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ELIASEN v. ITEL CORP.

April 24, 1995

AXEL N. ELIASEN, ROBERT V. ROLLHEISER and ALLAN L. APTER, on behalf of themselves and all others similarly situated, Plaintiffs,
v.
ITEL CORPORATION, a Delaware Corporation, ITEL RAIL CORPORATION (f/k/a Itel Rail Car Division), a Delaware Corporation, HOWARD L. CHABNER, JAMES CHANDLER, ROD F. DAMMEYER, JACK P. EDWARDS, DESMOND HAYES, WILLIAM J. HERNDON, GARY M. HILL, CURTIS J.. HOCKADAY, ROBERT C. KIEHNLE, JAMES E. KNOX, PAUL L. LOVEDAY, CARL V. LYON, CHARLES D. MARTIN, SAMUEL ZELL, THOMAS O. KLOEHN, and QUARLES & BRADY, Defendants.



The opinion of the court was delivered by: ROBERT W. GETTLEMAN

 Plaintiffs, Axel N. Eliasen, Robert V. Rollheiser and Allan L. Apter, on behalf of themselves and all others similarly situated, bring this eighty-two page, nine count putative class action complaint against defendants Itel Corporation ("Itel"), Itel Rail Corporation ("Itel Rail"), Howard L. Chabner, James Chandler, Rod F. Dammeyer, Jack P. Edwards, Desmond Hayes, William J. Herndon, Gary M. Hill, Curtis J. Hockaday, Robert C. Kiehnle, James E. Knox, Paul L. Loveday, Carl V. Lyon, Charles D. Martin, Samuel Zell ("the Individual Defendants"), and Thomas O. Kloehn and Quarles & Brady, alleging violations of the federal RICO statute, 18 U.S.C. § 1962(a),(c),(d); Section 10(b) of the Securities Exchange Act, 15 U.S.C. § 17(j); and state common law claims of breach of fiduciary duty, tortious interference with contract, conversion of property rights, accounting, as well as a claim for declaratory judgment. Federal jurisdiction is based on the RICO counts, 18 U.S.C. §§ 1964(a),(c), and 28 U.S.C. § 1331. All defendants have moved to dismiss all counts pursuant to Fed. R. Civ. P. 12(b)(6) for failure to state a claim upon which relief can be granted, and pursuant to Fed. R. Civ. P. 8(a)(2) and 9(b) for failure to set forth a short plain statement of the claim and failure to plead fraud with particularity. For the reasons set forth below, defendants' motions are granted and the case is dismissed.

 This is the latest (and hopefully the last) chapter in a long saga involving the rights of the holders of Class B debentures of the Green Bay & Western R. R. Co. ("GB&W"). Plaintiffs are all holders of Class B debentures who claim that pursuant to the wording of the securities issued by GB&W, as well as the Articles of Incorporation, they, as holders of Class B debentures, are entitled to a pro rata distribution of the net proceeds of the recent sale of GB&W. plaintiffs claim that defendants, through a series of schemes, sought to destroy the value of the Class B debentures.

 Defendant Itel is a Delaware corporation engaged in various businesses through its subsidiaries. Defendant Itel Rail is a wholly owned subsidiary of Itel that leases rail cars, and manages various short line railroads. In 1983, Itel, which owned 99.9% of the GB&W capital stock and a majority of the GB&W Class B debentures, transferred all of its railroad operation to Itel Rail, including the GB&W capital stock and the GB&W Class B debentures. The individual defendants are all current or past officers and/or directors of Itel, Itel Rail, or GB&W. Defendant Kloehn is an attorney with the Wisconsin law firm of Quarles & Brady ("Quarles"), which plaintiffs allege represented GB&W and Itel at all relevant times, and who were aware of the alleged scheme to defraud the Class B debenture holders and advised and counseled Itel and Itel Rail with respect to many of the alleged wrongful acts.

