Heller v. Boylan

Full title: HELLER et al. (MANDELKER, Intervener) v. BOYLAN et al

Court: Supreme Court, Special Term, New York County

Date published: Jun 13, 1941

29 N.Y.S.2d 653 (N.Y. Misc. 1941)

Opinion

May 27, 1941. On Rehearing June 13, 1941.

Derivative action by Esther Heller and others, suing on behalf of themselves and all other stockholders of the American Tobacco Company similarly situated, against Richard J. Boylan and others, wherein Minnie Mandelker intervened.

Judgment for plaintiffs in accordance with opinion.

M. Paulson, of New York City, general counsel for plaintiffs and plaintiff-intervenor and for plaintiff E. Heller.

J. Nemeroy, E. Rothenberg, and M. Shapiro, all of New York City, for plaintiff I.S. Wile.

S.L. Chess and R. Ratner, both of New York City, for plaintiff D. Hart.

Gates Levitt, of New York City (A.N. Geller, of New York City, of counsel), for plaintiff P.P. Sharffin.

A.M. Glickman and N.H. Mandelker, both of New York City (A.M. Glickman, P.E. Jackson, and M. Loewe, all of New York City, of counsel), for plaintiff-intervenor M. Mandelker.

Bijur Herts, of New York City (H. Bijur and H.H. Herts, both of New York City, of counsel), for plaintiff L. Bijur.

Appel Tannenbaum, of New York City (A. Appel and H.A. Tifford, both of New York City, of counsel), for plaintiff G.A. Zagor.

S.B. Olney, of Brooklyn, for defendants R.J. Boylan, F.B. Reuter, T.T. Harkrader, P.H. Gorman, J.A. Crowe, A.H. Gregg, J.R. Coon, and E.A. Harvey.

C.J. Shearn, of New York City, for defendants Hahn, Riggio, Neiley and Hill, Jr., G.Z. Medalie, of New York City (L. Haimoff, of New York City, assistant counsel), for defendant Hill, Sr.

Chadbourne, Wallace, Parke Whiteside, of New York City (G.W. Whiteside and R.D. Ray, both of New York City, of counsel), for defendant American Tobacco Co.

COLLINS, Justice.

In this derivative action 7 out of a total of 62,000 stockholders — holding under 1,000 out of a total of 5,074,076 shares — of the American Tobacco Company, seek recovery for the corporation from the Company's directors for alleged improper payments to certain of the Company's officers.

The suit derives from an incentive compensation by-law of the Company, known as Article XII, virtually unanimously adopted by the stockholders in March, 1912. Thereunder 10 per cent of the annual profits over the earnings of the corresponding properties in 1910 are to be distributed, 2½ per cent to the president and 1½ per cent to each of the five vice-presidents "in addition to the fixed salary of each of said officers."

The profits, and consequently the bonuses, undulated with the years; but at all times they were quite lush. By virtue of this by-law, the officers have received from and including 1929 to and including 1939 — in addition to $3,784,999.69 in salaries — bonuses aggregating $11,672,920.27, or total compensation during that eleven-year period of $15,457,919.69. The president alone, George W. Hill, Sr., received $592,370 in 1929; $1,010,508 in 1930; $1,051,570 in 1931; $825,537.49 in 1932. The other payments to him during such period were obese, the thinnest being $137.042.65, in 1938, and the average around $400,000. The other officers likewise received handsome compensation though not as huge.

The plaintiffs maintain that these large bonus payments bore no relation to the value of the services for which they were given, that, consequently, they were in reality a gift in part, and that the majority stockholders committed waste and spoliation in thus giving away corporate property against the protest of the minority. Rogers v. Hill, 289 U.S. 582, 590-592, 53 S.Ct. 731, 77 L.Ed. 1385, 88 A.L.R. 744.

