UNITED STATES DISTRICT COURT FOR THE DISTRICT OF NEW JERSEY
September 7, 1988
PROSPECT PURCHASING CO., INC., Plaintiff,
WEBER, LIPSHIE & CO., Defendant; WEBER, LIPSHIE & CO., Third-Party Plaintiff, v. PROSPECT INDUSTRIES CORP., Third-Party Defendant
The opinion of the court was delivered by: WOLIN
SUPERCEDING SUPPLEMENTAL OPINION
ALFRED M. WOLIN, UNITED STATES DISTRICT JUDGE.
This opinion supplements and modifies this Court's opinion delivered on the record following oral argument for defendant's motion to dismiss on July 25, 1988. The issue facing the Court is whether plaintiff's federal securities claims brought pursuant to section 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b), and Rule 10b-5 promulgated thereunder by the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5, are barred by the federal one-year statute of limitations borrowed pursuant to the Third Circuit's opinion in In re Data Access Systems Securities Litigation, 843 F.2d 1537, Fed.Sec.L.Rptr. (CCH) para. 93, 704 (3d Cir. 1988) (in banc). For the following reasons, this Court finds that retroactive application of the Data Access opinion appropriately bars plaintiff's federal securities action. However, this Court will not dismiss plaintiff's pendent state law negligence claims.
The facts of this case, although complicated, may be greatly simplified for purposes of this motion. Prospect Industries Corp. (the "Company"), the third-party defendant herein, was involved in the manufacture and sale of steel drums and pails. The principal shareholders of the Company (approximately 17% of which has been publicly owned since 1969) prior to the transaction which is the subject of this lawsuit, were Milton Gold and his brother Sol Gold (the "Golds"), and Karel Sokoloff and his brother Abraham Sokoloff (the "Sokoloffs").
On September 3, 1982, the brothers Daniel and Nathan Milikowsky consummated a deal whereby the recently created Prospect Purchasing Co., Inc. ("Purchasing Co."), the plaintiff herein, would acquire the 83% of the Company's stock which was owned by the Golds and the Sokoloffs.
Upon acquisition of the Company, it appears that the Milikowskys and William Kane, whom the Milikowskys had just installed as President of the Company, quickly discovered that certain aspects of the Company appeared to have been overvalued.
Upon transmittal of the suspected fraud to the Golds and Sokoloffs during a meeting between the buyers and sellers on or about December 9, 1982, the terms of the deal were amended effective December 28, 1982.
In spite of mounting losses, the Milikowskys continued to operate the Company throughout 1983. In 1984, however, Prospect Industries Co. was liquidated piecemeal. Finally, in 1985, the Milikowskys attempted to sell the Company's manufacturing plant. Whereupon in the Spring of 1985, the Milikowskys discovered that the plant's grounds were contaminated with waste products and that the New Jersey Department of Environmental Protection would prohibit the sale of the plant until the site was cleaned up.
In August of 1985, the Milikowskys, on behalf of Jordan International Co., Inc. and Purchasing Co., caused this action to be filed in federal district court. The complaint contained allegations of negligence, securities fraud and aiding and abetting of securities fraud by Weber, Lipshie in conducting an audit of the 1981 financial statements of the Company. Jurisdiction was alleged to exist by virtue of diversity of citizenship, section 10(b) of the 1934 Securities and Exchange Act and principles of pendent jurisdiction.
In October 1987, plaintiffs Purchasing Co. and Jordan sought leave to amend the complaint to include the same federal and common law allegations with respect to the 1979 and 1980 audits of the Company's financial statements performed by Weber, Lipshie.
Weber, Lipshie opposed the motion on several grounds, including the ground that Jordan was not a proper party to this action. In a decision dated November 4, 1987, Magistrate Hedges granted Purchasing Co.'s motion to amend the complaint, extended the time within which to complete pre-trial discovery and dismissed Jordan from the action. This order was appealed to Judge Lechner who, on December 14, 1987, affirmed the order with respect to these issues.
Defendant has now moved to dismiss the federal securities fraud count of the amended complaint on the grounds that it is time-barred by the applicable statute of limitations as a result of the Third Circuit's in banc opinion in In re Data Access Systems Securities Litigation.5 In response, plaintiff does not contest that if the Data Access one-year rule is applied to its federal claim THEN it would be time barred. Instead, plaintiff contends that the Data Access rule should not be applied retroactively to this action.
