UNITED STATES v. DIEBOLD, INC.
Legal provision: Federal Rules of Civil Procedure, including Appellate Procedure (or relevant rules of a circuit court)
Argument of Daniel M. Friedman
Chief Justice Earl Warren: Number 286, United States, Appellant, versus Diebold, Incorporated.
Mr. Daniel M. Friedman: Mr. Chief Justice, may it please the Court.
This case hereon appealed to the District Court for the Southern District of Ohio is a government civil antitrust case under Section 7 of the Clayton Act.
The compliant charged of the acquisition of the appellee Diebold of all of the assets have a firm called the Herring-Hall-Marvin Safe Company was in violation of Section 7 of the Clayton Act because the effect to the acquisition maybe substantially to lessen competition or to tend toward a monopoly in the business of manufacturing and selling bank vault equipment and related products.
The question on this appeal is the propriety of the action of the District Court in granting the appellee's motion for summary judgment and dismissing this complaint without a trial on the merits on the ground that at the time of the acquisition of the company by Diebold, the acquired company Herring-Hall-Marvin was a failing company.
And hence that under the doctrine enunciated by this Court in the International Shoe case in 280 United States such an acquisition in not subject to the probations of Section 7 of the Clayton Act.
And just by way of brief introduction, the decision of this Court in the International Shoe case enunciated the doctrine which we have set forth at page 21 of our brief.
That were a corporation is in failing circumstances with resources so depleted and the prospect of rehabilitation so remote that it face to the grave probability of a business failure with the resulting loss to its stockholders and injury to the communities were its plants were operated, the purchase of its capital stock by a competitor there being no other perspective purchaser.
Now, with the purpose to lessen competition but to facilitate the accumulated business of the purchaser and with the effect of mitigating its seriously injurious consequences otherwise probable is not in contemplation of law prejudicial to the public and does not substantially lessen competition or restrain commerce within the intent of the Clayton Act.
I think it's important at the outset to emphasize just what this failing company exception is.
It's put in terms of the failing company defense to a Section 7 case.
But what it amounts to basically is this, that there maybe circumstances where because of the condition of the company, it's acquisition by a competitor maybe lawful under Section 7 of the Clayton Act without regard to its effect upon competition.
The theory as we understand it is, that if the company is failing in the sense that without the acquisition of what have gone out of business, it would have ceased to be a competitive factor anyhow.
And therefore, the theory seems to be that in those circumstances, the acquisition by a competitor will not have be condemn adverse effect on competition.
Our position on this appeal is that the facts before the District Court affirmatively showed that this was not a failing company contrary to the District Court's conclusion and that in any event, sufficient factual issues were raised to preclude the grant of summary judgment against the Government holding that the failing company defense had been established.
Justice John M. Harlan: (Inaudible) summary judgment.
Mr. Daniel M. Friedman: Oh, that's correct.
Whereas -- were say -- we say first that on this record, the District Court should have held that the failing company defense was not applicable.
But in any event, we don't believe that on this record, the Court could've granted summary judgment in favor of the appellee.
Justice Potter Stewart: Well, your first point is, the Court should have been the summary judgment in your favor, is that right?
Mr. Daniel M. Friedman: Well, not summary -- no there was only a motion for summary judgment in favor of the appellee.
We have had no trial on the merits in this case.
Justice Potter Stewart: Well, I don't quite understand your first point.
Mr. Daniel M. Friedman: Well, that -- that on the showing made, the District Court should have rejected the failing company defense and going to a trial of the merits of this case.
That is to determine the effect on constitution.
Justice Potter Stewart: Wasn't that just one point?
Mr. Daniel M. Friedman: Well, we put it -- we put it in two steps, we think that this record affirmatively we showed there was no failing company defense.
Justice Potter Stewart: But are you asking us here to render a summary judgment in your favor?
Mr. Daniel M. Friedman: Oh no.
We're asking for reversal of the judgment dismissing this compliant and sending it back for a trial.
Justice Potter Stewart: And that's all you're asking for?
Mr. Daniel M. Friedman: That's correct.
We hope -- we hope that this Court will agree with us that the summary -- that the failing company defense was not established on this --
Justice William J. Brennan: Well, you want us to say that, don't you?
Mr. Daniel M. Friedman: We do, yes.
Justice William J. Brennan: You want us to say send it back for a new trial on embarrassed by the failing company.
Mr. Daniel M. Friedman: That's what we hope.
But in the event, the Court is not prepared to go that far.
We think certainly, they should have been --
Justice William J. Brennan: Merely a question on the issue of failing company.
Mr. Daniel M. Friedman: That's correct, yes.
Justice William J. Brennan: No, (Inaudible)
Mr. Daniel M. Friedman: Yes Mr. Justice.
Now, the company that was acquired the Herring-Hall-Marvin Company -- Safe Company was basically a one man operation under the control of its president Mr. Mosman, who had 88% of the outstanding stock.
Beginning around 1957, Mr. Mosman made several attempts to dispose of a company.
And finally in May of 1959, Mr. Mosman entered into an oral agreement with the Diebold Company, the appellee, to sell the assets of Herring-Hall-Marvin to Diebold.
The transaction took the form of an option to purchase, to which there was attached a proposed contract purchase and sale.
The option agreement was signed on June 16th.
And approximately one month later, the 17th of July, the contract was signed.
The purchase price was $3,000,000 in cash plus the assumption by Diebold of all the liabilities of Herring-Hall-Marvin to the date of the closing in this case.
The balance sheet was submitted as of the 30th of April, and Diebold undertook to paying not only all the liabilities shown on the balance sheet but all liabilities that might develop between then and the closing.
The Government filed its complaint prior to the consummation of the transaction.
A motion -- an application for a preliminary injunction was denied.
And on September 11th 1959, this transaction was consummated.
There were various pre-trail proceedings and 14 months later, the contention was raised for the first time, that at the time of the acquisition, this company was a failing company.
And finally on January 19th, 1961 approximately 18, 17, or 18 month prior to the acquisition, the motion for summary judgment based on the failing company defense was filed.
The motion had attached to a number of papers.
There was an affidavit -- affidavits of the president and vice-president of the acquiring company Diebold and there was a special audit report prepared by Lybrand Brothers Ross and Montgomery the regular auditors of the company.
