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In a ruling that could result in a five-fold windfall for recipients of a stock warrant, the New York Court of Appeals Tuesday held that the contractual offering need not be adjusted to reflect a reverse split. It declined to imply a term that could have, but was not, included in the contract. The court’s unanimous decision in Reiss v. Financial Performance Corp. arises out of a dispute over whether the plaintiffs are entitled to buy stock at the pre- or post-split price. In an opinion by Judge George Bundy Smith, the court said the parties could have taken into consideration the possibility of a reverse split, and failed to do so. He said the court will not impose such a contingency now. In 1993, Financial Performance Corp. issued a warrant to Rebot Corporation that would allow Rebot to purchase up to 1,198,904 shares of Financial’s common stock at 10 cents per share until Sept. 30, 1998. Financial also authorized warrants to Marvin Reiss, who had served as a director of the company, enabling him to purchase 500,000 shares at 10 cents per share until Aug. 31, 1998. Financial’s shareholders in 1996 approved a one-for-five reverse split. The result was that shareholders then held one-fifth of their original shares with each share being worth five times its pre-split value. In other words, the shareholders’ percentage of ownership in the company was unchanged; they simply had far fewer individual shares that were worth far more than before the split. Rebot and Reiss in 1998 sought to exercise their warrants according to the terms of the earlier agreements. That would have allowed them to purchase at 10 cents per share stock that was inflated to 50 cents a share through the reverse split. The Appellate Division, 1st Department, dismissed an action by Rebot and Reiss to enforce the literal language of the warrants. In its 4-1 decision, the majority said that a court “is not required to disregard common sense and slavishly bow to the written word where to do so would plainly ignore the true intentions of the parties in the making of the contract.” Tuesday, the Court of Appeals said the warrants are enforceable according to their terms, and there is nothing in the terms to account for a reverse split. Judge Smith noted that warrant agreements issued to another investor, Robert S. Trump, the brother of real estate mogul Donald Trump, specifically referred to a reverse-split adjustment. The judge suggested that the failure to include such a provision in the Rebot and Reiss contracts may have been intentional. “[T]his Court will not imply a term where the circumstances surrounding the formation of the contract indicate that the parties, when the contract was made, must have foreseen the contingency at issue and the agreement can be enforced according to its terms,” Judge Smith wrote. Smith said that the situation might be different if Financial had effected a forward stock split. “It does not follow … that Financial should be given a comparable remedy to save it from the consequences of its own agreements and its own decision to perform a reverse stock split,” Smith said. Appearing were Joseph M. Weitzman of Manhattan for Rebot and Reiss, and Howard Grun of Kaufman Friedman Plotnicki & Grun in Manhattan for Financial Performance Corp. The court returned the case to the state supreme court for a calculation of damages. Weitzman said the sum could be enormous, since during the pendency of the matter the stock price hit approximately $16 per share, which would result in a profit of roughly $28 million. “It probably is a strong, strong message to the corporate bar and their corporation clients to do top-notch due diligence because this decision really says it is not the plaintiffs taking advantage of an anomaly of their warrant agreement and profiting from a reverse split,” Weitzman said. “What it really is, is the corporation and its attorneys failing to do due diligence and failing to know the details of the securities in their company at the time they did a recapitalization.”

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