A. Retroactivity - The Chevron Oil Test
In its simplest form, the question which remains before this Court is whether the Third Circuit's Data Access opinion should be applied retroactively in light of the three-part test articulated by the Supreme Court in Chevron Oil Co. v. Huson, 404 U.S. 97, 92 S. Ct. 349, 30 L. Ed. 2d 296 (1971):
In our cases dealing with the nonretroactivity question, we have generally considered three separate factors. First, the decision to be applied nonretroactively must establish a new principle of law, either by overruling clear past precedent on which litigants may have relied [citation omitted], or by deciding an issue of first impression whose resolution was not clearly foreshadowed [citation omitted]. Second, it has stressed that "we must . . . weigh the merits and demerits in each case by looking to the prior history of the rule in question, its purpose and effect, and whether retrospective operation will further or retard its operation. " [Citation omitted]. Finally, we have weighed the inequity imposed by retroactive application, for "where a decision of this Court could produce substantial inequitable results if applied retroactively, there is ample basis in our cases for avoiding the 'injustice or hardship ' by a holding of nonretroactivity. " [Citation omitted].
404 U.S. at 107-108, 92 S. Ct. at 355.
The application of the Chevron Oil retroactivity test with respect to Data Access is further facilitated by the Third Circuit's recent opinion in Hill v. The Equitable Trust Company, 851 F.2d 691 (3d Cir. 1988). As a threshold matter, the Equitable Trust court expressly stated that the majority of the Third Circuit in Data Access deferred the question of retroactivity:
Although the judges of this court were unanimous that this federal statute of limitations should apply in section 10(b) and Rule 10b-5 cases, the majority [in Data Access ] specifically declined to decide whether its holding would be retroactive.
Equitable Trust, at 695. But see Data Access 843 F.2d at 1552 (Seitz, J. dissenting) (under Chevron Oil, borrowed federal statute of limitation should be applied prospectively only). Although the Equitable Trust court concluded that "in the present litigation, at least two of the three Chevron factors counsel in favor of the general presumption of retroactivity and against the uncommon exception of prospectivity[,]" at 697, this Court must nonetheless independently apply the Chevron Oil factors to the facts of this case.
(1) Clear Past Precedent. With respect to the first Chevron Oil factor, the Equitable Trust Court noted that:
By the end of 1980, four judges from this court had considered the issue; two [ i.e., Gibbons, J. and Sloviter, J.] would have applied the state general fraud laws and two [ i.e., Seitz, J. and Weis, J.] would have used the Blue Sky statutes. Consequently the law in the [Third] Circuit on this point could fairly be described as uncertain.
At 697. The Equitable Trust court was referring to the Third Circuit opinions in Roberts v. Magnetic Metals Co., 611 F.2d 450 (3d Cir. 1979)
and Biggans v. Bache Halsey Stuart Shields, Inc., 638 F.2d 605 (3d Cir. 1980).
Although both Roberts and Biggans reversed decisions in which the district court originally applied the state Blue Sky statute of limitations and instead applied the pertinent general fraud statute of limitations, neither case was decided by a unanimous court and both were accompanied by strongly worded dissents.
In Equitable Trust, the Third Circuit limited its analysis to the state of the law as it existed in 1979, when the plaintiff first learned of the possible fraud, and as it existed in 1982, when the plaintiff filed suit. Similarly, this Court must focus on the state of the law as it existed in 1982 and 1985; plaintiff first learned of the alleged fraud on or about December 9, 1982, and plaintiff filed suit in August of 1985. The question remaining, therefore, is whether the extant state of the law significantly crystallized between 1980 and 1985 such that "clear precedent" was firmly established.
(a) The Third Circuit. The only other relevant Third Circuit decision after Roberts and Biggans during the time period in question is Sharp v. Coopers & Lybrand, 649 F.2d 175 (3d Cir. 1981), cert. denied, 455 U.S. 938, 102 S. Ct. 1427, 71 L. Ed. 2d 648 (1982), in which:
Plaintiff, purchaser of a limited partnership interest, brought a Rule 10b-5 action against the accounting firm which had prepared an opinion letter dealing with tax treatment of investors. The court, following Biggans, found that there could not have been an action under the Pennsylvania Securities Act because defendant was not the seller of the securities. The only state remedy being one for common law fraud, the court held the common law fraud period of limitations to be applicable.
Fickinger v. C.I. Planning Corp., 556 F. Supp. at 436.
