7547 Corp. v. Parker & Parsley Development Partners, L.P.

Citations: 38 F.3d 211; 1994 WL 600813Docket: 93-01880

Court: Court of Appeals for the Fifth Circuit; November 17, 1994; Federal Appellate Court

Original Court Document: View Document

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The United States Court of Appeals for the Fifth Circuit addresses the appeal from 7547 Corporation and Sonem Partners, L.P. concerning the district court's summary adjudication on their claims related to federal and state securities laws, and common law breaches of fiduciary duty, waste, and conversion. The district court concluded that the plaintiffs lacked standing, leading to its dismissal of certain claims. The appellate court upheld the dismissal of state law claims and the violation of federal proxy laws but reversed the ruling on the federal securities claims.

The plaintiffs, beneficial owners of units in Parker, Parsley Development Partners, L.P. (PDP), an oil and gas master limited partnership, allege that individual defendants, members of a management group, orchestrated a scheme to benefit from PPDC's ownership without a personal purchase. This scheme arose after an unsuccessful attempt by the management group to acquire PPDC due to financing issues. 

The pivotal event was a stock purchase agreement in May 1989, where Southmark and affiliates agreed to buy PPDC's stock. The transaction involved PPDC transferring its general partnership interest in PDP to P. P Equity, managed by PPDC, with P. P Ltd. acquiring the general partnership interest in P. P Equity. JM Petroleum Corporation financed the deal, receiving a profits interest and a $3 million liquidation preference in return. The SEC filings indicated that P. P Ltd. utilized part of the financing to acquire PPDC's interest, ultimately leading to PDP purchasing all outstanding stock in PPDC for $52.6 million.

Plaintiffs assert that the purchase price for PDP included the assumption of a $16.8 million debt and detail a complex structure of partnerships involving PDP, PPDC, P. P Equity, and P. P Ltd., with Midland Management Partners acting as the managing general partner. P. P Equity, as a Texas limited partnership, has Spraberry Development Corporation (SDC) as its sole limited partner, which is also owned by the individual defendants who control PPDC. The plaintiffs claim this arrangement enabled the defendants to dominate PPDC and its income while engaging PDP in unfavorable transactions with affiliates.

A key transaction highlighted is the crude oil purchase agreement established on May 24, 1989, under which P. P Ltd. was required to sell crude oil at prices significantly lower than market value. This resulted in financial detriment to PDP, which sold over $5 million of oil to JM in late 1989 and approximately 657 barrels in 1990.

The plaintiffs further note that during the 1980s, PPDC raised substantial capital through multiple oil and gas drilling partnerships, generating significant management and operational fees. In mid-1989, PPDC and P. P Ltd. collaborated on a ninth series of public programs, sharing management fees and expenses, but with PPDC bearing the bulk of organizational costs. They contend that P. P Ltd. stands to earn tens of millions in fees despite PPDC performing the actual management and operations.

Lastly, the plaintiffs express concerns regarding a proposed roll-up transaction that would consolidate the assets and liabilities of PDP, P. P Ltd., and Damson Oil Corporation into a new entity, Parker, Parsley Petroleum Company, which would distribute stock to former unitholders of the rolled-up partnerships, potentially disadvantaging them.

Agreements for a transaction involving PDP, P. P Equity, P. P Ltd., Midland, and others were executed in December 1990, including an amended exchange agreement and a consolidation plan for the Parker, Parsley partnerships. Approval from PDP's limited partners was necessary, leading to a Prospectus/Proxy Statement dated December 31, 1990, which outlined the transaction and the terms for P. P Petroleum stock distribution. Each PDP unit holder was to receive two shares of P. P Petroleum common stock for each unit owned, while P. P Ltd. was set to receive either 2.3 million shares (assuming full participation) or 1.9 million shares (if only the P. P partnerships participated). Plaintiffs argue this allocation is unfair, asserting P. P Ltd. would receive a disproportionately higher percentage of stock compared to an arms-length transaction, negatively impacting PDP unitholders during liquidation. 

