The opinion of the court was delivered by: LOUIS H. POLLAK
a group of individual investors, purchased security interests in two limited partnerships -- the Sovereign Realty 1984-VII, Ltd., d/b/a The Sovereign Building, a Pennsylvania limited partnership ("the Sovereign Partnership") and Sovereign Realty 1985-2 Ltd., d/b/a Crestwood Apartments, limited partnership ("Crestwood Partnership") -- organized and promoted by defendants, Sovereign Group, Inc., Butcher & Company, Sovereign Realty Management, Deilwydd Properties 303-A, Ltd., Lyle W. Hall, Jr., John S. Seal, Jr., Deilwydd Properties 603-A, Ltd., Butcher & Singer, Inc., B&S and Sovereign Management,
and Deilwydd Properties 304-A. Plaintiffs from Exhibit A of the amended complaint ("A-plaintiffs") purchased securities in the form of cash and notes in the Sovereign Partnership, while plaintiffs from Exhibit B of the amended complaint ("B-plaintiffs") purchased securities in the form of cash and notes from the Crestwood Partnership.
In connection with the above securities transactions, A-plaintiffs allege that Sovereign Group, Inc., Butcher & Company, Sovereign Realty Management, Deilwydd Properties 303-A, Ltd., Lyle W. Hall, Jr., John S. Seal, Jr., Deilwydd Properties 603-A, Ltd., and Butcher & Singer, Inc. ("Sovereign defendants") violated § 10(b) of the Securities Exchange Act (15 U.S.C. § 78j(b)) and Rule 10b-5 promulgated thereunder (Claim I). In addition, all plaintiffs allege that defendants: engaged in a pattern of racketeering activity in violation of RICO, 18 U.S.C. §§ 1961 et seq. (Claim II); and engaged in conduct that was fraudulent (Claim III), negligent (Claim V),
and in breach of their fiduciary duty (Claim VI).
Presently before the court is defendants' motion to dismiss plaintiffs' claims pursuant to Federal Rules of Civil Procedure 9(b) and 12(b)(6). For the following reasons, defendants' motion shall be granted in part and denied in part.
A claim should be dismissed under Fed.R.Civ.P. 12(b)(6) only where, taking all allegations of the complaint as true, and making all reasonable inferences in the complainant's favor, "it appears beyond doubt that the plaintiffs can prove no set of facts in support of their claim which would entitle them to relief." Wisniewski v. Johns-Mansville Corp., 812 F.2d 81, 83 n.1 (3d Cir. 1987) (citations omitted); see also Unger v. National Residents Matching Program, 928 F.2d 1392 (3d Cir. 1991.) The standard is the same for RICO and non-RICO claims. Rose v. Bartle, 871 F.2d 331, 355 (3d Cir. 1989).
In general, a court may not consider materials outside the pleadings and the briefs without converting a motion to dismiss into a motion for summary judgment. Fed.R.Civ.P. 56. However, since the above three documents are integral to the plaintiffs' complaint, I believe that they are properly reviewable on a 12(b)(6) motion. "A contrary holding would enable plaintiffs to survive a 12(b)(6) motion where the terms of the document on which the claim is based would render the complaint insufficient as a matter of law, simply by refusing to attach the document to the complaint." Goodwin v. Elkins & Co., 730 F.2d 99, 113 (3d Cir. 1984) (Becker, J., concurring).
See In re Donald Trump Casino Securities Litigation, 793 F. Supp. 543, 546 n. 1 (D.N.J. 1991). See also I. Meyer Pincus & Assoc. v. Oppenheimer & Co., 936 F.2d 759, 762 (2d Cir. 1991); Romani v. Shearson Lehman Hutton, 929 F.2d 875, 879 n. 3 (1st Cir. 1991). While I will refer to the three documents mentioned, as well as to the published opinions from the district courts from the Southern District of New York and from the District of New Jersey, I find it unnecessary to refer to the other materials submitted by defendants to decide the present motion.
As explained by plaintiffs, defendants formed a number of limited partnerships during the early 1980's. These limited partnerships would purchase or lease property, offering for sale units of the property to interested investors. At that time, investment in real estate was a rather safe investment, providing opportunities for property appreciation, profit and tax benefits.
According to plaintiffs, defendants played the following roles within the limited partnerships:
(a) Deilwydd Properties 303-A, Ltd. ("303-A") is a Pennsylvania limited partnership. 303-A acted as general partner for the Sovereign Partnership. 303-A's general partners were defendants Lyle W. Hall, Jr. and John S. Seal, Jr.