Basically, the primary contention of Diebold was it is this company was a failing company because of its cash shortages at the time of the acquisition and for period of approximately eight months before that.
Now, you --
Chief Justice Earl Warren: Because, what did you say?
Mr. Daniel M. Friedman: Pardon sir?
Chief Justice Earl Warren: Because, what did you say?
Mr. Daniel M. Friedman: Because of the shortages of cash the company --
Chief Justice Earl Warren: Oh yes.
Mr. Daniel M. Friedman: -- had difficulty paying its bills of short of cash.
Now, I have more to say about that shortly.
After this motion was filed on January 19th, on the 1st of March, about six weeks thereafter, the Government filed its opposition material.
This consisted of two affidavits and an accountant and the economist, coupled with various supporting documents and schedules which in the view of the accountant and the economist demonstrated that this company was not a failing company.
And we have set forth in our brief considerable length the various economic factors which were relied upon the criteria financial analysis to show that this company was not failing at that time.
I just like to infer here briefly to three or four of the most significant ones.
Justice John M. Harlan: What is irrelevant to that, judgment (Inaudible)
Mr. Daniel M. Friedman: Why I --
Justice John M. Harlan: An acquisition at the time (Inaudible)
Mr. Daniel M. Friedman: I would think at the time of the acquisition Mr. Justice.
In this case of course, we sought to enjoin it that before the acquisition disputed.
I would think the critical thing would be as of the time of the acquisition in this case.
But we think that in making that determination, you must look behind the immediate period of acquisition and trace the whole history of the company.
Now, the first factor we relied on is that this company had a remarkable sales growth in the 15 years preceding the acquisition.
Beginning in 1944, it sales were a little over million dollars.
By 1949, five years later, it sales have increased to $5,000,000.
The following five years later in1954, the sales was $6,000,008.
And by 1957, these company sales have increased to $10,672,000.
Now, need to the two years following this as the appellees make great point of, the sales drop to up by $300,000.
But 1959, the last full year before the acquisition, I might mention this company was on a fiscal year basis so that the year we're talking of for Herring-Hall-Marvin is the year ending 30th of June.
And the last full fiscal year before the acquisition, the company still had sales of $10,023,000, the third highest in its history and approximately double with the sales had been 13 years before 1959.
And we think that while there has been some drop off, the company still showed a very substantial sales at that period.
At the same time that the company had have this growth in sales, it had a history of successful operations for the five fiscal years before the merge in 1955 to 1959, its net income always exceeded $100,000.
In one year, it was as high as $250,000.
And for each of the three preceding years, it was better than $180,000 and the last year, 1959, it was $187,000, a few thousand dollars higher than each of the two preceding years.
And this net income of the company showed more than a return of more than 11% after taxes for the five average years and almost 9% after taxes for the year 1959.
Now, as of the close of the past fiscal year, June 30th 1959, this company Herring-Hall-Marvin had no long-term debt.
It had previously, in 1955, had a mortgage of $325,000.
This had all been paid off by June 30th, 1958.
That is one year before the closing of the fiscal year.
In addition to that, in the fiscal year in 1959, the company had reduced its liability on notes and loans payable from approximately $700,000 to $300,000.
Another fact that we think is significant was that over the 15-year period, the company's retained earnings had grown tremendously starting with a deficit of $300,000 in 1944.
They rose to more than $2,000,000 in 1959.
Justice Potter Stewart: These are all this -- this data that you're giving us is for the company's books, is that right?
Mr. Daniel M. Friedman: That's from a company's published financial state.
Justice Potter Stewart: Now, isn't the -- isn't the basic claim of the respondents that these books were only that they didn't show the correct picture?
Mr. Daniel M. Friedman: That is correct.
But well, there are two claims.
The first claim is that the books did not show the correct picture.
In the sense, they fail to reflect the cash shortage.
There is one other finding, however, which I would like to infer to.
The District Court found and finding 13 at pages 564 to 565.
I'm sorry, I misspoke myself, it's finding 20 at page 567, states and although the annual balance sheets in profit and law statements purported to show a modus improvement in the company's financial condition from year-to-year.
These books fail -- figures failed completely to reflect the actually insolvent condition of the company.
And then the Court makes the statement, “The books who prepared in accordance with management policy.”
Now, this latter statement that the books who prepared in accordance with management policy.
Rest exclusively on a memorandum set forth at page 560 of the record, which was a confidential memorandum for Mr. Mosman, the president of the company to the treasurer of the company, in which he suggested, “I would like the following things to be done before the end of June.”
And he sets out four things he'd like to have done to make certain payments and then he says, “I would like to show a net profit after taxes of at least $150,000.”
And then he says, “I would like to show a net worth of approximately $2,100,000.”
And next to each one of this remarks of that the initial is, okay.
And then as a concluding statement of the end of thing saying, he urges Mr. (Inaudible) to see if we can work toward these goals.
Now this, we think is a -- an ambiguous document, we don't know what this means.
There was no testimony as to what this means.
It's of course susceptible to the interpretation given it by the District Court that the books were adjusted that year to show this thing.
It may also be no more that a hope and expectation by Mr. Mosman to the treasurer that he hopes the company will be able to achieve these results.
Furthermore, this relates only to one year, and certainly affords no basis for the court's general finding that these books are defective for the entire period.
And finally, the mere facts of that in a company like this, there were some adjustments made to show profit after taxes for $150,000 or net worth of $2,100,000 does not itself prove that the books were misleading because there are many areas in which adjustments -- accounting adjustments maybe made in one year or the other in which would affect the particular showing in that year.
Now, one other fact --
Unknown Speaker: Did the court find the books were full supplied?
Mr. Daniel M. Friedman: Pardon?
Unknown Speaker: Did the court find the books were full supplied?
Mr. Daniel M. Friedman: No, the Court didn't find the books were full supplied.
The Court found that these books did not reflect the true status of the company.
There's one other fact that I just like to --
Justice Potter Stewart: (Inaudible)
Mr. Daniel M. Friedman: Well, I think that -- I think the difference is that if the books have been full supplied, intentionally full supplied, you could say that -- if there were such a finding, you could fairly conclude that the -- the books weren't worth anything because they did not reflect any of the conditions.
