Evidence - Admissibility of Business Records

Obtaining the admission of business records is a often a critical component of any trial. It is a must in any business litigation and can cause problems if it is not carefully considered. Obviously, if you cannot obtain the admission in evidence of business records, such as invoices, you can't win even the most simple collection lawsuit.

Under Rule 803(6) if a document qualifies as a business record, it is not hearsay. The rule applies whether or not the declarant is available as a witness. The Rule presupposes that a business will have strong incentives to keep accurate records. Timberlake Construction Co. v. U.S. Fidelity and Guaranty Co., 71 F.3d 335 (10th Cir. 1995). I will discuss several recent decisions discussing the admission of business records.

I. The Rule

The Rule defines a business record as "a memorandum, report, record, or data compilations, in any form, of acts, events, conditions, opinions, or diagnoses, made at or near the time by, or from information transmitted by, a person with knowledge." Rule 803(6) is not limited to businesses. The Rule specifies that "the term 'business' as used in this paragraph includes business, institution, association, profession, occupation, and calling of every kind, whether or not conducted for profit." Rule 803(6).

A business record is admissible if it is "kept in the course of a regularly conducted business activity, and if it was the regular practice of that business activity to make the [record]." Id. A business record is not admissible where "the source of information or the method of circumstances of preparation indicate lack of trustworthiness." Rule 803(6).

The Ninth Circuit summarizes the Rule's requirements as follows: "a business record is admissible when (1) it is made or based on information transmitted by a person with knowledge at or near the time of the transaction; (2) in the ordinary course of business; and (3) is trustworthy, with neither the source of information nor method or circumstances of preparation indicating a lack of trustworthiness." The Monotype Corporation PLC v. Int'l Typeface Corp., 43 F.3d 443, 449 n.6 (9th Cir. 1994).

II. Regularly Conducted Business Activity

The key foundational inquiry is whether the document was prepared in the course of "a regularly conducted business activity." The document must concern business activity. In Hargett v. National Westminster Bank, 78 F.3d 836 (2d Cir. 1996), plaintiff, an african-american, was terminated from his position as an executive of the defendant bank after he allegedly retained a stripper to perform at an office meeting. Plaintiff alleged that he was terminated by reason of his race. At trial, he sought to introduce a handwritten note allegedly prepared by a co-employee of the defendant bank in which the co-employee admitted that he had procured the services of the stripper. The note was unsigned. The district court denied plaintiff's offer of admission because plaintiff could not establish a foundation for its admissibility as a business record. Indeed, it is hard to imagine that the letter was "a record of regularly conducted activity." Moreover, plaintiff could not offer testimony concerning when and where the handwritten letter was prepared.

The business activity must also be regular. In The Monotype Corporation, the defendant and plaintiff entered into a licensing agreement to allow plaintiff to distribute several of defendant's typefaces. Plaintiff developed several typefaces independently and began selling them to purchasers. Defendant claimed that plaintiff's typefaces were copies of its typefaces. Plaintiff sued to bar defendant from making such claims to plaintiff's customers, including Microsoft. At trial, defendant sought to admit a report prepared by an employee of plaintiff's customer Microsoft concerning the similarities in several typefaces sold by plaintiff and defendant. The report was not a business record because it was not Microsoft's regular practice to prepare such reports. Id. at 449-50 (also excluding an electronic mail message which was a one-time event).

III. The Chain Of Knowledge

The proponent must establish a chain of knowledge. According to Weinstein's Evidence, "Each participant in the chain producing the record -- from the initial observer-reporter to the final entrant -- must be acting in the course of the regularly conducted business." 4 Jack B Weinstein & Margaret A. Berger, Weinstein's Evidence P803(6) [04] (1994). In United States v. Warren, 42 F.3d 647 (D.C. Cir. 1994), the defendant was found in a room containing drugs and a handgun. The defendant sought to introduce a statement from a police report that two other occupants of the apartment were dealing drugs and carried handguns. The police report did not qualify as a business record because the defendant could not show that the report's author had personal knowledge concerning the activity of the other occupants of the apartment or had based the statement on information provided to him by a person with personal knowledge acting in the regular course of business. Id. at 656.