(b) Deilwydd Properties 603-A, Ltd. ("Contractor") is a Pennsylvania limited partnership. Deilwydd Properties 603-A acted as the contractor for the Sovereign Partnership. The Contractor's general partners were also defendants Lyle W. Hall, Jr. and John S. Seal, Jr.
(c) Deilwydd Properties 304-A ("304-A") is a Pennsylvania limited partnership. 304-A acted as general partner for the Crestwood Partnership. 304-A's general partners are also defendants Lyle W. Hall, Jr. and John S. Seal, Jr.
(d) Lyle W. Hall, Jr. ("Hall") acted as a general partner of 303-A, 304-A and Contractor.
(e) John S. Seal, Jr. ("Seal") acted as a general partner of 303-A, 304-A and Contractor.
(g) Butcher & Company ("Butcher") is a Pennsylvania corporation and is the parent company of Sovereign. In addition to Sovereign Group, Inc., . . . Butcher and Singer, Inc. is a wholly owned subsidiary of Butcher.. . .
(h) Butcher and Singer, Inc. ("B & S") is a Pennsylvania corporation and a wholly owned subsidiary of Butcher. B & S acted as the selling agent for both the 303-A and 304-A partnerships.
(i) Sovereign Realty Management ("Sovereign Realty") is an unincorporated subsidiary of Butcher. Sovereign Realty acted as the management company for the 303-A and 304-A projects.
Amended Complaint ("Am. Comp.") at P 7. This case involves defendants' conduct with respect to two of their supposedly many limited partnerships: the Sovereign Partnership and the Crestwood Partnership. I will address each transaction in turn.
A. The Sovereign Partnership
The Sovereign Partnership, in which only the A-plaintiffs invested, was formed "to acquire, renovate and operate, as an office and retail complex, four buildings located next to each other in Philadelphia, Pennsylvania." Am. Comp. at P 20. The goals of the partnership were to preserve the partners' capital contribution, garner a return on the investment once the project began operating in 1989, appreciate the value of the project, and receive tax benefits. Am. Comp. at P 22 (citing the Private Placement Memorandum distributed by the Sovereign Partnership ("Sovereign PPM") in connection with the sale of the property units).
The renovation of the Sovereign buildings was supposed to commence in 1984 and be completed by 1985. Am. Comp. at P 21. Defendant Deilwydd Properties 603-A, Ltd. was hired by the Sovereign Partnership as the contractor responsible for the renovation. Under the construction contract, the contractor was responsible for the design and execution of all renovations, and would pay "all project costs" as defined in the contract. Am. Comp. at P 25.
The construction contract, affixed as an appendix to the Sovereign PPM, also provided that the renovation was to be done for the fixed price of $ 10,550,000. Am. Comp. at P 26. Accordingly, the Sovereign Partnership acquired a $ 12,000,000 loan to finance the project. Am. Comp. at P 26. A-plaintiffs explain that they distinctly relied on defendants' representation that the construction costs would be fixed in deciding to invest in the partnership. Am. Comp. at P 27.
However, not atypically, the construction costs exceeded expectations and the contractor refused to complete the renovation for $ 10,550,000, claiming that the contract did not contemplate "finishing" costs. The Sovereign Partnership agreed and permitted an increase in construction costs. The Sovereign Partnership was forced to negotiate a new loan in 1987 for $ 18,000,000 -- 50% more debt than plaintiffs originally expected to incur. Plaintiffs contend that the Sovereign Partnership was not in a sufficiently strong financial position to service the increased debt. Yet, defendants failed to inform the investors of the threatened state of the partnership.
About two years later, though, in July 1989, the Sovereign Partnership did inform plaintiffs of the partnership's "dire financial straits." Am. Comp. at P 32. In addition, defendants told its investors that Seal and Hall were being replaced as the general partners of 303-A, "and as a requirement for the change, the limited partners [of the Sovereign Partnership] would be forced to relinquish a substantial portion of their interest in the limited partnership." Am. Comp. at P 32.
B. The Crestwood Apartment Project
The Crestwood Partnership was "organized to acquire and operate a 267-unit apartment complex located in Mesa, Arizona." Am. Comp. at P 43. The goals of the partnership were to preserve the partners' capital contribution, to appreciate the value of the project, and to receive tax benefits and cash distributions. Am. Comp. at P 44 (citing the Crestwood Apartment Private Placement Memorandum ("Crestwood PPM") distributed to investors in connection with the sale of the property units).
