SEC v. Happ

392 F.3d 12

• Court: Court of Appeals for the First Circuit
• Decided: October 20, 2006
• Docket: 04-1406
• Status: Published

Opinion

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

-2- 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,

-3- 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

-4- 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

-5- 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).

-6- 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).

-7- 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

-8- 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).

-9- 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.

-10- 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

-11- 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.

-12- 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.

-13-