The validity of the by-law is not challenged. Indeed, its legality has been sustained. Rogers v. Hill, supra. Nor do plaintiffs impugn the principle of incentive compensation. Rather, they regard it "a legitimate means of accomplishing a desired result," and do not question "that the extra effort, spurred by the promise of extra compensation, may have been an important factor in the prosperity of the Company." That the Company has been singularly prosperous is indubitable. Its growth has been prodigious, its record for earnings is an enviable one, the management has been extraordinarily efficient, and the stockholders, as well as the officers, have been the beneficiaries of this immensely capable organization. The Company has made money even in direful times. Its capital investment is $265,000,000. It produces more than 200,000,000 cigarettes a day. In 1939 the Company's sales amounted to $262,416,000, its most popular brand — "Lucky Strike" — yielding $218,542,749. The Company is one of the world's giant industrial enterprises. Its activities are far-flung, if not world-wide. Nevertheless, charge the plaintiffs, the payments to the officers have become "so large as in substance and effect to amount to spoliation or waste of corporate property." Rogers v. Hill, supra.

This is not the first time some of these payments have been attacked. An earlier assault was made by another stockholder, Richard Reid Rogers, and from that litigation stems several of the issues involved in the present suit. It is the principle evoked by the Rogers case which mainly supplies the pattern for this one.

Supplementing their claim that the compensation payments to the officers bore no relation to the value of the services rendered, and that they were not, therefore, equitable, the plaintiffs maintain that the Company's treasurer, delegated by Article XII with the power of declaring what payments the officers were to receive thereunder, misinterpreted the by-law to the officers' undue enrichment, and that the treasurer was under the domination and subserviency of the other officers, more particularly the president.

Besides this, the plaintiffs assert that the directors caused the Company to pay to the law firm of Chadbourne, Stanchfield Levy, the Company's attorneys, roughly three-fourths of $375,000 for compensation in connection with the Rogers litigation, and that inasmuch as the Company was but a nominal defendant in that litigation and was in truth the real plaintiff, this $375,000 — or the major portion thereof — should have been borne by the sued directors themselves.

Still another of the plaintiffs' contentions is that two of the defendants — Hill, Sr., and Hahn — misused their fiduciary positions with the Company to effect a loan of $250,000 for their personal benefit, from Lord Thomas, who handle the Company's advertising. This loan was — in form at least — to James J. Sullivan, deceased, a business associate of quondam Circuit Judge Martin T. Manton, and was never repaid.

For these payments and offenses the plaintiffs earnestly strive to fasten liability not alone upon the actual recipients, but (except as to the Lord Thomas transaction) upon all the directors — recipient and nonrecipient alike — on the theory of negligence.

According to the plaintiffs, the defendants should restore to the corporation around $3,000,000, plus such excess incentive compensation payments found by the Court to constitute waste or spoliation.

Thus, the case divides itself into these four major facets:

I. The incentive compensation received by the officers; whether such payments were fair and equitable and bore any relation to the value of the services for which they were made.

II. Whether or not, apart from the issue posed by segment I, the officers were overpaid in consequence of the treasurer's misinterpretation of Article XII. This entails a construction of the by-law, and more especially the force and effect to be accorded that provision which constitutes the treasurer the sole and final arbiter.

III. The propriety of the allocation of the $375,000 payment to Chadbourne, Stanchfield Levy — whether or not this allocation should be revised more favorably to the Company.

IV. The personal liability of Hill, Sr., and Hahn for the $250,000 loaned by Lord Thomas to Sullivan.

Propounded, too, are:

V. The effect of ratification by the stockholders.

VI. Whether the six or ten year statute of limitations governs.

VII. If restoration is compelled, which of the defendants come within the compulsion.

The discussion of these troublesome issues will be prefaced by a brief reference to the Company's genesis, and to the Rogers litigation.

The old American Tobacco Company was founded in 1890, its controlling head and guiding spirit being the late James B. Duke. In 1901, a group of bankers and financiers formed a holding Company under the name of Consolidated Tobacco Company. In 1904, the Consolidated, the Continental and the American were merged into the old American Tobacco Company. This merged Company continued until May, 1911, when the Supreme Court of the United States declared it illegal as a trust, and ordered its dissolution. An elaborate plan of dissolution was evolved by certain Circuit Court Judges, Attorney General Wickersham and his Special Assistant, Mr. McReynolds (later Mr. Justice McReynolds), Mr. Duke, the late Lewis Cass Ledyard, Sr., and Mr. Junius Parker. The assets of the trust were divided among sixteen corporations, one of which was the present reorganized American Tobacco Company. The design was to so unscramble and segregate the numerous holdings of the trust as to engender, foster, and maintain competition.