The plaintiffs challenge the valuation methods used for determining share allocations: PDP's oil and gas reserves were valued as of December 31, 1989, while P. P Ltd.'s were valued as of September 30, 1990, after a spike in oil prices due to geopolitical events. This discrepancy is said to significantly affect the valuation of P. P Ltd.'s reserves. Additionally, plaintiffs claim P. P Ltd. misappropriated management fees and revenues from partnerships, which were then factored into the stock allocation, further skewing the distribution in its favor. They also argue that all fees and expenses related to the roll-up were unfairly charged solely to PDP. Collectively, these factors are said to disproportionately diminish the stock allocation for PDP unitholders.

The Prospectus/Proxy Statement related to a proposed amendment to the PDP partnership agreement led the general partner of PDP to solicit proxies from its limited partners for a special meeting on February 19, 1991. Plaintiffs allege that the Prospectus/Proxy Statement was materially false and misleading, impacting the accompanying registration statement filed with the SEC. The allocation section of the statement, detailing how P. P Petroleum shares would be divided between PDP and P. P Ltd., outlines specific percentages but does not explain the methodology behind the stock allocation. Plaintiffs argue that the Prospectus/Proxy Statement fails to adequately disclose several key points, including alternative valuation methodologies, comparisons with similar companies, the allocation of transaction costs, changes in asset value, the SEC-10 valuation of P. P Ltd.'s reserves, PDP's liquidation value, and the relationship between Dean Witter and the defendants. These omissions led plaintiffs to claim that the statement misrepresented the aggregate consideration for the partnerships as the "fair market value" of their assets.

In 1990, PPDC acquired 5.67% of total PDP units, thereby owning 10.27% of its parent corporation, which plaintiffs assert should be regarded as held in PDP's treasury. They argue that these acquisitions, which favored the proxy proposal, decreased the necessary minority unitholder votes required for approval, and assert that the purpose of these acquisitions should have been disclosed earlier.

Kaufmann initiated a derivative action on September 6, 1990, on behalf of PDP against multiple defendants, including P. P Equity and P. P Ltd., with PDP named as a nominal defendant. Following the defendants' registration statement filed with the SEC on December 31, 1990, an amended complaint was filed on January 16, 1991, alleging claims under Texas law and federal securities laws, specifically the Securities Act of 1933 and the Securities Exchange Act of 1934.

Defendants filed motions to dismiss and for summary judgment, arguing that plaintiffs lacked standing for their claims. Subsequent to the defendants' amended motions, plaintiffs responded and sought class certification, which was denied as moot. After limited discovery on standing, the district court recharacterized the defendants' amended motion as a summary judgment request, granting it on September 2, 1993. This led to an appeal focusing on multiple standing issues, including: 

1. Plaintiffs' inability to pursue state law derivative claims due to not being admitted as limited partners.
2. Lack of standing under federal securities laws, as plaintiffs were neither "purchasers" nor "sellers" of unit interests.
3. Failure to demonstrate injury from deceptive practices.
4. Ineligibility to assert violations of federal securities laws regarding proxy solicitation since plaintiffs were not eligible to vote.

The district court determined that these standing issues were jurisdictional, necessitating resolution before any claims could be adjudicated. Under Texas law, the plaintiffs were deemed not to have standing to bring derivative claims as they had not been made limited partners of the partnership. The Texas Revised Uniform Limited Partnership Act stipulates that only those who are limited partners at the time of the action and the transaction may file derivative actions. Additionally, a transferee can become a limited partner if the partnership agreement allows it or if all partners consent. The PDP partnership agreement outlines the process for a transferee to become a "Substituted Limited Partner," which includes receiving units, submitting a transfer application, and obtaining the general partner's consent, which is discretionary.

Consent for admission into the partnership can be "deemed" given if the general partner does not explicitly withhold it. P. P Equity, the general partner of PDP, explicitly denied consent for Kaufmann, 7547 Corporation, and Sonem, with a letter dated September 14, 1990, specifically stating Kaufmann was not permitted as a limited partner. This denial extended to affiliates like 7547 Corporation, which acquired units from Kaufmann after the notice was sent, meaning 7547 Corporation could not claim limited partner status under the "deemed consent" provision. Plaintiffs admitted they never filed applications to be limited partners and proposed several arguments regarding their standing to sue derivatively. They argued for equitable standing as limited partners, claiming wrongdoing by the general partner prevented their admission, but could not provide legal support for this theory under Texas law. The Texas statute requires derivative standing to be granted only to those who are limited partners at the time of the action, emphasizing a clear distinction between limited partners and assignees. The statute indicates that assignees do not have the same legal status and protections as limited partners, and the legislature intentionally excluded them from derivative standing. Consequently, the court determined it could not alter the statutory language to grant the plaintiffs standing based on equitable considerations.