 Plaintiffs claim that as holders of Class B debentures they are the true owners of the equity of GB&W, and that defendants have concocted various elaborate schemes to destroy the value of the Class B debentures such that their actual value never exceeded their face value. To accomplish this goal, plaintiffs allege that defendants developed schemes to: (1) fraudulently deprive the minority holders of Class B debentures of their right to receive payments out of annual net income of GB&W; (2) fraudulently misuse the monies withheld from the Class B debenture holders by "loaning" said monies to Itel; (3) materially decrease the value of the GB&W securities by withholding the payments due out of annual income so that the securities could be purchased at artificially low prices; (4) fraudulently transfer approximately $ 10 million of GB&W's operating assets' "value" to another railroad owned by Itel, so as to deny the minority Class B debenture holders their full equity value in GB&W; (5) fraudulently deny the minority Class B debenture holders the value of that part of the equity of GB&W to which the Class B debenture holders were entitled, which exceeded the $ 1,000 face amount of the Class B debentures; (6) fraudulently misrepresent to the Class B debenture holders, the state and federal governments, and state and federal courts through the use of the U.S. mail, the rights of the Class B debenture holders and the value of the Class B debentures in order that Itel could obtain possession of the Class B debentures at prices drastically below the face value; and (7) cause GB&W to lease rail cars from Itel on terms overly favorable to Itel and extremely unfavorable to GB&W, which reduced the annual net income of GB&W, reduced the value of the GB&W, and in turn reduced the value of the Class B debentures.

 According to the complaint, in 1993 Itel Rail sold the GB&W assets and property to Wisconsin Central Transportation Corp. ("Wisconsin Central"), along with the assets of the Fox River Valley Railroad ("FRVR"), which was wholly owned by Itel Rail. At the time of the sale, Itel Rail owned 99.9% of the outstanding capital stock of GB&W, but only 78% of the Class B debentures. Plaintiffs allege that from the time Itel acquired GB&W in late 1978, until the time it sold GB&W, Itel sought to destroy the value of the Class B debentures by reducing the value of the GB&W assets. In addition, plaintiffs allege that Itel put into place a scheme to change the nature of the Class B debentures from equity status, which plaintiffs claim they enjoy under Green Bay & W. R. Co. v. Commissioner of Internal Revenue, 147 F.2d 585 (7th Cir. 1945), and Biltchik v. Green Bay & W. R. Co., 250 Wis. 177, 26 N.W.2d 633 (1978), to debt status.

 To understand the nature of plaintiffs' complaint, it is necessary to review the history of GB&W, the history of the Class B debentures, and the history of the litigation surrounding those debentures.

 From 1871 through 1873, Green Bay & Lake Pepin Railway Company built the railroad that is the subject of this lawsuit. In 1873, that company changed its name to the Green Bay & Minnesota Rail Road Company. On January 23, 1876, the Green Bay & Minnesota went into receivership, and the mortgage bondholders foreclosed on their mortgages. On May 16, 1881, a committee of the mortgage bondholders chartered the Green Bay, Winona & St. Paul Railway Company, which purchased the property of the Green Bay & Minnesota at a foreclosure sale. That company defaulted on the interest payments due on its first mortgage bonds on August 1, 1888, and went into receivership on July 31, 1890. A voluntary reorganization agreement was reached in 1892, but proved unsuccessful. On December 27, 1895, another foreclosure sale was ordered. At that sale in May 1896, a committee for the first consolidated mortgage bondholders purchased the property of the railroad.

 On May 27, 1896, the GB&W charter was issued. That charter embodied a plan of reorganization between the securities holders of the Green Bay, Winona & St. Paul Railway Company. The members of the first consolidated mortgage bond committee were identified as the purchasers of the railroad and property and as the incorporators and first board of directors of GB&W. The articles of incorporation provided for three types of securities: $ 2,500,000 of $ 100 par value capital stock; $ 600,000 of $ 1,000 face value Class A debentures; and $ 7,000,000 of $ 1,000 face value Class B debentures.

 The 25,000 shares of capital stock were distributed to the first mortgage and first consolidated mortgage bondholders of the Green Bay, Winona & St. Paul Railway Company. The 7,000 Class B debentures were to be distributed to the holders of the second mortgage income bonds and to the holders of the common and preferred stock of the Green Bay, Winona & St. Paul Railway, after the committee of the second mortgage income bonds and preferred and common stockholders of the Green Bay, Winona, St. Paul purchased the 600 Class A debentures for $ 570,000 in cash.