According to plaintiffs, these goals could only be achieved if the Crestwood Partnership held the land for several years. During those years, the partnership would be responsible for certain monthly expenses and debt service payments. In order to assure investors that the Crestwood Partnership would have sufficient incoming income to cover their costs, the partnership hired the accounting firm of McGlarrey, Henderson and Pollen to prepare income projections regarding revenues and expenses. These projections, included in the Crestwood PPM, concluded that the partnership's receipts would cover the expenses. Am. Comp. at P 48.
Now, plaintiffs contend that the assumptions used to create the projections were unreasonable. A good portion of the Crestwood Partnerhip's revenues would come from apartment rentals. In making the partnership's financial projections, the accounting firm assumed a vacancy/rent loss rate
of 5%. According to plaintiffs, the vacancy/rent loss rates for the Phoenix metropolitan area -- which includes Mesa -- ranged from 6.8% to 10.8% in 1984. Am. Comp. at PP 51,53. In that the financial projections for the partnership served to predict the ultimate viability of the Crestwood Partnership project, plaintiffs allege that they relied on them in the decision to purchase their interests.
This is not the first time the plaintiffs have brought suit against the defendants with respect to the Sovereign or Crestwood Partnerships. On February 1, 1990 A-plaintiffs sued the Sovereign defendants in the Southern District of New York. According to plaintiffs, "the allegations in that [New York action] Complaint are essentially repeated here in this Amended Complaint." Plaintiffs' Mem. of Law in Opp. to Defendants' Motion to Dismiss ("Plaintiffs' Opp.") at 16. The Sovereign defendants moved to dismiss the complaint on the grounds that the forum selection clause in the Sovereign Partnership Agreement required that the case be heard in Pennsylvania. The district court agreed and dismissed the case on October 4, 1991. Plaintiffs' Opp. at 17.
Plaintiffs filed the present action on April 9, 1992.
Defendants assert that plaintiffs' amended complaint should be dismissed under Fed.R.Civ.P. 12(b)(6) as plaintiffs have failed in each count to state a claim upon which relief can be granted. According to defendants, all of plaintiffs' claims are either time-barred or do not state a cause of action. In addition, defendants contend that plaintiffs' fraud claims should be dismissed under Fed.R.Civ.P. 9(b) as plaintiffs have failed to plead fraud with sufficient particularity.
I will discuss each of plaintiffs' five claims.
A-plaintiffs have alleged that the Sovereign defendants violated § 10(b) and Rule 10b-5 by making material misrepresentations and omissions in the Sovereign PPM in connection with the sale of securities. Am. Comp. at P 66; Plaintiffs' Opp. at 43-44. Sovereign defendants contend that A-plaintiffs' securities claim is time-barred. I agree.
1. Statute of Limitations
A-plaintiffs filed their § 10(b) claim in New York district court in February 1990. Upon the dismissal of the claim by the New York court, A-plaintiffs refiled their § 10(b) claim in Pennsylvania district court in April 1992. In the time between these two filings, the law concerning the limitations period for § 10(b) claims underwent a dramatic change.
The Securities Exchange Act does not specify the limitations period for § 10(b) claims, and as of February 1990 the circuits were split as to how this time period should be determined. At that time, a number of circuits -- including the Second Circuit -- ascertained the statute of limitations for § 10(b) claims by looking to state statutes of limitations for parallel causes of action. See Ahmed v. Trupin, 781 F. Supp. 1017 (S.D.N.Y. 1992) (discussing history of Second Circuit law concerning limitations period for § 10(b) claims). For example, the Second Circuit applied the New York statute of limitations for fraud to § 10(b) claims, requiring § 10(b) plaintiffs to bring their claims within two years of discovering the violation and in no case later than six years of the violation. N.Y.Civ.Prac.L. & R. § 213(8). Other courts -- including the Third Circuit -- considered it inappropriate that the statute of limitations for a § 10(b) claim would vary from state to state and believed there should be a uniform federal statute of limitations. See In re Data Access Systems Securities Litigation, 843 F.2d 1537 (3d Cir.), cert. denied, 488 U.S. 849 (1988); Short v. Belleville Shoe Manufacturing Co., 908 F.2d 1385 (7th Cir. 1990), cert. denied, U.S. , 111 S. Ct. 2887 (1991). Looking to the limitations periods for analogous federal securities law,
the Third Circuit concluded that the statute of limitations for a § 10(b) claim was "one year after the plaintiff discovers the facts constituting the violation, and in no event more than three years after such violation." Data Access, 843 F.2d at 1550; accord Belleville Shoe, supra. In November 1990, some months after A-plaintiffs commenced their action against Sovereign defendants in New York court, the Second Circuit changed its practice and adopted the federal limitations period set out in Data Access and Belleville Shoe. Ceres Partners v. GEL Associates, 918 F.2d 349, 358-60 (2d Cir. 1990).
