The reasons for that conclusion are set out in the discussion which follows.
This action arises out of a Proxy Statement and Solicitation mailed to Ernst's shareholders on October 11, 1983 and supplemented November 9, 1983. The Proxy Statement notified those shareholders of a special meeting to be held on November 22, 1983
and solicited their votes on a proposal to amend Ernst's Articles of Incorporation to authorize additional shares of common stock at decreased par value and to approve the so-called Bourse Agreement providing for the issuance of newly authorized common stock to Bourse. If the proposal was adopted, the equity interests of the present shareholders would be markedly decreased and Bourse's equity interests in Ernst would be substantial.
Ernst is an electrical construction and contracting firm. The plaintiffs were officers of Ernst until removed from their positions in 1978. On December 1, 1978, Ernst filed a petition for Chapter XI bankruptcy with the Bankruptcy Court in the Southern District of New York. Since that date, it has been operating as a debtor-in-possession. Ernst is currently attempting to obtain that Court's approval of a Plan of Arrangement ("the Plan") which would allow it to emerge from bankruptcy.
One continuing financial problem for Ernst had been the refusal of its surety, the Travelers Indemnity Co. ("Travelers"), to provide performance and payment bonds for Ernst. That refusal had the adverse effect of preventing Ernst from obtaining new contracts. As a result, in 1979, Ernst and Travelers entered into an agreement whereby, among other things, Travelers agreed to issue surety bonds for new contracts and to guarantee a line of credit, secured by an interest in all of Ernst's assets. Ernst also granted Travelers an option ("the Option") to purchase all of its authorized but unissued stock at a specified price level. In 1981, a Plan of Arrangement was approved by Ernst's creditors subject to approval by the Bankruptcy Court.
The Plan required financing and the Bourse became its source of financing. Travelers was necessarily involved in the discussions because it was both Ernst's surety and also a significant creditor. In August, 1983, Bourse, Ernst and Travelers entered into several agreements relative to the financing of the Plan. In one agreement Travelers assigned the Option and $832,112.40 in indebtedness to the Bourse in exchange for Bourse's indemnification of Ernst's surety bonds. Another agreement related to the issuance of bonds after emergence from bankruptcy and the settlement of Ernst's post-petition indebtedness to Travelers.
A third agreement was made between Ernst and the Bourse ("the Bourse Agreement"). Under the agreement, Bourse would purchase 32 million shares of newly authorized common stock with a par value of $.01 for $1 million and 15,000 shares of cumulative, convertible preferred stock for $1.5 million. Bourse also agreed to arrange a $3 million line of credit for Ernst. In order to effectuate the Bourse Agreement, Ernst shareholders were required to approve an amendment of the Articles of Incorporation to authorize the issuance of up to 100 million shares of common stock and to decrease the par value of the stock from $.40 per share to $.01 per share. The Proxy Statement sought shareholder approval of the amendment to the Articles of Incorporation and of the Bourse Agreement.
On October 4, 1983, the Bourse exercised the option to purchase all of the authorized and the unissued common stock of Ernst.
The Option was exercised at the par value of stock, $.40 per share by Ernst agreeing to cancel the $832,112.40 in debt assigned to Bourse by Travelers. Prior to the exercise of the Option, plaintiffs owned approximately 20 percent of the outstanding stock of Ernst. After the exercise of the Option, Bourse owned approximately 52 percent of Ernst's stock and the plaintiffs' equity was correspondingly reduced to less than 10 percent. If the Bourse Agreement is implemented, Bourse will own approximately 93 percent of the outstanding shares of Ernst stock and plaintiffs will own approximately two percent of Ernst shares.
Since the Amendment to the Articles and the Bourse Agreement were approved in the special shareholders' meeting, the Plan needs only to be confirmed by the Bankruptcy Court. A confirmation hearing was scheduled for July 10, 1985. However, a favorable disposition of the pending motion for summary judgment in the instant case would invalidate the Proxy Statement, which is the partial basis for the financing of the Plan. The Bankruptcy Court proceedings have been postponed pending a ruling on the plaintiffs' motion for summary judgment.
Plaintiffs contend that the Proxy Statement violated SEC Rule 14a-9.
The Rule provides that:
No solicitation subject to this regulation shall be made by means of any proxy statement, form of proxy, notice of meeting or other communication, written or oral, containing any statement which, at the time and in the light of the circumstances under which it is made, is false or misleading with respect to any material fact, or which omits to state any material fact necessary in order to make the statements therein not false or misleading or necessary to correct any statement in any earlier communication with respect to the solicitation of a proxy for the same meeting or subject matter which has become false or misleading.