Opinion
00 Civ. 4878 (HB).
December 17, 2001.
OPINION ORDER
Following a three day trial the jury returned a verdict on April 4, 2001 in favor of defendant MRV Communications ("MRV") on the two legal claims presented, breach of contract and negligent misrepresentation. With respect to the two equitable claims, for which the Court requested that the jury provide advisory verdicts, the jury found for MIRV on the promissory estoppel claim and for Halifax Fund, L.P. ("Halifax") on the equitable estoppel claim, and awarded $3,625,049 in damages. Both parties submitted post-trial motions requesting that the Court decline to adopt the recommendations of the jury. For the reasons discussed below, I subscribe to the jury's advisory verdicts in regards to liability on equitable claims, and award damages to Halifax of $1,799,417.
BACKGROUND
In 1996, Thomas Lumsden ("Lumsden") of Promethean Investment Group ("Promethean") approached MIRV to determine whether MIRV would be interested in raising capital through a private financing arranged by Promethean MRV was interested and Promethean proceeded to line up investors, negotiate the terms of the financing with Edmund Glazer ("Glazer"), MRV's Chief Financial Officer, and perform other services, for which Promethean was compensated by the other investors. The financing consisted of the sale of debentures and warrants, and occurred in three tranches the last of which closed on August 7, 1996. The warrants issued in connection with the financing granted the warrant holders the right to purchase a predetermined number of common shares at a predetermined price within a given period of time. All of the warrants issued through the financing expired on August 7, 1999
Halifax, an investment fund managed by The Palladin Group, L.P. ("Palladin"), purchased debentures and warrants from MRV, and later purchased more MIRV warrants from two other investors, Samyang Merchant Bank ("Samyang") and CIBC Wood Gundy ("CIBC"). The current litigation concerns only the warrants purchased from Samyang and CIBC; the debentures and warrants that Halifax purchased directly from MRV are not at issue.
In order to their ownership, Promethean forwarded the Samyang and CIBC warrants to MIRV in January 1997 and mid-February 1997, respectively, and requested that MRV reissue those warrants in Halifax's name. The Samyang warrants conferred the right to purchase 35,000 shares of MIRV common stock at a price of $26.25 per share, and the CIBC warrants conferred the right to purchase 51,000 shares at $26.65 per share. For a number of months MRV sat on the warrants and did nothing despite several requests from Promethean. Although there is some dispute about the implications to the investors of not having physical possession of the warrants, there is no question that the investors were anxious that MIRV complete their task and reissue the warrants.
On or about June 15, 1997, MRV issued two warrants to Halifax ("reissued warrants"), one for 35,000 shares and the other for 51,000 shares. Each reissued warrant was dated June 6, 1997, and stated, as had each warrant when originally issued, that it expired on the date "thirty-six (36) months after the date hereof" This language, identical to the expiration clauses of the warrants issued to Samyang and CIBC on August 7, 1996 and later purchased by Halifax, had on its face the effect of extending the exercise period 10 months until June 6, 2000. At the same time, MRV reissued warrants to other investors from the financing, all with the same expiration clause and all having the effect of extending the original warrant period until June 6, 2000.
Jeffrey Devers ("Devers"), Palladin's principal, noticed the extension immediately after receiving the reissued warrants and contacted James O'Brien of Palladin to confirm that the extension had been intentional. As told by Devers, O'Brien reported that Lumsden had negotiated the extension with Glazer as compensation for the delay in MIRV's reissuance of the warrants. O'Brien has no recollection of the conversation, and the jury found that Lumsden had not negotiated such an extension and I see no reason to disturb their finding. While I find that Devers did have a conversation with O'Brien in which the warrant extension was discussed, I cannot credit Devers' testimony about the contents of that conversation. Devers did not contact MIRV directly.
Had the jury found otherwise, it would have returned a verdict for plaintiff on the contract claim.
Several years later on March 9, 2000, well before the putative June 6, 2000 expiration of the exercise period, Promethean advised MIRV that it wanted to exercise its reissued warrants. At that time, MIRV stock, which had long been trading at prices below the $26.65, the exercise price of the options, was enjoying a meteoric rise and was trading at prices nearing $200 per share. Edmund Glazer of MIRV, however, refused to honor the request to exercise the reissued warrants on the ground that the expiration date indicated on the reissued warrants had been a mistake and that the warrants had expired on August 7, 1999. Glazer testified that he had been unaware of the mistake before Promethean's exercise request, and that it occurred to him at that time that others of the warrants might have the same mistake. That realization, though, apparently did not prompt Glazer to check any of the other warrants, a task amounting to no more than flipping through the binder in which the warrants were kept, or to notify the investors that the warrant period extension was a mistake and that the warrants had in fact expired. Indeed, two weeks later Angelo Gordon, another investor, attempted to exercise its reissued warrants and was refused by MRV. Again, Glazer apparently neither checked other warrants for a mistake nor took steps to notify the investors. Instead, he instructed Lyran Talmor, a MRV employee responsible for the mechanical aspects of exercising warrants, that he should not accept funds from warrant holders or in any way facilitate a warrant exercise until he learned from Glazer that the warrants in question were exercisable. (T. 399-403).