Evidently, it was Mr. Duke's policy that the Company be managed by trained men with a personal stake in the profits. Pursuant to such policy, the by-law in question was adopted. As observed, the adoption was by practically unanimous vote of the stockholders. Here is the by-law:

"Article XII

"`Section I. As soon as practicable after the end of the year 1912 and of each year of the Company's operations thereafter, the Treasurer of the Company shall ascertain the net profits, as hereinafter defined, earned by the Company during such year and if such net profits exceed the sum of $8,222,245.82, which is the estimated amount of such net profits earned during the year 1910 by the businesses that now belong to the Company, the Treasurer shall pay an amount equal in the aggregate to ten per cent. of such excess to the President and five Vice-Presidents of the Company in the following proportions, to wit: One-fourth thereof, or 2½% percent, of such amount, to the President, one-fifth of the remainder thereof, or 1½ per cent. of such amount, to each of the five Vice-Presidents as salary for the year, in addition to the fixed salary of each of said officers.

"`Section 2. If any such office be vacant for a time amounting in the aggregate to one month in one year, so much of the amount provided by this resolution to be paid to the incumbent of such office as is proportionate to the time of such vacancy shall be returned into the general profit of the Company. If there shall be a change during the year in the incumbent of any office, the amount hereinbefore provided to be paid shall be divided among the different incumbents of such office in the proportion of their respective periods of incumbency during the year, subject to the above provision in relation to vacancies.

"`Section 3. For the purpose of this By-Law the net profits earned by the Company in any year shall consist of the net earnings made by the Company in its business as a manufacturer and seller of tobacco and its products after deducting all expenses and losses, such provisions as shall be determined by the Board of Directors of the Company for depreciation and for all outstanding trade obligations, and an additional amount equal to 6 per cent. preferred stock, to which profits shall be added, or from which profits shall be deducted, as the case may be, the Company's proportion (based on its stock holdings) of the net profits or losses for the year of its subsidiary companies engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes, or little cigars, except earnings on preference shares of British-American Tobacco Company, Limited, and shares of Imperial Tobacco Company (of Great Britain and Ireland), Limited.

"`Section 4. The declaration of the Treasurer as to the amount of net profits for the year and the sum due anyone hereunder shall be binding and conclusive on all parties, and no one claiming hereunder shall have the right to question the said declaration, or to any examination of the books or accounts of the Company, and nothing herein contained shall give any incumbent of any office any right to claim to continue therein, or any other right except as herein specifically expressed.

"Section 5. This By-Law may be modified or repealed only by the action of the stockholders of the Company and not by the directors.'"

Article XII enjoyed a tranquil life until 1931, when Rogers loosed his barrage. Before that, however — in 1929 — the directors voted the management still additional bonuses in the form of valuable stock rights, and in 1931 the management participated in an "employee's stock subscription plan", which the stockholders had adopted. The value of the rights granted to Hill, Sr., in 1929 was estimated at $705,550, his 1931 grant $1,169,280; other officers received substantial rewards. Dissenting opinion of Mr. Justice Stone. Rogers v. Guaranty Trust Co. of New York, 288 U.S. 123, 135, 53 S.Ct. 295, 77 L.Ed. 652, 89 A.L.R. 720.

The Rogers Litigation

In March, 1931, Richard Reid Rogers, a lawyer, and a stockholder of the Company, commenced an action in this Court against George W. Hill, the president, and four of the vice-presidents of the Company, and the Company itself. The defendants removed the case to the United States District Court for the Southern District of New York; the plaintiff's motion to remand was denied by Judge Woolsey on the ground that the action presented separable controversies. Rogers v. Hill, D.C., 53 F.2d 395. Meanwhile, in May, 1931, a companion action, upon substantially the same complaint, was instituted by Rogers in the United States District Court for the Southern District of New York, against the fifth vice-president, Thomas R. Taylor. By stipulation both actions were consolidated. In one action Rogers sought to compel the directors to restore to the Company corporate stock voted to them under the allotment plan whereunder the directors and certain employees received 56,712 shares at a price of $25 per share at a time when the market value thereof was approximately $112. This action finally reached the Supreme Court of the United States, which dismissed it on the ground that it involved the interpretation of New Jersey statutes, and should, therefore, be adjudicated in that State. Rogers v. Guaranty Trust Co. of New York, 288 U.S. 123, 53 S.Ct. 295, 77 L.Ed. 652, 89 A.L.R. 720. Mr. Justice Stone wrote a vigorous dissent. 288 U.S. at page 135, 53 S.Ct. at page 299. Heeding the suggestion of the Supreme Court, Rogers sought relief in the Chancery Court of the State of New Jersey. The action there was consolidated with another action, called the Matthews action.