IV. The Custodian's Knowledge

The custodian of business records need not have detailed knowledge concerning who prepared a particular business record. The custodian need only show that he is "sufficiently familiar with the business practice" of the business and show that the record was made pursuant to that practice. Phoenix Associates III v. Stone, 60 F.3d 95 (2d Cir. 1995). In Phoenix Associates, the plaintiffs claimed that they had an oral contract with defendant. At trial, plaintiffs sought to introduce a record of a wire transfer to substantiate the claimed oral contract. Plaintiff's witness, its records custodian, testified that plaintiff's accounting department regularly compiled records of every wire transfer it received or issued. The district court denied plaintiff's offer of the exhibit on the ground that the records custodian worked for both the plaintiff and another company which made the wire transfer. The Court of appeals reversed. The custodian's source of employment was irrelevant "as long as his testimony can supply a sufficient foundation." Id. at 101. Moreover, the custodian was not required to demonstrate personal knowledge of the actual creation of the document. Nor was he required to identify the specific employee who prepared the document. The Rule required only that the proponent prove that the business entity's regular practice was to obtain the information from the person who created the document. Id.

V. Is The Document Trustworthy?

The Rule requires the court to determine whether the source of the information or the method or circumstances of the preparation of a document cast doubt on its trustworthiness. In Hoselton v. Metz Banking Co., 48 F.3d 1056 (8th Cir. 1995), plaintiffs, minority shareholders in defendant's business, claimed that defendants breached their fiduciary duties when they were excluded from a sale of the business to a third party. Notes taken by plaintiffs' accountant were properly admissible because they were prepared in the regular course of the accountant's activity. The notes appeared to be trustworthy because the accountant had professional duties to his clients which would give him strong motivation to make accurate notes. Id. at 1061.
Information provided by the customers of a business can create problems under the Rule because many businesses do not verify information received from customers. Such information may be admissible under Rule 803(6) if the proponent can show that "the business entity has adequate verification or other assurance of accuracy of the information provided by the outside person." United States v. McIntyre, 997 F.2d 687 (10th Cir. 1993), cert. denied, 114 S.Ct. 736 (1994). In McIntyre, the court listed two ways to demonstrate reliability: (1) proof that the business has a policy of verifying patrons' identities by examining their credit cards and other forms of identification; or (2) "proof that the business possesses 'sufficient self-interest in the accuracy of the [record]' to justify an inference of trustworthiness." United States v. Cestnik, 36 F.3d 904, 908 (10th Cir. 1994) (quoting McIntyre, 997 F.2d 687, 700 (10th Cir. 1993). In McIntyre, the court held it was improper to admit a hotel's guest registration cards because it was unclear whether the hotel had procedures to verify the accuracy of the cards. 997 F.2d at 701.

VI. Documents Prepared In Anticipation of Litigation

Documents prepared in anticipation of litigation are usually not admissible because they were not prepared in the regular course of business. Timberlake Construction Co., 71 F.3d 335; Fed. R. Evid. 803(6) Advisory Committee Note. In Timberlake Construction, the plaintiff claimed that the defendant insurer wrongfully denied insurance coverage. At trial, plaintiff introduced several letters written by plaintiff's president and by plaintiff's attorney containing legal conclusions claiming the existence of insurance coverage. The court of appeals reversed on the ground that the letters were written in anticipation of litigation and therefore did not fall within Rule 803(6).

However, an auditor's report prepared in anticipation of litigation may also qualify as a business record. In United States v. Frazier, 53 F.3d 1105 (10th Cir. 1995), the defendant was convicted of falsely describing his use of government funds on official forms. At trial, the Government admitted the report of a government auditor as a business record. The defendant objected that the report was prepared in anticipation of litigation. The court found that the report was trustworthy because the auditor prepared it pursuant to a contract with the government, the auditor had ten years experience in preparing that type of audit report and the auditor was a "neutral party" who had "nothing to gain" from litigation against the defendant. Id. at 1110.

