SEC v. Happ

United States Court of Appeals
For the First Circuit
No. 06-1324
ROBERT D. HAPP,
Plaintiff, Appellant,
v.
CORNING, INC. and CORNING NETOPTIX, INC.,
Defendants, Appellees.
APPEAL FROM THE UNITED STATES DISTRICT COURT
FOR THE DISTRICT OF MASSACHUSETTS
[Hon. George A. O'Toole, Jr., U.S. District Judge]
Before
Boudin, Chief Judge,
Selya, Circuit Judge,
and Schwarzer,* Senior District Judge.
Gary C. Crossen with whom Rubin and Rudman, LLP was on brief
for appellant.
Jonathan Sablone with whom Michael L. Cornell and Nixon
Peabody LLP were on brief for appellees.
October 20, 2006
*
Of the Northern District of California, sitting by
designation.
BOUDIN, Chief Judge. This appeal, involving issues of
indemnification and duress, arises out of easily described events.
From 1995 to 2000, Robert Happ served as a director of Galileo
(later renamed NetOptix), a company that has now become a
subsidiary of Corning, Inc. During his service as a director, Happ
was covered by provisions, common in modern corporations,
providing indemnification for Happ for liability he might incur on
account of directorship.
Using the language of Delaware law, Del. Code Ann. tit.
8, § 145(a) (2006), the company provided (through by-law and
contract) for indemnification so long as Happ "acted in good faith
and in a manner he reasonably believed to be in or not opposed to
the best interests of the Company . . . ." The company also agreed
to advance upon request expenses for any covered lawsuit, provided
that the director execute an undertaking to repay the advances "if
it shall ultimately be determined that [the employee] is not
entitled to be indemnified against such expenses . . . ."
On April 20, 1998, Galileo held a board meeting with
Happ--chair of the board's audit committee and a financial expert--
participating by telephone. The board was told of business
problems whose impact on second quarter earnings was small but
which could cause a greater impact in the third quarter if not
resolved. By late June, the company was having difficulties and
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the chief executive officer, William Hanley, decided to seek Happ's
advice.
According to his later testimony, Hanley left two voice-
mail messages for Happ--one on Thursday, June 25, 1998, and the
other on the Sunday following; each message stated that the company
was having "some difficulties" with its third quarter and requested
a meeting with Happ early the following week. On Monday, Happ
called Hanley's assistant to schedule a meeting; the same day, Happ
sold all of his 4,000 shares of the company's stock for about
$47,000.
In late July 1998, the company revealed that its third
quarter difficulties had produced a net loss of $3.3 million
instead of the forecast profit of $160,000. The stock price fell
from $8.25 to $3 per share (and Happ then purchased 5,000 shares).
After an investigation, the Securities and Exchange Commission in
October 2000 filed a civil complaint against Happ charging that he
had traded on material, nonpublic information when he sold his
4,000 shares in June 1998. 15 U.S.C. §§ 77q(a), 78j(b) (1994).
At the time that Happ sought advances to cover the cost
of his defense, the company had become a subsidiary of Corning,
renamed Corning NetOptix. Corning required Happ to sign an
undertaking in which he agreed to repay Corning for defense costs
if it were "finally determined" that he "wrongfully used material
non-public information of Galileo Corp. . . . for personal gain,
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either with intent or recklessly, in selling shares of Galileo
stock."
This arrangement was agreed to between Corning and Happ's
counsel, but only after unfriendly negotiations that lasted until
March 2001. Happ says that Corning refused to provide him with
pertinent documents and denied any obligation to advance funds in
this case. Happ also asserts that he was under financial pressure
due to ongoing and foreseeable defense costs. Corning eventually
paid $878,877.92 to cover much of Happ's counsel fees.
In July 2003, Happ sued Corning and Corning NetOptix,
primarily over how much Corning should advance for counsel fees.
