Drobbin v. Nicolet Instrument Corp. (631 F. Supp. 860, 1986)

MEMORANDUM OPINION AND ORDER

HAIGHT, District Judge:

These actions are brought under the federal securities laws. State statutory and common law claims are also asserted by pendent jurisdiction. In addition, it appears that subject matter jurisdiction derived from diversity of citizenship exists.

The litigation represents, in essence, efforts by competing interests to obtain control of a corporation which owns, or is the exclusive licensee, of patents covering medical diagnostic devices. The case is before the Court on cross-motions for preliminary injunctions. Following extensive discovery and an evidentiary hearing, the Court propounds the following findings of fact and conclusions of law. Rule 65, F.R. Civ.P.

I.

The Parties

Braintech, Inc. (“Braintech”) is a publicly-held Nevada corporation. It owns or holds exclusive licenses to patents covering the technology which is described under Point II, infra.

Nicolet Instrument Corporation (“Nicolet”) is a large, publicly-owned Wisconsin corporation whose shares are traded on the New York Stock Exchange. Nicolet manufactures and markets a broad range of technological instrumentation, including biomedical research and diagnostic equipment.

Poseidon Capital Corporation (“Poseidon”) is a privately-held New York corporation. James C. Couri is the president of Poseidon.

William Stewart and Barry Kass have been, since the inception of Braintech in 1980 or shortly thereafter, officers of Braintech. They currently serve on the Braintech board of directors.

Keith Brue, Robert Penrod, and Russell B. Cichy are officers or employees of Nicolet who currently serve on the board of directors of Braintech. Together with Stewart and Kass, these three individuals make up the entire five-man board of Braintech.

John B. Krauss is the president of Nicolet.

Mitchell Drobbin is a public shareholder of Braintech, who has intervened in the litigation under circumstances to be related infra.

II.

The Technology

This litigation is concerned with five patents on a device for scanning the human brain and diagnosing brain dysfunction. The device is known as the Brain Electrical Activity Mapping, or “BEAM,” system. The device is the joint invention of Frank H. Duffy, M.D., a physician, and N. David Culver, a computer engineer and consultant. Duffy and Culver formed Braintech in December 1980 for the purpose of manufacturing and marketing the BEAM system. Of the five patents which protect the device, Braintech owns two of them directly, and holds exclusive licenses on the other three. Those three patents are owned by the Boston Children’s Hospital. Duffy was affiliated with Children’s Hospital at the time he and Culver founded Braintech.

The initial intended use of the BEAM technology was to furnish a more sophisticated diagnostic tool for neurological conditions. As a medical witness explained it, the currently existing electroencephalogram (“EEG”) can detect relatively gross brain wave disorders; but an EEG tracing of less marked abnormalities can cause ten neurologists to give ten different diagnoses. The BEAM system, combining electronic and computer technologies, is a superior neurological diagnostic device. There is in addition some medical evidence for the proposition that the technology may be valuable in non-neurological medical fields as well.

III.

Summary of the Litigation

As Judge Kaufman had occasion to write in Norlin Corp. v. Rooney, Pace Inc., 744 F.2d 255, 258 (2d Cir.1984):

“Contests for corporate control have become ever more frequent phenomena on the American business scene____ Skirmishes are fought in company boardrooms, in shareholders’ meetings, and, with increasing regularity, in the courts.”

The court skirmishes in the cases at bar are fought over control of Braintech and its technology.

Poseidon fired the opening broadside on August 3, 1985 when it filed a complaint in this Court against Nicolet, Braintech, Stewart, Kass, Brue, Krauss, and two individuals who are no longer parties: Lauress V. Ackman and David Granquist, who were at the pertinent times and remain today officers of or affiliated with Nicolet. 85 Civ. 6118. I will summarize the 30-page, 70-paragraph complaint.