VII. Laying A Foundation

The lawyer seeking to admit the business record must, however, lay a foundation that the record was, in fact a business record. A recent Seventh Circuit case discusses the requirement that a foundation be laid. In United States v. Adrianoros, 578 F.3d 703 (7th Cir. 2009), the Government obtained the admission of a summary of telephone and bank records of the illegal activity. The Government called a policeman to testify that he obtained records by serving a subpoena. The Government sought to admit the records under FRE 1006, which allows a party to present, and enter into evidence, a summary of voluminous writings, recordings or photographs. However, the Seventh Circuit held that the records were improperly admitted because there was no testimony to establish that the records were kept in the course of regularly conducted business activity and there was no certification by the custodian of the records. Thus, no foundation was laid and it was error for the district judge to admit the document in evidence.

A foundation must even be laid in the summary judgment context. The party seeking admission of the business record need not have secured the deposition testimony of the records custodian. The proponent of the document must establish sufficient indicia of reliability. Thanongsinh v. Board of Education, 462 F.3d 762 (7th Cir. 2006).

VIII. Specific Types of Documents

1. Laboratory Reports

It is well established that a laboratory report identifying a substance as a narcotic is admissible as a business record because such reports are routinely prepared by government lab technicians. United States v. Roulette, 75 F.3d 418 (8th Cir. 1996). Additionally, in Roulette, the defendant argued that under the Confrontation Clause, the government should be required to provide proof of the unavailability of the lab technician when admitting the report. The court disagreed reasoning that the exception to the hearsay rule was "firmly rooted." Id. See also Sherman v. Scott, 62 F.3d 136, 140-41 (5th Cir. 1995).

2. Computer Records

Computer business records are admissible if (1) they are kept pursuant to a routine procedure designed to assure their accuracy, (2) they are created for motives that tend to assure accuracy (e.g., not including those prepared for litigation), and (3) they are not themselves mere accumulations of hearsay." United States v. Hernandez, 913 F.2d 1506, 1512 (10th Cir. 1990), cert. denied, 499 U.S. 908 (1991). Computer records are thus treated no differently than other business records.

VIII. Conclusion

The business records exception is commonly used to admit documents which contain hearsay declarations. The rule presupposes that a business has strong incentives to keep accurate records. Thus, it is difficult to resist the admission of a business record, unless the record was prepared in anticipation of litigation or its trustworthiness can be legitimately questioned.

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Securities Law - The Dodd-Frank Wall Street Reform and Consumer Protection Act

The Dodd-Frank Wall Street Reform And Consumer Protection Act (the “Act”) is a massive revision of the way in which financial services are furnished. The Act was signed by President Obama on July 23, 2010.Many of the changes become law on the effective date. However, the Act promulgates various studies which could lead to other changes. Some changes may not go into effect but will become bogged down in contentious disputes. If control of Congress should change in November, some changes may never go into effect. The Act will cause a disruption in the way various issues are perceived.

Mayer Brown has published a complete summary of the Act. It was a massive undertaking. At least eight Mayer Brown lawyers worked on the summary.

The securities section of the Act sets forth a significant number of investor protection measures. Those sections of the Act dealing with Securities Law changes will be referred to as the “Amendments.” The Amendments require the SEC to conduct a six-month study of the need to impose a fiduciary duty on brokers providing personalized investment advice to retail customers. Various factors must be taken into account in determining the effectiveness of existing standards of care.

The Amendments establish within the SEC an Investment Advisory Committee composed of (1) an investor advocate who reports directly to the Chairman of the SEC, (2) a representative of State Securities Commissionaires, (3) a representative of the interest of senior citizens and (4) between ten and twenty additional members appointed by the SEC. The Committee has a responsibility of consulting with the SEC on regulatory priorities, the substance of proposed regulations and initiatives by the SEC to protect investors and promote investor confidence in the market.
The Chairman of the SEC will appoint an Investor Advocate to lead a new office within the SEC. An ombudsman will act as liaison between retail investors and the SEC in resolving issues with the SEC and/or the securities Self-Regulatory Organizations (“SRO”). The Chairman of the SEC is responsible to take action to address deficiencies identified by a report of investigation by the SEC.
The stock exchanges must, as directed by the SEC, enforce requirements in the Amendments for clawing back incentive compensation paid to executives mistakenly paid based on erroneous results later corrected and restated within three years of such payment.

The SEC must hire a consultant to study its operations and the possible need for reform of the agencies and furnish within 150 days a report to the SEC and Congress making legislative regulatory and administrative recommendations for improvement in the SEC.