 None of the three classes of securities have a fixed rate of return, and any annual payments that might have been paid are not cumulative. None of the securities have a maturity date; but the Class A and Class B debentures are payable only in the event of a sale or reorganization of the railroad and property of the company. Only the capital stock has voting power.

 The capital structure of GB&W has remained unchanged since it was created in 1896. In January 1978, Itel acquired the GB&W through an amended tender offer. At that time, Itel acquired more than 97% of the outstanding common stock, more than 4,919 of the 7000 Class B debentures, and two of the three outstanding Class A debentures. The terms of the amended tender offer were $ 330 per share of common stock, $ 1,050 per Class A debenture, and $ 325 per Class B debenture.

 HISTORY OF THE CLASS B DEBENTURES

 As noted by Chief Judge Reynolds in Eliasen I (569 F. Supp. at 88):

 
The Class B debentures are an unusual security that cannot easily be classified. The rights that the holders of Class B debentures enjoy cannot be ascertained merely by referring to the terms of the instrument and the GB&W's articles of incorporation. Interpretation of their rights requires an understanding of the circumstances surrounding the organization of the GB&W in 1896, and of the litigation that has already occurred over these debentures.
 
The holders of this series of Debentures shall in lieu of interest thereon participate in the distribution of annual net income to the following extent only: viz., so much of the annual net earnings of the said Company in any year as would be applicable to the payment of dividends on stock shall be applied as follows: viz., to the holders of a Class A debenture 2-1/2% upon the face value thereof, or if such annual net earnings are insufficient for the payment of the same, then all such net earnings shall be distributed pro rata among the holders of said Class A debentures. After payment of 2-1/2% upon the face value of Class A debentures, the stockholders of the Company are entitled to receive the balance of such net earnings until 2-1/2% have been paid out of the same upon the par value of said stock, and all surplus net earnings then remaining shall be paid to the holders of Class A debentures and of the stock, pro rata, until 5% shall have been paid upon the face value of said Debentures, and upon the par of said stock for such year, and any surplus net earnings arising in such year which may then remain shall be paid to and distributed among the holders of the Class B debentures pro rata. None of such payments shall be cumulative. The amounts, if any, payable upon this series of Debentures out of the net earnings in any year, will be fixed and declared by the board of directors . . ..

 The second term deals with repayment of the debenture upon maturity. The debentures do not have a specified maturity date, but rather mature only upon a sale or reorganization of the railroad and property of the company. Specifically, the Class B debentures provide:

 
The Green Bay & Western Railroad Company hereby certifies that this is one of a series of 7,000 of its Class B Debentures, in the sum of ONE THOUSAND DOLLARS each, aggregating in all the sum of Seven Million Dollars, which sum of One Thousand Dollars will be payable to the bearer hereof as follows: viz., only in the event of a sale or reorganization of the Railroad and property of said Company, and then only out of net proceeds of such sale or reorganization which may remain after payment of any liens and charges upon such Railroad or property, and after payment of Six Hundred Thousand Dollars to the holders of a series of Debentures known as Class A, issued or to be issued, by said Company, in the sum of Two Million Five Hundred Thousand Dollars to and among the stockholders of said Company. Any such net proceeds remaining after such payments shall be distributed pro rata to and among the holders of this series of Class B debentures.

 The first litigation arising out of the Class B debentures was reported in Green Bay & Western Railroad Company v. Commissioner of Internal Revenue, 147 F.2d 585 (7th Cir. 1945). In that case, the issue was whether amounts paid to the holders of Class A and Class B debentures by the GB&W from its annual income should be treated as interest or dividends under the income tax laws. After reviewing the wording of the debentures, the court held that the amounts paid were dividends. In so doing, the court stated:

 
The debentures on their face disclose that they had no fixed maturity; that the dividends were not cumulative and were payable within the discretion of the board of directors; that there was no provision for interest on unpaid dividends; that the debenture holders had no right to maintain an action in case of default as to the payment of dividends inasmuch as such payment was in the discretion of the board of directors; that the status of the debenture holders of Class A was on a par with that of stockholders; and the rights of the debenture holders both Class A and Class B were inferior to those of creditors. Moreover, investments in the debentures represent value paid in at the time of the petitioner's incorporation and constitute a large part of its operating capital. Furthermore, the ...

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