The decision in Griffin v. Box, 910 F.2d 255 (5th Cir.1990) significantly restricts the plaintiffs' interpretation of the statute. In Griffin, the plaintiffs, who held depositary receipts for the OKC Limited Partnership, sought to replace the general partners due to dissatisfaction with their performance. They attempted to gather consents from other receipt holders to amend the partnership agreement, which required "limited partners" to take such actions. Despite obtaining over fifty percent of the votes, the general partners successfully obtained an injunction against the plaintiffs, with the court ruling that the plaintiffs were not "limited partners" under Texas law because they lacked the general partners' consent for admission. The court affirmed that the partnership agreement's requirements for admission were clear, emphasizing that compliance with these procedures is necessary to establish limited partner rights. The plaintiffs argued for analogies to cases allowing non-shareholders to assert claims on behalf of corporations; however, these cases did not interpret Texas law, unlike Griffin, which did. The plaintiffs also contended that the district court granted summary judgment prematurely, asserting they had recently found a blanket consent document to support their status as "substitute limited partners." This document, however, was not part of the original court record and could not be considered for appeal. The court noted that to request additional time for discovery under Federal Rule of Civil Procedure 56(f), the non-movant must demonstrate a prior request for discovery, notify the court of this request, and specify how the discovery relates to the summary judgment motion.

The plaintiffs failed to provide any evidence or request a continuance for the summary judgment motion pending further discovery, aside from minor extension requests that were granted. Therefore, the district court's decision to grant summary judgment is upheld as not premature. 

The plaintiffs claim that the "near total domination and influence" of P. P Equity over PDP's operations necessitated trust in the general partner, which they argue constitutes a basis for a direct action against the general partner. This argument references Texas law, which recognizes that a fiduciary relationship exists when one party reposes special confidence in another. The court finds it appropriate to apply state law to determine if a claim against general partners in a limited partnership is derivative or direct.

No Texas cases specifically address whether a unitholder or limited partner can sue directly for injuries sustained by the limited partnership. The defendants argue that, similar to shareholder cases where breaches of duty by corporate officers affect the corporation rather than the individual shareholders, claims against general partners also belong to the partnership entity, not the individual partners. This principle asserts that damages suffered by the partnership must be pursued by the entity to ensure recovery benefits creditors and proportional distributions to partners.

The court cites various precedents reinforcing that injuries sustained by a corporation or limited partnership must be pursued through derivative action, not direct action by individual partners or shareholders. Thus, a limited partner's ability to address grievances related to the partnership is equivalent to that of a corporate shareholder, with limited standing to bring direct claims against management.

A Texas court is likely to view the state law claims as derivative rather than direct due to a statute allowing limited partners to sue derivatively on behalf of the partnership, aligning their status more closely with shareholders. The plaintiffs have alleged collective damages resulting from a scheme by the defendants to misappropriate funds and resources belonging to PDP and its unitholders, asserting that these injuries are akin to those experienced by shareholders when a corporation is wronged. The mere potential for these damages to affect unitholders upon liquidation does not transform the claims into direct actions. The plaintiffs referenced cases where fiduciary duties were established between general partners and unitholders; however, those cases do not support allowing a direct action in this instance. Notably, Eisenbaum involved a breach of duty owed directly to a limited partner, which is not subject to the derivative action rule. The court concludes that the plaintiffs' claims should be classified as derivative, and Texas law does not permit them to pursue these claims, thus precluding their assertion.