Although not cited by the Equitable Trust court, the Sharp opinion, notwithstanding the fact that it was decided by a unanimous panel, does not appear to lend significant clarity to this "uncertain" point of law. Unlike both Roberts and Biggans, which involved detailed analyses of the theories of applicability as between the fraud and blue sky limitations statutes, the Sharp court gave this issue only "abbreviated consideration." 649 F.2d at 191. The extent of the analysis in Sharp was thus:
This Court has recently examined the applicable statute of limitations for rule 10b-5 case in two decisions. The first, [ Roberts ], held that a rule 10b-5 action arising in New Jersey would be governed by the six year statute of limitations for common law fraud rather than the statute applicable to actions under the New Jersey Uniform Securities Act. In [ Biggans ], we held that the six year statute of limitations for common law fraud, [footnote omitted] rather than the one year limitation in § 504 of the Pennsylvania Securities Act, applied to a rule 10b-5 action for "churning" that arose in Pennsylvania. The court reasoned that the Pennsylvania securities statute grants a private remedy to a buyer only against his seller. It concluded that an action against a broker would not lie under the statute, and that the most analogous state action was an action for common law fraud.
649 F.2d at 192 (citing Biggans, 638 F.2d at 610). The Sharp court, in applying the common law fraud statute of limitations, concluded that Biggans was not distinguishable because the defendant was not the seller and that a state securities action would not lie.
Accordingly, the uncertainty in the Third Circuit as of 1980 created by Roberts and Biggans is not substantially abated by the mere addition of Sharp in 1981. Thus, if it is fair to describe the law of the Third Circuit as uncertain in 1980, the same must have been as of 1985.
(b) The District Courts. During this relevant time frame, it appears that the only decision in the District of New Jersey was filed on May 10, 1982, by Judge Gerry in Corson v. First Jersey Securities, Inc., 537 F. Supp. 1263 (D.N.J. 1982). Judge Gerry aptly noted that "the decision in Biggans relies heavily on the reasoning of Roberts and cannot be read separate and apart from that earlier precedent." 537 F. Supp. at 1266.
More importantly, in Corson, Judge Gerry acknowledged that he was faced with "the already convoluted task of ascertaining the appropriate limitations period, an important consideration to the dissenters in both Roberts and Biggans." Id. at 1267. And in holding that the two-year statute of limitations of the New Jersey Uniform Securities Act was applicable in Corson, Judge Gerry went on to note that:
The Blue Sky law, by design, was not intended to preempt the field with respect to available remedies and does preserve common law causes of action. If the [ Biggans ] court had intended to hold that only the six year limitation applied, it would have done so in much clearer terms.
537 F. Supp. at 1266. Clearly, Corson stands for the proposition that within the District of New Jersey, no clear precedent existed during the time period in question.
Moreover, a survey of other district courts within the Third Circuit reaffirms the proposition that there existed no clear precedent with respect to the application of statutes of limitations in 10b-5 litigation. See, e.g., Hill v. Der, 521 F. Supp. 1370, 1382-1383 (D. Del. 1981) (noting "narrowness" of Roberts and Biggans and "lack of firm consensus as to proper guidelines"); Goodman v. Moyer, 523 F. Supp. 35, 37 (E.D. Pa. 1981) (selection of proper period of limitations is "confused and inconsistent body of law") (quoting Biggans, 638 F.2d at 612 (Weis, J., dissenting)).
And in applying the general fraud limitations, the court in Steinberg v. Shearson Hayden Stone, Inc., 598 F. Supp. 273 (D. Del. 1984), stated:
The Third Circuit has adopted neither the blue sky limitations period nor the common law fraud period as exclusively applicable to 10b-5 cases. Rather, it has taken a functional approach aimed at promoting the policy of repose of the forum state and the substantive federal policy advanced by the federal cause of action.
598 F. Supp. at 1276 (footnote omitted).
Notwithstanding the lack of clear precedent in the Third Circuit, however, district courts began following a rule-of-thumb that Blue Sky limitations are the "logical candidate for regulating 10b-5 claims." Conley v. First Jersey Securities, Inc., 543 F. Supp. 368, 371 (D. Del. 1982) (quoting Hill v. Der, 521 F. Supp. at 1383). The Conley court went on to note that this "presumption" was subject to one significant exception:
If the underlying state Blue Sky law does not afford a civil damage action to remedy the behavior challenged by the 10b-5 claim and the plaintiff would be relegated to a common law fraud action for state relief, the courts must apply the fraud limitations provision to the 10b-5 action.
