Blue Sky L. Rep. P 72,742unpublished Dispositionjerome S. Cardin; Jerome J. Coller, M.d.; Kenneth E.hansen, Plaintiffs-appellees, v. Charter Medical Corporation, a Delaware Corporation,defendant-appellant, v. Morton D. Goldman; Stanley E. Krosin; George Abdow;gerald I. Moskowitz, Third-party Defendants, 850 F.2d 688 (4th Cir. 1988)

As realigned by the district court, Charter Medical Corporation (Charter) sued Jerome S. Cardin, Jerome J. Coller and Kenneth E. Hansen, the principal stockholders of Psych Systems, Inc. (PSI), alleging violations by the defendants of the Georgia Securities Act and the federal securities laws, common law fraud and breach of contract in Charter's purchase of defendants' shares constituting 25% of the total stock of PSI.^*  The district court after trying the case non-jury for two weeks granted a motion at the close of Charter's evidence for defendants pursuant to Rule 41(b), F.R.Civ.P. The district court rendered a thorough oral opinion and made detailed findings of fact.

Charter appeals, and we affirm.

Charter is the owner and operator of a number of hospitals throughout the United States and abroad, approximately 30 of which are devoted primarily to rendering psychiatric care. This case is unique as an example of the subsequently established ill-advised persistence of Charter, to obtain control, if not ownership, of PSI, which produced and sold computerized psychiatric testing systems, notwithstanding that it was fully advised that PSI was losing substantial sums of money and that it was on the verge of the bankruptcy which shortly ensued. Undoubtedly Charter believed that if it obtained control, its management expertise and large infusions of cash that it could provide, could render PSI a profitable enterprise. Unfortunately, Charter's faith in its own abilities was sadly misplaced.

Initially Charter sought to merge with PSI, but in June 1984 its acquisition effort took the form of a stock purchase agreement whereby it purchased 25% of PSI's stock from defendants at a price of $3.50 per share. It was further agreed that Charter would make a tender offer at a later date to acquire all of PSI's remaining stock at $5.00 per share. Settlement of the purchase from defendants was made within three days after agreement was reached, and Charter further agreed to pay defendants an additional $1.50 per share for their stock if the proposed acquisition of the remainder of the stock was consummated. Pursuant to the stock purchase agreement, Charter obtained immediate control of PSI's board of directors.

Prior to the June 1984 stock purchase and during the merger negotiations, Charter had obtained audited financial statements of PSI's operations. They showed that for the fiscal year ending November 30, 1983, PSI had an operating loss of $1.2 million and for the first quarter of 1984, losses of $587,000, which, if annualized, would indicate a loss of $2.35 million for fiscal 1984. Immediately prior to the execution of the stock purchase agreement and the accelerated settlement thereunder, Charter was told that PSI'S financial condition had worsened since the audited financial statements and that bankruptcy was imminent. The district court found that Charter was in fact motivated to enter into the stock purchase agreement by news of PSI's imminent bankruptcy. The stock agreement was negotiated and executed within two days, and settlement occurred only three days later. The district court found that Charter knew that to keep PSI alive, it would have to advance substantial funds to PSI immediately, but that it decided to proceed with the agreement based on "pro forma future projections." Charter's hopes rested largely on a license from which 60% of PSI's earnings were derived, despite the fact that Charter knew that PSI had been told the license would expire and was unlikely to be renewed. The district court found that Charter Vice President Robert Porter was "so desperately anxious to make the deal" that he "chose to overlook" the fact that a license owned by one of its competitors would soon expire. We may infer that Porter somehow hoped the license could be extended. The district court found that Porter told his superior at Charter that an extension would be forthcoming despite the absence of such a guarantee.

By July 1984, Charter became aware that certain sales figures reflected in the financial statements for fiscal 1983 and the first quarter of fiscal 1984 were inflated. PSI and its principals had been alerted to this possibility earlier by its accountants, PSI had instructed its accountants "to get it right," and the accountants had disallowed some sales. If the remaining inflation of sales not disallowed by AG & Co. were eliminated from the financial statements, obviously PSI had experienced even more dismal operating results in fiscal 1983 and the first quarter of fiscal 1984.

Notwithstanding this knowledge, Charter persisted in its efforts to make PSI an operating success after the June 1984 stock purchase agreement. It continued to supply working capital and other funds. In the interim Charter learned that PSI's software license would definitely not be renewed. Nonetheless, in late August and early September 1984, Charter proceeded with a tender offer to acquire PSI's publicly owned stock at $1.50 per share. The offer was subsequently withdrawn in October 1984.

On September 5, 1984, Charter notified defendants that it was rescinding the stock purchase agreement and would seek damages for breach of contract and fraud. The district court found that Charter's rescission was precipitated by notice that the software license would not be renewed. This suit was filed October 5, 1984, and PSI filed Chapter 11 bankruptcy proceedings on October 24, 1984.

Charter's suit alleged causes of action arising under Sec. 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l (2), Sec. 18(a) of the Securities Exchange Act of 1934, 15 U.S.C. § 78r and Rule 10b-5 promulgated thereunder, 15 C.F.R. Sec. 240.10b-5, the Georgia Securities Act, common law fraud and breach of contract. With respect to each, the district court made extensive findings of fact and stated conclusions of law.

Most importantly the district court found that any omissions or misrepresentations of financial facts were not material to Charter's decision to purchase PSI's stock, that Charter in its purchase decision did not rely on historical financial facts, that there was no proximate causation between what defendants and AG & Co. did or said and Charter's loss, and that Charter obtained what it bargained for in the stock purchase agreement. Specifically it found that even if some of the sales had been reversed, the financial statements would not have been materially affected, and, further, that even if adjustments claimed by Charter had been made, they would not have been material to Charter's investment decision and would not have been relied on by Charter.