The Controller General of the United States is to issue rules surrounding employees who leave the SEC for employment with regulated firms in the securities industry and report to the SEC and the House Financial Services Committee (“HFSC”) within one year of enactment of the Act.

The SEC must establish an Investor Protection Fund from revenues from certain sanctions. The Fund to be used among other things to pay whistle-blowers who provide original information in a SEC action.

The SEC will be authorized to make nationwide service of subpoenas of civil actions filed in federal court.

The Amendments change who qualifies as an “accredited investor”. These investors must now have $1 million excluding the value of their primary residence, whereas the old standard was simply a $1 million net worth.

The Amendments also authorize the SEC to limit or prohibit the mandatory predispute arbitration clauses that apply to most brokerage accounts. Such clauses force brokerage customers to take any disputes that may arise with their broker before arbitration panels, which critics claim often favor the brokerage industry, rather than taking their claims to court.

The Anti-Fraud provisions of the Federal Securities Laws were extended to apply to “conduct within the United States that constitute significant steps in the furtherance of a violation even if the securities transactions occur outside of the United States and involve only foreign investors.”

The Government Accountability Office (“GAO”) must report to Congress within one year regarding the potential consequences of authorizing a prior right of action against any person who aids or abets another person in violation of the Federal Securities laws. In other words, the new statute reverses the Stoneridge ruling. Stoneridge Investment Partners, LLC v. Scientific Atlantic, Inc., 522 U.S. 148 (2008). In Stoneridge, the U.S. Supreme Court held that those who aid or abet securities fraud are not liable.

Various changes regarding the regulation of credit rating agencies are prescribed. For example, the SEC must establish an office of credit ratings designed to administer the SEC rules applicable to Nationally Recognized Statistical Rating Organizations (“NRSRO). It can make exceptions for smaller NRSRO’s as it considers appropriate. At least two persons on the Board of Directors of NRSRO’s must be independent directors.
Not later than 270 days after the enactment of the Amendments, the SEC, Federal Reserve Board (“FRB”), Federal Deposit Insurance Corporation (“FDIC”) and (Office of the Comptroller of the Currency (“OCC”) must issue rules requiring a securitizer of an asset backed security (other than a residential mortgage-backed security) to retain at least 5% of the credit risk in any asset that the securitizer transfers or sells to a third party. The rules become effective two years after the final version is published in the Federal Register.

Executive compensation is to be revised as follows:

Effective six months after enactment of the Amendments, publicly traded companies must hold a non-binding vote to approve the compensation of executives who are among those disclosed in public filings pursuant to SEC rules (i.e., say-on-pay votes) at least once every three years, and a separate resolution must be offered at least once every six years for a vote to determine whether say-on-pay votes should occur every one, two or three years. Although a “no vote” is not binding, it would likely cause the Board of Directors to take some action to adjust compensation standards.

The Conference Committee also agreed to require these companies to provide a non-binding vote to approve golden parachutes (effective six months after enactment). Institutional investment managers subject to Section 13(f) of the Exchange Act must annually disclose how they vote on say-on-pay and golden parachute matters unless their votes are otherwise publicly reported under SEC rules. The Amendments place ultimate responsibility for compensation decisions for executives with the respective Compensation Committees, which must be comprised of independent directors and advised by compensation consultants, legal counsel, and other advisers who are independent as well.

The SEC is required to amend item 402 of Regulation S-K under the Securities Act to require companies to disclose the relationship between executive compensation and financial performance and the ratio between the CEO’s compensation and the median compensation of all other employees.

The SEC must issue a rule requiring publicly traded companies to disclose whether executives are permitted to hedge the value of any equity securities granted to such executives as compensation.

The SEC must conduct a study, and report to Congress within two years of enactment, regarding the use by publicly traded companies of compensation consultants.

The FRB, in consultation with the OCC and FDIC, has the responsibility of establishing standards making it an unsafe and unsound practice for the holding companies of depository institutions to pay compensation that is excessive or could lead to material financial loss to the holding companies.

There will be many 3 – 2 notes by the SEC with the Commissioners nominated by the democrats winning the contentious issues but only after delays and many dissents.