A third action was instituted by Rogers attacking still another allotment plan involving 46,500 shares to the directors at $50 below the market price. This third action ended by the restoration of the stock.

A fourth action in the United States Federal Court, Southern District, sought recovery of the bonuses. Here, Rogers attacked the by-law as unlawful and the payments thereunder as waste of corporate assets. An injunction pendente lite was granted by Judge Caffey, restraining payment of bonuses until the trial. The United States Circuit Court of Appeals, however, reversed Judge Caffey's injunctive order and directed a dismissal of the action on the merits. Judge Manton wrote the prevailing opinion, in which Judge Chase concurred. Rogers v. Hill, 2 Cir., 60 F.2d 109, 113. Robustly dissenting, Judge Swan wrote:

"In 1912 the stockholders of the appellant adopted a by-law which provided that 10 per cent. of the annual `net profits' be distributed, 2 1/2 per cent. to the president and 1 1/2 per cent. to each of the five vice presidents `in addition to the fixed salary of each of said officers.' The by-law does not expressly say that the payments provided for are by way of additional compensation to the officers, and the notice of the meeting at which the by-law was adopted referred to the proposed resolution as one for the distribution of profits. If it was really a distribution of profits rather than a method of compensation, the majority stockholders had no power to vote it. I shall assume, however, that the by-law was valid when passed. But it does not follow that it will remain valid for all time regardless of the amount payable under it. If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority. See Endicott v. Marvel, 81 N.J.Eq. 378, 384, 87 A. 230; Collins v. Hite, 109 W.Va. 79, 153 S.E. 240.

"The present suits attack payments made under the by-law since 1921, totaling more than $10,000,000, and seek an injunction against further payments. The bonuses paid to the president increased from $90,000 in 1921 to $840,000 in 1930. In the latter year his additional emoluments included a fixed salary of $168,000 and `special cash credits' of $270,000. Bonuses paid four of the vice-presidents for that year totaled $1,830,000, in addition to which they received fixed salaries and special credits totaling $700.000. Apparently these sums were thought insufficient, for in that same year the board of directors initiated a plan which resulted in the distribution to these five officers and directors of almost 30,000 shares of stock at $87 per share less than its then market value. The court below thought that a sufficient showing of invalidity had been made to justify a temporary injunction against future payments under the by-law. In my opinion a bonus of $840,000 to an officer receiving a fixed salary of $168,000 is presumptively so much beyond fair compensation for services as to make a prima facie showing that the corporation is giving away money, and a by-law which sanctions this is prima facie unreasonable, and hence unlawful. This is all we need to hold to support the injunction pendente lite.

"The determination of fair compensation for services is primarily for the directors. Courts hesitate to overrule the discretion of directors fairly exercised. Here the directors have exercised no discretion; they rely upon a by-law to relieve them of that duty, and the by-law, as it now operates, results in so large a payment that the trial court thought it probably invalid as applied to future earnings. Under such circumstances the courts do not and should not refuse to consider whether a bonus plan is fair or oppressive [citing cases]."

Undaunted, Rogers prosecuted a successful appeal to the Supreme Court of the United States, Rogers v. Hill, 289 U.S. 582, 53 S.Ct. 731, 735, 77 L.Ed. 1385, 88 A.L.R. 744, where Butler, J., for the unanimous Court, enunciated the principle which controls the determination of the bonus question, thus:

"It follows from what has been shown that when adopted the by-law was valid. But plaintiff alleges that the measure of compensation fixed by it is not now equitable or fair. And he prays that the court fix and determine the fair and reasonable compensation of the individual defendants, respectively, for each of the years in question. The allegations of the complaint are not sufficient to permit consideration by the court of the validity or reasonableness of any of the payments on account of fixed salaries or of special credits or of the allotments of stock therein mentioned. Indeed, plaintiff alleges that other proceedings have been instituted for the restoration of special credits, and his suits to invalidate the stock allotments were recently considered here. Rogers v. Guaranty Trust Co., 288 U.S. 123, 53 S.Ct. 295, 77 L.Ed. 652 [89 A.L.R. 720]. The only payments that plaintiff by this suit seeks to have restored to the company are the payments made to the individual defendants under the by-law.