But where the finding is that they didn't accurately reflect the condition of the company where that finding as we think doesn't rest on anything that supports it, we think in that circumstance, the books of the company do show, do accurately reflect the condition of the company.
I might --
Justice Potter Stewart: Well, of course that court found otherwise, as a matter of that --
Mr. Daniel M. Friedman: The court found otherwise, but we think without basis in this record.
Justice Potter Stewart: The court did find that the books did not give a -- that the books gave a false picture of the correct picture of the actual situation.
Mr. Daniel M. Friedman: That -- the --
Justice Potter Stewart: Or maybe full supply is the word but full is certainly would be.
Mr. Daniel M. Friedman: That's correct, but we think that finding is not supported by the record in this case.
Justice Potter Stewart: Well, (Inaudible)
Justice Hugo L. Black: Is it based entirely on this colloquy you just (Inaudible) this finding itself, what is the based though?
Mr. Daniel M. Friedman: This finding?
Justice Hugo L. Black: Yes.
Mr. Daniel M. Friedman: This finding as far as I can tell Mr. Justice, is based on this memorandum that I --
Justice Hugo L. Black: You just read.
Mr. Daniel M. Friedman: I read to you, because the finding quotes --
Justice Hugo L. Black: I mean affidavits, is there anything (Inaudible) that the court did.
Mr. Daniel M. Friedman: Well, there are statements by the accountants relating to the shortages of cash.
And there is the evidence that at the time when the transaction was ended into, Mr. Mosman gave his company a balance sheet which showed receivables and ca -- showed cash of $115,000 and later on before the transaction was consummated.
He advised the Diebold Company that that in that balance sheet, he didn't properly shown $100,000 of cash which in fact were receivables.
There is that.
But I --
Justice William J. Brennan: Wasn't that all -- was there something about the bank balances that didn't reflect outstanding --
Mr. Daniel M. Friedman: Yes, I --
Justice William J. Brennan: -- perhaps --
Mr. Daniel M. Friedman: There -- that is there basic -- that is -- I think excellence substance of their case basically.
Their case turns on the cash shortage and then I'll explain what that is about.
This company we concede was in difficulties in 1959 with its cash position, it was short of cash.
And it followed a practice of frequently when invoices would come in of drawing the check and payment of the invoice and withholding the dispatch of that check for a period sometimes two or sometimes three months.
Now, the calculation as upon which Diebold's case rests assumes that all of these checks that had been drawn but had not been released were in fact presented for payment.
And if all those checks have been presented for payment as of the date on which they withdrawn, there were not sufficient funds in the bank at that time to pay them all.
Of course, the checks were not always presented for payment at that time.
And the record is uncontradicted that at no time during this alleged critical period was any check drawn by Herring-Hall-Marvin ever refused payment by the bank.
In other words, there were always sufficient funds available in the bank to permit the payment of the checks.
And we just don't know why this thing was done.
We don't know for how long this practice had been followed.
It certainly is not inconceivable that since Mr. Mosman was anxious to sell this company, before we now he may have intended to conduct his operation on a thin cash basis, so that when he can to sell the company, he could show a company that was free from many long-term debt.
This company at one time, it had a mortgage which had been paid off.
I also like to suggest since Diebold urges that there's been no showing of any in way in which this company could've obviated his problems, that at the time when this cash shortage become critical, we think that Diebold at least could've explored the possibility of seeking to put on some long-term in debits.
We don't know whether Mr. Mosman could or couldn't have but certainly this should have been explored.
The company admittedly had barrowed to the limit of its possibilities and its principle depository in the City of Hamilton, its main city.
It could, however, at least have sought to borrow some additional funds and some of its other depository.
Now, there's one other thing which we think here is quite significant on dealing with the problem of whether this was a failing company.
And that is the content of the seller, Mr. Mosman during this entire -- this entire transaction.
One would normally think that if you had a company that was failing and that you saw the end rapidly approaching, you would be anxious to try to sell this company on the best possible term, if you wouldn't insist of tremendous demands.
You'd also think that once you had accomplished a sale on favorable terms, you would be anxious to go through with it.
Mr. Mosman, this record shows, didn't do either of these things.
First of all, he repeatedly insisted that the sale be only for cash and all cash sales what he wanted.
Secondly, on two occasions, first after the option had been executed and secondly, after the contract had been signed, he tried to get out of the contract.
In the first occasion, the result was the company was forced to improve the terms.
He first tried to get out of the contract when word got out of this deal.
He claimed that there'd been a matter that you'd be kept confidential.
And when word got out of this deal, he tried to get out.
He, again, tried to get out of this contract when both companies received an inquiry from the Department of Justice.
And finally, at the time the Government sought its preliminary injunction, affidavits were filed both by Mr. Mosman and by Mr. Koontz, the president of Diebold.
And both of these affidavits, there was no reference at all to any claim that this company was failing.
Both affidavits indicated that Mr. Mosman had stated two reasons why he wanted to sell this company.
First, he needed a cash to pay his estate taxes.
Secondly, he was concerned that there was no available management personnel to takeover the company if he should retire or quit.
Now, the facts in this case, we think stand in short contrast to the facts in the International Shoe case.
The International Shoe case, the Court concluded that without regard to the effect on competition, the acquisition thereby International Shoe of the Makwanyane case did not substantially less in competition and hence was beyond the reach of Section 7.
But in International Shoe, the acquired company was truly in a serious predicament.
In the year before the acquisition, it had lost $6,000,000 as distinguished from this company wherein the year before the acquisition had made $187,000.
In the year before the acquisition, it had exhausted a $4,000,000 surplus and pilot for $4,000,00 deficit.
In contrast to this company, which in the year before the acquisition, it's substantially improved its current surplus, at that -- in the year of the time of the acquisition of company owed $15,000,000 to the banks and $2,000,000 on current account.
Here again in the present case, the company had reduced its intendedness to the banks and had no long-term debt.
Now, in the another important fact that was in the International Shoe case, this Court emphasize that the officers of the acquired company after a long and careful consideration of the situation had concluded that the company was faced with financial ruin and that the only alternatives presented were liquidation through a receiver or outright sale.
