## Facts

- Kaiser-Frazer Corporation agreed to sell 900,000 shares of unissued common stock to a syndicate led by Otis & Co. for $11.50 per share, for public resale at $13 per share, with a scheduled closing shortly after execution.
- The underwriting agreement conditioned the underwriters’ purchase obligation on, among other things, (i) counsel’s opinion regarding the absence of material legal proceedings and (ii) a registration statement/prospectus that complied with the Securities Act of 1933 and contained no material misstatements or omissions.
- The registration statement became effective the same day the agreement was signed, and the parties planned a near-term closing at which the issuer would deliver shares and the underwriters would pay the purchase price.
- On the closing date, Otis and another underwriter refused to accept and pay for the shares, disputing the adequacy of the issuer’s counsel opinion and objecting that the registration materials were inaccurate or incomplete.
- The dispute centered on the issuer’s earnings disclosure: the registration statement and prospectus overstated December 1947 earnings, which in turn misstated the overall earnings picture for the relevant period presented to investors.
- Kaiser-Frazer sued for breach of the underwriting agreement and won a substantial damages award in the district court.
- Otis appealed, asserting that the offering materials were materially misleading under federal securities law and that the underwriting agreement therefore could not be enforced.

## Issues

1. Whether the registration statement and prospectus contained a material misstatement or omission, particularly regarding December 1947 earnings and related year-end financial presentation.
2. Whether an underwriting agreement tied to a public distribution may be enforced when performance would proceed on the basis of materially misleading offering materials in violation of the Securities Act of 1933.
3. Whether the underwriters’ obligations failed because contractual conditions precedent requiring accurate, non-misleading disclosure were not satisfied, and whether underwriter knowledge could bar reliance on illegality or nonoccurrence of conditions.

## Decision

- The Second Circuit reversed the district court’s judgment for Kaiser-Frazer.
- The court held that the registration statement and prospectus were materially misleading because they overstated earnings.
- The court concluded that the underwriting agreement was illegal and unenforceable because it was integral to a public offering to be made on the basis of materially misleading disclosure.
- The court further held that the agreement’s conditions precedent requiring accurate, non-misleading registration materials were not met, relieving Otis of any duty to close.
- Otis was not liable to Kaiser-Frazer for breach of contract damages.

## Legal Principles

- A contract that contemplates performance in violation of the Securities Act’s disclosure requirements, and is integral to a public distribution based on materially misleading offering materials, is illegal and unenforceable as a matter of public policy.
- A material misstatement about earnings in a registration statement or prospectus can be material even if it concerns a limited time period, where it distorts the overall picture of profitability and prospects presented to public investors.
- When an underwriting agreement expressly conditions the underwriters’ purchase obligation on the absence of material misstatements or omissions in the registration statement/prospectus, a material defect constitutes failure of a condition precedent and excuses performance.
- Underwriter knowledge of the true facts does not cure illegality where enforcement would effectively validate a public offering made on misleading disclosure; investor protection and the statutory scheme control over private equities between sophisticated parties.

## Conclusion

The Second Circuit treated accurate securities disclosure as a prerequisite to enforcing an underwriting contract for a registered public offering, holding that material misstatements in the prospectus both defeated contractual conditions precedent and rendered the agreement unenforceable on illegality and public-policy grounds, thereby barring the issuer’s claim for breach damages.


Kaiser-Frazer Corp. v. Otis & Co., 195 F.2d 838 (2d Cir. 1952)