryan Homes back to the corporation (Ryan Homes) in May, 1965, under circumstances which made imperative the application of the antifraud provisions of the Securities and Exchange Act of 1934.
Plaintiff Harnett began to work for Ryan Homes in 1961 after working as a home salesman for several years with another company. Harnett was a good salesman and by 1965 had become an excellent sales executive with extensive knowledge of home building, sales and land development. He moved rapidly up the Ryan Homes corporate ladder
and by 1965, when he left Ryan Homes under circumstances which we shall explore in detail, he was Vice-President of Marketing and a member of the Operating Committee. Harnett and Ryan Homes President, Edward Ryan, developed a close business and personal relationship and Harnett became Ryan's able and trusted assistant.
Employees of Ryan Homes were permitted to purchase stock in the company. On the advice and with the financial assistance of Edward Ryan, Harnett purchased 1000 shares over several years time. All stock held by employees was subject to a so-called buy-sell or trust agreement. The agreement which plaintiff Harnett had executed required that when a stockholder left the employ of the company that he sell his shares back to the company at a price equal to their book value at the end of the prior quarter.
In 1963 or early 1964, Edward Ryan, a talented executive and experienced home builder, became aware of the existence and availability of an 8000 acre tract near St. Charles City, Maryland.
He considered the land suitable for housing construction if sufficient funds and personnel could be found to develop it. Edward Ryan intended to undertake this vast project with Ryan Homes, but he found opposition within his Board of Directors.
Mr. Ryan was not easily dissuaded. Thwarted by his Board of Directors in his plan to have Ryan Homes directly involved in the development of the St. Charles tract, Ryan sought to involve the company indirectly. It was at this time (late 1964) that Sampson-Miller Associated Companies, Inc., (hereafter SMAC) entered the picture. No doubt, however, there had been prior discussion with SMAC, and there is no doubt that Edward Ryan sought the assistance of SMAC
so that he could use it and its subsidiaries to develop the land. Ryan Homes then would have an outlet in Maryland for its homes.
On December 26, 1964, SMAC (which by this time Edward Ryan controlled through stock and financial arrangements)
through its wholly owned subsidiary, Hallmark Homes, Inc., entered into an agreement with St. Charles City, Inc. to purchase 1400 lots in the St. Charles development on which it would build homes. The agreement, among other things, gave Hallmark exclusive building rights at St. Charles and set up a multi-step schedule under which St. Charles City, Inc. would "develop" the lots on the tract of land. The lots, of course, were of no great value until developed (i.e., roads, streets, curbs, etc., in place), approved by the municipalities involved and ready for sale to a builder who could build and sell homes.
SMAC was not able financially without Edward Ryan's help and backing to engage in the contemplated construction of homes. In fact, it was involved in Chapter XI bankruptcy proceedings. St. Charles City, Inc. was also in some financial difficulty. Nevertheless, Edward Ryan, who saw a great opportunity in the St. Charles project, was able to arrange and negotiate a $4.75 million loan to St. Charles City, Inc. from Western Pennsylvania National Bank for use in so-called acquisition and development. Edward Ryan personally guaranteed $200,000 of the loan and persuaded Celotex Company to guarantee $500,000 and the Berens Company, (through their parent company, Associated Mortgages Company, Inc.) to guarantee another $500,000.
The financing for the development of the land having been arranged, the project hit a snag: Sampson Brothers of Maryland which had started to build a few homes in early 1965 was having trouble pleasing customers. One veteran, in particular, complained to the Veterans Administration (VA) that the defective foundation in his new house did not meet VA standards. Consequently, SMAC began to get into hot water with both the VA and The Federal Housing Administration (FHA) -- a critical development since no project the size of St. Charles could succeed without homes that met the standards required to obtain VA and FHA financing. In March 1965 the VA was threatening to disqualify SMAC as a builder of VA financed homes.
By April, 1965, it appears to us that Edward Ryan was in considerable trouble. He was deeply involved in a project that was starting to turn sour. He had personally guaranteed a $200,000 loan to St. Charles and had used his friendship and connections with the Celotex Corporation to involve them in what appeared might be a highly precarious loan guarantee. The Ryan Homes Board of Directors was not interested in a merger with SMAC and had affirmed their previous coolness toward the St. Charles project in general. Edward Ryan turned to his brother, James, who we have previously indicated was also a Ryan Homes executive, and attempted to persuade him to take over and manage the St. Charles development. James Ryan, however, remained adament in his opposition to the project and refused his brother's offer.
Edward Ryan then turned to Harnett. Edward Ryan had brought Harnett into the Ryan Homes organization, trained and promoted him, and considered him an extremely able executive (an assessment later events demonstrated to be amply correct). In the course of their business and personal relationship Harnett became privy to Edward Ryan's business thinking and planning, especially about taking Ryan Homes public. He had also become familiar -- perhaps intimately familiar -- with the St. Charles project. He was acquainted with the operations and personnel of St. Charles City, Inc., SMAC, Hallmark Homes and Sampson Brothers of Maryland. He knew about their involvement in the St. Charles project and the role and motives of Edward Ryan in backing SMAC. In fact, he made trips to Maryland and attended meetings concerning the St. Charles project on behalf of Edward Ryan.