We have referred in our brief to the record in the International Shoe case in which the officers testified that day-after-day, they try to see what else could they do in this company that was failing, and the only alternative that seemed open to them was a sale to the International Shoe Company.
In the present case, there's nothing in this record to indicate that Mr. Mosman thought his company was failing, that he studied other possible methods of disposing of it, or indeed as I've indicated that the financial difficulties with the course of the sale.
Chief Justice Earl Warren: Mr. Friedman, is there anything in the record except this current cash situation of the company and the slightly decreasing sales last year or so that would tend show its failing --
Mr. Daniel M. Friedman: Well, we don't think --
Chief Justice Earl Warren: -- situation.
Mr. Daniel M. Friedman: We don't think so Mr. Justice but let me state some of the other material they rely on, because I don't want to get the thought --
Chief Justice Earl Warren: Well, don't -- you don't have to make that case.
I've just asked you --
Mr. Daniel M. Friedman: There is --
Chief Justice Earl Warren: -- if you see it.
Mr. Daniel M. Friedman: There is some other material which Mr. McGovern I'm sure will allude to in details.
Chief Justice Earl Warren: Yes.
But -- okay.
Mr. Daniel M. Friedman: But we say that all of this material -- all of this material does not refute our showing of the basically healthy condition of this company.
And I just want to emphasize before sitting down.
Once again the context in which this issue arises, the -- this case is a frequent presented as a narrow issue as the company failing or isn't it failing.
It sometimes sounds as though were bankruptcy proceeding.
This was a broad on that.
The basic issue in this situation is whether the condition of a company is such that its acquisition by a competitor, by a competitor which would ordinarily violates Section 7 other things being equal, may nevertheless to be held to be beyond the reach of Section 7 of the Clayton Act, and that the case maybe dismissed without any inquiry as to the actual effect on competition.
And we think that before such a dismissal maybe sanctioned, it's important that there'd be a very clear and definite showing that the company is truly failing in the sense that if it we're not for the acquisition, the company could not continue as an independent competitor.
And I think one of the significant factors here I just like to just mention is that in this situation, there were other perspective purchases for the company.
Three people indicated interest in this company, at least one of them was very serious about it.
And this again is in contrast with International Shoe where the Court twice stressed that they were no other purchases.
And of course, if there's another purchaser who may be available to acquire as a company, this which we think a different completion on the case, because if there's another purchaser it means that the company despite its adverse condition may nevertheless continue as a competitor if it's operated by this other person.
I'd like to reserve the balance of my time.
Chief Justice Earl Warren: You may Mr. Friedman.
Argument of William L. Mcgovern
Mr. William L. Mcgovern: Mr. Chief Justice, and may it please the Court.
I suggest if the Court please that the only essential difference between the Government and ourselves here is really one of perspectives.
The Government points to the long range fortunes of Mr. Mosman as HHM company in the burgeoning economy that followed upon the demand created by World War II.
We emphasize the rim, short-run factors that faced him with the slim operating capital in the recession market of 1958, 1959.
It is the fact and the Government concedes this that at all times from 1946 down through the sale on September 10th of 1959, HHM was extremely short of working capital.
This factor both sides concede.
It's our contention that that being the case, that whatever the relative merits of the long and short run view of a company's economic health may be in other circumstances that where you are trying to gage the survival prospects of a company in an adverse market with slim working capital historically and at that very time that then the only relevant critical criteria you have available is the short run view, will he survive?
The long run view we suggest, is a luxury for a man like Mosman that we just couldn't afford to indulge.
It wasn't a question, if the Court pleases, whether Mr. Mosman would be alive in ten years hence.
The question was would he be alive tomorrow, next week, or six months hence.
As John Maynard Keynes once remarked, “We'll all be dead in a long run.”
And we suggest to the Court that on this record, it's pretty clear that have this sale not taking place as it did.
On September 10th of 1959, Mr. Mosman and HHM would have been dead.
In fact, we submit to the Court that most government fiscal expert themselves is almost universally agree that where you are considering the survival prospects of a company with marginal working capital, you must realize that that marginal working capital position subjects that company to the constant jeopardy of insolvency if there is suddenly an adverse turn in the market.
And I should like to address the Court's attention to the United States Department of Commerce's own hand book for businessmen, guides for business analysis, which contains this warning about the very situation before the Court today.
I'm quoting, “It should be emphasized that when sales are supported by an inadequate working capital, the very delicate balance of incoming and outgoing funds that results is easily upset with any interruption in the flow of funds such as the sudden loss of sales or poor collection performance.”
Now as Mr. Friedman mentioned, whatever the historical growth of this company over a period of 14 years have been, beginning with the recession of 1957, in the next two succeeding years that have suffered a loss in sales of approximately $300,000 in each of those years.
Its inventories built up correlatively and operating on a low cash margin, it began to be in grim financials grace.
And it's our contention that when the business recession of 1957 through 1959 hit that HHM's ability to survive particularly in this critical period in 1959 could only be tested by the short run factors that affected his constant day-to-day opportunity to be alive tomorrow.
Now, if the Court please, what were those critical short-term factors that the District Court found so persuasive on this point?
The first fact that we must start with here is that at every point from January 1 down -- January 1 of 1959 down through April, down to September rather of 1959, the date of the actual acquisition, I think there was no argument on the phase of this record that HHM was in solvent by any customary test.
And certainly by the simplest test of all that during that nine-month period, that critical period before the court for determination in this case, during that entire period, HHM was unable to meet its debts as they matured.
Now, if the Curt please, that is set forth and demonstrated by an indisputable showing in the record.
At 235, we have a nagging of the past-due accounts of the Herring-Hall-Marvin Company, made mind you by Lybrand Ross Brothers and Montgomery who were Herring-Hall-Marvin's accountants.
They were not Diebold's accountants and have never been Diebold's accountants.
That aging schedule, -- schedule aging at 235 of the record, shows that at the time of the acquisition on September 10th, he had 244,000, approximately a quarter of a million, past-due accounts going back to sometime prior to January 1, 1959.
Now over and above that, if the Court please, he also had $500,000 of currently due accounts.