Poseidon alleged it is a shareholder of Braintech. It acquired its initial Braintech shares in consequence of a May 31, 1985 written agreement in which Braintech authorized Poseidon to restructure its debt, negotiate a merger, consolidation, or sale of assets and/or to obtain debt or equity financing, and to provide other services. Other shares were acquired in circumstances to be related. Poseidon complained of subsequent dealings between Nicolet and the Braintech board of directors which culminated in a July 31, 1985 written agreement between Braintech and Nicolet. That agreement resulted in the sale of Braintech shares to Nicolet, and contemplated subsequent agreements whereby Braintech would sell assets and license technology to Nicolet.

Poseidon asserted derivative claims on behalf of all Braintech shareholders, as follows:

First claim: Poseidon alleged that Nicolet, Kass, Stewart, Granquist, Krauss and Brue, in their conduct of the Nicolet/Braintech negotiations and transactions, breached fiduciary duties owing to Braintech shareholders.

Second claim: Poseidon alleged against all defendants the inevitable “civil RICO” cause of action, 18 U.S.C. § 1961. The predicate criminal acts are alleged to be violation of a New Jersey bribery statute, and the federal mail and wire fraud statutes.

Third claim: Poseidon alleged that all defendants violated the disclosure requirements of section 13(d)(1) of the Securities Exchange Act of 1934 (the “1934 Act”), 15 U.S.C. § 78m(d).

Poseidon prayed for an order removing Brue, Kass and Stewart from Braintech’s board, enjoining the consummation of further transactions between Nicolet and Braintech, and enjoining the issuance by Braintech of any additional shares of common stock, warrants or options.

Braintech and Nicolet responded on August 7,1985 with a complaint against Couri and Poseidon. 85 Civ. 6151. They filed an amended complaint on September 5. That 66-page, 153-paragraph pleading asserted five claims:

First claim: Violations by Couri and Poseidon of the disclosure requirements of section 14(f) of the 1934 act, 15 U.S.C. § 78n(f), and SEC Rule 14f-l, in connection with Couri’s and Poseidon’s assumption of control of Braintech in May-July, 1985.

Second claim: Violations by Couri and Poseidon of section 10(b) of the 1934 act and Rule 10b-5 in connection with defendants’ relations with Braintech.

Third claim: Violations by Couri and Poseidon of section 13(d) of the 1934 act.

Fourth claim: Civil RICO.

Fifth claim: Violations by Couri and Poseidon of sections 78.210 and 78.270 of the Nevada Revised Statutes (Braintech being a Nevada corporation) in respect of the issuance of 4.5 million shares of Braintech stock to Poseidon on July 14, 1985.

Sixth claim: Breaches by Couri “and his designees” of common law fiduciary duties owing to Braintech’s shareholders, including Nicolet, at a time when Couri and his designees were controlling Braintech’s affairs.

Seventh claim: Violation by Couri of section 78.140 of the Nevada Revised Statutes in respect of transactions between Braintech and Poseidon which Couri caused the Braintech board to approve.

Eighth claim: Common law fraud in respect of Poseidon’s acquisition of Braintech shares.

Ninth claim: In the alternative, breaches by Poseidon and Couri of contracts entered into with Braintech.

Braintech and Nicolet prayed for judgment declaring null and void all issuances of stock and all options, warrants and other rights to acquire stock granted by Brain-tech to Poseidon and Couri during the relevant periods of time; declaring null and void certain agreements between Braintech and Poseidon; and enjoining Couri and Poseidon from acting in furtherance of those agreements, exercising voting rights in Braintech shares, acquiring additional Braintech shares, transferring those shares, warrants or options which they held, and engaging in proxy solicitation of Braintech "Shareholders.

On October 3,1985 Drobbin intervened in 85 Civ. 6188 to assert claims against Nicolet, Kass, Stewart, Brue, Penrod, Cichy and Braintech. Drobbin identified himself as a Braintech shareholder. He styled his intervenor’s complaint as a stockholders’ derivative action. Drobbin alleged, in respect of events beginning in late July 1985 and extending through September, the breach by Kass and Stewart of fiduciary duties which they owed as Braintech directors to Brain-tech and its public shareholders. Drobbin also charged Nicolet, as controlling shareholder of Braintech during that period, with violation of its fiduciary duties to Braintech and its public shareholders. Drobbin prayed that the issuance to Nicolet of certain Braintech shares and warrants be declared null and void; that an asset purchase agreement and a license agreement between Nicolet and Braintech also be declared null and void; and that a court-supervised receiver be appointed to manage Braintech’s affairs.