Because A-plaintiffs filed their claim in the midst of this upheaval concerning the limitations period for § 10(b) claims, a question arises as to what statute of limitations applies to their claim. A-plaintiffs argue that the New York statute of limitations for § 10(b) claims as of February 1990 applies, while the Sovereign defendants contend that the uniform federal statute of limitations announced in Lampf and/or Data Access controls.
On the same day that the Court decided Lampf, the Court also decided James Beam Distilling Co. v. Georgia, 501 U.S. , 115 L. Ed. 2d 481, 111 S. Ct. 2439, 2448 (1991), concluding that in the civil context "when the Court has applied a rule of law to the litigants in one case it must do so with respect to all others not barred by procedural requirements or res judicata." In light of James Beam, it was "evident that the retroactive ruling in Lampf [was] to be applied retroactively to all cases not finally adjudicated on the date when Lampf was decided." Welch v. Cadre Capital, 946 F.2d 185, 187 (2d Cir. 1991) ("Welch II ").
In an effort to limit the retroactive application of Lampf, Congress amended the Securities Exchange Act of 1934 on December 19, 1991 by adding after section 27, 15 U.S.C. § 78aa, a new section 27A, 15 U.S.C. § 78aa-1. Under § 27A, Lampf applied only to cases commenced after the day Lampf was decided, June 19, 1991. See Securities Exchange Act of 1934, § 27A, 15 U.S.C. § 78aa-1. Section 27A states:
(a) EFFECT ON PENDING CAUSES OF ACTION. -- The limitations period for any private civil action implied under 10(b) of this Act that was commenced on or before June 19, 1991, shall be the limitation period provided by the laws applicable in the jurisdiction, including principles of retroactivity, as such existed on June 19, 1991.
(b) EFFECT ON DISMISSED CAUSES OF ACTION. -- Any private civil action implied under section 10(b) of the Act that was commenced on or before June 19, 1991 --
(1) which was dismissed as time barred subsequent to June 19, 1991, and
(2) which would have been timely filed under the limitation period provided by the laws of applicable in the jurisdiction, including principles of retroactivity, as such laws existed on June 19, 1991,
shall be reinstated on motion by the plaintiff not later than 60 days after the date of enactment of this section.
Federal Deposit Insurance Corporation Improvement Act of 1991, Pub.L. No. 102-242, § 476, 105 Stat. 2236. See generally Maio v. Advanced Filtration Systems, et al., 795 F. Supp. 1364 (E.D. Pa. 1992).
The centerpiece of A-plaintiffs' argument is their belief that under the Pennsylvania saving clause, 42 Pa. Cons. Stat. Ann. § 5535 (1981),
they had a grace period of one year in which to refile their action following the dismissal of their New York action without prejudice. According to A-plaintiffs, they had one year from October 4, 1991 to refile their complaint, and they did so -- filing the present complaint in April 1992.
However, a state saving clause can not be used to extend a federal limitation period. See 4 C.Wright & A.Miller, Federal Practice and Procedure § 1056, 192-193 (1987). Whether one looks to the date A-plaintiffs filed their New York action (February 1990), or the date the case was dismissed (October 1991), or the date the case was refiled in this court (April 1992), the Third Circuit at all these times applied a federal statute of limitations to § 10(b) claims. See Data Access, supra (decided in 1988). Accordingly, A-plaintiffs' reliance on § 5535 is unavailing. The only question then is whether A-plaintiffs filed their § 10(b) claim in this court within the federal statute of limitations set out in Data Access.
Nor did plaintiffs file the action within three years of the events complained of. Defendants suggest that the date the securities were purchased by investors marks the date of the violation. See Defendants' Motion to Dismiss Amended Complaint ("Motion to Dismiss") at 14. Plaintiffs on the other hand suggest that the violation occurred when Sovereign defendants wrote the allegedly false Sovereign PPM. See Plaintiffs' Opp. at 21-22. Using either date, A-plaintiffs' § 10(b) claim is untimely. A-plaintiffs state that the alleged § 10(b) violation "commenced in approximately 1984." Am. Comp. at 66. Given that the renovations were supposed to be completed by 1985, it makes sense that both the sale of the securities and the writing of the Sovereign PPM occurred at least before 1985. Under Data Access, therefore, the latest plaintiffs could have filed their § 10(b) claim in Pennsylvania court would have been some time in 1987. Again, A-plaintiffs did not file the present matter until April 1992.
In sum, A-plaintiffs' § 10(b) and Rule 10(b)(5) claims were not filed within the statute of limitations. Thus, claim I will be dismissed.