In the midst of this private lawsuit, the SEC enforcement action
concluded when, on October 9, 2003, a jury found that Happ was
liable for insider trading. He was ultimately ordered to pay
$34,758 as disgorgement, a penalty in the same amount, and
substantial interest. SEC v. Happ, 295 F. Supp. 2d 189 (D. Mass.
2003), aff'd, 392 F.3d 12 (1st Cir. 2004).
Following the final decision in the SEC case, Corning and
Corning NetOptix filed a counterclaim in Happ's district court
action against them, seeking repayment of Corning's advances to
Happ. The district court thereafter held on summary judgment that
the undertaking required the repayment and had not been secured by
duress (as Happ claimed). Corning was awarded repayment in the
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amount of $878,877.92. Happ v. Corning Inc., No. 03-11258-GAO,
2005 U.S. Dist. LEXIS 39554 (D. Mass. Nov. 28, 2005).
Happ now appeals, arguing that duress vitiated the
undertaking or at least was an issue for the jury. Alternatively,
he says that the undertaking, if valid, should be read in light of
the indemnification agreement and, so read, does not require
repayment because there is at least a genuine issue of material
fact as to whether Happ had acted in good faith and not adversely
to the company. The grant of summary judgment is reviewed de novo,
drawing inferences in favor of Happ. Thomas v. Eastman Kodak Co.,
183 F.3d 38, 47 (1st Cir. 1999), cert. denied, 528 U.S. 1161(2000).
Both defendant companies are incorporated in Delaware and
the parties assume without discussion that the Delaware statutory
standard in section 145--the good faith/not adverse to language
quoted above--governs indemnification unless narrowed by the
undertaking. The parties also agree that Massachusetts law governs
the duress claim and the construction of the undertaking, although
they add that Delaware law on duress is similar to that of
Massachusetts.
A contract signed under duress, including economic
duress, is not binding under Massachusetts law, but a party
claiming to have entered into a contract under duress has the
burden of showing that (1) he has been the victim of some unlawful
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or wrongful act or threat; (2) the act or threat deprived him of
his free or unfettered will; and (3) due to the first two factors,
he was compelled to make a disproportionate exchange of values.1
Happ's claim of duress fails at the first of these
hurdles. Physical duress is almost always wrongful but much
commercial bargaining involves economic pressure; "absent an
improper threat, the driving of a hard bargain is not duress." 7
J. Perillo, Corbin on Contracts § 28.3, at 47 (rev'd ed. 2002).
Whether or not pressure existed, Corning's insistence on the
undertaking was not unlawful or wrongful within the meaning of the
duress doctrine.
True enough, Happ already had a bargain--his by-law and
contract-based right of indemnification--as well as an advance
conditioned on a promise to repay if indemnification proved
unwarranted. Yet the contract and the by-law did not say precisely
how the undertaking should be phrased or whether the company had a
right to insist on spelling out the circumstances in which Happ
would not be entitled to indemnification.
Happ's legal position--that the undertaking should have
been phrased solely in terms of Delaware law--was plausible and
perhaps right; but Corning had some basis for its own position.
1
Int'l Underwater Contractors, Inc. v. New Eng. Tel. & Tel.
Co., 393 N.E.2d 968, 970 (Mass. App. Ct. 1979) (quoting 13 W.
Jaeger, Williston on Contracts § 1617, at 704 (3d ed. 1970));
accord Ismert & Assocs., Inc. v. New Eng. Mut. Life Ins. Co., 801
F.2d 536, 544 (1st Cir. 1986).
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This is so because Delaware law is unclear as to whether Happ could
ever be indemnified if he lost an insider-trading suit and,
further, because the company had even more reason to assert that he
would not be entitled to be indemnified under Delaware law if he
lost this suit.
We put to one side the argument that federal law--
although only by implication--forbids indemnification for federal
regulatory violations like insider trading. This is a view taken
by some circuits for reasons explained in those decisions;2 but our
circuit has not ruled on the issue and arguments can be made both
ways. Neither side has even adverted to the federal issue and we
need not pursue it.