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Securities Law - State Jurisdiction Issue

STATE SECURITIES LAW - JURISDICTION

Bulldog Investors and its principal, operating a group of hedge funds, by offering an unregistered security through Bulldog’s website and an email to a Massachusetts resident violated the Massachusetts Uniform Securities Act. Bulldog and its principal officer Goldstein denied violating the Act and asserted that its actions were protected under the First Amendment and that personal jurisdiction was lacking. The Administrative Hearing Officer stated that he lacked authority to consider the constitutional question. Bulldog then proceeded to court to enjoin the Secretary of State’s enforcement action. In the meantime, the Hearing Officer continued the administrative proceeding and found that Bulldog and Goldstein made an offer of an unregistered security that was not exempt. The hearing officer’s finding consisted of a cease and desist order and a $25,000 fine.

Plaintiffs’ in the Superior Court, Bulldog Investors General Partnership, et al v. Secretary of the Commonwealth Of Massachusetts, SJC 10589 (07/02/2010) asserted that the Secretary of State lacked personal jurisdiction and filed a motion for judgment on the pleading. The Court concluded that personal jurisdiction was appropriate and denied Plaintiffs’ motion.

The Bulldog Firm appealed and contended that the maintenance of a website and the sending of this email to a Massachusetts resident was not sufficient contact with the Commonwealth to create personal jurisdiction. The Court agreed with the Secretary Of State that the Massachusetts Uniform Securities Act authorized the Secretary Of State to exercise personal jurisdiction over non-residents in an administrative proceeding. According to the Court, the purpose of the Act, was to protect Massachusetts residents from offers of unregistered securities directed at them from other jurisdictions, and that the Secretary Of State’s authority to conduct investigations outside the Commonwealth would be meaningless if it did not have the authorization to subject non-residents to enforcement proceedings. Plaintiffs’ rights to due process were not violated according to the Court because Plaintiffs availed themselves of the privilege of conducting business activities in Massachusetts and came within the reach of its laws.

The Appellate Court declined to consider the First Amendment argument because the issue had not been raised on appeal. The Court reaffirmed that Plaintiffs’ email message to a Massachusetts resident offering a non-exempt unregistered security was a violation of the Massachusetts Uniform Securities Act.

Bulldog, by sending one email, voluntarily subjected itself to the Massachusetts Uniform Securities Act.

This case is significant because it illustrates how a company can become subject to a state securities law.

Look for an appeal by Bulldog to the United States Supreme Court. Bulldog would argue that there were insufficient contacts to allow Massachusetts to assert jurisdiction over it.

Edward X. Clinton, Sr.

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Securities Law - Noncompetitive Trading

NON-COMPETITIVE TRADING

The United States District Court for the Northern District of Illinois froze the assets on records of a man who claims to be a Russia national after the Commodity Futures Trading Corporation (“CFTC”) charged him with trades on the Chicago Mercantile Exchange (“Exchange”) which were not competitive (CFTC v. Yunuso, N.D. Ill., 10-3619, Judge Bucklo). According to the CFTC, Yunuso controlled two firms: Open E Cry, LLC and Velocity Futures, LLC to enter a buy or sell contract for one of his accounts and then within seconds enter an opposite or equal quantity buy or sell contract for the other account. Because the commodities were thinly traded his orders were marketed against each other. Then Yunuso would enter orders to offset the initial position and complete an equal but opposite round turn trade for each account. His trading according to the Exchange resulted in more than $7.8 million in lawsuits and an approximate $7.2 million profit in the Velocity Futures, LLC account. At the end of the trading session, Yunuso had a debit balance of about $8,000 with Open E Cry, LLC and thus no money to cover the losses.

According to CFTC, Yunuso by consistently executing trades between the Open E Cry account and the Velocity account during periods of low volume, Yunuso in effect entered into transactions without intent to take a genuine bona fide position in the market.

The CFTC is seeking restitution, fines, a trading registration ban and a permanent injunction against Yunuso and his entities.

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Securities Law - Illinois Securities Law Statute of Limitations

This case is interesting because the plaintiffs abandoned claims under the Illinois Securities Law - to avoid a dismissal on the ground that the action was time-barred.