"We come to consider whether these amounts are subject to examination and revision in the District Court. As the amounts payable depend upon the gains of the business, the specified percentages are not per se unreasonable. The by-law was adopted in 1912 by an almost unanimous vote of the shares represented at the annual meeting and presumably the stockholders supporting the measure acted in good faith and according to their best judgment. The tabular statement in the margin shows the payments to individual defendants under the by-law. Plaintiff does not complain of any made prior to 1921. Regard is to be had to the enormous increase of the company's profits in recent years. The 2½ per cent. yielded President Hill $447,870.30 in 1929 and $842,507.72 in 1930. The 1½ per cent. yielded to each of the vice presidents, Neiley and Riggio, $115,141.86 in 1929 and $409,495.25 in 1930 and for these years payments under the by-law were in addition to the cash credits and fixed salaries shown in the statement.

"While the amounts produced by the application of the prescribed percentages give rise to no inference of actual or constructive fraud, the payments under the by-law have by reason of increase of profits become so large as to warrant investigation in equity in the interest of the company. Much weight is to be given to the action of the stockholders, and the by-law is supported by the presumption of regularity and continuity. But the rule prescribed by it cannot, against the protest of a shareholder, be used to justify payments of sums as salaries so large as in substance and effect to amount to spoliation or waste of corporate property. The dissenting opinion of Judge Swan indicates the applicable rule: `If a bonus payment has no relation to the value of services for which it is given, it is in reality a gift in part, and the majority stockholders have no power to give away corporate property against the protest of the minority.' 60 F.(2d) 109, 113. The facts alleged by plaintiff are sufficient to require that the District Court, upon a consideration of all the relevant facts brought forward by the parties, determine whether and to what extent payments to the individual defendants under the by-laws constitute misuse and waste of the money of the corporation [citing cases]."

Following Rogers' victory in the Supreme Court, and before the "investigation in equity" was launched, negotiations for adjustment were started. These eventuated in a settlement, from which the Company benefited — at the time of the settlement in July, 1933 — by $6,200,000 and a further saving of about $2,250,000 by March, 1940. Many more millions were saved — inasmuch as the settlement reduced the bonus base and the employee's stock subscription plan was revised. In addition, Rogers was paid a fee of $525,000, the net being $263,000, and the income tax thereon exhausting the remaining $262,000. Thus ended the Rogers campaign.

But the echoes therefrom persisted. Seven stockholders, including three of the plaintiffs in this action (Heller, Wile and Mandelkor), and represented by most of the attorneys who appear for the plaintiffs here, assailed the settlement and sought to have it cancelled on the ground that the huge fee to Rogers was in the nature of a bribe. He received it, accused the seven, without the knowledge of the Court which approved the settlement, and in violation of his obligation to the Company, for whose benefit the litigation was prosecuted. In an arresting opinion Judge Leibell rejected the petition and declined to disturb the settlement, holding it a most advantageous one for the corporation. Considering the benefits to the corporation, Rogers' fee of $525,000 was held earned and "moderate". Rogers v. Hill, D.C., 34 F.Supp. 358, 365.

It was in connection with the Rogers litigation that Chadbourne, Stanchfield Levy were paid $375,000 and which fee forms segment III of this case.

The Perplexities of the Case.

Quite obviously, this case carries a number of perplexities. A few of them will be noted:

1. The general reluctance of the Courts to interfere with the internal management of a corporation. Pragmatism by the Courts — interference or meddling with free and lawful enterprise honestly conducted — is repugnant to our concept of government. Of course the hesitancy is overcome if fraud or bad faith or over-reaching appears — if the fiduciaries have been faithless to their trust.

