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ECODYNE CORP. v. GUTHRIE NORTH AMERICA

August 10, 1989

ECODYNE CORPORATION, Plaintiff,
v.
GUTHRIE NORTH AMERICA, INC., Defendant



The opinion of the court was delivered by: BUA

 NICHOLAS J. BUA, UNITED STATES DISTRICT JUDGE.

 Plaintiff Ecodyne Corporation ("Ecodyne") filed the instant action claiming that defendant Guthrie North America, Inc. ("Guthrie") defrauded Ecodyne in connection with a securities transaction. Ecodyne complains that Guthrie failed to disclose certain material facts in connection with Ecodyne's purchase of all the stock of Guthrie's former wholly-owned subsidiary, Water Refining Co., Inc. ("WRC"). Specifically, Ecodyne claims that Guthrie failed to fully disclose information regarding a design defect in one of the products manufactured by WRC. Ecodyne's amended complaint contains six counts. Counts I and II allege violations of § 10(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78j(b) (1982); § 17(a) of the Securities Act of 1933, 15 U.S.C. § 77q(a) (1982); and Rule 10b-5 of the Securities and Exchange Commission, 17 C.F.R. § 240.10b-5 (1986). The remaining counts assert state law claims for consumer fraud, common law fraud, and breach of contract.

 This order concerns Guthrie's motion for partial summary judgment. Guthrie argues the undisputed facts establish that Ecodyne's securities law claims are barred by the applicable three-year statute of limitations. Therefore, Guthrie has asked the court to enter summary judgment in its favor on Counts I and II and to dismiss the remaining pendent claims for lack of federal jurisdiction. For the reasons stated herein, Guthrie's motion is granted.

 FACTS

 In early 1983, Ecodyne entered into negotiations with Guthrie for the purchase of all the stock of WRC. WRC was a subsidiary of Guthrie in the business of manufacturing and selling water softener units, among other products. Prior to its purchase of WRC, Ecodyne conducted a "due diligence" investigation of WRC's operations. Ecodyne's due diligence investigatory team was led by Ecodyne's controller, Fred Kemph. As part of his investigation, Kemph looked into matters relating to WRC's insurance, product and warranty claims. Kemph specifically inquired about product defects to Steve Davis, WRC's Director of Engineering and Manufacturing. Davis discussed with Kemph an alleged defect in the 110-volt water softener manufactured and sold by WRC. Davis told Kemph that several insurance claims and a lawsuit had been filed against WRC claiming that the 110-volt water softener had caused fire damage. Davis opined that the lawsuit was merely a "nuisance" action and there was no real problem with the 110-volt unit.

 Kemph believed Davis' statement that there was no real problem with the 110-volt water softener for several reasons. First, he had reviewed auditing statements of WRC prepared by the accounting firm of Deloit, Haskins & Sells. These statements did not contain any specific reserve for fire damage caused by product defects. Second, Kemph was familiar with a similar product manufactured by Ecodyne which he believed could not cause fire damage. Kemph's opinion in this regard was buttressed by statements from Ecodyne's technical personnel, who assured Kemph that Ecodyne's water softener could not cause residential fires. *fn1" Finally, Kemph stated he believed Davis because none of the WRC documents or reports which he reviewed indicated that the fire damage claims against WRC had a common cause.

 After Kemph's team completed its investigation, Ecodyne decided to purchase WRC from Guthrie. On April 14, 1983, Ecodyne entered into a written agreement with Guthrie under which Ecodyne purchased all of the outstanding shares of WRC stock for $ 2,700,000. Attached to the agreement was a written disclosure by Guthrie of all the product insurance claims and lawsuits pending against WRC as of January 10, 1983. The list identified six of the twelve insurance claims and one of the three lawsuits as relating to fire damage allegedly caused by product defects. After the transaction was consummated, WRC became a wholly-owned subsidiary of Ecodyne.

 Sometime in the early half of 1984, F. Stuart Mitchell, then President of Ecodyne, inquired about the fire problems that WRC had experienced with its 110-volt residential water softeners. Mitchell asked Steve Davis, who had been promoted as Acting General Manager of WRC, to prepare a memo addressing the history and status of the product defect matter. Davis was the most knowledgeable person at WRC with respect to the 110-volt water softener. In response to Mitchell's request, Davis sent Mitchell a memo dated July 18, 1984, discussing the fire problem. Davis' memo informed Mitchell that the problem was due to "catastrophic [solenoid] coil failures" in the 110-volt water softeners. Davis' memo indicated that the problem arose in approximately 1972 and that in the mid-1970s, WRC developed an asbestos cover which had "100% solved the problem" when placed over the solenoid coil. With respect to whether the cover was fitted to all previously manufactured units already in the field, Davis stated in his memo:

 
. . . it was . . . discussed at WRC about the advisability of notifying all dealers of the potential danger involved and to offer them this particular cover which they could add to those given units in the field. At this moment, I can't factually tell you if a memo went out to the field or not. Some think that it did but yet we can't find a record showing that this was done.

 Davis also stated in the memo that the coil failures "continue to plague [WRC] today" and estimated their occurrence at about "2-4 per year." He concluded the memo by stating:

 
As far as the future, we have no reason to believe that our track record of failures should improve -- in fact it may get worse. What we must be concerned about is potential loss of life which has not occurred.

 Nowlin then contacted Davis and asked him for more information on the fire problem. Davis told Nowlin the problem involved overheating of the solenoid coils on WRC's 110-volt water softeners manufactured in the early 1970s. Davis explained that the overheating caused a flare-up, a ball of fire, to appear atop the solenoid. Davis also informed Nowlin that WRC had implemented various changes in the product in an attempt to solve the fire problem. These corrective measures were listed in a memo dated January 10, 1978, from Davis to former WRC President D. Bower. The 1978 memo was attached to Davis' July 18, 1984 memo to Mitchell. Davis told Nowlin that the last corrective step taken was the application of an asbestos cover which solved the fire damage problem in 110-volt units by containing, although not eliminating, the fire. However, Davis could not definitively tell Nowlin whether all the dealers had been notified of the fire problem or had equipped their 110-volt units with the asbestos cover. In addition, Davis had no knowledge that any ...


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