Plaintiffs in the case captioned Carpenter, et al. v. Exelon Enterprises Company, LLC, and Exelon Corporation, Appeal No. 1-09-1222 (4th Circuit), sued Exelon claiming that Exelon abused its position as majority shareholder of InfraSource in such a way that the rights of the minority shareholders were violated and not represented fairly in a merger and sale transactions.

Exelon filed a motion to dismiss on the grounds that it was barred by the three-year Illinois Statute Of Limitations. The trial court denied Exelon’s motion to dismiss determining that the Illinois Securities Law limitation period was inapplicable and plaintiffs’ suit was therefore timely filed within the residual five-year limitation period found in § 13-205 of the Code Of Civil Procedure. However, the trial court stayed the proceedings and certified the issue of the appropriate statute of limitations for an interlocutory appeal.

Exelon filed a motion to dismiss on the grounds that the Statute Of Limitations under the Illinois Securities Law of three years was applicable and the case should be dismissed. The Plaintiffs did not respond to the motion choosing to voluntarily dismiss their initial complaint and they refiled an amended complaint. In the amended complaint, the plaintiffs abandoned their Illinois Securities Law claims and proceeded under Delaware law instead.

The amended complaint contained additional allegations of the conduct of Exelon and contained an explicit statement that it purported to be brought under Delaware law and did not allege that defendants’ conduct constituted a violation of the Illinois Securities Law. Plaintiffs sought damages in excess of $11,000,000. Exelon again filed a motion to dismiss complaining, notwithstanding the changes in the amended complaint, that the manner for which relief was sought was still provided under the Illinois Securities Law and it was therefore barred by the three-year statute of limitations. The trial court disagreed and found that the suit was properly filed within the five-year limitation of § 13-305 of the Code. The trial court entered an order denying Exelon’s Motion To Dismiss but stayed further proceedings and certified the following question for interlocutory appeal, as the trial court found this issue involving the question of law upon which substantial ground for difference of opinion existed:
“Whether plaintiffs’ claim that Exelon Enterprises Company, LLC, as majority shareholder of InfraSource, Inc., breached its fiduciary duties in connection with InfraSource, Inc.’s 2003 merger transaction is governed by the three year statute of limitations contained in the Illinois Securities Law of 1953, 815 ILCS 5/13(d).”

The trial court granted Exelon’s petition for leave to appeal the interlocutory order of the trial court denying the motion to dismiss.

The trial court made reference to of § 13 of the Illinois Securities Law which delineates the private and other civil remedies available for violations of the Law. It pointed out that of § 13(A) provides that every sale in violation of the provisions of the Act is voidable at the election of the purchaser and that § 13(B) and § 13(C) outline various notice and mitigation requirements that a purchaser must fulfill before electing the option of rescission. Subsection 13(D) provides a three-year statute of limitation.

Exelon cited various federal cases which held that the Illinois three-year statute of limitation provided a bar to certain claims for relief. On the other hand, Plaintiff states that the claim is one of minority shareholder oppression and not covered by the Illinois Securities Law or the statute of limitations.

The Defendant, Exelon, argued that of § 13(F) and of § 13(G) provides injunctive relief as well as a right of rescission to “any party in interest”. The Court while acknowledging a contrary holding by a federal court in Klein v. George G. Kerasotes Corp., 500 F.3d 669 (7th Cir. 2007) held that plaintiffs were not barred by the three-year statute of limitations.

The Appellate Court held that the three-year limitation contained in of § 13 applies to relief under § 13 for which relief is granted by § 13. Section 13 provides only for (1) a retroactive right of rescission to purchase under subsection 13(A) and (2) a prospective remedy to the Illinois Secretary Of State and “any party in interest” under of § 13(F) and of § 13(G). Section 13 does not concern retroactive common law damage claims for breach of fiduciary duty both by sellers of securities in general or minority shareholders in particular. For the three year limitation contained in § 13(D) does not apply does not apply to claims of the plaintiffs against Exelon. Therefore the certified question is answered in the negative. Such being the case, the five-year of limitations applies and the case is timely.

Abandoning a claim for relief under the Illinois Securities Law was successful.

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Securities Law - Statute of Limitations Merck v. Reynolds

On April 27, 2010, the United States Supreme Court issued its decision in Merck & Co v Reynolds, 08-905. The issue was whether the plaintiff's claim was barred under the applicable statute of limitation. The Statute of Limitations for securities claims alleging fraud, deceit or contrivance is that the claim must be filed not later than 2 years after disclosure of facts constituting the violation or 5 years after the violation. 28 U.S.C. Section 1658(b).