But the point I am making is that from January 1, 1959, right down from the closing, he was insolvent in the sense that he could not pay his debts as they matured.
Chief Justice Earl Warren: When was that audit have made before or after the -- before or after the transaction?
Mr. William L. Mcgovern: I beg you pardon Mr. Chief Justice Warren.
Chief Justice Earl Warren: When was that audit made --
Mr. William L. Mcgovern: This -- this --
Chief Justice Earl Warren: -- before or after the transaction?
Mr. William L. Mcgovern: This order was made by Lybrand Ross after the transaction.
Chief Justice Earl Warren: Were these facts that you're talking about now known to Diebold at the time they purchased?
Mr. William L. Mcgovern: They were not -- have no one to Mr. Chief Justice.
And we regret to say that until the time we finally had discovery of the company's files, during the course of the pretrial discovery in the case itself, we were ourselves completely unaware of the conditions that we're going on in back of the formal published book reports of the company.
We knew the company was in some difficulty, after all most companies were in some difficulty during that period of time.
We, ourselves, were primarily concerned about getting plant space.
We knew he had plant space, and I want to underscore this proposition.
The only direct intimate knowledge, first hand knowledge we had of a company's operations or assets or facilities prior to the sale was a personal viewing of the plant.
Our treasurer was allowed to walk through the plant, see the facilities, see the tools, jigs and dice and see the inventory.
We never saw a book of any kind other than this April 30th balance sheet which he gave us which as Mr. Friedman has pointed out was phony.
That's the only word you can use to describe it and I will come to that in just a moment.
But I should like to point out the over and above this aging schedule, which reflects on the face of the data itself irretrievably that the company was unable to meet its debts as they matured.
We also have a schedule of checks that were issued by the company and that board cancellation stamps on the back of the checks ranging from anywhere from one to six months after the date that was written on the check.
Now, those checks are set forth in the record at 556.
And I would like to come to just one of those checks to give the Court some impression of the incredible nature of this operation prior to the time that we took it over.
At page 556 to the record, if the Court please, there are set forth a number of examples of checks taken at random from the -- the various checks and accounts of HHM.
We could have larded this record out, let me say in passing by including thousand upon thousand of these checks, but this due the purpose as well, they are a sample, they were taken at random.
I should like to address the Court's attention to check number 7 -- 7 -- 17471.
A check made out to the Aluminum Company of America in the amount of $16,494.
That check for a date on its face of January 15th, 1959, the first cancellation stamp on the back of the check is April 10th, 1959.
Now, the stableness of these checks resulted from a rather fabulous practice engaged-in by HHM as its cash got shorter and shorter and its predators began to press more and more.
The company through Mr. Mosman and his treasure were compelled to resort to something I can only describe as an extraordinary piece of financial leisure demand.
They employed a little device that is now known on the face of this record as the “little black box.”
As predators -- trade predators invoices matured and were approved for payment, they would write the check.
But the treasurer would be fully aware at that time that he had no money in the bank to cover the check that indeed in fact at that very time, the company had substantial overdrafts outstanding against its existing bank balances.
Therefore, he would put the check in what is known as the "little black box", it would stay in that little black box for periods of up to 90 to 120 days until such time as the treasurer felt he could safely predict that when that check went out through circulation in the flotation of checks he had going, and got back to the bank, there would be money in the bank to cover it.
Now, that flotation was carried on during most of the entire month -- during most of the entire first nine months of the year.
It's extraordinary that at no time, if one of those checks actually get refuse payment at the bank.
Down to the very end, there was always at least a small cash balance in the bank to cover the checks as they came back.
However, this flotation situation was audited thoroughly by Lybrand Ross and there was just no doubt on the face of this record.
And indeed, the Government doesn't really dispute this.
There is just no doubt on the base of his record, that it was this flotation of checks, this dexterous handling of the circulation of the checks through banks for all across the country, that kept this company of float for an additional seven or eight months during this critical period in 1959, when frankly the company was financially bleeding to death.
That's what the record compels want to conclude.
With respect to Mr. Friedman's suggestion that nobody knows how many checks get out that little black box, I will concede that is true.
Nobody does and nobody ever will.
But what Lybrand Ross did was look only at the cancelation stamp on the back of the checks and they certified as checks in float on any given date, only checks would have a bank cancellation stamp on the back of them.
So however it may have been with other checks, in a little black box, we know conclusively that the checks to get out in float and got a bank cancellation stamp had actually been issue because they were in circulation.
The Lybrand Ross figures, therefore if the Court please, we submit minimum figures.
We know he had a minimum of this amount outstanding and in float.
We never will know the maximum of course.
Justice Tom C. Clark: So they check this from the back of the checks against the accountants?
Mr. William L. Mcgovern: They did.
The difficulty Mr. Justice Clark is that of course we're now going back, trying to reconstruct this -- l say rather incredible picture of operations in 1959.
The black box is long since gone.
We cannot be sure for example that in a date with Lybrand Ross suggest on the base of cancellation stamps from the back of the checks that there was an overdraft outstanding in all the accounts, let's say in the amount of $75,000.
We cannot be sure that they were not in additional $50,000 or $60,000 of checks floating around that have not yet clear the bank because Lybrand Ross certified only with respect to checks that had a bank cancellation stamp on the back.
Justice Tom C. Clark: Let's say they went to send the check out of the box, and we thought it had the money in the bank to pay for it (Voice Overlap) --
Mr. William L. Mcgovern: No, if you permit me Mr. Justice Clark, they wouldn't kick the check out of the box into float until they could predict it by the time the check cleared all the banks that have to clear and get back, there would be funds in the bank at time to cover it.
They have no funds in the bank at the time it was issued to cover it.
Justice Tom C. Clark: You would send the check through the (Inaudible) and he would deposit it in (Inaudible)
Mr. William L. Mcgovern: That's right.
Justice Tom C. Clark: (Inaudible)
Mr. William L. Mcgovern: That's right.
Justice Tom C. Clark: And they -- they would (Inaudible) you said at the time, they had to check if it was actually mailed by HHM, he did not handed them?
Mr. William L. Mcgovern: They would not have had enough money in the bank to cover that check on the date it was sent out.
That's absolutely right.
