Shulton, Inc. v. Rubin

PIammond, J., delivered the opinion of the Court. The controlling issue in this suit in equity for rescission of a contract by which Shulton, Inc., a relatively large and rich chemical corporation (the complainant below and appellant here), purchased the controlling capital stock of Chemed, Inc., a smaller chemical corporation (an appellee here), is whether the purchase was induced by material misrepresentations of fact made by Martin Rubin, another appellee, the founder, chairman of the board and principal stockholder of Chemed, and by other agents of that corporation. Martin Rubin was awarded the degree of doctor of philosophy in organic chemistry by Columbia University in 1942, his doctoral thesis having been on the subject of steroidal heart drugs. ⁶⁷² The year before he had held a fellowship at Johns Hopkins Medical School. After he graduated from Columbia he worked with, and as consultant to, several chemical firms, and after this he became an associate professor at both the Georgetown Medical School and its Graduate School.

He has been granted some twenty-five patents in the field of chemistry and drugs and has had published over fifty scientific articles. In 1953, Dr. Rubin, with a former schoolmate who was practicing law in White Plains, New York, formed Chemed, Inc. Chemed progressed slowly and in 1963 was leasing a small plant in Odenton, Maryland, from one William Starr who at one time had been its president and was its largest stockholder other than Dr. Rubin. It had four sources of income—fine chemicals, bulk finished products, research and development operations, and the production of hecogenin, an intermediate substance used in the making of steroid drugs, which Dr. Rubin had attempted to isolate from Mexican sisal plants over a number of years. Chemed needed capital and chemical manufacturing facilities and Dr. Rubin began seeking them out.

Through an intermediary he was put in touch with Shulton, which was interested in entering the field of steroid chemical production. After introductions had been arranged and preliminary discussions held, Dr. Rubin sent Shulton a written projection of Chemed’s income and expenses for the fiscal year July 1, 1963-June 30, 1964, and for the fiscal years 1964-65, 1965-66, 1966-67; the estimated receipts from fine chemicals were respectively $36,000, $48,000, $60,000 and $85,000 from bulk finished products $15,000, $25,000, $40,000 and $60,000, from research and development $8,000, $10,000, $25,000 and $25,000, and from the hecogenin, which Dr. Rubin listed as “Bulk Manufactured Products,” the estimated receipts were $45,000, $75,-000, $150,000 and $225,000. The total projected receipts for the first year were $104,000 with estimated expenses of $162,000 (loss of $58,000), for the succeeding years respectively $158,-000 and $219,000 (loss of $61,000), $275,000 and $231,000 (profit $44,000), and $395,000 and $257,000 (profit $138,000). In explanation of the figures for the hecogenin, Dr. Rubin wrote Shulton, “Chemed presently has a contract to deliver $45,000.00 of hecogenin to Glaxo in England, during 1963/64. ⁶⁷³ * * * Trial lots have been made, shipped, accepted (and paid for!) by the customer.” Shulton’s interest in Chemed was several fold.

It not only wished to enter the field of steroid chemicals but to obtain the results of the knowledge and research of a highly reputable chemist outstanding in the field of the production of pure hecogenin from Mexican sisal, a result which others had not been able to obtain satisfactorily because of the difficulty of eliminating from the finished product tigogenin, present with hecogenin in Mexican sisal. It also wished to obtain the continuing benefits of Dr. Rubin’s advice and skills. The intermediary who had brought Chemed to the attention of Shulton was a Dr. Jelling, to whom Dr. Rubin wrote that Chemed was a: “* * * major owner of a Mexican subsidiary which produces and ships to us * * * a raw material from the sisal plant from which Chemed has developed processes for manufacture of Hecogenin, one of the recognized steroid raw materials. We have just signed a one year contract to supply our product in reasonable quantity to Glaxo in England.