There have been division in the circuits on when a claim accures and whether a plaintiff had to have notice of scienter. Scienter has been defined as a mental state embracing intent to deceive, manipulate, or defraud. Ernest & Ernest, .v Hochfelder, 425 U. S, 185. In a 10b-5 case the plaintiff must prove that a defendant made a material misstatement with intent to deceive, not merely innocently or negligently.

The case arose out of the controversy involving the drug Vioxx. The District Court held that the state of Limitations barred the claim because investors were placed on inquiry notice of the claim more than 2 years before they filed suit. Inquiry notice exists when the victim is aware of facts that would lead a reasonable person to investigate and consequently acquire knowledge of the defendants misrepresentations, Great Rivers Cooperative v Farmland Industries, Inc. 120 Fed. 3rd 893

In September 2001 the FDA released a letter that stated that Merck had misstated the safety of the drug. The District Court referred to various press articles to support that proposition because of the widespread adverse publicity the investors were on notice more that 2 years before the lawsuit was filed The Third Circuit reversed and said that was not sufficient t to establish inquiry notice. The Court also stated that Merck at about the same time issued notices describing the drugs safety.

The Supreme Court granted certiorari and said that a plaintiff was required to discover facts of scienter. It started with the statutory language that the limitations period begins to run once there has been discovery of facts constituting the violation and noted that scienter was both a fact and an element of a Sec.10 (b) 5 violation. The Court concluded that facts of scienter can be distinct from establishing that there has been a material misrepresentation because an incorrect prediction does not show whether the speaker deliberately lied or just made an in an innocent error. The Court held that the statute of limitations does not begin to run until the plaintiff discovers or a reasonably diligent plaintiff would have discovered facts constituting the violation. Thus, the plaintiff's claims were not barred by the statute of limitations.

The Supreme Court affirmed the decision of the Third Circuit to the effect that Plaintiff’s claim was not barred by the statute of Limitations.

The case is also interesting because the decision of the Supreme Court was unanimous.

Edward X. Clinton, Sr.
www.clintonlaw.net

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Corporate Law - Agent Lacks Authority to Bind Company

CORPORATE LAW - COURT HOLDS THAT PURPORTED AGENT LACKED AUTHORITY TO BIND CORPORATION TO SUSPICIOUS TRANSACTIONS WHICH WERE HARMFUL TO THE CORPORATION.


Herbert W. Fritzsche, et al. v. Gregory LaPlante and M. Christine Rock, 2-09-0329, Illinois Appellate Court Second District.

This issue raised in this case is whether or not a corporate officer had the authority to bind the corporation to some highly unusual transactions. The backstory is that the corporate officer was the daughter of the founder and President of the company and that she was apparently involved a feud with her siblings.

M. Christine Rock, acting as secretary/treasurer of a family corporation, Fritzsche Industrial Park (FIP) and as holder of a power of attorney for her father, Herbert W. Fritzsche, signed a lease agreement with her live-in boy friend, Gregory LaPlante. The lease named the Industrial Park as lessor and Gregory as lessee. The premises included 16 properties within the Industrial Park. Christine Rock owned 60 shares of a total of 1,000 shares that were issued and outstanding. Her father owned the majority of 685 shares. Christine Rock, at about the same time, also signed a promissory note in favor of Gerald Shaver in the principle amount of $450,000. The maker of the note was listed as Fritzsche Industrial Park and Park National Bank as Trustee under a Land Trust.

Plaintiffs, the corporation and other family members, filed this lawsuit alleging that Christine acted without Corporate authority and entered into the lease and note and without any authority as her father’s power of attorney in entering into the Lease Agreement. Because Christine refused to furnish records of rents and expenses, the shareholders informed her that she would be removed as Secretary/Treasurer. The suspect transactions were entered into after Christine learned that she would soon be removed as Secretary/Treasurer.