An option to buy a stock at a price higher than the current market price is often said to be "under water."
In early June 2000, Halifax faxed a notice of the exercise letter to MIRV and was told shortly thereafter that MIRV would not honor the request. Halifax then sued MIRV in this Court, asserting four causes of action: breach of contract, negligent misrepresentation, promissory estoppel and equitable estoppel. Following a three day trial, the jury returned a verdict in favor of MIRV on each of the two legal claims. It determined that the reissued warrants were not enforceable contracts, and that MIRV had not negligently misrepresented that the warrants would expire 10 months prior to the date indicated on the warrants themselves. Acting in an advisory role, the jury found for defendant on the promissory estoppel claim, but found for plaintiff on the equitable estoppel claim, awarding damages of $3,625,049. Thus, although the jury found that there was not an enforceable agreement to extend the warrant period, and that MIRV had not made negligent misrepresentations or promises (promissory estoppel) to Halifax with respect thereto, it did find that MRV had wrongfully concealed its knowledge that the warrants had expired, and if timely informed Halifax would have spent $3,625,049 less than it ultimately did covering short market positions taken pursuant to a trading strategy that presumed the validity of the warrants as written. In calculating damages as $3,625,049, the jury apparently relied upon Halifax's exhibit number 38.
On the equitable estoppel claim, the jury was charged on April 4, 2001 as follows
"Plaintiff must prove by clear and convincing evidence that:
(1) MIRV knew as of March 2000 that the extension of the expiration period on Halifax's reissued warrants was a mistake, (2) After it learned of the mistake, MIRV deliberately concealed that information from Halifax, (3) Halifax did not know that the reissued warrants contained a mistake and that information was not readily accessible to Halifax, (4) MIRV knew Halifax would rely upon the date indicated on the reissued warrants, and (5) Halifax relied on the date indicated on the reissued warrants to its detriment."
DISCUSSION
Promissory Estoppel
Under New York law, to prevail on a promissory estoppel claim the plaintiff must prove the following three elements by clear and convincing evidence: (1) a clear and unambiguous promise existed between the parties; (2) the party to whom the promise was made forseeably and reasonably relied on the promise; and (3) such party sustained injury as a result of its reliance. See Cyberchron Corp. v. Calldata Sys. Dev. Inc., 47 F.3d 39, 45 (2d Cir. 1995) (citation omitted). Here, there was no clear and unambiguous promise. Although the reissued warrants clearly provided for an expiration date of June 6, 2000, the 10 month extension of the warrant period was a mistake and thus did not constitute an enforceable promise. See Edward Joy Co. v. Noise Control Products, Inc., 443 N.Y.S.2d 361, 362 (N.Y.Sup.Ct. 1981) ("[n]o authority has been supplied to the court nor could the court find any in which the theory of promissory estoppel was enforced against proof of an honest mistake"). To constitute a promise for purposes of the promissory estoppel doctrine, the representation must be intentional. Since the extension of the warrant period was a mistake, the extension is not a promise and the promissory estoppel claim fails.
Equitable Estoppel
To establish a claim for equitable estoppel under New York law, Halifax must show by clear and convincing evidence: "(1) An act constituting a concealment of facts or a false misrepresentation; (2) An intention or expectation that such acts will be relied upon; (3) Actual or constructive knowledge of the true facts by the wrongdoers, (4) Reliance upon the misrepresentations which causes the innocent party to change its position to its substantial detriment." General Electric Capital Corp. v. Armadora, 37 F.3d 41, 45 (2d Cir. 1994); Farkas v. Farkas, 168 F.3d 638, 642 (2d. Cir. 1999) (equitable estoppel analysis focuses upon "intentional concealment"). An act, such as the failure to disclose information, may constitute an act of concealment. See Decarlo v. Archie Comic Publications, Inc., 127 F. Supp.2d 497, 509 (S.D.N Y 2001); LaPorto v. Village of Philmont, 39 N.Y.2d 7, 12 (1976). Such is the case "when one party in a relationship with another has an opportunity to speak in order to avoid harm or injury to the other party and fails to do so to the ultimate prejudice of the other party." Columbia Broad Sys. Inc. v. Stockely-Van Camp. Inc., 522 F.2d 369, 377 (2d Cir. 1975). Equitable estoppel is an equitable remedy, and its application turns upon a close examination of the facts and the equities.
