STRATTON GROUP, LTD. v. SPRAYREGEN

OPINION

KEVIN THOMAS DUFFY, District Judge:

This action was originally brought by the Stratton Group Ltd., [hereinafter referred to as "Stratton"] against Gerald, Herman and Seymour Sprayregen, three officers and/or directors thereof, [hereinafter collectively referred to as "the Sprayregens"] alleging violations of Section 10(b) of the Securities Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder, as well as claims of common law fraud and breach of fiduciary duty. The defendants, as third party plaintiffs, have individually filed complaints, pursuant to Rule 14, Fed. R.Civ.P., against seven third party defendants. Four of the third party defendants — Marshall, Bratter, Greene, Allison and Tucker ("Marshall Bratter"), Laventhol and Horwath Accountants ("Laventhol"), Moe Bordwin ("Bordwin") and Stanley Gruber ("Gruber"), have moved, pursuant to Rules 12 and 9 of the Fed.R.Civ.P., to dismiss the complaints for failure to state a claim upon which relief can be granted or, in the alternative, for failure to plead fraud with the requisite particularity. A fifth third party defendant, Milton Hausen ("Hausen"), has moved for summary judgment.

The main action, as well as the third party action, emanate from an agreement, executed in April 1970, between John's Bargain Stores, as predecessor of Stratton, and N.L.P. Fredi Inc., a newly formed subsidiary of Stratton. Pursuant to said agreement, Fredi agreed to issue all of its common stock to Stratton and all of its preferred shares to the Sprayregen & Co., Inc. shareholders, which included only one of the third-party plaintiffs herein — Gerald Sprayregen. These preferred shareholders were given the option to put all their shares, staggered over a three-year period, to Stratton. The contract also imposed certain restrictions upon which funds were to be used by Stratton to pay the agreed consideration of $15,000,000 for the put:

The Stratton complaint charges that Gerald and Herman Sprayregen, as officers and directors of Stratton, together with Seymour Sprayregen, as a Stratton director, engaged in a variety of fraudulent conduct calculated to induce Stratton to enter into the Agreement of April, 1970, which provided for a grossly inflated price to be paid for the shares to be put by the shareholders of Sprayregen & Co., Inc. thereunder. It was further charged that upon inducing the Agreement the defendants, to complete their fraudulent scheme, caused Stratton to pay for the put shares out of funds other than "excess cash," in violation of the conditions set forth in the Agreement. Plaintiffs argue that defendants' activities were violative of Section 10(b) and Rule 10b-5, as well as constituting common law fraud and breach of their respective fiduciary relationships with Stratton.1 Suffice it to say that the complaint alleges intentional fraud and deception attributable to the Sprayregens.

The defendants have in turn charged, in their third party complaints, that should they be held liable to Stratton they are entitled to "indemnity, reimbursement and contribution" from third party defendants based upon the roles played by the various third party defendants in the execution of the April Agreement and the subsequent put made pursuant thereto.

Marshall, Bratter

Marshall Bratter, a partnership engaged in the practice of law, was apparently acting as legal counsel to both Stratton and Gerald Sprayregen during the time period relevant to this action.2 It is upon this relationship that the three Sprayregens bring their third party actions against Marshall Bratter. More particularly, the complaints, each parroting the identical language, charge that:

A complaint should be dismissed for failure to state a claim only when it can be demonstrated beyond doubt that the plaintiff can prove no set of facts in support of his claim entitling him to relief. Cruz v. Beto, 405 U.S. 319, 322, 92 S.Ct. 1079, 31 L.Ed.2d 263 (1972).

Applying this standard to the complaints lodged against Marshall Bratter I find all three complaints unable to survive the instant motion.

It is undisputed that the three Sprayregen complaints in issue stem solely from the attorney/client relationship between Marshall Bratter, Gerald Sprayregen and the Stratton Corp. Moreover, in this regard the complaints allege claims founded exclusively upon the law of negligence.

In order to state a valid claim for negligence, sufficient to withstand a motion to dismiss, a plaintiff must allege (i) the existence of a duty owed by defendant to plaintiff; (ii) breach of this duty; (iii) resultant injury to plaintiff; and, (iv) a causal relationship between defendant's conduct and plaintiff's injury.

Applying these elements to the individual complaints of Herman and Seymour Sprayregen, I find them woefully deficient. The complaints are void of any allegations whatsoever concerning what, if any, relationship existed between Herman, Seymour and the law firm of Marshall Bratter. Indeed, they do not contend, nor could they on the facts of this case, that there existed any attorney/client relationship between them and Marshall Bratter.3 Absent such relationship they have failed to allege any basis upon which a duty owed by Marshall Bratter to Herman and Seymour may be founded. Consequently, their complaints, as against Marshall Bratter, must fall.

Turning to Gerald Sprayregen a different analysis obtains. It appears that Marshall Bratter represented Gerald Sprayregen between September 1970 through February 1971. (See Third-Party Plaintiff's Exhibit A). Thus, he has established a relationship sufficient to state a claim for negligence. The question remains, however, whether a theory of negligence is sufficient to support a claim of contribution4 in the instant action.