Conley, 543 F. Supp. at 371 (quoting Der, 521 F. Supp. at 368 (citing Sharp, 649 F.2d at 191-192)).
In the instant case, plaintiff maintains that this rule, as enunciated in Conley, constitutes clear precedent. And under the New Jersey Uniform Securities Act, N.J. Stat. Ann. § 49:3-71(e), which appears to provide a cause of action only as against sellers of securities, plaintiff claims that clear precedent existed upon which to base its reliance on the six-year common law fraud limitations period. The shortcoming of this argument, however, is that the premise of the Conley rule is based on the notion that:
It is clear from [ Roberts and Biggans ] that where a plaintiff has no remedy under the state's Blue Sky law, but the operative facts alleged in the complaint give rise to a complaint under the state's common law, it is the limitations period applicable to a common law claim rather than a Blue Sky period which governs federal claims under Rule 10b-5.
Dofflemyer v. W.F. Hall Printing Co., 558 F. Supp. 372, 377 (D. Del. 1983). Dofflemyer, Conley, and Der all rest squarely on the clarity of Roberts and Biggans. In Equitable Trust, however, the Third Circuit expressly stated that Roberts and Biggans were "uncertain." Plaintiff, therefore, argues for a so-called line of precedent which is lacking a foundation. Accordingly, as noted in Equitable Trust, this Court is not "convinced that Data Access signalled an abrupt change in clearly established law . . . . [and] the first of the Chevron criteria is [not] satisfied here." At 698.
(2) Retrospective Operation. As did the Equitable Trust court, this Court finds that "resolution of the second Chevron criteri[on] -- whether retrospective operation would further or retard the rule's function -- is neutral." At 698 (citing Al - Khazraji v. St. Francis College, 784 F.2d 505, 513 (3d Cir. 1986), aff'd, 481 U.S. 604, 107 S. Ct. 2022, 95 L. Ed. 2d 582 (1987).
(3) Risk of Inequitable Result. In Equitable Trust, the Third Circuit concluded that the risk of producing inequitable results -- the third Chevron factor -- was plaintiff's weakest position. At 698. Unlike the present action, the Court in Equitable Trust noted that application of either the federal or the relevant state statute of limitation, led to the identical result -- a limitations period of one year.
However, in the instant action, plaintiff relied on the six-year general fraud statute of limitations of New Jersey, N.J. Stat. Ann. § 2A:14-1. Clearly under the six-year statute, plaintiff's action is timely. On the other hand, if the two year Blue Sky limitation had been appropriate (and this Court recognizes that Magistrate Hedges, as affirmed by Judge Lechner, found it not to be), then plaintiff, which acquired knowledge of the alleged fraud in or about December of 1982, would have been untimely in bringing its action in 1985. In other words, the effect of the two-year New Jersey Blue Sky limitation would be the same as that of the one-year federal limitation borrowed in Data Access.
Therefore, notwithstanding the extensive amount of discovery already taken in this case, this Court looks with great significance to the comment in Equitable Trust that the state of the law as to which statute of limitations to apply was less than clear following the Roberts and Biggans decisions.
As noted in the analysis under the first of the Chevron factors, even in 1985 when plaintiff filed suit, due to the lack of clear precedence, there certainly existed the possibility that a court in this district might apply the shorter Blue Sky limitations period. Although, not identical on the facts, the rationale of Equitable Trust translates intact to this case. In short, this Court holds that it is not "Monday morning quarterbacking" to retroactively apply Data Access to this case.
Accordingly, this Court finds that plaintiff's federal 10(b) action is barred by the federal statute of limitations.
B. Pendent Claims - The Gibbs Test
In United Mine Workers v. Gibbs, 383 U.S. 715, 86 S. Ct. 1130, 16 L. Ed. 2d 218 (1966), the Supreme Court, in a discussion of the theory of pendent jurisdiction, stated:
Needless decisions of state law should be avoided both as a matter of comity and to promote justice between the parties, by procuring for them a surer-footed reading of applicable law. Certainly, if the federal claims are dismissed before trial, even though not insubstantial in a jurisdictional sense, the state claim claims should be dismissed as well.