Yet even under Delaware law, it is debatable whether an
insider-trading violation can ever be "not opposed to" the best
interests of the company. There is respectable commentary that
Delaware law permits indemnification for at least some violations
of this type;3 but one could also argue that insider trading
2
E.g., First Golden Bancorporation v. Weiszmann, 942 F.2d 726,
728-29 (10th Cir. 1991); Globus v. Law Research Serv., Inc., 418
F.2d 1276, 1288-89 (2d Cir. 1969), cert. denied, 397 U.S. 913(1970); see also Raychem Corp. v. Fed. Ins. Co., 853 F. Supp. 1170,
1176-77 (N.D. Cal. 1994).
3
See Joseph Warren Bishop, Jr., The Law of Corporate Officers
and Directors: Indemnification and Insurance § 6:7 (2005); Joseph
F. Johnston, Jr., Corporate Indemnification and Liability Insurance
for Directors and Officers, 33 Bus. Law. 1993, 1996-98 (1978).
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inherently damages a company by poisoning relations with current
and prospective shareholders who supply the capital.
Thus, Corning's insistence on its phrasing of the
undertaking was not unreasonable, although this position might not
have prevailed in court. Further, if Happ disputed Corning's
position--as he certainly could--and insisted on an undertaking
phrased solely in terms of the Delaware standard, he had a
straightforward remedy. He could have sued Corning immediately for
declaratory judgment in his favor on his claim for an advance
qualified only by section 145's language, and moved for summary
judgment. See, e.g., Ismert, 801 F.2d at 549.
Whatever financial pressure Happ faced, there is no
evidence that bankruptcy imminently threatened. Indeed, his full
liability if he lost the SEC suit appears to have been pretty
modest; his main problem was legal bills that would be incurred
over a period of several years. Neither his immediate risks, nor
longer term consequences of losing the SEC suit, prevented him from
seeking a declaratory ruling as to the advance.
Happ says that the question of how much pressure he was
under presented a factual issue that should have been presented to
the jury rather than resolved on summary judgment. This argument
is debatable: Happ's affidavit says that he was in financial peril
and inferences were to be drawn in his favor; yet the affidavit is
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quite vague as to the details of the threat. Either way, Happ had
the option of suing rather than signing.
So even if a jury could find that Happ was under
financial pressure, Corning had a plausible, if debatable, position
that the undertaking it sought was within its rights; and Happ had
a legal remedy if he disputed this position. Until a court
clarified its obligation, Corning no more abused its position by
refusing to advance funds without the requested undertaking than
did Happ by insisting on payment without the undertaking sought for
Corning.
The case law is consistent with our view. A few courts
may confine "wrongfulness" in the duress doctrine to conduct
actually illegal, but most extend the term to blameworthy conduct
in a larger sense.4 However, it is clear enough from the case law
that an act is not wrongful in this sense if there is a good faith
belief by the "pressuring" party that its position represents a
plausible one to take under a governing contract.5 The result
4
Grace M. Giesel, A Realistic Proposal for the Contract Duress
Doctrine, 107 W. Va. L. Rev. 443, 488-90 (2005). Compare Quigley
v. KPMG Peat Marwick, LLP, 749 A.2d 405, 411-12 (N.J. Super. Ct.
2000), with Hurd v. Wildman, Harrold, Allen & Dixon, 707 N.E.2d
609, 614-15 (Ill. Ct. App. 1999).
5
See Rumsfeld v. Freedom NY, Inc., 329 F.3d 1320, 1331 (Fed.
Cir. 2003), cert. denied, 541 U.S. 987 (2004); Agroindustrias Vezel
v. H.P. Schmid, Inc., 15 F.3d 1082, 1994 WL 12342, at *3-4 (9th
Cir. 1994) (unpublished opinion).