It is now settled that contribution is a remedy which is available to defendants guilty of violations of the federal securities laws.5 See, e. g., Rice v. McDonnell & Co., Inc., 442 F.Supp. 952, 954 (S.D.N.Y.1977). It is equally as clear, however, that the right of contribution in such cases has been limited solely to recovery among joint tortfeasors.6 See Index Fund, Inc. v. Hogopian, 417 F.Supp. 738, 746 n.6 (S.D.N.Y.1976) (emphasis added). Thus, a necessary predicate for contribution in the instant action is an allegation that Marshall Bratter was a joint participant in the fraud alleged in the main action. de Haas v. Empire Petroleum Co., 286 F.Supp. 309, 815-16 nn.9-10 (D.Colo.1968), modified in 435 F.2d 1223 (10th Cir.).

Applying this standard to the complaint in issue it is obvious that the complaint is totally deficient. There is simply no allegation whatsoever that Marshall Bratter was a joint participant in the alleged fraud. Indeed, the only conduct allegedly engaged in by Marshall Bratter was preparation of the Agreement of April 1970. Absent an allegation that the Agreement was somehow fraudulent per se, mere preparation of the Agreement is a far cry from the type of joint participation necessary for purposes of contribution. Indeed, even assuming Marshall Bratter was "negligent" in the preparation of the Agreement in issue, this would cast Marshall Bratter at best as an independent or concurrent tortfeasor. As such, Marshall Bratter does not fall within the doctrine of contribution.

Gerald Sprayregen argues that in order to state a valid claim under Rule 14, Fed.R.Civ.P., he must simply allege that the third-party defendant "is or may be liable" to him and not that the third-party defendant is liable to the plaintiff in the main action.7 This is undoubtedly true. See, e. g., Index Fund, Inc. v. Hagopian, 417 F.Supp. 738 (S.D.N.Y.1976). What Gerald Sprayregen fails to perceive, however, is that Rule 14 is merely a procedural device, the availability of which is governed by the above stated principle. Once the third party action is properly brought, the liability of the third-party defendant requires an independent substantive basis. In other words, Rule 14 does not in itself provide a substantive theory of recovery but stands merely as a procedural device. Index Fund, supra, 417 F.Supp. at 743-44.

In the case at bar Gerald Sprayregen grounds his third party action on the substantive law of contribution between joint tortfeasors. Consequently, it is upon Gerald Sprayregen's failure to state a claim capable of remedial action under the substantive law of contribution that the complaint in issue fails rather than upon a failure to satisfy the procedural requirements of Rule 14.

The same analysis applies with equal force to Gerald Sprayregen's attempt to seek contribution on the basis of common law fraud. A precondition of contribution between two parties is that they be joint tortfeasors, the absence of which precludes any claim for contribution. The complaints in issue fail to allege any joint participation between Marshall Bratter and the Sprayregens in the alleged fraud. In light of the frivolous nature of the actions filed against Marshall Bratter, I find this an appropriate situation in which to assess costs and attorneys fees against the three Sprayregens on a pro rata basis.

Moe Bordwin and Stanley Gruber

Moe Bordwin, an attorney, was retained by Stratton as counsel and was a member of its board of directors when the April Agreement was executed and when the put was exercised thereunder. Stanley Gruber was executive vice president of Stratton during this same period.

The third party complaints lodged against Bordwin allege that not only was he instrumental, as corporate counsel, in the execution of the Agreement in issue, but he was also responsible, in part, for Stratton's decision to make the payments in issue.8

The complaints filed against Gruber charge that as "a key member of Stratton's management" he had specific duties under the Agreement, which included an obligation to obtain verification from independent accountants as to the existence of "excess cash" for purposes of the put. The substantive basis for the complaints against Bordwin and Gruber are, once again, grounded in negligence.

Bordwin and Gruber argue that since the third party complaints against them allege only negligence, they suffer from the same substantive defect as the complaints dismissed against Marshall Bratter and should suffer a similar fate. I disagree.

Here, unlike the situation with Marshall Bratter, the individuals held executive positions in Stratton during the period relevant to this action. Given this relationship between the parties and the liberal construction of pleadings under the Federal Rules, the complaints, although cloaked in terms of negligence, will support allegations of intentional conduct on the part of Bordwin and Gruber sufficient to withstand the instant motion. Thus, I am unable to say beyond doubt that the complaints, however inartfully drawn, will under no circumstances entitle third-party plaintiffs to remedial action.

Turning to motions by Bordwin and Gruber under Rule 9, however, a different result obtains. Since I have liberally construed the complaints in issue to include intentional fraudulent activities in relation to the Agreement and the put thereunder, these activities must be pleaded with a certain degree of particularity.