Id. at 726, 86 S. Ct. at 1139 (footnotes omitted). The Gibbs court, faced with a "substantial" federal claim "sufficient to confer subject matter on the [federal] court[,]" 383 U.S. at 725, 86 S. Ct. at 1138, and a state claim which derived from a "common nucleus of operative fact[,]" id., commented that federal courts clearly had the power to hear pendent claims and the exercise of that power, albeit discretionary, was driven by "considerations of judicial economy, convenience and fairness to litigants[.]" Id. at 726, 86 S. Ct. at 1139.
Subsequently, in Rosado v. Wyman, 397 U.S. 397, 90 S. Ct. 1207, 25 L. Ed. 2d 442 (1970), the Supreme Court was faced with the question of whether the mooting of the constitutional claim (i.e., the basis of federal jurisdiction), "removed not only the obligation but destroyed the power of a federal court to adjudicate the pendent claim." 397 U.S. at 402, 90 S. Ct. at 1212 (emphasis in original; footnote omitted). The Supreme Court rejected the proposition that loss of a jurisdiction-conferring claim always strips a federal court's power to hear pendent claims.
The court, in referring to Gibbs, noted that:
On remand the District Court correctly considered mootness a factor affecting its discretion, not its power, and balanced the policy considerations that have spawned the doctrine of pendency and the countervailing policy of federalism: the extent of the investment of judicial energy and the character of the claim.
Rosado, 397 U.S. at 403, 90 S. Ct. at 1213 (citing Gibbs, 383 U.S. at 727, 86 S. Ct. at 1139).
In Tully v. Mott Supermarkets, Inc., 540 F.2d 187 (3d Cir. 1976), the Third Circuit acknowledged that "pendent jurisdiction is essentially a discretionary doctrine[.]" 540 F.2d at 195. The Tully court, in dismissing plaintiff's pendent claims because there was no standing under the federal 10b-5 claims, went on to note that:
If it appears that the federal claim is subject to dismissal under Fed.R.Civ.P. 12 (b) (6) or could be disposed of on a motion for summary judgment under Fed.R.Civ.P. 56, then the court should ordinarily refrain from exercising jurisdiction in the absence of extraordinary circumstances.
540 F.2d at 196 (citing Kavit v. A.L. Stamm & Co., 491 F.2d 1176, 1180 (2d Cir. 1974)). Moreover, the Tully court, although it did not define "exceptional circumstances," it did so to great lengths to note that "substantial time [already] devoted to the case and the expense incurred by the parties" did not fall within the ambit of exceptional circumstances.
Similarly, in Weaver v. Marine Bank, 683 F.2d 744 (3d Cir. 1982), the Third Circuit, relying on the rationale of Tully, dismissed plaintiff's pendent claims upon the dismissal of all federal claims because:
The primary justification for exercising pendent jurisdiction is missing if the substantial federal claim to which the state courts could be appended is no longer viable.
683 F.2d at 746.
On the other hand, in Cooley v. Pennsylvania Housing Finance Agency, 830 F.2d 469 (3d Cir 1987), an opinion which discussed both Tully and Weaver, the Third Circuit concluded that notwithstanding the dismissal of the federal claims, extraordinary circumstances existed such that dismissal of the pendent claims would have amounted to an abuse of the district court's discretion. The Cooley court noted:
It is clear that Cooley's state law claims would be extinguished by the running of the applicable Pennsylvania statute of limitations, a matter of extreme prejudice to Cooley . . . . If fairness to the litigants is a proper consideration under Gibbs, supra, we would find that a compelling injustice would result if this matter were dismissed here in toto.
830 F.2d at 476 (footnote omitted).
Although not "inequitable" under the language of Chevron Oil, the application of the Data Access rule to this case is, in the estimation of this Court, an "extraordinary circumstance" under the reasoning of Tully, Weaver and Cooley. As did the court in Cooley, this Court will not now abide the total dismissal of plaintiff's action in federal court and possibly leave plaintiff without any forum because of the belated application of the statute of limitations. Even though mere time and money invested in federal court will not preserve pendent jurisdiction, this Court is sensitive to the peculiar procedural posture of this case. Accordingly, at this time, defendant's motion to dismiss plaintiff's pendent claims is denied.
For all of the above-noted reasons, defendant's motion to dismiss plaintiff's federal securities actions (i.e., Count II of the complaint) is hereby GRANTED with prejudice. With respect to plaintiff's pendent state law claims, defendant's motion to dismiss is hereby DENIED without prejudice to renew at such time as an action is initiated in state court.
An appropriate order is to be submitted forthwith by counsel for the defendant.