Glaxo is the major user of this route to the steroid end products. This contract was obtained after a year of development work in which our product has been evaluated vigorously by the British and found to be, by their admission, superior to their own manufacture. “At the present moment, we have completed arrangements with the Mallinckrodt Chemical Works in St. Louis to carry out the most difficult (for us in our present location with present facilities) phase of the production of our product for Glaxo. “Chemed is now actively seeking funds to: * * * “2. Construct a suitable production unit for the meeting of our present Glaxo order and provide a base for future massive expansion in raw material production.” ⁶⁷⁴ Dr. Jelling wrote to the president of Shulton on March 27, 1963, repeating in essence what Dr. Rubin had written him. Thereafter Dr. Rubin and Dr. Fishbein, president of Chemed, met on various occasions with executive officers of Shulton and represented to them that Chemed had developed and used a dependable, reproduceable series of steps which could be relied on to produce, from sediment fermented from the juice of Mexican sisal plants, pure hecogenin at the rate of five to six per cent of the quantity of sediment worked, and that the product could be sold to Glaxo and others in commercial quantities of, initially, at least one hundred kilograms a month, at approximately three cents a gram.

They also represented that Chemed had produced from Mexican sisal commercially disposable kilograms of hecogenin which Glaxo previously had bought and paid for and which, under its testing, had been found to meet its exacting standards. Glaxo, an English company, was a large and perhaps the leading user of hecogenin which it made by patented processes from African sisal (which, unlike Mexican sisal, was not plagued by the presence and tenacious perseverance in remaining present of tigogenin). Because of the political uncertainties in Africa, Glaxo wished to insure an alternate source of supply of hecogenin which met its standards and therefore was very much interested in exploring the potential capabilities of Chemed. Before Shulton entered the picture, both Dr. Rubin and Dr. Fishbein had made various representations to Glaxo that the hecogenin it had shipped and the hecogenin it was to ship to meet Glaxo’s purchase orders, (and these representations continued thereafter) had been made by it from Mexican sisal and that it had the capacity to produce one hundred kilograms a month from such sisal. 1 ⁶⁷⁵ During the negotiations Shulton sent its men to Chemed’s plant to inspect its facilities and its limited inventory and to check its financial structure, but Shulton was never told the details of Dr. Rubin’s method of producing hecogenin from Mexican sisal because the method was not patented and was deemed a trade secret by Dr. Rubin.

Chemed had only one class of stock, the charter authorizing 20,000 shares of common stock of which 12,400 shares were outstanding, 7,240 shares being owned by Dr. Rubin. There were also outstanding 3,040 warrants and options to purchase Chemed common stock at $25.00 a share. It was proposed that the existing Chemed stock be converted to a new Class B common, having the right as a class to elect two directors, and that a new Class A common, having the right as a class to elect three directors, be created and bought by Shulton in an amount equal to the number of shares of Class B common to remain outstanding, so that the existing stockholders of Chemed would elect two of five directors and Shulton three. Shulton agreed to pay $150,000 for such a share interest and to lend up to $150,000 more as additional capital when and as needed.

It was agreed that there should be 10,000 Class B and 10,000 Class A shares. Dr. Rubin stated that certain existing stockholders of Chemed would have to be bought out, since they would not, he was sure, agree to the conversion of their controlling common stock to Class B stock with limited voting rights. He estimated the number of shares of such dissident stockholders as “about 2,000 shares” and the amount needed to buy them out as about $50,-000. He told Shulton that subscriptions to Chemed stock had been at around $25.00 a share and that this was its present going price.

Dr. Rubin further told Shulton that because Chemed owed $60,000 to Georgia Capital Corporation, a small business investment company, and federal law and regulations, applicable in this situation, forbade direct redemption of shares of dissident ⁶⁷⁶ shareholders, it would be necessary for Shulton to buy the necessary shares and turn them in as part of the price to be paid by it for its Class A common stock, thus reducing the $150,000 purchase price by the amount Shulton paid for the stock of dissident holders. Dr. Rubin proposed and Shulton agreed that he should negotiate for and buy the shares at not more than $25.00 a share and resell them to Shulton for exactly what he paid for them. Shulton required and obtained an agreement by Dr. Rubin that the outstanding warrants and options would be exercisable only against the new Class B common and that he would place in escrow sufficient shares from his own holdings of such stock to meet any exercise of such warrants or options. ■- The understandings and agreements of the parties were finally settled and defined at a meeting on June 14 between Dr. Rubin and Shulton’s president and its executive vice-president. Thereafter Shulton’s general counsel, assisted by a lawyer in a leading New Jersey firm who was retained by Shulton on the one hand, and Dr. Rubin’s long time friend and legal adviser, who had joined with him in forming Chemed on the other, were instructed to and did prepare the necessary written agreement and the complementary corporate and closing papers.