The Lybrand Ross reports are absolutely clear.
That as of a given day, they were overdrafts in the amount as high as $75,000 out floating around in circulation, checks to banks out in the west coast, checks to credit it in New York, Maine, elsewhere, just floating around.
Justice Tom C. Clark: They're all paid in (Inaudible)
Mr. William L. Mcgovern: They all paid -- well, after the closing on September 10th of 1959, I regret to say that a large number to the tune of about 300,000 were paid for by us.
Justice Hugo L. Black: Where those in the box or out of the mail?
Mr. William L. Mcgovern: They were out in the mails.
But at the day of the closing on September 10th, Mr. Mosman informed us at the closing they could not give us.
We are buying the assets of the company.
He informed us he could not give us a check for his bank balances because on that date, he had overdraft outstanding.
And those overdrafts came back into the next 60 days to dug our own efforts to try to put the company back on its feet.
Justice Byron R. White: But Mr. McGovern --
Mr. William L. Mcgovern: Mr. Justice --
Justice Byron R. White: -- you say didn't know the actual condition of the company at the time --
Mr. William L. Mcgovern: We did not know.
Justice Byron R. White: -- you contracted by --
Mr. William L. Mcgovern: That's right.
Justice Byron R. White: When did you sign the -- were you ever obligated to buy before the closing day?
Mr. William L. Mcgovern: Yes, we are obligated to buy at whatever time Mr. Mosman would finally convene his stockholders and got their approval to go ahead for the sale.
Justice Byron R. White: He just didn't give you an option.
Mr. William L. Mcgovern: Well, we have an option to begin what the option was exercised.
Justice Byron R. White: And what was a period of time that's been exercising, between the time you were bound and time you closed?
Mr. William L. Mcgovern: The record shows Mr. Justice White, I would say between about some time around July 20th and the actual closing was on September 10th.
The difficulty --
Justice Byron R. White: You didn't arrange for a -- for audits prior to closing.
Mr. William L. Mcgovern: We didn't arrange for more audits.
We were entitled of more audits either under the contract unfortunately.
Justice Byron R. White: But you didn't know the addition of company prior to closing --
Mr. William L. Mcgovern: We did --
Justice Byron R. White: You thought, it was a -- you thought it was a company in reasonably good shape?
Mr. William L. Mcgovern: No, we didn't think the company was in reasonably good shape.
I say we know from trade scuttle bug, we knew my wrong difficulties in selling at time that the -- there was recession on, there were adverse conditions effecting the market.
No argument about -- that everybody knew it.
Steel Company's knew it, we knew it, everybody knew it.
Justice Byron R. White: Did you realize at the time of closing and it was in a -- that it was insolvent in the sense that you speak out?
Mr. William L. Mcgovern: No.
Justice Byron R. White: -- that he's unable to pay his debts?
Mr. William L. Mcgovern: No we did not.
Except insofar as one could now look back on this situation, say we should have been alerted to the fact --
Justice Byron R. White: But you thought there was a lot better shape in -- then it really was?
Mr. William L. Mcgovern: We certainly did Mr. Justice White.
We thought we were buying a variable company.
We knew I say that they were -- they were having some difficulties but we never have those remorse ideas that would ever in cover the kind of a situation we have here.
Justice Byron R. White: Would you say --
Mr. William L. Mcgovern: But this thing is so extraordinary, I don't think that any rational person ever could've conceived of it.
Justice Byron R. White: Well, do you -- do you say that as a matter fact, this company was insolvent in the bankruptcies that his assets exceeded his -- or his liability exceeded in his assets?
Mr. William L. Mcgovern: No.
We have never contended that, only because of the fact that so difficult to figure out how you would evaluate his liabilities and his assets.
Justice Byron R. White: What --
Mr. William L. Mcgovern: If you take all this floating checks outstanding, if you take his demand notes to the bank, you see, he had borrowed the limit -- the legal limit of his local bank to lend him money and demand notes by the tune of about $300,000 just prior to the closing.
We, again, had to pick up those demand notes and merely upon taking over the company because the bank calls to their payment.
The bank as his own bank has testified on deposition that had they themselves being compelled by a bank examiner to cause Mr. Mosman to liquidate anyone of those notes that they didn't know where he would have gotten the money.
Justice Byron R. White: What is meant by tangible net worth in those findings, could tell us?
Mr. William L. Mcgovern: Tangible net worth?
I would rather not tell you Mr. Justice White.
Why would tangible net worth is only because the factor I get frankly confused with these accounting concepts.
I think like the District Court, I myself tend to deal with the situation that is tangible for me.
A man writes a check and hadn't gotten money in the bank that covered it, I figured he's in bad shaped because I regard that as a strategy of desperation.
And whatever else this record suggested about Mr. Mosman, it doesn't make him out as a complete Charlotte.
I think quite clear these practices that were engaged in because he was desperate short of cash and he had no choice.
Justice Byron R. White: Mr. McGovern, isn't this the normal situation for someone to seek chapter 10 rather than straight bankruptcy?
Mr. William L. Mcgovern: Yes, I would say so.
Yes, I say Mr. Justice White, all we emphasize with regard to our first major proposition here is that certainly the man was insolvent.
In the equities sense, he could not pay his debts that they matured, that much as clear.
There is no argument about that on the record.
Chief Justice Earl Warren: Well, Mr. McGovern, I'm just wondering if so far as the status of the company is concerned that there'd be any great difference between this little black box situation and just as delaying granting checks for two or three months?
Mr. William L. Mcgovern: No, Mr. Chief Justice, I don't think it'd be the slightest (Voice Overlap) --
Chief Justice Earl Warren: Could be always (Voice Overlap) --
Mr. William L. Mcgovern: The only significance for us Mr. Chief Justice is by virtual of doing the way he did, we are now --
Chief Justice Earl Warren: Yes.
Mr. William L. Mcgovern: -- able to reconstruct the record, because we see the --
Chief Justice Earl Warren: Yes.
Mr. William L. Mcgovern: -- dates.
Chief Justice Earl Warren: Yes.
I see that.