Braintech and Nicolet moved to dismiss the derivative action brought by Poseidon. I granted that motion for reasons stated on the record and not repeated here. Couri and Poseidon thereafter filed an amended and supplemental answer and Poseidon filed counterclaims in the action commenced against them by Braintech and Nicolet. The counterclaims are as follows:

First claim: Violations of section 14(f) of the 1934 act in respect of an election of Braintech directors on July 30, 1985.

Second claim: Violation of section 14(f) in respect of a section 14(f) report subsequently filed by Braintech on August 29.

Third claim: Violation of section 13(d) in respect of Nicolet’s June 17, 1985 section 13(d) filing, and subsequently.

Fourth claim: Violations of section 10(b) and Rule 10b-5 in respect of Nicolet’s acquisitions of Braintech shares.

Fifth claim: Breach by Braintech and its board of section 78.140 of the Nevada Revised Statutes in respect of agreements entered into between Braintech and Nicolet in late July 1985 and thereafter.

Sixth claim: Breach of a consulting agreement dated July 11, 1985 entered into between Poseidon and Braintech.

Seventh claim: Anticipatory breach of a July 22, 1985 agreement entered into between Poseidon and Braintech.

Eighth claim: Tortious interference by Nicolet with a May 31, 1985 agreement entered into between Braintech and Poseidon.

Ninth claim: Fraudulent inducement by Kass and Stewart (who together with Krauss, Brue, Penrod and Cichy had been added as additional counterclaim defendants) of the May 31, 1985 agreement between Poseidon and Braintech.

On its counterclaims, Poseidon prayed to enjoin Nicolet from acquiring or disposing of any assets or voting securities of Brain-tech, from soliciting proxies from other Braintech shareholders, and from influencing or controlling the management of Braintech. Poseidon further prayed that Nicolet be divested of its purchases of Braintech shares; that proper disclosures be made; and that a stock purchase agreement, a stock option agreement, a license agreement, and an asset purchase agreement entered into between Braintech and Nicolet be declared null and void.

In addition to the injunctive remedies sought by the parties against each other, as summarized supra, the complaints and counterclaims contain demands for money damages.

The case came on for hearing before the Court on cross-motions for preliminary injunctions. Poseidon asked that, within the context of a shareholders’ meeting to be held to vote upon the asset purchase agreement between Braintech and Nicolet, Nicolet be denied the right to vote its Braintech shares, or be required to vote them pari passu with the votes cast by public shareholders at the meeting.

Braintech and Nicolet asked that Couri and Poseidon be restrained from transferring any Braintech shares they hold to others.

At the beginning of the hearing on these applications for preliminary injunctions, the Court ordered the trial of the actions on their merits, insofar as they sought equitable relief, to be advanced and consolidated with the hearing of the applications. Rule 65(a)(2), F.R.Civ.P. The hearings extended over three weeks, generating 2,000 pages of transcript and almost 200 exhibits. The summations of counsel and post-hearing memoranda request broad equitable relief. Poseidon now contends that all of Nicolet’s Braintech shares should be returned to the Braintech treasury, and all agreements between Braintech and Nicolet be declared null and void. Nicolet and Braintech contend that all of Poseidon’s and Couri’s Braintech shares should be returned to the Braintech treasury, and all agreements between Braintech, Poseidon and Couri be declared null and void. Intervenor Drobbin makes common cause with Poseidon against Nicolet and Braintech, and prays for the appointment of a receiver over Braintech’s affairs.

IV.

