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February 22, 1982


The opinion of the court was delivered by: Bua, District Judge.


Plaintiff sold his stock to F.D. Farnam Company prior to its purchase by Colt, for allegedly less than its true value as a result of a settlement agreement entered into in a prior lawsuit in this court entitled Dungan v. F.D. Farnam Co., et al., No. 77 C 1620 (N.D.Ill. 1980). The case at bar is an action for compensatory and punitive damages for failure to disclose material information concerning the value of the stock.*fn1 Plaintiff relies on a theory of breach of fiduciary relationship as well as 15 U.S.C. § 78j and S.E.C. Rule 10b-5 as authority for this action. Jurisdiction over this matter lies under 28 U.S.C. § 1331, 1332 and 15 U.S.C. § 78aa. The case has been tried on stipulated facts.

As the stipulated facts indicate, the settlement in the first lawsuit was originally negotiated in a pretrial conference held between attorneys for the plaintiff and defendants on July 10, 1978. The court entered an order allowing the plaintiff's jury demand and ordering the cause dismissed by agreement of the parties "all matters in controversy having been settled." Also, at the July 10, 1978 pretrial conference, plaintiff's attorneys informed the court that the settlement amount of $107,109.59 was subject to approval by the plaintiff. Accordingly, the court entered and continued generally a motion to reinstate the action.

Subsequently, negotiations between the attorneys for the plaintiff and defendants continued. On August 2, 1978, plaintiff's counsel informed defendants that plaintiff had approved the settlement amount. At the same time, counsel requested that the settlement amount be paid on a deferred basis to assist plaintiff's income tax planning which required that the transfers not be completed until January 2, 1979. As an accommodation to plaintiff regarding his tax situation, defendants agreed to this request.

The actual exchange was implemented by means of an escrow agreement entered into by the parties on October 7, 1978. The agreement provided that the plaintiff was to receive $60,000 for his stock. Five thousand dollars were paid to the plaintiff when the stock was transferred to an escrow account, and the balance of $55,000*fn2 was to be paid to the plaintiff on January 2, 1979.*fn3

On September 12, 1978, Robert Burns, president of Holley Carboretor, a subsidiary of Colt Industries, Inc., telephoned Robert G. Farnam concerning the purchase by Colt Industries of the F.D. Farnam Company's stock. The deal was negotiated in the following weeks and finalized on September 26, 1978 when Colt offered to buy 100% of the F.D. Farnam Company stock for $16,000,000 to be paid at a closing scheduled for January 3, 1979. On October 9, 1978, Colt was informed by Robert G. Farnam of the settlement of plaintiff's original lawsuit, and the selling price of the Farnam stock was accordingly reduced by $60,000 — the amount to be paid by F.D. Farnam to the plaintiff for his stock. At the same time, as a condition of its purchase, Colt required that it be indemnified by the stockholders in Farnam against any further claims by William J. Dungan and/or others related to transactions or settlement. It was agreed that Colt would retain $300,000 for one year from the closing date to cover contingent liabilities.*fn4

At the outset, this court finds unpersuasive plaintiff's argument that the sale of his stock was not consummated until October 7, 1978 when plaintiff and defendant entered into the escrow agreement or January 2, 1979 when the stock was ultimately transferred from the escrow account to Farnam and Company. Plaintiff asserts that either of these is the crucial date prior to which this court must assess the existence or nonexistence of omissions of material facts regarding the sale. As has already been stated, the manner in which the stock transfer was implemented was merely a concession to plaintiff's tax planning. It cannot be said that the mode of transfer in any way affected the finality of the settlement and sale agreed to by the attorneys for the parties on July 10, 1978 and ratified by the plaintiff on August 2, 1978. It is well settled that settlement agreements are contracts and are governed by general principles of contract law. Ransburg Electro-Coating Corp. v. Spiller and Spiller, Inc., 489 F.2d 974, 977 (7 Cir. 1973); Roberts v. Browning, 610 F.2d 528, 533-536 (8th Cir. 1979). In this case, although it might be said that the contract was formed on either July 10 or August 2, under no theory could this court find that the date of contract formation was October 7, 1978 or January 2, 1979.*fn5 Therefore, the central issue in this lawsuit is whether or not defendants, other than Colt, in negotiating their purchase of plaintiff's stock, failed to disclose any material facts known to them prior to August 2, 1978 which might have affected the settlement figure. It is this court's conclusion that defendants*fn6 did not make full disclosure of material information in their possession at the time plaintiff ratified the settlement figure, and that, as a result, plaintiff is entitled to recover under Count II of his complaint.*fn7

Based on the deposition testimony which was taken in connection with plaintiff's motion to vacate the prior action and which has been incorporated as part of the present lawsuit, the court finds that prior to August 2, 1978 defendants 1) had been advised by their accountant, defendant Jacks, that they needed three years of profitable performance before they could successfully sell the Farnam Company, 2) were aware of the fact that fiscal year 1978 (which ended on May 31) had been a "third good year," and 3) had in fact discussed the possibility of selling the company with certain unidentified interested parties. In light of these facts and the reasonable inferences that may be made from them, this court concludes that defendants 1) had seriously contemplated sale of the entire Farnam Company prior to negotiating the purchase of plaintiff's stock, 2) that this fact is one which would have materially affected the value of plaintiff's stock, 3) that plaintiff relied on defendant's statements as to the value of the stock, 4) that defendants knowingly failed to disclose the information in their possession, and 5) that, as a result, defendants violated the federal securities laws.

The depositions of Edward Jacks and Robert G. Farnam provide ample support for this court's factual findings. Defendant Jacks in his deposition, indicated that he had counseled the Farnam Company with regard to the fact that three good years were needed before the company could seriously contemplate sale. (Jacks Deposition at 7.) This fact is corroborated by the deposition of defendant Robert G. Farnam. The questioning was as follows:

  Q Do you recall a conversation with Jacks in which
    he said that if you're going to sell your stock
    to the company, you better wait till you've had
    three good years?
  A We've talked about different things of that
    nature, sure. That's right.

(Farnam Deposition at 18.)

The deposition testimony also compels the court's finding that defendants were aware of the fact that fiscal year 1978 had been a third good year. Robert G. Farnam, at page ...

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