Escott v. Barchris Constr. Corp.

283 F. Supp. 643 (1968)

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Nature of the Case

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Facts

BarChris (D) was involved in the bowling business. In 1960, D installed three percent of all lanes built in the United States. According to the prospectus, net sales, in round figures, in 1956 were some $800,000, in 1957 $1,300,000, in 1958 $1,700,000. In 1959 they increased to over $3,300,000, and by 1960 they had leaped to over $9,165,000. For some years, the business had exceeded the managerial capacity of its founders. Vitolo and Pugliese are each men of limited education. Vitolo did not get beyond high school. Pugliese ended his schooling in seventh grade. Pugliese devoted his time to supervising the actual construction work. Vitolo was concerned primarily with obtaining new business. Neither was equipped to handle financial matters. Russo, an accountant, joined them in the days of the partnership and handled many of the transactions which figure in this case. Kircher, a certified public accountant who had been employed by Peat, Marwick became treasurer in 1960. In October of that year, another ex-Peat, Marwick employee, Trilling, succeeded Kircher as controller. At approximately the same time Birnbaum, a young attorney, was hired as house counsel. He became secretary on April 17, 1961. D would get a small down payment on the purchase price, and proceed to construct and equip the bowling alley. When the work was finished and the building delivered, the customer paid the balance of the contract price in notes, payable in installments over a period of years. BarChris discounted these notes with a factor and received part of their face amount in cash. The factor held back part as a reserve. In 1960 it began a sale and leaseback arrangement. BarChris was compelled to expend considerable sums in defraying the cost of construction before it received reimbursement. BarChris was in constant need of cash to finance its operations. In December 1959, BarChris sold 560,000 shares of common stock to the public at $3.00 per share. This issue was underwritten by Peter Morgan & Company, a present defendant. By early 1961, BarChris needed additional working capital. The proceeds of the sale of the debentures involved in this action were to be devoted, in part at least, to fill that need. They filed debentures with the Securities and Exchange Commission on March 30, 1961. The registration statement became effective on May 16. The closing of the financing took place on May 24. On that day BarChris received the net proceeds of the financing. BarChris was experiencing difficulties in collecting amounts due from some of its customers and difficulties increased. In 1961 and 1962, it was apparent that the industry was overbuilt. Operators of alleys, often inadequately financed, began to fail. In 1962, BarChris tried to raise more money by the sale of common stock. That failed, and on October 29, 1962, it filed a petition for an arrangement under Chapter XI of the Bankruptcy Act. BarChris defaulted in the payment of the interest due on November 1, 1962, on the debentures. This action was brought under Section 11 of the SEC ACT of 1933. Ps allege that the registration statement contained false and material omissions. The evidence showed that BarChris had made a number of false statements and omissions in the 1961 debenture registration. It overstated sales by about $500,000, income by over $250,000, assets by over $500,000 and unidentified liabilities by at least $500,000. Backlog was overstated by $4.5 million, and $500,000 in officers’ loans were not listed as outstanding and unpaid. It also ignored $1.1 million in use proceeds and $1.35 million in delinquencies from customers. Ds plead defenses under Section 11 as well as the statute of limitations. Ps sued everybody. All Ds who could plead their available defenses under Section 11. Ds filed motions to dismiss on their Section 11 defenses.