Appeal from the United States District Court for the Northern District of Illinois, Eastern Division. No. 07 C 5238-John W. Darrah, Judge.
The opinion of the court was delivered by: Posner, Circuit Judge.
Before CUDAHY, POSNER and KANNE, Circuit Judges.
The plaintiff, Jack Smith, appeals from the dismissal, for failure to state a claim, of his diversity suit for fraud. Fed. R. Civ. P. 12(b)(6). The parties disagree on whether Illinois or North Carolina law governs the substantive issues, but as nothing turns on the dispute, because there is no material difference between the relevant laws of the two states, we ignore it.
In 1999 Smith sold a controlling interest in his medical-testing company, together with patents and other intellec- tual property, to Dade Behring, Inc., a closely held corporation. As part of the consideration for the sale Smith received options, valid for ten years, to purchase 20,000 shares of Dade Behring's common stock at $60 a share. He also became an employee of the company. But the relationship soon soured and on May 3, 2002, he signed an agreement ending his employment. By the terms of the agreement he received $1.4 million in cash and retained his stock options with their $60 exercise price, although the appraised value of the stock was only $11.
Three months later the company declared bankruptcy under Chapter 11 of the Bankruptcy Code, and as part of the ensuing reorganization of the company Smith's stock options were extinguished. He sued three officers of Dade Behring (including its chief financial officer), who had negotiated the termination agreement with him and who he says knew that the company was planning to declare bankruptcy in a pre-packaged bankruptcy filing that would propose cancellation of the stock options. He contends that the defendants had a duty to disclose these facts to him. The reorganization was successful, and stock and stock options in the reorganized company were issued to the defendants, but of course not to Smith.
Smith argues that had they told him the company was planning to declare bankruptcy and that as a result his 20,000 stock options would be cancelled, he would have refused to sign the termination agreement unless he had been given more than $1.4 million to do so. He argues in the alternative that he should be entitled to the value of the shares in the reorganized company ($76 when he sued) that he would have owned had he been issued (and exercised) stock options in the company on the same terms as the options he had owned before the reorganization. This alternative theory of damages is preposterous. Smith does not claim that the Chapter 11 reorganization was fraudulent (though he contends that the defendants hoped to profit from it by obtaining stock and stock options in the reorganized company), or otherwise invalid and so should not be deemed to have extinguished existing stock and stock options. The company was broke, and the extinction of equity interests is the usual consequence of bankruptcy. Smith could not have enforced his options once bankruptcy was declared, and he had no right to receive stock and options in the reorganized company and would not have had the right even if he had continued as an employee. Even if it's true, as he argues, that "if Smith had the ability to exercise the options he was granted under the [termination agreement], he would now realize a gain of approximately $10.9 million," the premise cannot be satisfied; he could not exercise the options because they were eliminated in a valid bankruptcy proceeding.
His complaint is not about the bankruptcy, but about the failure of the defendants, who for all we know were not acting with the company's knowledge or authorization, to tell him that the company would be declaring bankruptcy. The bankruptcy is not in issue in this case, which is why the defendants do not argue that the judgment in the bankruptcy case bars the plaintiff's claim.
Smith's only remotely plausible argument is that had the defendants told him the company was about to file for bankruptcy he would have demanded and received more cash, in lieu of the stock options that were about to disappear. But how likely is that? And how could such pressure have been effective? Had the defendants told him the company was about to declare bankruptcy, he would have realized, if he didn't already, that his bargaining position was weak, because in bankruptcy he probably would get nothing at all. When two parties are trying to negotiate a contract, the one who if the contract is made will be the paying party will generally try to give the impression that he cannot afford to pay a very high price and that the other party therefore has little bargaining power. The defendants didn't try to do that, as they could have done by telling the plaintiff that the company was going to declare bankruptcy.
Nor is it argued that they would have been authorized by the company to increase the amount of cash that Smith would receive under the termination agreement had he expressed dissatisfaction with the $1.4 million cash settlement upon learning that the stock options had no value. Since, as he emphasizes, the defendants and their superiors in the company foresaw that all existing stock and stock options in the company would be extinguished in bankruptcy because it was a pre-packaged bankruptcy and extinction was part of the package, they would not have paid him anything to relinquish his stock in the termination agreement. Had he said to the defendants, "Well, since the options have no value, I am willing to relinquish them, but I want to be compensated for surrendering this valueless asset," they would have scratched their heads in puzzlement.
Thus the likeliest explanation of why the defendants did not tell Smith about the bankruptcy is that they assumed, and assumed he assumed, that the parlous state of the company-known to all and symbolized by the disparity between the appraised value of the stock ($11) and the exercise price of the stock options ($60)-made his retention of the stock options of no conceivable significance.
He does argue that the defendants expected the company to emerge from bankruptcy in fine shape; and indeed by the time he sued the value of the stock of the reorganized company had soared. But they were not required to share their hopes or expectations with him. When an alleged fraud consists of failing to tell the alleged victim something (in this case that the defendants' employer was about to declare bankruptcy) rather than telling him something that is untrue, he must show that there was a duty to tell him that something. Such a duty-call it the duty of candor-is sometimes imposed as a matter of law, as in the case of a fiduciary relation-ship. See, e.g., Chiarella v. United States, 445 U.S. 222, 227-28 (1980); United States v. Holzer, 816 F.2d 304, 307 (7th Cir. 1987); In re Tallant, 218 B.R. 58, 65 (9th Cir. BAP 1998); W. Page Keeton et al., Prosser & Keeton on the Law of Torts § 106, pp. 738-39 (5th ed. 1984); Restatement (Second) of Torts § 551(2)(a) and comment f (1977). But often it arises in the absence of any special relationship-arises just because the defendant's silence would mislead the plaintiff because of something else that the defendant had said, id., § 551(2)(b); Union Pacific Resources Group, Inc. v. RhonePoulenc, Inc., 247 F.3d 574, 584-86 (5th Cir. 2001); Okland Oil Co. v. Conoco Inc., 144 F.3d 1308, 1324 (10th Cir. 1998); V.S.H. Realty, Inc. v. Texaco, Inc., 757 F.2d 411, 414-15 (1st Cir. 1985), or because of other circumstances, as in Mathias v. Accor Economy Lodging, Inc., 347 F.3d 672, 675 (7th Cir. 2003). We held in that case that it was a fraud for a motel not to warn customers that their room was infested with bed bugs, since the customers would in the absence of warning have assumed it was not infested.
The case of a special relationship, such as the lawyer's fiduciary obligation to his client, is really just a special case of the general proposition that context can create a duty of candor. The lawyer's specialized knowledge invites the client to repose trust in what the lawyer tells him, and the client's expectation would be shattered if the lawyer could be uncandid with impunity, as is normal in arm's length dealings between buyers and sellers.
Had the defendants (or the company) told Smith that the company was doing great, so that he should be happy that the consideration he would receive under his termination agreement included stock options and so he should not ask for more cash, this would have put out of his mind any concern that the company might go broke and therefore his stock options become valueless. The defendants would then have been duty-bound to disabuse him of the misleading impression that they had created. But not only did they not say anything to lull him into thinking bankruptcy not in the cards; when they sent him the initial draft of the termination agree-ment they didn't bother to provide in it that he would retain his stock options-implying that they were worth too little to warrant mentioning. Rather than puffing up the value of the ...