2. Though this is a derivative stockholders' action, only 7 out of 62,000 stockholders have joined the onslaught; these 7 holding less than 1,000 out of a total of 5,074,076 shares of the Company. This factor, though significant, bears only on the equities; it is by no means decisive. Tyranny over the minority by the majority is abhorrent and will not be tolerated. The majority cannot, save by due legal process, make that which is illegal, legal, nor can it confiscate the company's assets or dispense them as unearned bounties. Majority rule does not license subjugation or immunize spoliation. The possession of power does not authorize or excuse its abuse. Power is not a franchise to do wrong. The majority cannot any more than the minority violate the law with impunity.

3. This case differs from most stockholders suits in that in those cases it is the conduct of directors which forms the basis of the complaint, whereas here not only is the by-law a creature of the stockholders, but on at least two other occasions, one in April, 1933, and again in April, 1940, the stockholders, by almost unanimous vote, ratified many of the payments involved in this suit. To be sure, "the majority stockholders have no power to give away corporate property against the protest of the minority." Rogers v. Hill, supra [60 F. 114].

4. The fact that the by-law has been in existence since 1912 and has been held valid.

5. The embarrassment which some of the defendants might experience in refunding even a part of what they received, especially since taxes were paid thereon.

6. The language of finality contained in paragraph 4 of the by-law.

7. The paucity of apposite precedents.

Let it be emphasized, however, that the above are alluded to only as difficulties; they enter into the equities, but do not constitute a bar.

I. Should the Court Revise These Bonus Payments?

In Gallin v. National City Bank of New York, 152 Misc. 679, 702, 273 N.Y.S. 87, 113 — a vital case of this genre — Mr. Justice Dore made the following pertinent comments on profit-sharing plans:

"Predetermined incentive compensation to corporate officers based on a share of profits in addition to salary has been an accepted and wide-spread practice both in the United States and Europe during the past twenty years or more. No question is raised in the books but that a corporate officer may be paid a percentage of profits (see numerous cases cited in L.R.A. 1915D, page 638 et seq.), and that such compensation, contingent upon net earnings, is a cost of the enterprise and not a distribution of funds exclusively allocated to stockholders. Such plans, if fair and not oppressive, have received both judicial and economic approval. Yale Law Journal, vol. 41, 1931, p. 109 et seq.; idem, vol. 42, 1932-33, p. 419 et seq.; Harvard Law Review, March, 1933, vol. 46, p. 828 et seq.; Central Law Journal, vol. 86, 1918, p. 208 et seq.; Seitz v. Union Brass Metal Mfg. Co., 152 Minn. 460, 189 N.W. 586, 27 A.L.R. 293, 300 et seq.

"We have long since passed the stage in which stockholders, who merely invest capital and leave it wholly to management to make it fruitful, can make absolutely exclusive claim to all profits against those whose labor, skill, ability, judgment and effort have made profits available. The reward, however, must have reasonable relation to the value of the services for which it is given and must not be, in whole or in part, a misuse or waste of corporate funds, or a gift to a favored few, or a scheme to distribute profits under a mere guise of compensation, but in fact having no relation to services rendered. Rogers v. Hill, 289 U.S. 582, 590, 53 S.Ct. 731, 77 L.Ed. 1385, 88 A.L.R. 744; Godley v. Crandall Godley Co., 212 N.Y. 121, 105 N.E. 818, L.R.A. 1915D, 632. To come within the rule of reason the compensation must be in proportion to the executive's ability, services and time devoted to the company, difficulties involved, responsibilities assumed, success achieved, amounts under jurisdiction, corporation earnings, profits and prosperity, increase in volume or quality of business or both, and all other relevant facts and circumstances; nor should it be unfair to stockholders in unduly diminishing dividends properly payable. Heublein v. Wight (D.C.) 227 F. 667; Berendt v. Bethlehem Steel Corp., 108 N.J.Eq. 148, 154 A. 321; Shera v. Carbon Steel Co. (D.C.) 245 F. 589, 591; Church v. Harnit, 6 Cir., 1929, 35 F. (2d) 499, 502; Putnam v. Juvenile Shoe Corp., 307 Mo. 74, 269 S.W. 593, 40 A.L.R. 1412; Venner v. Borden Co., N.Y.Sup.Ct., decided Oct. 11, 1927; Scott v. P. Lorillard Co., 108 N.J.Eq. 153, 154 A. 515 (1931)."

As observed, the plaintiffs do not contest the general principle of the bonus plan — they complain of its alleged runaway operation.

