Sterman v. Ferro Corp.
785 F.2d 162, 54 U.S.L.W. 2520 (1986)
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Rule of Law:
Structuring the price of a stock transaction to accommodate a seller's Section 16(b) short-swing profit liability does not constitute an illegal waiver of that liability, provided the sale is not final until the parties are irrevocably committed and the liability is actually paid to the issuer.
Facts:
- Between early 1981 and November 1982, Crane Co. acquired a 22.4% ownership stake in Ferro Corporation.
- On November 3, 1982, representatives from Ferro and Crane met to discuss Ferro repurchasing Crane's stock.
- The parties tentatively agreed on a price of $30.30 per share, which was subject to the approval of Ferro's board of directors.
- After the meeting, Crane's chairman, Thomas Evans, informed Ferro that Crane could not accept the tentative price due to the short-swing profit liability it would incur under Section 16(b).
- The parties renegotiated, with Ferro agreeing to consider a higher price that would allow Crane to net $30.30 per share after paying its Section 16(b) liability.
- On November 8, 1982, Ferro's board of directors formally approved the repurchase at a new price of $31.03 per share.
- The increased price resulted in an additional payment to Crane of $1,260,975, the exact amount of Crane's calculated short-swing profit liability.
- On November 11, 1982, Crane delivered a check for $1,260,975 to Ferro, satisfying its Section 16(b) liability.
Procedural Posture:
- Harry Sterman and Etta K. Steiner filed a derivative lawsuit against Ferro Corporation, its directors, and Crane Co. in the United States District Court.
- Plaintiffs alleged that the defendants engaged in an illegal waiver of short-swing profits in violation of the Securities Exchange Act of 1934.
- The district court granted the defendants' motion for summary judgment, dismissing the plaintiffs' claim.
- The plaintiffs (appellants) appealed the district court's decision to the United States Court of Appeals for the Sixth Circuit.
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Issue:
Does a corporation's agreement to increase the repurchase price of its own stock to cover a corporate insider's Section 16(b) short-swing profit liability constitute an illegal waiver of that liability under the Securities Exchange Act of 1934?
Opinions:
Majority - Krupansky, Circuit Judge.
No. A corporation's agreement to increase the repurchase price of its own stock to cover a corporate insider's Section 16(b) liability does not constitute an illegal waiver because the transaction's price was merely structured to accommodate the liability, which was then paid in full. The court determined that the initial discussions on November 3 did not constitute a binding sale, as a 'sale' for Section 16(b) purposes only occurs when a party incurs an 'irrevocable liability' to complete the transaction. Here, the parties were not irrevocably committed until Ferro's board of directors formally approved the final agreement on November 8. The court reasoned that structuring a transaction to account for Section 16(b) liability is permissible, distinguishing it from an illegal attempt to avoid paying the liability altogether. Since Crane fully paid the short-swing profit to Ferro, there was no violation of Section 16(b) or its anti-waiver provision.
Analysis:
This decision clarifies the application of Section 16(b) in negotiated corporate buybacks, reinforcing that the statute's strict liability nature does not prohibit parties from structuring transactions around it. The case solidifies the 'irrevocable commitment' test as the standard for determining the date of a sale, preventing parties from using preliminary agreements to manipulate timing for Section 16(b) purposes. By permitting parties to openly negotiate terms that account for 16(b) liability, the ruling provides a clear framework for insiders and corporations to structure transactions legally, provided the statutory obligation to disgorge profits is ultimately met.