The district court found that Charter was fully informed of PSI's disastrous financial state as of June, 1984, so that there could be no proper basis on which to find a breach of contract. It also found that defendants had no scienter on which to support a claim of breach of securities laws. The finding that the alleged misrepresentations and omissions were not material and that Charter did not in fact rely on historical financial information were repeated. Charter's claim of common law fraud was rejected because there was no proof on the part of any defendant of an intent to deceive and there was no proof on the part of Charter of reliance. Finally the district court found that Charter had ratified the transaction by its actions following the alleged discovery of misrepresentations and omissions.

Our review of the record and consideration of the arguments, both oral and written, persuades us that the district court's findings of fact are not clearly erroneous and its conclusions of law are correct. Except for supplementation to deal specifically with two arguments vigorously pressed on us, we are altogether satisfied to affirm the district court's judgment on its opinion. Charter Medical Corporation v. Cardin, Civ. No. H-84-3714, D. Md., July 15, 1987 (unreported). We turn then to the arguments pressed on us that Charter proved a cause of action for breach of warranty and a cause of action for violation of Sec. 12(2) of the Securities Act of 1933, 15 U.S.C. § 77l (2).

Both of the alleged causes of action arise from the inclusion of inflated sales figures and the omission of certain liabilities in the financial data furnished Charter prior to settlement of the stock purchase agreement. Charter argues that sales were inflated in the approximate amount of $300,000 and that a $700,000 liability of PSI to a supplier was omitted. While defendants contest the correctness of the figures advanced by Charter, the district court made no finding as to the exact amount of either. We cannot determine the exact total of inflated sales not disallowed by AG & Co. before the stock purchase agreement was executed, but our study of the record indicates that it could range from $117,823 to $297,868. The alleged liability of $700,000 stands on a different footing, however. It was disclosed in some versions of PSI's 1983 financial statement.

We discuss the alleged liability first. It is claimed to be to Oceanic Enterprises, Inc. (OEI), which supplied PSI with computer equipment manufactured by Digital Equipment company. OEI, of course, maintained an inventory of what was needed from time to time, but under the agreement between them, PSI was not obliged to pay OEI until OEI shipped equipment to one of PSI's customers. After Charter bought control of PSI and announced its tender offer of $1.50 per, OEI asked PSI to pay for OEI's inventory which was held for PSI's customers. OEI claimed that PSI had orally agreed to do so. There is no evidence that OEI had even made a previous demand, or that there was such an oral agreement, or that the statute of frauds would not bar the claim. In any event neither Charter's outside counsel nor its accountant took the claim seriously. Indeed, PSI, on March 14, 1985, when it was controlled by Charter advised the SEC that it "was aware of no documentation to support the claim, disputes the claim, and has recorded no obligation for such equipment." We therefore conclude that this item was not an improperly omitted liability and that the most which concerns us is the inflation of sales in the range we have set forth.

We do not think that the alleged inflated sales give Charter a meritorious cause of action. A cause of action under Sec. 12(2) requires proof of "an untrue statement of a material fact or.... [the omission] to state a material fact necessary in order to make the statements....not misleading," but the section further provides that seller of securities shall not be liable thereunder if he shows "that he did not know, and in the exercise of reasonable care could not have known, of such untruth or omission ..." 15 U.S.C. § 77l (2).

Although Sec. 12(2) may be construed to place the burden of proof on the seller to demonstrate lack of knowledge, the district court found that "the evidence does not indicate that the defendants had knowledge of the falsity of the alleged misstatements or omissions," that " [t]here is nothing to indicate defendants ... had any knowledge that any of the sales ... were in fact fraudulent sales," and that defendants had made a reasonable effort to cure the problem and could reasonably believe the problem had been completely solved by AG & Co. We think that these findings are the functional equivalent of that required by Sec. 12(2). These findings are not clearly erroneous. The district court credited testimony that one of defendants told PSI's auditor to "get it right" and it found that none of the defendants attempted in any way to hinder an investigation of all the financial facts, thus demonstrating reasonable care. See Sanders v. John Nuveen & Co., 619 F.2d 1222, 1227-28 (7 Cir. 1980), cert. denied, 450 U.S. 1005 (1981). We therefore conclude that defendants did not know and should not have known of inflated sales in the audited November 30 sales figures so that Charter has no cause of action therefor under Sec. 12(2).

We do not think that Charter's breach of warranty claim has any greater merit. While it is true that in the stock purchase agreement, defendants warranted the financial reports as not containing "any untrue material fact or omitt [ing] any material fact required to be stated therein or necessary to make the statements therein not misleading," the warranty was qualified by the exception of "any document delivered pursuant to or in connection with this Agreement or otherwise disclosed by Shareholder [defendant] or their representatives to Charter " (emphasis added). Even if inflated sales of .1-.3 million abstractly was a material fact, we think that the intelligence that PSI was on the verge of bankruptcy, communicated before settlement under the stock purchase agreement, not only fell within the exception but made those inflated sales that remained uncorrected not material. In regard to the latter, we note that the district court found that what prompted purported recession of the stock purchase agreement was the letter that PSI's license agreement would not be renewed. That finding is not clearly erroneous.

In any event Charter learned that sales may have been inflated on July 17, 1984. It did not rescind then or in a reasonable time thereafter. Instead it continued to receive the benefit of the contract until September 5, 1984 when it learned of the license nonrenewal. Even then it began a public offer to purchase PSI stock thereafter. We think that the district court correctly concluded that even if there had been a breach of warranty, Charter ratified its previous contract by deferring any effort to rescind and by proceeding to acquire PSI's remaining stock.

AFFIRMED.