The following tabulation discloses the compensation in the form of bonuses and fixed salaries received by the defendants during the years 1928 to 1939, inclusive:

Year for Which Total Payment G.W. Hill, Received by Was Made G.W. Hill C.F. Nelley V. Riggio P.M. Hahn T.R. Taylor Jr. Defendants 1928 $ 355,204.00 $ 39,167.00 $ 37,500.00 ......... ......... ........ $ 431,871.00 1929 592,379.00 163,475.00 163,475.00 ......... $ 20,833.00 ........ 940,153.00 1930 1,010,508.00 459,495.00 459,495.00 ......... 45,833.00 ........ 1,975,331.00 1931 1,051,570.00 487,883.00 487,883.00 $ 45,833.00 50,000.00 ........ 2,123,169.00 1932 825,537.49 473,322.49 473,322.49 50,000.00 50,000.00 ........ 1,872,182.47 1933 137,042.68 60,225.61 60,225.61 50,000.00 50,000.00 ........ 357,493.90 1934 287,126.40 150,275.84 150,275.84 150,275.84 150,275.84 ........ 888,229.76 1935 226,067.95 113,640.76 113,640.76 113,640.76 113,640.76 ........ 689,639.99 1936 232,284.76 117,370.85 117,370.85 117,370.85 62,852.12 $ 9,583.35 656,832.78 1937 380,976.17 206,585.69 206,585.69 206,585.69 ......... 20,833.34 1,021,566.58 1938 331,348.73 176,809.23 176,809.24 176,809.23 ......... 103,516.76 965,293.19 1939 420,299.58 230,179.74 230,179.74 230,179.74 ......... 230,179.74 1,341,018.54 Now, ever a high-bracketer would deem these stipends munificent. To the person of moderate income they would be princely — perhaps as something unattainable; to the wage-earner ekeing out an existence, they would be fabulous, and the unemployed might regard them as fantastic, if not criminal. To others they would seem immoral, inexcusably unequal, and an indictment of our economic system. The opinion of Judge Swan has been unfairly paraphrased as announcing that "no man can be worth $1,000,000 a year". But see George T. Washington, of the Cornell Law School, The Corporation Executive's living wage, Harvard Law Review, March, 1941, Vol. LIV. 759. Many economists advocate a ceiling for compensation.

At the stockholders meeting on April 3, 1941, a holder of 80 shares of common stock — who thought the compensation grandiose — offered a resolution to restrict the president's bonus to a maximum of $100,000 and to impose other limitations. But the resolution was defeated by 2,193,418 votes to 74,571. Harvard Law Review, supra 747.

Let it be boldly marked that the particular business before this Court is not the revamping of the social or economic order — justiciable disputes confront it.

Preliminarily, the parties are at variance concerning the burden of proof. The plaintiffs asseverate that the burden is on the defendants. as fiduciaries to justify the payments (Schall v. Althaus, 208 App. Div. 103, 203, N.Y.S. 36; Carr v. Kimball, 153 App.Div. 825, 139 N.Y.S. 253); the defendants just as stoutly counter that inasmuch as the payments were made under a by-law tantamount to a contract (Thompson on Corporations 3rd Ed., Sec. 1150), it rests with the plaintiffs to make good their challenge. Furthermore, the plaintiffs indicate that the defendants offered no proof as to the reasonable value of the services; they place the case on a par with that of a lawyer or physician suing for the fair and reasonable value of professional services.

While I do not agree with the plaintiffs' analogy, the question of burden of proof, though provocative, does not impress me as cardinal. The rule is chiefly one of procedure. Inasmuch as all the evidence is in, the procedural query is mostly moot. All the officers testified in great detail anent their services. No, they did not in so many words affirm that in their opinion their services were fairly and reasonably worth what they were paid. Winch v. Warner, 186 App.Div. 710, 174 N.Y.S. 819. But such self-appraisal would have appended no weight to their testimony. It is assumed that had they been asked, they would have unabashedly estimated the value of their services at what they received. In all candor, granting, arguendo, that expert testimony had been obtainable, what would have been its worth to the Court?