Edmund Glazer knew on March 9, 2000 when Promethean attempted to exercise its reissued warrants that at least some of the warrants reissued on June 15, 1997 mistakenly extended the warrant period, and he knew or should have known that there was a distinct possibility that Halifax mistakenly believed that their warrants could still be exercised. (T. 399-403). He also knew that MIRV's stock was trading in the stratosphere and that the warrants were now incredibly valuable. And yet, Glazer took no steps to determine whether Halifax's warrants bore the same mistake as Promethean's or to notify the other investors that there might be a problem. In sum, he chose not to disclose the mistake to Halifax. At trial, Glazer accounted for this striking omission by stating that he presumed Promethean would have notified the other investors, since most of the information during the financing had been run through Promethean with little direct communication between MRV and any of the other investors. Creative but unlikely. The warrants included a provision that required MIRV to provide direct notice to the warrant holder in certain circumstances, and the investors never designated Promethean as its conduit for information from MRV. Further, since there was no evidence that Promethean even possessed copies of the other investors' warrants, Promethean would not have known if Halifax's warrants included the same mistake as their own Perhaps most importantly, Glazer had personally signed each of the reissued warrants and each of the warrants was a misrepresentation, albeit an unintentional one. Thus, Glazer bore a heightened responsibility to find out whether Halifax's warrants included the mistake and if so to notify Halifax.
MIRV argues that even if Glazer did conceal the mistake from Halifax while knowing that Halifax would rely on the exercise date provided on the reissued warrants, Halifax's reliance on the warrants was not reasonable. See Bove v. New York City, 99 civ. 9181, 2000 U.S. App. LEXIS 11895, *6 (2d Cir. 2000) ("[t]he ready availability of the allegedly concealed information to the plaintiff fatally undermine his claim of equitable estoppel"). Not the case. Here, Devers, Palladin's principal, noted that the reissued warrants included a 10 month extension, had a conversation with O'Brien about the extension, and acted in accordance with information provided.
While I do not credit Devers' statement that he was told by O'Brien that the extension had been intentional, I am persuaded that Devers' did discuss the extension with O'Brien.
Equitable Estoppel — Damages
Because it was not told of the mistake on March 9, 2000, Halifax continued to pursue its short selling market strategy, which in vastly oversimplified terms worked as follows. Halifax sold options to buy MRV common stock (that Halifax did not actually own) at a particular price (the "strike price") within a fixed period of time. Typically, investors who make these "short sales" are betting that the market price will not exceed the strike price and that the option buyer will have no opportunity to exercise the option. If the short seller guesses incorrectly, and the market price rises above the strike price before the option expires, then he/she must "cover" the short sale by purchasing shares on the common market.
The sale of the option nets a small amount which varies according to the likelihood that it will be profitable for the option buyer/holder to buy the common shares at the strike price from the option seller/writer.
Halifax, however, was not like most short-sellers in that it did not execute trades based on assumptions about the future price of MRV stock. Instead, Halifax's trading strategy pursued market neutrality — or, put another way, indifference to the market's movement — which it could do because of MIRV warrants. Since the MIRV warrants gave Halifax the right to buy 86,000 shares of MIRV stock at approximately $26 per share, Halifax could cover any short position of 86,000 shares or fewer at a cost of $26 per share, regardless of MIRV's market price. For complicated strategic reasons beyond the scope of this decision, Halifax engaged in a series of transactions — primarily short sales and short covers — to maintain a constant short position of 86,000 MRV shares, but never exercised the MRV warrants. Indeed Halifax's strategy was to "lock in" small profits and was bottomed on Halifax holding onto the warrants until the very end of their exercise period when Halifax would exercise and close out its entire MRV short position. Halifax assumed that date would be June 6, 2000.
For example, in March 2002, Halifax short sold MIRV stock in 18 separate transactions at different strike prices in quantities of 20 and 40 shares, and covered short positions in 10 separate transactions at quantities ranging between 10 and 19,600 shares.