Three days after the June 14 meeting, which crystallized the agreements between Dr. Rubin, Chemed, and Shulton, Dr. Rubin wrote Georgia Capital Corporation telling it that Shulton would put up. some $50,000 to acquire about 2,000 outstanding common shares in order to reduce the total outstanding (which were to be converted to Class B stock) to 10,000 shares and would invest in Chemed about $100,000 additional as the further purchase price of the total of 10,000 shares of new Class A stock it was to buy and also lend an additional $150,-000 in the next few years. He further advised Georgia that Shulton would control Chemed through its three directors, that all outstanding warrants would be met from the new Class B stock, and added: “The only drawbacks to our acceptance of this opportunity are those that involve myself. You have noted, I am sure, that the provision that warrants be ⁶⁷⁷ exercised from the pool of new non voting stock means in essence that I will have to carry this burden alone. This means, as the situation stands now, that I have to provide for the 2,640 warrants to Georgia Capital and the folks in New York City as well as the option provided to Dr. Fishbein of 100 shares [actually 400 shares] as well as any new warrants that may have to be given to Dr. M. Selling [sic] who acted as ‘finder’ in the Shulton negotiation.

These warrants would come from my present holdings of about 7,000 shares and represent an onerous burden and a bitter pill for the acceptance of the Shulton proposal. I am loathe to do this and would make the folio-wing request: “That in the event the proposal Re: Shulton, outlined above be accepted and the loan of Georgia Capital to Chemed, Inc. be repaid with the contract penalty that: “Georgia Capital agree to then exercise at least 50% of the warrants which I would be required to provide by payment to me of 30,000 at the rate of $25/non voting share of Chemed stock. “I am hopeful that the management of Georgia Capital will understand my position and willing to accept my request.” Georgia agreed to the Shulton deal and advised Dr. Rubin it would exercise 1,200 warrants—and only 1,200. Dr. Rubin began buying Chemed shares on June 16. On that day he bought 3,000 shares from Mr. Starr, the former president and early stockholder of Chemed and its current landlord, for $20,000 or $6.67 a share—without revealing to Mr. Starr in any way that the Shulton deal was imminent—and 200 shares held by Mr. Starr for two of his employees for $2,000.

Between June 16 and July 10 he bought 100 shares from his lawyer at $25.00 a share, 20 shares for $30.00 a share from another holder, and 1,240 shares for $28.00 a share from five other stockholders, a total of 4,360 shares at an aggregate price of $54,220. A draft of the proposed contract was sent to Dr. Rubin and ⁶⁷⁸ his lawyer about June 28. On July 1, Dr. Rubin informed Shulton’s executive vice-president that the number of shares acquired by him for resale to Shulton, so that Shulton could deliver the shares to Chemed as partial payment of its $150,000 equity investment in that company, totalled 2,400 and that they had been bought at an average price of $23.00 a share. Because Dr. Rubin was scheduled to leave soon for Europe the execution of the contract and the settlement under it and the various corporate maneuvers in connection with it were all planned to take place as one integrated transaction on July 10.

On July 5, a pre-closing four hour conference was held between counsel for Shulton and the lawyer representing Dr. Rubin and Chemed, at which the papers were gone over and revised and the preparation of those not yet written planned and assigned. On July 10, the parties and their lawyers met at Shulton’s office. Dr. Rubin, Chemed and Shulton then executed a written agreement calling for: 1. The purchase by Dr. Rubin of 2,400 shares of outstanding Chemed common stock and the sale thereof to Shulton at closing at the prices paid by Dr. Rubin up to a maximum of $25.00 a share. 2.