Well, I was just -- I was just wondering if every company that is late three or four months late in paying his bills is failing company in the sense that the Internationally Shoe Company contemplated
Mr. William L. Mcgovern: Mr. Chief Justice if we have (Voice Overlap) --
Chief Justice Earl Warren: In times of depression, in times of depression --
Mr. William L. Mcgovern: Yes.
Chief Justice Earl Warren: -- particularly.
Mr. William L. Mcgovern: Mr. Chief Justice, we have nothing more in this record than simply late payment of bills.
I would be inclined would to agree that in and off itself perhaps does not conclusively established anything.
But I'm saying that is not the end of the story for us here.
That is the beginning of the story, that he was insolvent in the sense he couldn't pay his debts as they matured.
Now, let us look at the other short-term factors that I suggest.
Simply forced the District Court to conclude that Mosman couldn't have survive, not for an additional 10 days indeed at the time we bought him.
The first thing was the fact that in April 1959, he prepared this balance sheet which Mr. Friedman has adverted to, in which he reclassified $100,000 of receivables as cash, and then showed a balance of $115,000.
The truth of the matter is that he was actually concealing on that date.
He wasn't just beating up a narrow cash position of $15,000 to $115.
The truth of the matter is that on very date, he was concealing the fact that he not only have -- not $15,000, he did not have any money at all in the bank in terms of the checks outstanding because the audit shows on that very date, he was over drawn, he had overdrafts outstanding in circulation in the amount of $12,650.
The audit also shows just to take one sample month because we couldn't to throw these tenths of thousand of checks for every month.
But to take a sample month, the month of May, the record shows at page 233, that during the month of May, he disbursed four consecutive payrolls in amounts ranging as high as $56,000 at a time when he didn't have the funds in his payroll account to cover them.
What he would do is he would issue $56,000 with the checks on Friday.
And then experience had taught him that it took some of those checks a little time to clear around town other banks and get back.
On that date, he might have $6000 in his payroll account to back up $56,000 worth of checks.
He would deposit additional $10,000 in the account on Friday making a $16,000 but with the deficit of 40,000 in terms of those outstanding checks.
And then during the next four working days of the coming week Monday, Tuesday, Wednesday, and Thursday, and his own bankers testified on this on record on deposition.
He would deposit $10,000 each day.
In the hope of highest hope that that money would get in there in time to cover those payroll checks outstanding.
Now, I suggest that however else you play fast and loosing the checking account Mr. Chief Justice, you don't write payroll checks without funds in the bank to cover at the time you write.
That is a crime in most state of the union.
Now, then --
Justice John M. Harlan: Is there any a suggestion that to the condition of this company is the result of dishonesty in the part of (Inaudible)
Mr. William L. Mcgovern: None of to all as far we are concerned Mr. Justice Harlan.
This accounting, the vices and these internal working arrangements are extraordinary from our point of view.
We have never heard of any other company engaging in them and certainly, we do not and would never think.
For example of issuing a payroll check and not having to cash in the bank that cover then the day it's issued because the employee he might just pass and walk right down to the bank and try get his check cashed.
I think that this mechanism that was established, the elaborate extensive check floating scheme, the simultaneously deposit of checks and so forth.
I suggest you -- in this all I suggest where the devices of desperation forced upon on man who was desperate to keep his head above the financial orders.
We have no reason to suppose that there was any fraud of any kind going on other than the (Inaudible) set forth here.
Have in mind Mr. Justice Harlan that this was almost wholly owned company.
Mr. Mosman, I suppose in one sentence of the word, to take the position he was entitled to do with his own company what he saw it did.
The remaining stockholders were largely employees as wide-pose so as if he is in company.
Now, these payroll checks Mr. Chief Justice that I say were issue without funds in the bank at the time where there issuance to cover them.
Those deficits in the payroll account were themselves reimbursed on the following four days of the week by other checks written on the general account of the company and those checks themselves representative overdrafts in the general account because the general account itself overdrawn during all this period of time in the sense that more checks were outstanding, there were funds to cover them.
Chief Justice Earl Warren: Mr. Friedman suggested that as a possibility, he may have had financial credit that would have unable him to carry over but then he did this in order to keep his company without any long time indebtedness, is there any -- what is your --
Mr. William L. Mcgovern: Well --
Chief Justice Earl Warren: -- response to that?
Mr. William L. Mcgovern: I say that I cannot believe Mr. Chief Justice that a man with credit at the bank would write a payroll check and not have funds in the bank to cover it.
Insofar as his local bank is concerned, Mr. Friedman knows better, because his local bankers have loaned him their legal limit to loan $300,000.
The record shows on their deposition, they were pressing him to turn those notes over because they were concerned that a bank examiner coming through might ask him, "How do you happen to have these demand notes outstanding so long?"
He couldn't have borrowed any money from his local bank that is for sure.
Chief Justice Earl Warren: Is there any finding that of the court on that issue?
Mr. William L. Mcgovern: On this last point about --
Chief Justice Earl Warren: Yes.
Mr. William L. Mcgovern: -- yes.
The court had found that his local bankers found -- his local bankers testified that they didn't know where he could get the funds to pay off his demand notes outstanding in the bank at that time.
With regards to the implication and the earlier suggestion you made Mr. Chief Justice as to whether he had credit, let me reminds you of the reference to the record at 556 where I showed you a check being written to Alcoa --
Chief Justice Earl Warren: Yes.
Mr. William L. Mcgovern: -- that check we now know was withheld in the little black box for about 90 days.
Your Honor in the record at 558, 559, you will find an exchange of correspondence between Alcoa and HHM, just prior to this particular incident in January of 1959 in which the HHM asked Alcoa to give them a 90-day extension on credit terms and Alcoa wrote back and said, "We're sorry, we can't do it.
It would be discriminatory against all of other accounts.”
And yet through the practice of the little black box, Alcoa was compelled almost involuntary to extend the 90-day extension of credit.
But they have specifically refused at very request.
In the remaining time, may I just advert briefly to one additional practice that I think the District Court found as it credible as we did and yet is set forth indisputably of the face of the record.
During much of the nine months of 1959, Mr. Mosman had the habit of depositing simultaneously in three or more banks in identical check representing a single sum of money.
To illustrate that, the record shows at 55455 that on January 30, if he received a check for $34,000 of an agent out in California, that check was good at represented a fund owing to him.