Undisputed Facts

Many factual aspects of the case are in dispute. Primarily they relate to inferences to be drawn, and characterizations to be made. But many significant facts are undisputed. It is useful to set certain of them forth now, in order to narrow the issues and furnish the background against which the disputes must be resolved.

(A) The Genesis of Braintech

The BEAM inventors, Duffy and Culver, formed Braintech in December 1980. Stewart joined the corporation in December 1982 as a director and vice president in charge of operations. Kass became a director, vice president, and eventually president of Braintech.

While Braintech has certain other assets, it is common ground that the BEAM technology is by far its most valuable. However, Braintech has been singularly unsuecessful in marketing this apparently promising device.

With the assistance of its investment ad-visor, Muller & Company, Braintech first offered its stock to the public in October 1983. The offering price was $5 per unit, each unit consisting of four shares and a warrant. That offering raised several million dollars. However, by the spring of 1985, Braintech was in extremis. It had spent the funds raised by the 1983 public offering. It had accumulated debts in excess of $1 million. Braintech’s work force had shrunk from a previous high of 28 employees to three: Kass, the president; Stewart, the vice president; and Suzette Stewart, Stewart’s daughter, who was employed as an administrator, secretary and bookkeeper. Duffy and Culver remained the major shareholders of Braintech, but held no offices in the corporation. None of the three employees had been paid any salary since September of 1984.

During 1983 and 1984, Braintech actively solicited, and proclaimed itself eager to receive, overtures of any feasible kind from other companies. No acceptable offers were received. Some witnesses suggested that Culver, then active in Braintech’s affairs, put off potential suitors with an abrasive manner. For whatever reason, it is apparent that Braintech made strenuous efforts to attract the interest (and the funds) of others, to no avail.

To be sure, Nicolet had demonstrated interest in Braintech and the BEAM technology. Nicolet management made overtures to Culver and to the corporation in June 1984 and again in December 1984. But Braintech rejected as unsatisfactory Nicolet’s suggestions: that Nicolet’s sales force sell the BEAM technology (June 1984 proposal), or that Nicolet acquire all of Braintech’s shares (December 1984 proposal). Those in charge of Braintech rejected the purchase price contained in the latter proposal as insufficient in amount.

As of spring 1985, Braintech had placed only eight of its machines “in the field.” Even as to these, the corporation was encountering difficulties in realizing revenues from them. Other Braintech machines were in inventory, with no immediate sales prospects at an asking price in excess of $600,000 each. The company was, in a phrase suggested by the Court and adopted by counsel, “brain dead.”

These were the circumstances when Couri and his corporation, Poseidon, were introduced to Braintech.

(B) The Advent of Couri and Poseidon

Poseidon was incorporated in October 1984. Couri is the president. Poseidon’s principal business is described as “investments and management consultancy.” Poseidon has not to date filed a tax return, or prepared a financial statement. It has no payroll or telephone number. Poseidon’s mailing address is that of Howard Krantz, an attorney who has represented Couri in unrelated matters, and is a close personal friend.

Poseidon has three shareholders: Krantz; one Tompkins (of whom the evidence reveals nothing else); and CTC Venture, a sole proprietorship owned by Couri’s wife Carla, whose general power of attorney Couri holds. At one time pertinent to this litigation, Couri’s brother John was a Poseidon shareholder. He is no longer. It is common ground that Couri controls Poseidon; and that (save for certain Braintech shares here at issue) Poseidon has no assets.

It has become equally apparent during discovery and trial that Couri has no personal assets. On the contrary, he has a sizably negative net worth, as the result of an absence of assets and the presence of judgments against him and other indebtedness.

Couri has a checkered past. He has twice pleaded guilty in this Court to charges of fraud. One charge involved securities fraud. The other involved fraudulent statements made to a bank in connection with an art gallery Couri controlled. Couri is the subject of an injunction against securities laws violations obtained by the Securities and Exchange Commission.

