a resolution on December 21, 1961 authorizing the issuance of 64,534 shares of the authorized but theretofore unissued and unregistered shares of the common stock, at a price of $6.00 per share, to themselves and other purchasers under agreements to hold the shares for investment purposes only, but providing that the corporation would cause the shares to be registered within eighteen months following the date of issue.
At the time of the adoption of the resolution there were issued and outstanding 318,000 shares which had been registered and were traded on the American Stock Exchange since 1960. The original issue of Hydromatics' stock to the public was at a price of $10.00 per share.
During the period from January 1, 1961 to January 16, 1962, the price of the stock of the corporation being traded on the Exchange ranged between a low of 10 3/8 and a high of 24 7/8.
The corporation was engaged in the business of manufacturing ball valves. Its principal market had been in the military field but during the year 1960 the corporation developed a new line of ball valves for the civilian market, for the entry into which management had estimated that additional capital of $2,000,000 would be required.
During the fiscal year ended August 31, 1961 the corporation had moved its plant to new leased quarters, in connection with which it underwent some extraordinary expense. Its net sales dropped from $3,621,160 in 1960 to $2,373,361 in 1961. During the 1960-1961 fiscal year, the corporation suffered a loss of approximately $215,000; it had outstanding debts consisting of a long-term unsecured bank loan of $500,000 and two 90-day renewable notes in the amount of $350,000. Pertinent provisions of the larger of these items of indebtedness are set out in footnote 3. The terms of this loan agreement further provided that in the event of the breach of any of the foregoing conditions, the lending bank might put the corporation on written notice of the default and if the default persisted for thirty days thereafter, the loan would become callable. For the fiscal year ended August 31, 1961 the corporation's pre-tax loss was $442,000 which, however, included $117,000 in engineering development costs charged against fiscal 1960-61 operations. Despite a small profit for the first quarter of fiscal 1961-62 ($16,612 after taxes), the corporation was in need of additional capital and was threatened not only with the calling or requirement of full collateralization of its long-term loan indebtedness, but had been refused delivery by an unpaid supplier, preventing the making of deliveries to a principal customer.
The resolution unanimously adopted by the directors of Hydromatics at the meeting of the board held on December 21, 1961, authorized the corporation to enter into agreements to sell a total of 100,000 common unregistered shares of stock of the company to a limited number of private investors, not in excess of 15, including some small investment companies, the stock to be acquired for investment and not for resale, and to be offered at a price per share of $4.00 below the market price (then approximately $10.00 per share), or at a price of $6.00 per share. The resolution also directed that management agree to purchase similar stock of the company at the same price, to meet the conditions imposed by the prospective private investors, in an aggregate of approximately $152,000, and that in further compliance with the requirements of the private investors the corporation agree that "on or before the expiration of eighteen months from the date of the agreement with them * * * the company prepare and file, at its own cost, such proceedings as may be necessary to cause any shares so issued for investment to be registered pursuant to the Federal Securities Exchange Act of 1933 as amended, [sic] to the end that said shares * * * shall be qualified for public sale and distribution." The meeting was informed that one of the directors had discussed the proposed transaction with a prospective private investor who had agreed to purchase $50,000 of investment stock at $6.00 a share "upon the condition that the directors, including the president, would likewise purchase investment stock, and that this investor had about three friends in New York who would also invest on a similar basis." A list of the private investors contemplated by the resolution was made up and attached to the minutes of the meeting after they had been written up at a subsequent date. Between December 21, 1961 and January 2, 1962, negotiations were had in behalf of the corporation, through certain of its officers, with various prospective private investors, and written sales agreements, and investment letters between the corporation and the respective private investors were drafted and executed. By the terms of these documents the corporation sold to the investor and the investor purchased from the corporation a specified number of shares of unregistered common stock of the corporation for a price of $6.00 per share; the investor agreed that he would hold these shares for investment and not assign or distribute the same, and the corporation agreed to cause the shares to be registered with the S.E.C. within a period of eighteen months from December 21, 1961; failing which the corporation would pay to the investor a penalty of 1/2 of 1% per share per month during such portion of the next succeeding eighteen months period as the shares remained unregistered.
A regular meeting of the stockholders of the corporation was noticed for and held on February 8, 1962. The notice of and proxy for that meeting advised the stockholders that the board of directors would seek stockholder approval of the action of the board in authorizing and consummating the sale of the $6.00 shares.
The notice also stated that the officers and directors would vote all of their shares, including the $6.00 shares which they had purchased from the corporation, in favor of ratification of the directors' action. The minutes of the meeting indicate that this purported ratification was made by a majority of 251,864 out of the 268,585 stockholders voting.
This action was instituted after the resolution of the board of directors, but prior to the stockholders' meeting and an application for a preliminary injunction to prevent the holding of the stockholders' meeting was denied by this Court's order of February 8, 1962.
Plaintiffs stated their claims at pretrial conference as follows:
(1) Defendants caused the corporation to issue the $6. shares at less than true value, thus defrauding the corporation.
(2) Defendants falsely represented to the corporation that the private investors required that the directors participate in the purchase of the $6. shares; and that the price of $6. per share was prescribed by the private investors.