When MIRV refused to honor Halifax's request to exercise the warrants on June 5, 2000, Halifax had no choice but to cover the entire 86,000 share short position through market purchases. By the time Halifax completed its cover on June 22, 2000, Halifax had spent $10,399,417.50 (the "June cover"). See Def.'s Ex. 8. Thus, for the equitable estoppel claim, the measure of Halifax's damages is the difference between the June cover and what it would have cost Halifax to cover had it been told on March 9, 2000 that the extension of the warrant period had been a mistake and that the warrants had already expired (the "March cover").
To this much the parties largely agree. Where they disagree is in the calculation of the March cover. In Schultz v. Commodity Futures Trading Commission, 716 F.2d 136 (2d. Cir. 1983), the Second Circuit stated that:
By Halifax's reckoning its damages are at least $3,625,049, the amount awarded by the jury in its advisory verdict, apparently in reliance upon Plaintiff's exhibit 48, at 3 In stark contrast, MRV calculates Halifax's damages as $0.
"[T]he proper rule to be applied in calculating damages when an item of fluctuating value is wrongfully sold, converted or not purchased when it should have been. . . . is either (1) its value a the time of the [wrong] or (2) its highest intermediate value reached by the stock between notice of the [wrong] and a reasonable time thereafter during which the stock could have been replaced . . . whichever of (1) or (2) is [better for the wronged party]."Id. at 139, 141 (hereinafter, "Shultz rule"). Subsequent courts have applied this damages rule with respect to warrants for the purchase of common stock and to claims for breach of contract, see e.g., Commonwealth Assoc. v. Palomar Medical Tech., Inc., 982 F. Supp. 205 (S.D.N.Y. 1997);Flickinger v. Harold C. Brown Co., 789 F. Supp. 616 (W.D.N.Y 1992), and I find that the rule should be applied to the facts presented here, notwithstanding MRV's concern that to determine "a reasonable time" this Court must engage in speculation and guesswork. See Palomar, 982 F. Supp at 208 ("certainty as to the amount of damages is not required, particularly when it is the defendant's breach that has made such imprecision unavoidable"). Certainly, as MRV argues, it would be little more than a mechanical exercise to calculate damages as of the date Halifax was informed of the mistake in the warrant period, but the purpose of the rule is "to provide a fair valuation of stocks, by allocating the risk of market fluctuation to the breaching party," Payne v. Wood, 1995 U.S. App. LEXIS 22551, *23 (6th Cir. 1995), and to redress the unfairness that would result from allowing the party in the wrong to dictate the timing of the innocent party's trading and thus the recoverable damages. See id. ("[t]he risk . . . should be assumed by the perpetrator, not by the victim of the wrong"); Lucente v. Int'l Business Machines Corp., 117 F. Supp.2d 336, 356 (S.D.N.Y. 2000) ("the actual loss to the injured party is the loss associated with being forced to sell at an unfavorable time and being denied the opportunity to sell at a favorable time"). These fairness concerns are of particularly salient with respect to equitable claims and in connection with loss mitigation. Where, as here, the innocent party is trading in the market to reduce losses caused in large measure by defendant's mistake, there is no risk of a windfall to the plaintiff. See Schultz, 716 F.2d at 141.
As MRV points out in its brief, since Schultz some courts outside of the Second Circuit, none within, have declined to apply the Schultz rule to breach of contract cases. See Skully v. U.S. Watts Inc., 238 F.3d 497 (3d Cir. 2001) However, the damages here do not arise from a breach of contract claim, and like every other court in this Circuit since Schultz I do not share the Third Circuit's view that "the speculativeness and hindsight problems attendant to the conversion theory" preclude a court from calculating damages based on stock trades beyond the date of the wrong Id. at 512-513.
The application of the Schultz rule in this case has one unusual permutation. As in Schultz and in the cases applying its rule, MIRV's commission of a wrong prevented Halifax from trading at favorable prices. In those cases, however, the plaintiff was prevented (either by the nondelivery of stock or for some other reason) from selling stock when market prices were high. See Palomar, 982 F. Supp. 205 (defendant refusal to exercise warrants prevented the plaintiff from selling common shares). For that reason, the Schultz rule speaks of a plaintiff's right to the "highest intermediate" sales price. Here, in contrast, MIRV's failure to give timely notice obligated Halifax to make market purchases to cover an open short position. Thus, as applied to these facts, theSchultz rule entitles Halifax to the "lowest intermediate" purchase price within a "reasonable time."