In early 1965 Edward Ryan began to attempt to persuade Harnett to go to SMAC and take over the St. Charles project. Harnett testified he was reluctant to leave Ryan Homes for the new position, essentially because he did not want to sell his 1000 shares of Ryan Homes stock (as the buy-sell agreement would require) when it seemed that Ryan Homes was about to go public and he would be able to sell his shares at a great profit. On April 24, 1965, Edward Ryan told the Ryan Homes Board of Directors that no employee except himself would be able to sell his shares to the public for five years after the first public offering. Subsequently, on May 13, 1965, Harnett and Edward Ryan reached an agreement under which Harnett went to SMAC.
The basic agreement was embodied in a handwritten note (Exhibit H-W49B) signed by both Harnett and Edward Ryan. Although it contained many terms, in essence the agreement was that Harnett would resign from Ryan Homes and go to work for SMAC; that he was to receive a salary of $4000 per month;
and that he was to sell his 1000 shares of Ryan Homes stock back to the corporation for $150.00 per share.
A "run-up" clause provided that Harnett would also be paid the difference, if any, between the price he received for the stock when he sold it and what it was worth on December 31, 1965.
As agreed Harnett did resign from Ryan Homes and go to work for SMAC. In fact, he became a director of SMAC and we believe he was a substantial guiding force in SMAC after his arrival. He was not paid by SMAC, however. He was paid through the PennClair Construction Company, a corporation wholly owned by Edward Ryan.
It was out of this basic story that the present litigation evolved. For purposes of perspective and context, we will fill in the picture of the years 1965 to 1968 with sketchy details now, and provide more substance when we consider and evaluate the particulars of the 10(b)-5 action and the other breach of contract questions.
In June, 1965, Edward Ryan issued a directive that the name "Ryan Homes"
not be used in descriptions of the homes built at St. Charles.
In July, 1965, Edward Ryan told Harnett that the underwriters for the public stock offering, White, Weld, had advised him in late 1964 or early 1965 that in order for Ryan Homes to go public, Ryan Homes had to disassociate from SMAC. According to Harnett's testimony this was the first he had heard about any possible disassociation.
In September, 1965, Edward Ryan told Harnett that on December 28, 1964, Ryan Homes had received an option to take from Hallmark Homes (SMAC's wholly owned subsidiary) at any time, its exclusive rights under the basic December 26, 1964 contract to construct homes at St. Charles. Again, according to Harnett's testimony, this was the first time he had known of the right of reassignment.
In October, 1965, the threatened VA and FHA disqualification of SMAC occurred. In order to get around the disqualification and still fulfill SMAC's obligations under the December 26, 1964 agreement with St. Charles City, Inc., a new corporation, Washington Homes, was formed. Harnett paid the $10,000 organizational fees and became President, Chairman of the Board, and only stockholder of Washington. Hallmark assigned the December 26, 1964 agreement to Washington and Washington then owned all of the exclusive rights which Hallmark had owned and had optioned to Ryan Homes.
By December, 1965, White, Weld and Co., for reasons not in the record, had decided not to take Ryan Homes public. In 1966, Ryan Homes suffered severe financial reverses but in 1967 had begun a comeback. In 1968 Ryan Homes finally went public in an offering in which some Ryan Homes employees in addition to Edward Ryan were permitted to participate. The underwriting firm was Faulkner, Dawkins and Sullivan Securities, Inc.
Washington Homes became a successful and profitable corporation and in 1969 it, too, went public.
Both Edward Ryan and Harnett have become very wealthy men. It is apparent that Harnett has gained at least as much wealth from the ownership or sale of Washington stock as he would have gained from the ownership or sale of the Ryan Homes stock he now seeks to recover.
(1) Edward Ryan made a misrepresentation of material fact or misleading statement by omission when he told the Ryan Homes Board of Directors in April, 1965, that no Ryan Homes employee except himself could go public for five years after the first public stock offering.
(2) Edward Ryan made misrepresentations of material facts or misleading statements by omission when, during negotiations with Harnett in the spring of 1965, he said that "Ryan Homes" would always be built in St. Charles.
(3) Edward Ryan made misrepresentations of material facts or misleading statements by omission when, during negotiations with Harnett in the spring of 1965, he said that Ryan Homes and SMAC would merge.
(4) Edward Ryan made a misleading statement by omission when, during the course of negotiations with Harnett in the spring of 1965, he did not tell Harnett that Ryan Homes had an assignment option on the December 26, 1964 agreement between St. Charles City, Inc. and Hallmark Homes.
As we see it, allegations numbers 1, 2, and 3, in effect, assert alternate violations: either the statements themselves were false, or there was a misleading omission. The misleading omissions in allegations 1, 2 and 3 were:
(1) that under the first allegation at the time or shortly after Edward Ryan made the statement to the Board of Directors he had devised a plan under which some employees of Ryan Homes would go public; and
(2) that under the second and third allegations Edward Ryan did not tell Harnett that White, Weld Co. had advised him in late 1964 or early 1965 that they would not take Ryan Homes public unless it disassociated from SMAC. (Consequently, "Ryan Homes" would not be built at St. Charles and there would be no merger between Ryan Homes and SMAC).
In summary our rulings are as follows:
(1) Harnett was an insider insofar as the alleged misrepresentations in No. 2 and No. 3 and the alleged omission in No. 4 are concerned because we think he must ...