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would be otherwise if Corning's legal position were absurd or
otherwise evidently taken in bad faith.6
Thus, the duress claim was properly rejected on summary
judgment; and Happ's obligation to repay is governed by the
undertaking. The undertaking said Happ had to repay the advance if
it was "finally determined" that he "wrongfully used material non-
public information of Galileo Corp. . . . for personal gain, either
with intent or recklessly, in selling shares of Galileo stock."
The jury in the SEC suit returned a special verdict saying just
this.
The jury found, inter alia, that Happ was an insider who
possessed and used nonpublic information regarding Galileo when he
sold his stock in that company; that he engaged in an act which
operated or would by a reasonable person have been expected to
operate as a fraud or deceit upon some person; that he violated a
duty of trust and confidence that he owed to Galileo and its
stockholders; and that he acted with intent. SEC v. Happ, 295 F.
Supp. 2d at 195.
Happ nevertheless argues that the undertaking should be
read broadly as adopting the test of Delaware law. He says first
that related documents (here, the by-law/contract provisions and
6
Totem Marine Tug & Barge, Inc. v. Alyeska Pipeline Service
Co., 584 P.2d 15, 22 (Alaska 1978); Rich & Whillock, Inc. v. Ashton
Dev., Inc., 204 Cal. Rptr. 86, 89-90 (Ct. App. 1984); Int'l
Underwater Contractors, 393 N.E.2d at 971.
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the undertaking) should be read harmoniously. Such a doctrine
exists, is well settled as to provisions in the same agreement,
e.g., Kinek v. Paramount Communications, Inc., 22 F.3d 503, 509 (2d
Cir. 1994) (citing Restatement (Second) of Contracts § 202(2)
(1981)), and can also play a role in the reading of distinct but
related documents that concern the same transaction, see 11 R.
Lord, Williston on Contracts § 30:26, at 239-53 (4th ed. 1999), but
the doctrine applies primarily in cases of uncertainty and cannot
undo plain language which makes perfect sense in context.
Even in the case of contemporaneous documents, the notion
that instruments should be read together is not mechanical. See 11
Lord, Williston on Contracts, at 247-48. Here, the undertaking was
made at a later date than the contract and by-law provisions; and
the circumstances--including Corning's insistence and Happ's
protests--confirm what is evident from language alone: that the
very purpose of the undertaking was to supply a restrictive gloss
that Corning would have favored and Happ would have opposed.
Happ also says that one of the purposes for the "not
inconsistent with" language in the Delaware law was to permit
indemnification in insider-trading cases. See note 3, above. That
may be so but this works against Happ's own claim that the
undertaking replicates the statute. The arguable gap between what
Delaware law might permit and what Corning was willing to do
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explains why Corning sought an undertaking more restrictive than
the wording of the by-law and contract obligations.
As it happens, Happ's claim to indemnification would
probably fail even if the undertaking were phrased solely in the
language of section 145. This is so because, given the jury
verdict in the enforcement action, Happ could not easily meet
either of the two requirements of Delaware law--namely, that the
conduct to be indemnified have been (1) in good faith and (2) not
opposed to the best interests of the company.
It is hard to see how the good faith test could be
satisfied if Happ knowingly violated a federal regulatory statute
aimed at protecting the public. Happ does not claim to have been
ignorant of insider-trading restrictions; rather, he argued in the
enforcement case that his sale of shares was not prompted by inside
knowledge but rather by a need for cash. It is apparent from the
jury's verdict that it did not agree.
Similarly, even if an act of insider trading might occur
without being adverse to the interests of the company, that would
not appear to help Happ: the jury's special verdict in this case
found that Happ had violated a duty of trust and confidence owed to
the company and its stockholders. Either a finding of bad faith or
of opposition to company interests would bar Happ's claim under
Delaware law. Here the jury appears to have made both.
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We do not rely upon the apparent bar of Delaware law.
Whether Happ is bound by the jury findings has not been litigated
on this appeal, and perhaps the surface reading of the findings in
the SEC enforcement action could be disputed. Still, despite the
arguments Happ has ably presented, the SEC verdict may well have
doomed Happ's claim at the start.
Affirmed.
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