Lucent May Be Liable in Contract for Delay in Filing SEC Form S-3

September 3, 2002. The U.S. Court of Appeals (5thCir) issued its opinion [21 pages in PDF] in Herrmann Holdings v. Lucent, holding, as matter of Texas law, that a clause in a merger contract that provides that the acquiring company will use its best efforts to promptly file an S-3 form with the SEC, may give rise to a breach of contract action.

Background. Herrmann Technology, Inc. (HTI) designed and developed passive thin film filters for use in telecommunications optical networking. It was owned by Herrmann Holdings Ltd and others (hereinafter Herrmanns). On June 16, 2000, Lucent and the Herrmanns signed an agreement whereby Lucent acquired HTI for 6,770,200 shares of Lucent stock, then worth about $438 Million, based on the closing stock price of $60.

The Herrmanns could not sell any of their Lucent stock in a public transaction on the open market until Lucent filed, and the Securities and Exchange Commission (SEC) declared effective, a Form S-3 registration statement. Under the agreement, Lucent was to "use its reasonable best efforts to prepare, file and cause to become effective, as promptly as practicable". However, Lucent repeatedly delayed, over the Herrmanns' objections. It took six weeks to file. During this delay, the price of Lucent stock dropped by nearly one third.

District Court. The Herrmanns filed a complaint in U.S. District Court (NDTex) against Lucent. Jurisdiction was based upon diversity of citizenship. The Herrmanns alleged breach of contract and violations of Article 581-33 of the Texas Securities Act and Section 27.01 of the Texas Business and Commerce Code. The District Court dismissed the complaint for failure to state a claim, pursuant to FRCP 12(b)(6), and failure to plead fraud with specificity, pursuant to FRCP 9(b), and entered judgment for Lucent. The Herrmanns appealed.

Appeals Court. The Appeals Court reversed the dismissal as to the contract claim, but affirmed as to the two other claims.

The Court first addressed the breach of contract claim. It noted that as a diversity case, it would apply the law of the state, Texas. However, it concluded that "The Texas Supreme Court has not yet ruled on the enforceability of best efforts clauses in breach of contract actions." Hence, it predicted how the Texas Supreme Court would rule on this issue, pursuant to Erie v. Tompkins.

The Appeals Court concluded that "the goal or guideline established by the best efforts provision in the Agreement was for Lucent to file and cause to become effective, ``as promptly as practicable创 and ``in the most expeditious manner practicable,创 a registration statement covering the Herrmanns' shares. Here, by alleging that the parties had a contract, that it contained two ``best efforts创 provisions that required Lucent to file and cause the S-3 to become effective ``as promptly as practicable创 and ``in the most expeditious manner practicable,创 that Lucent breached that contractual obligation, and that the Herrmanns suffered damages as a result of that breach, the Herrmanns successfully state a claim for breach of contract. ... Therefore, the district court erred in dismissing the Herrmanns' breach of contract claim."

The Appeals Court affirmed the Districts Court's dismissal of the two other claims. It affirmed the dismissal of the Texas securities fraud claim, for failure to plead fraudulent intent adequately under Rule 9(b); however, it allowed the Herrmanns leave to amend this claim.