Plaintiffs filed a motion for summary judgment alleging that even if Christine had been the true Secretary/Treasurer of FIP and Herbert’s power of attorney, she still would not have had the authority to enter into the lease or the note. Plaintiffs allege that Christine did not have the authority to enter into the lease under either the common law or a statute. An affidavit was attached to the Plaintiff’s Motion For Summary Judgment which stated that at no time did the shareholders of FIP or the Board meet to vote on the lease or the note and that the Board never authorized Christine to act on behalf of FIP with regard to the lease or the note. Because there was no approval by the Board of Directors Ms. Rock lacked authority to cause the corporation enter into the lease or the note.

Ms. Rock and her boyfriend argued that Board approval and other corporate formalities were not required in order to allow Christine to execute the lease. Defendants stated that some of the properties included in the lease were not owned by Fritzsche but were owned by Herbert or some other member of the Fritzsche family and, therefore, corporate formalities were not necessary.

The trial court granted summary judgment for the plaintiffs - the corporation and Herbert W. Fritzsche.

Defendants appealed the grant of summary judgment. The Appellate Court affirmed the grant of summary judgment in all respects. The Appellate Court held that the Trial Court was correct in ruling that Christine did not have authority to enter into the lease or the note.

Under common law, the mere fact that a corporation has the power to make a certain type of contract does not, of itself, clothe even the highest officer of the corporation with the apparent authority to bind the corporation to such a contract. Corn Belt Bank v. Lincoln Savings & Loan Ass’n, 19 Ill.App. 3d 238, 245 (1983). Further, officers have no apparent authority to make unusual or extraordinary contracts on behalf of a corporation. Corn Belt Bank, 119. Ill.App. 3d at 245. “’If the president of a corporation were authorized to make contracts of this character without action of the directors and without notice to or knowledge of anyone, the directors would not at any time know whether it was headed for bankruptcy.’” Sacks v. Helene Curtis Industries, Inc., 340 Ill. App. 76, 91 (1950), quoting Warszawa v. White Eagle Brewing Co., 299 Ill. App, 509. Plaintiffs further argued that the Lease of the entire industrial park was an extraordinary transaction and that Illinois common law and its statutes prohibit an officer from entering into extraordinary and unusual contracts and/or contracts involving substantially all of the corporations assets, outside the ordinary course of business, without the board's consideration and approval.

The Court concluded that the Lease was an extraordinary transaction and, it implied, one that no rational corporation would approve. "Here, FIP/Christine transferred numerous properties contained int he Fritzsche Industrial Park to Gregory, a nonfamily member and a nonofficer/nonshareholder. The Lease does not specify Gregory's obligations to FIP's existing tenants. Although the Lease includes properties under trust, no trustees ever signed the Lease. Although the Lease involved 26 different properties (PINs), it seems no professionals, such as attorneys or realtors, were involved in drafting the Lease; defendants are the only signatories and/or witnesses to the Lease. Perhaps most strangely, the Lease seems to provide Gregory profit with little to no risk or investment. If he generates income, he pays a relatively small percentage of that income to the corporation; if he generates no income, he pays the corporation only taxes due to the government. As such, under common law, the Lease is the sort of transaction that would require authorization by the Board."

The Court also made specific reference to the Illinois Compiled Statutes, § 805 ILCS 5/11.55 which provides that where a sale, lease or exchange of assets involves, 'all, or substantially all, the property and assets ...of a corporation,' the board of directors must adopt a resolution recommending the transaction, whereupon said resolution shall be submitted to a vote by the shareholders at a meeting. § 805 ILCS 5/11.60(1).

The court held that the Lease essentially put the corporation out of business and, thus, was an extraordinary transaction.

In regard to the note that was executed, the Court made specific reference to Fritzsche’s by-laws entitled “Contracts, Loans, Checks and Deposits” which states “No loan shall be conducted on behalf of the Corporation and no evidence of indebtedness shall be issued in its name unless authorized by a resolution of the Board of Directors." Of course, the promissory note was never submitted to the Board for its consideration. The Court held that Christine was not permitted to bind the corporation by executing the note and that the note was void and unenforceable.

Thus, the Appellate Court found that Christine was not authorized to enter into the lease or make the note and, accordingly, affirmed the Trial Court’s grant of summary judgment to plaintiffs. The opinion contains a through discussion of corporate formalities and the need to comply.

Edward X. Clinton, Sr.

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