After retirement of the 2,400 shares, the conversion of existing Chemed common stock-—-10,000 shares—to Class B common stock, with the sole voting right to elect two of Chemed’s five directors. 3. The subscription to and purchase at closing of 10,000 shares of Class A common stock of Chemed by Shulton at a price of $150,000, less the cost to Shulton of the 2,400 shares it bought from Dr. Rubin. 4. Loans from Shulton to Chemed from time to time as needed up to an aggregate of $150,000. In the agreement Dr. Rubin represented and warranted that the shares he sold Shulton were free and clear of encumbrances and that there were outstanding no warrants, options or “other devices” which could require the issuance by Chemed of Class B common stock or other security: “* * * except that there are warrants outstanding to purchase Chemed capital stock as follows: Georgia ⁶⁷⁹ Capital Corporation 2,400 shares; Lawrence Fishbein 400 shares; Samuel Beck 102 shares; Howard Weinberger 102 shares; Robert Markewich 36 shares; and as to these Rubin represents and warrants that the holders shall agree to have their warrants applicable against Class B Common Stock, restricted as other shares hereunder, and Rubin shall place shares of his own in escrow with Chemed for delivery against full or partial exercise of such warrants.” He also agreed that: “No representation or warranty by Rubin in this Agreement nor any statement or certificate furnished or to be furnished to Shulton pursuant hereto, or in connection with the transaction contemplated hereby, contains or will contain any untrue statement of a material fact, or omits or will omit to state a material fact necessary to make the statements contained therein not misleading.” In the agreement all obligations of Shulton were made subject to the fulfillment of the condition that: “The representations and warranties of Rubin and Chemed contained in this Agreement or in any certificate or document delivered pursuant to the provisions hereof or in connection with the transactions contemplated hereby shall be true at and as of the time of Closing as though such representations and warranties were made at and as of such time.” Dr. Rubin agreed to indemnify and hold harmless Chemed and Shulton at all times after the date of the agreement against and in respect of: “any and all damage or deficiency resulting from any misrepresentation, breach of warranty or non-fulfillment of any agreement on the part of Rubin under this Agreement or from any misrepresentation in or omission from any certificate or other instrument furnished to Shulton hereunder * * *.” ⁶⁸⁰ It was further provided that: “All statements contained in any certificate or other instrument delivered by or on behalf of Rubin pursuant hereto or in connection with the transactions contemplated hereby shall be deemed representations and warranties by Rubin hereunder.

All representations, warranties and agreements made by Rubin in this Agreement or pursuant hereto shall survive the closing hereunder and any investigation at any time made by or on behalf of Shulton.” At the closing meeting, Dr. Rubin signed and delivered to Shulton a statement, “* * * that the 2,400 shares of capital stock of Chemed, Inc. being sold by me this date to Shulton, Inc., were purchased by me at a net cost to me equal to the amount being paid to me by Shulton, Inc.,—$55,200.” Shulton delivered to Dr. Rubin a check in the amount of $55,200, bearing the notation on its face, “Payment for 2,400 shares of Chemed, Inc. common stock @ $23 per share,” which Dr. Rubin endorsed and deposited. Dr. Rubin also executed a stock deposit agreement in which, “in order to induce Shulton, Inc. to enter into an agreement of even date herewith with the parties hereto,” Rubin and Chemed stipulated that there were outstanding options to purchase Chemed common stock in the numbers listed, and further agreed, that Rubin simultaneously was to deposit with Chemed 1,840 shares of Chemed common stock registered in his name, endorsed in blank, and authorized Chemed to use said shares to fulfill his obligation to issue and deliver shares of capital stock in the event any or all of the foregoing options are exercised. Shulton agreed: 1. That Chemed would collect and remit to Rubin “the purchase price [$25.00 a share] received from the optionee(s).” 2.

That Chemed would deliver to Rubin all shares allocable to any option which expired unexercised. 3. That Rubin could vote and would receive dividends on the shares while they were held in escrow. Dr. Rubin delivered to