The district court did not individually analyze the federal securities claims, except for proxy rule violations, concluding that the plaintiffs were not limited partners. It is determined that the standing tests for federal securities claims do not align with Texas law, necessitating a separate evaluation of each claim. Regarding Section 11(a) registration liability, the court recorded that it is unclear whether the roll-up transaction was completed or if the plaintiffs received P. P Petroleum stock; however, the court assumed the transaction occurred for its decision. The district court's ruling that the plaintiffs lacked standing under Section 11(a) due to their status as non-limited partners is under review. The plaintiffs' standing to sue under Section 11 of the Securities Act is contingent upon whether they acquired shares through a defective registration statement. Defendants argue that only those who purchase shares under such a statement have standing, asserting that the plaintiffs do not meet this criterion. Case law supports that only purchasers of the challenged securities have standing to sue under Section 11. The definition of "sale" under the Securities Act encompasses all contracts of sale or security disposals for value.

The section interprets the exchange of one security for another as a "sale" under the Securities Act, supported by case law, specifically United States v. Wernes, which affirmed that exchanging beneficial trust certificates for limited partnership certificates qualifies as a sale. The Securities Act explicitly defines such exchanges as sales, except for specific exemptions like those pertaining to bankruptcy or government-sanctioned exchanges. SEC Rule 145 further clarifies that exchanges related to mergers and consolidations are considered sales, requiring registration under the Securities Act when security holders are presented with a new investment decision regarding a different security. 

The transaction in question was conducted via a Form S-4 registration statement and a prospectus aimed at PDP unitholders, confirming its classification as a sale. An exception exists for transactions solely changing the issuer's domicile, but this was not applicable here. The court's ruling establishes that while the exchange of limited partnership units for newly issued corporate stock constitutes a sale under the Securities Act, it does not qualify as a sale for private civil remedies. The Prospectus/Proxy Statement emphasizes the sale of P. P Petroleum common stock, detailing that each PDP Unit holder will receive two shares of common stock for each unit owned. The document serves dual purposes: soliciting proxies from limited partners for the roll-up and providing a prospectus about the offered securities to PDP unitholders and Damson interest-holders.

The Prospectus/Proxy Statement was provided to the plaintiffs, indicating its relevance to both "holders of PDP Units" and "limited partners." Specific sections address voting rights exclusive to limited partners, while others refer to benefits for all PDP unitholders, regardless of voting eligibility. The document defines "holders of PDP Units" as those with currently outstanding units of limited partner interest in PDP. The partnership agreement clarifies that a "unit" represents a limited partner interest calculated as a fraction of total outstanding units. An "Assignee" is someone who has received units through a permitted transfer, holding an economic interest akin to that of a Limited Partner but with certain restrictions. 

The plaintiffs claimed to be beneficial owners of PDP units and received the Prospectus/Proxy Statement related to a transaction exchanging their units for stock in P. P Petroleum. Although they did not apply to become substituted limited partners due to the general partner's prior denial, they argued that they were treated as "assignees," evidenced by their receipt of the Prospectus/Proxy Statement. This suggests a factual dispute regarding their standing to challenge the registration statement under section 11(a). The court found that summary judgment was inappropriate based on lack of standing as a "limited partner." The defendants acknowledged the transaction as a "sale" and the plaintiffs as "purchasers" under the Securities Act but contested the plaintiffs' demonstration of injury or causation, citing their significant investment gains as a barrier to standing.

The court cannot assess the merits of the plaintiffs' position due to insufficient evidence, specifically the absence of assignment agreements for the plaintiffs' units. As a result, no opinion is given on whether the plaintiffs qualify as "assignees." The court references Conkling v. Turner, noting that it may only affirm summary judgment on grounds raised in the district court, where both parties had the chance to present evidence. Under Section 12(2) of the Securities Act, liability arises for those who send prospectuses with false statements or omissions, contingent on the plaintiff being a "purchaser" of the security. The definitions of "sale" are consistent across claims. There remains an issue regarding the plaintiffs' standing, similar to that under Section 11, but the defendants' appeal arguments focus on the plaintiffs' failure to demonstrate materiality and knowing participation in the misstatements. This materiality issue was not presented at the district court level, thus cannot be considered now. 

Regarding Section 10(b) and Rule 10b-5 of the Exchange Act, the district court incorrectly linked the plaintiffs' standing as "limited partners" to their ability to assert these claims. The appropriate standing requires actual purchase or sale of securities with proof of injury due to fraud in connection with these transactions, as established by the "Birnbaum rule."