Because Halifax should have received notice of the mistake from MIRV on March 9, 2000 its damages equal the difference between the June cover and the hypothetical March cover, where the March cover is calculated by multiplying 86,000 shares by either (1) MRV's price on March 9, 2000 or (2) the stock's lowest intermediate value between March 9, 2000 and the expiration of a "reasonable time," whichever calculation produces a lower number. Since the price of MRV stock was at its zenith on March 9, 2000 ($190.5 per share), the March cover is determined by MRV's lowest intermediate value between then and a "reasonable time" thereafter.
Obviously, the lower the price of the March cover, the greater is the difference between the June cover and March cover, and, in turn, the greater is the size of Halifax's damages.
What constitutes a "reasonable time" varies from case to case,Schultz, 716 F.2d at 140, but includes at least a "reasonable opportunity to consult counsel . . . and to watch the market for the purpose of determining whether it is advisable on a particular day or when the stock reaches a particular quotation, and to raise funds if he decides to repurchase." Caballero v. Anselmo, 759 F. Supp. 144, 149 (S.D.N.Y. 1991). Here, the time that Halifax actually took to cover its position in June, 2000 provides some guidance as to reasonableness. Although MRV believed that Halifax should have covered earlier than it did, there is no evidence in the record that Halifax's cover period — which began when Halifax received notice from MRV on or about June 5, 2000 and concluded 3 weeks later on June 22, 2000 — was dilatory. Thus, I find that 3 weeks from March 9, 2000 constitutes a reasonable time. Although Halifax might have covered in less time, 3 weeks, if not a day or two longer, is a reasonable covered period, especially since MRV's stock was (1) at an all-time high on March 9, 2000 after a meteoric run-up, (2) had a highly volatile trading history of rapid gains and equally rapid retreats, and (3) began falling on March 10, 2000 and continued to drop steeply during the 3 week period. A professional investor like Halifax would likely have presumed that the share price would fall from its highs in early March and waited a short time before covering the enormous short position. See Palomar, 982 F. Supp. 205 ("[i]n determining damages, we look to what would most probably have occurred"). Between March 9, 2000 and March 30, 2000, the lowest intermediate closing price of MRV stock was $100 per share. Thus, the March cover equals $8,600,000 ($100 x 86,000 shares) and Halifax's damages (June cover — March cover) amount to $1,799,417 ($10,399,417.50-$8,600,000).
The record is not entirely clear as to when Halifax notified MRV of its intent to exercise, the most likely date is June 2, 2000, and is even less clear as to when MRV declined the exercise request. For the purpose of calculating damages only, I find that Halifax learned of MRV's refusal to exercise on June 5, 2000. Certainly, Halifax received notice no later than June 6, 2000, for on that day Halifax made its first covering transaction.
MRV cites to a variety of cases, most of them quite old, in which courts in this district and elsewhere have set the period for measuring damages at less than 3 weeks, but in each case the court set the period based upon the specific facts therein, none of which are present here. For example, in one such case, Flickinger v. Harold C. Brown Co., 789 F. Supp. 616 (W.D.N.Y. 1992), the court observed that a reasonable time "would be a relatively short period, perhaps ten days from the date of discovery" of the non-delivery of stock, but set the "reasonable time" as I month because the court could not determine precisely when the plaintiff discovered that the stock had not been delivered. Id. at 620. By the same token, Halifax's argument that a reasonable period is 4 weeks, rather than the 3 it actually used in the June cover, is supported by no specific facts and appears to be no more than an attempt to exploit the $73 price at which the stock was trading on June 6, 2000, the last day of those 4 weeks. While Halifax would likely have waited some time after March 9, 2000 to cover, I do not credit Halifax with market omniscience. For the same reason that I decline to accept Halifax's measure of a "reasonable time" I find that the jury was mistaken in relying, as apparently it did, Halifax's exhibit 48 which stated on page 3 of that exhibit that Halifax's damages were $3,625,049. Although the exhibit did indicate that the $3,625,049 presumed a "First Week of April" cover date, there was no mention of the "reasonable time" concept or explanation for Halifax's choice of an April cover date.
The Court also takes note of the high number of covering shares Halifax had to purchase (86,000), the relative difficulty of unwinding such a large short position, and the potentially significant time it would have taken for Halifax to confirm that the extension of the warrants had been a mistake, consult with counsel, determine that further negotiation with MIRV would be futile, and devise a cover strategy that took into account the volume of shares available in the market.
MIRV shares closed at $100 per share on March 29, 2000.
CONCLUSION
For the reasons set forth above, I find for MIRV on the promissory estoppel claim and for Halifax on the equitable estoppel claim. MRV must pay to Halifax damages in the amount of $1,799,417.