In April 1985, Couri formed a casual acquaintance with one Alex Lucas, an employee of Muller & Company. Muller, after taking Braintech public in 1983, had entered into a financial consulting agreement with Braintech. Pursuant to that agreement, Muller was attempting without success to find investors for Braintech. In a series of social meetings, Couri impressed Lucas with his stature and management skills. Whether Couri revealed his past to Lucas, as Couri says, or concealed it and misled Lucas about his present circumstances, as Lucas says, I need not decide for reasons I will discuss infra. But there is no question that Lucas regarded Couri as a potential investor and source of assistance to Braintech. In consequence, on May 4, 1985 Lucas took Couri out to the Braintech offices in South Plainfield, New Jersey for a meeting.

Attending that meeting were Lucas, Couri, Kass, Stewart and one Martin J. Kaplitt, M.D. Dr. Kaplitt, a practicing physician, is also president of Advanced Medical Imaging Corp. (“AMIC”), a company involved in medical technology. Kaplitt was also considering Braintech as a possible investment; his presence at the Brain-tech offices on the same day as Couri was coincidental. Both Couri and Kaplitt listened to a presentation of the BEAM technology by Dr. Duffy. Kaplitt could understand that presentation better than Couri. Kass and Stewart then described Brain-tech’s current financial condition. Everyone could understand that.

The Braintech people were looking for an investment of some $500,000. Couri stated that in the company’s condition, such an amount would simply vanish into the hands of the creditors. Couri added that he was not interested in investing any amount. However, he gave a preliminary description of how Braintech’s debt might be restructured and the company restored to financial health. His discourse apparently impressed Kass and Stewart, as well as Dr. Kaplitt, who stated to Couri as they left Braintech that he might be interested in talking to Couri again.

Following that initial meeting, Couri, Kass and Stewart held discussions concerning Couri’s suggestion that Poseidon might render investment and management advice to Braintech. These discussions also involved Kenneth M. Socha, an attorney who was secretary and counsel of Braintech. After passing through a draft dated May 28, 1985, these discussions culminated in a letter agreement dated May 31, 1985. This is the first significant document in the case. It involves three parties: Braintech, Poseidon, and AMIC. Kass, Stewart and Socha signed for Braintech; Couri signed for Poseidon; and Kaplitt signed for AMIC.

The May 31, 1985 letter agreement, together with other pertinent documents, have been analyzed, debated, testified to and argued about as if they were among the Dead Sea Scrolls. In point of fact, the salient features are relatively straightforward. In the case of the May 31, 1985 Braintech/Poseidon/AMIC letter agreement (the “May 31 agreement”), they are these:

* The purpose of Poseidon’s and AMIC’s intervention in Braintech’s affairs was described as “restructuring its debt, negotiating a potential merger, consolidation, sale of assets, etc. and/or in obtaining additional debt and equity financing

* During the next 90 days Poseidon was authorized to contact Braintech’s creditors and try to work out satisfactory arrangements; to negotiate on Brain-tech’s behalf “any potential merger, acquisition, consolidation, sale of assets, business combination, joint venture or licensing agreement or similar agreement”; and to liquidate Braintech's existing inventory and realize any receivables. * 300,000 shares of common stock of Braintech were to be issued to Poseidon for entering into the May 31 agreement, those shares not being contingent “upon Poseidon’s performance hereunder or otherwise.”

* Upon execution of the May 31 agreement, Poseidon and AMIC obtained the right to designate a majority of Brain-tech’s board of directors.

* When and if Poseidon and AMIC were satisfied with arrangements Poseidon had made with Braintech’s creditors, Poseidon and AMIC could each invest $250,-000 in Braintech, in exchange for an additional 1.5 million shares each of Brain-tech common stock and notes secured by Braintech’s assets; in the event AMIC failed to make the investment, Poseidon could fund the entire $500,000 investment in exchange for 3,000,000 shares and notes aggregating $250,000.

* Upon the investment of $250,000 and after Poseidon made arrangements with Braintech’s creditors, Poseidon would receive an additional 300,000 shares of Braintech common stock.

* Poseidon and AMIC each received options to purchase an additional 1,000,000 shares of Braintech common stock (at prices ranging from 15$ to 30