Federal courts recognize an exception to the general rule regarding investor rights when a merger, acquisition, or liquidation fundamentally alters an investor's interest in a company. This exception, known as the "forced seller" doctrine, emerged from a securities fraud case where the plaintiff had no choice but to exchange shares for cash due to a merger that eliminated the corporation in which they invested. The Vine case established that the lack of choice in such transactions allows the shareholder to be considered a seller under section 10(b) and Rule 10b-5.

Initially, the forced seller doctrine was narrowly interpreted, granting standing to investors only when their investment shifted from a stake in an operating business to merely a claim for cash. Over time, this interpretation has evolved to accommodate changes in the corporate landscape, adopting a broader "fundamental change in investment" test in cases involving involuntary securities exchanges. Subsequent rulings have allowed plaintiffs to assert claims under section 10(b) and Rule 10b-5 if there is a significant alteration in the nature of the investment. Most cases applying the forced seller doctrine in a restrictive manner involve claims of dilution or value loss of investments still held by the plaintiff, rather than an actual exchange for an unrelated investment.

Debenture holders, whose conversion rights were eliminated during a merger, were determined not to be "sellers" under section 10(b) of the Securities Exchange Act, as they retained debentures with an ongoing promise for principal and interest. In contrast, previous rulings indicated that a refinancing plan involving new shares in exchange for debentures did not constitute a "sale" of securities. In Dudley v. Southeastern Factor and Finance Corp., an investor became a forced seller when a corporation was liquidated, equating to a right to payment. Similarly, in Coffee v. Permian Corp., a potential forced seller status arose from an allegedly fraudulent liquidation. The court found that if an investor's shares in one company were converted into shares of another company through a merger, this could be treated as a "sale" and "purchase" of securities for Rule 10b-5 purposes. The legal standard for considering an exchange a forced sale requires a significant change in investment nature or risk, which necessitates evaluating the economic realities of the transaction rather than merely the nature of the claim. The Supreme Court's guidance on these matters remains limited, particularly regarding whether a merger exchange constitutes a purchase or sale under section 10(b).

The case establishes that the anti-fraud objectives of the relevant statute and rule are effectively supported by their application in this regulatory context. It highlights that the distinction between regulatory contexts and private rights of action has limited impact, as noted in Smallwood. The Supreme Court's decision in Blue Chip Stamps restricted standing under section 10(b) to actual purchasers and sellers, which is significant to this case. The plaintiffs in Blue Chip were offerees of a stock offering who opted not to purchase shares based on a pessimistic appraisal in the prospectus. The Court pointed out that Congress had repeatedly declined to amend section 10(b) to include offerees, reinforcing the validity of the Birnbaum rule over the past two decades. This rule aligns with Congressional intent and is seen as consistent with other provisions of securities law that only allow claims from actual purchasers and sellers. The ruling identifies three classes of potential plaintiffs excluded by the Birnbaum rule: (1) potential purchasers who declined to buy due to negative representations, (2) current shareholders who choose not to sell, and (3) shareholders or creditors suffering investment losses due to corporate actions. Notably, the Court did not categorize the plaintiffs in this case as being affected by the Birnbaum rule.

Perceived issues of proof arising from the absence of actual sales—such as a lack of documentation regarding the purchase or sale of securities—were central to the Court's analysis. The Birnbaum rule effectively restricts plaintiffs to those who have engaged with the specific security related to the alleged misrepresentation. This evidentiary challenge is absent in cases like the documented exchange of PDP units for P.P. Petroleum stock. The proof required for standing under the forced seller rule relies on objectively verifiable facts, suggesting that the principles established in Blue Chip Stamps do not exclude standing for investors of merged companies who can demonstrate significant changes in their investments. This aligns with various federal court rulings that recognize the fraudulent substitution of shareholder status as a legitimate legal injury. Notably, the forced seller doctrine has been broadened beyond short-form mergers, applying to situations where a defendant's fraud leads to a fundamental alteration of a plaintiff's investment without their consent. An example includes a limited partner required to accept stock in exchange for their partnership interest, which was upheld as having standing due to the fundamental change in investment. The Mayer case illustrates that standing can be granted when a plaintiff's investment undergoes a substantial transformation, differentiating it from the outcomes in Birnbaum and Blue Chip Stamps, where plaintiffs did not experience a change in their positions post-fraud.