Because the allegations of fraud underlie plaintiffs' RICO claim against defendants, it would be useful at this point to consider the validity of plaintiffs' common law fraud claim. Plaintiffs allege that the defendants' conduct with regard to the Sovereign and Crestwood Partnerships constituted fraud (claim III). Although the substance of the alleged fraud is not explicitly delineated by plaintiffs, it appears from the nature of the allegations against defendants that plaintiffs are raising a claim of fraudulent misrepresentation. To state a claim for fraudulent misrepresentation under Pennsylvania law, plaintiffs must plead (1) misrepresentation, (2) fraudulent utterance thereof, (3) intention by the maker that recipient will be induced to act, (4) reasonable reliance by the recipient on the misrepresentation, and (5) injury to recipient as a proximate result. See, e.g. Tunis Bros. Co., Inc. v. Ford Motor Co., 952 F.2d 715, 731 (3d Cir. 1991), cert. denied, 120 L. Ed. 2d 903, 112 S. Ct. 3034 (1992). In stating a claim for fraudulent misrepresentation, as compared to negligent misrepresentation, plaintiffs must demonstrate that the misrepresentation was made knowingly or recklessly by defendants. See, e.g. Brindle v. West Allegheny Hospital, 406 Pa. Super. 572, 594 A.2d 766, 768 (Pa.Super. 1991) (interpreting "fraudulent utterance" element as referring to defendant's scienter) (citing B.O v. C.0., 404 Pa. Super. 127, 590 A.2d 313 (1991)).
Taking a rather cynical view of plaintiffs' allegations, defendants suggest that plaintiffs' claims of fraud are nothing more than fraud by hindsight and should thus be dismissed under Fed.R.Civ.P. 12(b)(6). As defendants view the allegations, plaintiffs realized that defendants' projections regarding the success of the Sovereign and Crestwood projects were incorrect, and therefore concluded that there must have been fraud. Defendants further argue that where projections are accompanied by document language that "bespeaks caution," the projections even if incorrect cannot be the basis of a fraud claim. Motion to Dismiss at 33.
Since the allegations of fraud with respect to the Sovereign Partnership and the Crestwood Partnership differ, I will address them separately.
As an initial matter, I do not agree with defendants' characterization of plaintiffs' fraud claim against defendants with respect to the Sovereign Partnership. Upon review of the claims stemming from the Sovereign Building partnership, I am not convinced that they are an example of fraud by hindsight. Plaintiffs are not alleging, as defendants suggest, that the Sovereign PPM understated the potential benefits coming plaintiffs' way. Rather, in their main allegation of fraud plaintiffs assert that the Sovereign defendants promised to renovate the buildings for a fixed amount while knowing that the renovation would cost more. Am. Comp. at PP 37(a), 39(a),(b). While it is true that a promise to do something in the future can not serve as a basis for a fraud claim, the "essence of fraud is in the misrepresentation that occurs when a defendant makes a bargain with no intention of living up to it." American Trade Partners v. A-1 International Importing, 755 F. Supp. 1292, 1301 (E.D. Pa. 1990). Since plaintiffs have alleged that defendants had no intention of renovating the Sovereign buildings for the fixed price given in the offering memorandum, plaintiffs have a valid fraud claim with respect to the Sovereign Partnership.
Defendants argue that the presence of cautionary language in the Sovereign PPM specifically warning of the risks of construction precludes plaintiffs' fraud claim. If the facts of this case were only that defendants' estimated construction costs went awry, perhaps defendants' argument would be persuasive. However, defendants were not estimating a cost, they were promising a fixed price. The "bespeaks caution" doctrine has no application in the context of broken promises.
The case generally considered seminal with respect to the "bespeaks caution" doctrine, and cited by defendants, is Luce v. Edelstein, 802 F.2d 49, 56 (2d Cir. 1986). See In re Donald J. Trump Casino Securities Litigation, 793 F. Supp. 543, 549 (D.N.J. 1992) (noting that the First, Second, Sixth, Eighth and Ninth Circuit Courts have adopted the "bespeaks caution" approach of Luce). In Luce, plaintiffs alleged two groups of misrepresentations: one concerned the extent of tax and financial benefits the investors would receive and the other concerned promises made by the general partners to the investors. As to the first group of misrepresentations, the Luce court concluded:
the Offering Memorandum warned prospective investors that "actual results may vary from the predictions and these variations may be material." We are not inclined to impose liability on the basis of statements that clearly "bespeak caution." Polin v. Conductron Corp., 552 F.2d 797, 806 n. 28 (8th ...