In this regard, even the most liberal reading of the complaints before me fails to yield the degree of particularity contemplated under Rule 9. Accordingly, I dismiss the third party complaints against Gruber and Bordwin on this ground with leave for third party plaintiffs to replead within 20 days of this order to satisfy the requirements of Rule 9. In this regard, third party plaintiffs are directed to set forth in their amended complaints the precise fraudulent conduct engaged in by Bordwin and Gruber as joint tortfeasors with the Sprayregens. Complaints, such as those now before me, leveling at best vague and conclusory allegations of fraud will not be tolerated.

Laventhol

Laventhol is a partnership in business as certified public accountants. The three Sprayregen complaints, again employing identical language, allege:

The complaints, founded upon common law negligence and fraud under Section 10(b) and Rule 10b-5, are all insufficient to withstand the instant motion to dismiss.

The complaints of Herman and Seymour Sprayregen are defective on two grounds. First, inasmuch as they attempt to state a claim for negligence they are deficient as a matter of law. As previously stated the touchstone for any negligence action is the existence of a duty running from a defendant to a plaintiff. In the instant action, the Sprayregens admit that Laventhol's only connection with the instant action stems from a contract entered into by Stratton, the corporation, and Laventhol pursuant to which Laventhol agreed to perform certain accounting functions for the corporations. Thus, any duty of due care owed by Laventhol ran, if at all, exclusively to Stratton and not to the Spraygregens in their individual capacities. Accordingly, the negligence claims must fail.9

More importantly, however, any claim of fraud under Section 10(b) and Rule 10b-5 is also defective under the Birnbaum rule. It is well settled that since Section 10(b) and Rule 10b-5 proscribe fraud only "in connection with the purchase or sale" of securities, it is a necessary predicate to any action brought thereunder that the plaintiff be a defrauded seller/purchaser. Nowhere in the complaints of Herman or Seymour is there any allegation that either individual bought or sold any securities in connection with the alleged fraud. Indeed, the parties admit in their memorandum of law that among themselves only Gerald Sprayregen participated in the put.10

Turning to Gerald Sprayregen, it would appear that since he was a shareholder who "put" shares to Stratton, he alone would be able to assert a claim under the securities laws.

There is, however, an internal inconsistency in the complaint before me that warrants dismissal. It is alleged that the report, upon which the 10(b) claim exclusively relies, was certified as of March 18, 1971. The "put" in issue, however, took place in February 1971. I am hard pressed to understand third-party plaintiff's factual allegation that it was upon this report that he, as a shareholder, officer or director, relied upon in February 1971.

It cannot be disputed that Gerald Sprayregen's complaint must, in order to state a viable 10(b) claim, allege that any fraudulent misrepresentations or omissions must have been made prior to the put in issue. Denny v. Barber, 576 F.2d 465, 468 & 470 (2d Cir. 1978). Since Gerald Sprayregen has failed to allege any statement or omission made by Laventhol prior to the sale of his securities the complaint must be dismissed. Id.

Again, in light of the frivolous nature of the suits filed against Laventhol, I find this an appropriate situation in which to assess costs and attorneys fees against the Sprayregens on a pro rata basis.

Milton Hausen

Milton Hausen was a director of Stratton and a shareholder of Sprayregen & Co., Inc. during the time relevant to this action. As such he participated in the put of February 1971 and was paid $37,650 for his shares thereunder. The complaints charge Hausen simply with participating in the 1971 put and request that should third-party plaintiffs be held liable, Hausen be required to contribute the amounts received by him.

Hausen argues that certain releases executed between himself, Stratton and N.L.P. Fredi, Inc. preclude any attempted contribution by the Sprayregens. Hausen reasons that this Agreement, executed in October 1975, provides that New York Law should control interpretation of the Agreement. Accordingly, applying Section 15-108(b) of the General Obligations Law, N.Y. Gen.Oblig.Law § 15-108(b) (McKinney 1976), where one tortfeasor settles with an injured party this relieves him from liability to any other person for contribution.

The Sprayregens argue that despite the plain language of the release, federal law should control any contribution and that contribution is clearly available thereunder as against a settling tortfeasor. They also argue that since the Sprayregens were not privy to the release it cannot act to defeat their right to contribution. Although this argument flies in the face of reason, in addition to the strong public policy favoring settlement of lawsuits out of court, I need not reach this interesting, albeit thorny, question for determination of the instant motion.11

As more fully set out above, Rule 14 is merely a procedural device which depends ultimately upon the existence of a substantive legal theory under which a third-party plaintiff may recover. The three complaints seeking contribution from Hausen are totally void of any substantive legal theory upon which the contribution is grounded. The mere participation in the put, without more, is unquestionably insufficient to support a claim for contribution. There must be at least some allegation that Hausen was a joint tortfeasor in the scheme to defraud allegedly engaged in by the Sprayregens. There is simply no indication, vague or otherwise, in the complaints before me that Hausen had anything to do with the fraudulent scheme or was even negligent in relation thereto.

Thus, the complaints filed against Hausen, as pleaded, are wholly without merit and are dismissed.12

Accordingly, the motions of the third-party defendants to dismiss are, as provided above, granted.

Settle judgments on seven days' notice notice. Costs and attorneys' fees where allowed may be determined by appropriate motion.