A securities exchange may be deemed a forced sale under Section 10(b) and Rule 10b-5 if the plaintiff proves a "fundamental change in the nature of the investment." The court supports this application based on the allegations in the amended complaint. The defendants' attempts to distinguish their case from Mayer are unconvincing, particularly regarding the plaintiffs' standing to assert federal securities claims despite their lack of status as limited partners. The complaint includes specific allegations of fraud, countering the defendants' claim that Mayer did not involve an interest in a going concern. The court notes that the plaintiffs experienced a complete transformation of their investment, transitioning from units in a solvent limited partnership to shares in a corporation formed from multiple entities, including one described as financially troubled.

The plaintiffs successfully raise a factual issue regarding their standing under Section 10(b) and Rule 10b-5, despite the defendants' assertion that the plaintiffs did not demonstrate injury from the transaction, which the court declines to address due to lack of prior presentation. Additionally, under Section 14(a) of the Exchange Act, which prohibits misleading proxy statements, only interest-holders with voting rights are protected. The court references relevant case law indicating that those whose votes are not legally required for corporate actions cannot pursue claims under Section 14(a) without demonstrating a causal link between the proxy statement and their injuries.

The Supreme Court in J.I. Case Co. v. Borak emphasized that the purpose of section 14(a) is to regulate proxy solicitations to prevent abuses that undermine stockholders' voting rights. While it is not necessary for a plaintiff to have voted based on a misleading proxy statement to have standing under section 14(a), it is deemed excessive to allow those without voting rights to bring claims. The protective intent of section 14(a) is to safeguard the integrity of the voting process, acknowledging that shareholders can be affected by misleading statements even if they did not directly rely on them. Previous cases have established that non-voting shareholders may have standing due to potential harm from deception affecting other shareholders. However, the core distinction is that all cited cases involved shareholders with voting rights, and no precedent supports claims from individuals lacking such rights. The closest case, Palumbo v. Deposit Bank, involved a shareholder with voting privileges, underscoring that standing is contingent upon having voting rights. The court ultimately concludes that standing under section 14(a) should not extend to those not qualified to vote, reaffirming the necessity of voting rights for such claims and clarifying that the plaintiffs lacked the entitlement to vote on the relevant proposal.

Only limited partners of PDP as of December 26, 1990, per PDP's records, are entitled to vote or grant proxies at the limited partners' meeting. The partnership agreement stipulates that only Record Holders of Units who are Limited Partners on the designated Record Date may receive notice and participate in voting. For Units held by individuals not recognized as Limited Partners, the General Partner will vote in accordance with the voting percentages of other Units. The plaintiffs' receipt of proxy materials does not alter these provisions.

The December 18, 1990, letter from a PDP vice-president clarified December 26, 1990, as the record date for voting eligibility, reinforcing that only Limited Partners of record may vote. The plaintiffs argue that the defendants' counsel acknowledged that proxy votes from all unitholders would be counted at the February 19, 1991, meeting; however, this assertion is based on hearsay and does not prove that non-Limited Partner votes were included.

The plaintiffs are found to have standing to assert claims under federal securities laws, but the defendants argue that the allegations primarily concern mismanagement and do not constitute valid federal securities claims. The court acknowledges that while mismanagement alone may not invoke federal securities laws, the plaintiffs have identified specific misstatements and omissions in the Prospectus/Proxy Statement. This aligns with the Supreme Court's ruling in Santa Fe Industries, which allows for actions involving breaches of fiduciary duty to proceed if they include elements of deception.

The court has reviewed the amended complaint favorably for the plaintiffs and determined that they are capable of proving facts that could entitle them to relief, referencing Conley v. Gibson. The defendants did not provide evidence to demonstrate a lack of factual issues and only claimed that the plaintiffs did not sufficiently plead their claims related to federal securities laws. This assertion does not justify affirming the summary judgment on claims where standing has been established. Consequently, the court reverses the district court's summary judgment regarding the plaintiffs' claims under sections 11 and 12 of the Securities Act, as well as section 10(b) of the Exchange Act and SEC Rule 10b-5, and remands these claims for further consideration. The court affirms the remainder of the district court's judgment and orders that costs are to be borne by the defendants-appellees.