That was deposited in the Wells Fargo Bank on January 30th.
On the same day, January 30th, the company wrote three additional checks for $34,000.
One upon Wells Fargo for deposit in the Peoples -- the national of Pittsburgh one upon the Peoples National for deposit in the Irving Trust in New York and one upon the Irving Trust for deposit in its own bank in Hamilton.
A single -- sum of money $34,000 now appears on four different bank statements, the result of which was that had an auditor try to get a telegraphic confirmation of funds on deposit on February 1st, 2nd, 3rd, or 4th.
They would have shown a $136,000 in the bank.
Well, as a matter of actual factual, it was just one single deposit of funds that's $34,000 available in the Walls Fargo Bank out in California.
Now, as a result of this situation, it began to snowball out all them as of course Your Honor, will conceive that must have.
It begin to get tighter and tighter and in September of 1959, just prior to the closing on September 13th, his bank balance in the bank in Hamilton fell to $13.92.
And the audit shows that on the very date, September 3rd, 1959 instead of having $13 even in the bank, he had overdrafts outstanding in the amount of $75,000.
Now, I am saying the thing went on, operating loss is begin to experienced, beginning in July 1st, so the separate of an operating loss of $206,000 between July 1st and September 10th the closing, $206,000 operating loss, larger than its entire net profit for the entire preceding fiscal year.
Now, those were the factors among others that cause the District Court to conclude that Mosman not only was insolvent.
But as the District Court found, he was hopelessly insolvent and he had no prospect of survival.
I should like the remaining moments to come just briefly if the Court will permit me, to the Government's contention that summary judgment was not the appropriate mechanism for deciding this issue.
Your Honors will have in mind that this summary judgment was entered by the District Court not early in the game as so often happens.
Not merely upon affidavits as was the case, let's say in dipolar situation.
But the summary judgment here was entered, 18 months after the suit was filed.
It was entered after the Government had had a broad scale discovery on the Rule 34 in which literally thousands upon thousands of Diebold and HHM docs returned over to Government.
That is set forth in the record at the 200.
There were depositions taken with respect to all the principle actors and the drama before the Court here.
They have taken the deposition with full opportunity from cross-examination of Mr. Warren Mosman, president of HHM, Mr. Raymond Koontz president of Diebold.
All of the executive bosses, the most for safe company and most importantly, they have taken the depositions of Mr. Mosman's own bankers in Hamilton.
The bankers I suggest confirmed the fact that Mr. Mosman was in (Inaudible) and as they testified and they call upon the payroll is demand notes they -- who knew him best of all.
His local bankers, they didn't know were he would procure the funds to do so.
Chief Justice Earl Warren: Mr. McGovern, would you mind stating your opinion as to -- as of what date we should judge the failing condition of the company?
Mr. William L. Mcgovern: I would say Mr. Chief Justice in response to your question, the question of Mr. Justice Harlan that of course the appropriate date is the date of the actual sale, September 10th 1959.
Now, obviously you may discover your facts with respect to that subsequently as we did here.
But I think that the critical time for the application of failing company doctrine would of course be the date of the actual merger.
All I'm saying is that in terms of trying to evaluate what is condition was at that time Mr. Chief Justice, you cannot afford looking what he was doing back in 1954.
The question is, what was he's doing during the preceding nine months.
This is the critical period that determines whether or not you're going to survive in a circumstance where you have limited cash.
Where you've got $13 in the bank, there's no point of looking head 10 years and looking back 10 years.
With $13 in the bank, a $75,000 of checks outstanding, the question is, "Will I be alive tomorrow?"
That was the question to which the District Court addressed itself.
Chief Justice Earl Warren: Mr. Friedman.
Rebuttal of Daniel M. Friedman
Mr. Daniel M. Friedman: Mr. Chief Justice, may it please the Court.
Because it's very significant in considering this case that under the terms of the contract which was signed on July 17th.
From then on, Diebold had undertaken to pay all of the liabilities of this company.
And for example, Mr. McGovern made a great deal of the fact that the company had piled up larger amount of overdue trade bill.
But most of this overdue trade bills from the past bills were during the months of July and August in the first 10 days of September.
And similarly, the amount of money, the $300,00 that Mr. McGovern that pointed out, they had to advance almost immediately after the closing again.
This seems to us is merely the reflection of the obligation which they assumed to pay all the indebtedness of this company as of the date of the closing.
Now, we don't dis -- we don't deny.
We can't deny on this record that this company had a great deal problems and many problems with respect to its cash position.
But the fact is that at no time, at no time during this history had this company ever been unable to meet any check that was actually presented for payment?
Justice Potter Stewart: Mr. Friedman your basic deposition here is that there was error on the part of the District Court to grant a summary judgment in this case?
Mr. Daniel M. Friedman: That's right.
Justice Potter Stewart: Now, I ask you -- let me say it that we seem to have here a record of some 638 pages.
Now, I ask you what additional evidence the Government would have or could have adduced for their hearing.
Mr. Daniel M. Friedman: Well, I think Mr. Justice is this, that most of the pre-trial, the depositions that were refer to, were taken before the motion for summary judgment was made.
And that the depositions were not focused on all of this material which was brought out in the Lybrand Brother's report.
I think for example, if we have a further hearing, it would be appropriate to put Mr. Mosman on the stand to find out from just why he was doing this, how long these practices that continued --
Justice Potter Stewart: So why make any difference?
Mr. Daniel M. Friedman: Pardon?
Justice Potter Stewart: Does the motivation make any difference?
Mr. Daniel M. Friedman: Well, I -- I think the motivation maybe significant in the determining the basic situation.
In other words, was this really a company that was getting in hot water or was this something that Mr. Mosman was doing for his own reasons because he wished to keep a company that was free of any long term debt?
What attempts had he made?
It's mentioned here that the company had paid its legal limit.
If I may just point this --
Justice Potter Stewart: -- (Voice Overlap) --
Mr. Daniel M. Friedman: -- the company -- it's pointed out that the company was up to its legal limit with its bank.
That was the legal limit on unsecured demand note.
And I -- I think it would have been relevant to determine the whole history of this company in the light of what of the record show on its previous satisfactory position.