Yes, Judge Swan opined that "a bonus of $840,000 to an officer receiving a fixed salary of $168,000 is presumptively so much beyond fair compensation for services as to make a prima facie showing that the corporation is giving away money, and a by-law which sanctions this is prima facie unreasonable, and hence unlawful". Rogers v. Hill, 2 Cir., 60 F.2d 109, 114. The Supreme Court, however, did not embrace Judge Swar's precept. It ruled, instead, that "the prescribed percentages give rise to no inference of actual or constructive fraud * * *". The Supreme Court thought that the payments had become "so large as to warrant investigation in equity in the interest of the company". The inquiry is whether the sums as salary are "so large as in substance and effect to amount to spoliation or waste of corporate property". Again, "As the amounts payable depend upon the gains of the business, the specified percentages are not per se unreasonable". This inquiry must be determined "upon a consideration of all the relevant facts brought forward by the parties * * * whether and to what extent payments to the individual defendants under the by-laws constitute misuse and waste of the money of the corporation". Rogers v. Hill, supra [ 289 U.S. 582, 53 S.Ct. 735, 77 L.Ed. 1385, 88 A.L.R. 744].

In the Gallin case, 155 Misc. 880, 281 N.Y.S. 795, 802 (report confirmed by Mr. Justice Dore, 281 N.Y.S. 821), Referee Frank C. Laughlin (formerly of the Appellate Division, First Department), following Rogers v. Hill, supra, ruled that "the magnitude of the total compensation received by the different officers of the bank and company as salaries and under the management fund plan, in and of itself, does not show a breach of duty on the part of the directors or entitle the plaintiffs to recover, but merely requires an investigation by the court with respect to the existence of a cause of action and necessarily leaves the burden of proof on the plaintiffs". (Italics mine).

Another authority for casting the burden of proof on the plaintiffs is Seitz v. Union Brass Metal Mfg. Co., 152 Minn. 460, 464, 189 N.W. 586, 587, 27 A.L.R. 293, quoted with approval by Mr. Justice Dore in the Gallin case, 152 Misc. 679, 707, 273 N.Y.S. 87. In the Seitz case [ 152 Minn. 460, 189 N.W. 588], the Court observed: "The dissenting stockholder should come into court with proof of wrongdoing or oppression and should have more than a claim based on mere differences of opinion upon the question whether equal services could have been procured for somewhat less".

Here, the plaintiffs proffered no testimony whatever in support of their charge of waste. The figures, they reason, speak for themselves, and the defendants must justify them. The figures do speak, but just what do they say as a matter of equity? They are immense, staggeringly so. Even so, is that enough to compel the substitution of the Court's judgment for that of the stockholders? Larger compensation has been judicially approved. Thus, in the Gallin case, 152 Misc. pages 705, 706, 273 N.Y.S. page 116, Mr. Justice Dore, comparing the compensation in the contest before him — where the profits were less — to that in the Rogers case, said:

"The arguments capably urged in this case by defendants' able and distinguished counsel were fully presented and considered by the Supreme Court in the Rogers Case. Defendants' counsel there pointed out that during the life of their compensation plan the net earnings of the American Tobacco Company reached the stupendous sum of $356,000,000. In the present case during the entire period of the management funds the operating profits were also stupendous, viz. $204,831,298.93. The figures in the present case, at least for a few of the officers in the in the higher brackets, outdistance anything paid under the American Tobacco Company, Mr. Mitchell receiving an aggregate compensation from both funds in 1929 of $1,375,534.67, in 1928 of $1,417,149.72, and in 1927 of $1,156,230. Corporate powers are subject to equitable limitations. Here, as in the Rogers Case, there was in the formula applied each year no definite limits set except by percentages on the amount of profits officers should receive. Under the doctrine enunciated by the Supreme Court the above figures and certain others paid to a few of the officers at the top in the bank and the company are so large that without holding, before complete investigation, that they give rise to any inference of actual or constractive fraud or other breach of duty, I rule that they do warrant a full investigation by this court of equity in the interest of the corporation and objecting stockholders to determine whether there was in fact a deliberate or actionably negligent waste of corporate assets and, if so, to what extent.

"In determining whether there is a waste or spoliation of corporate property the same rules govern as in making any other test of alleged violation by directors of their common-law duty. The ruling in the Rogers Case did not intend to set aside these perfectly well-settled rules of law; it merely directed an inquiry to determine if they had been breached, and, if so, to what extent in damages. The inquiry is not merely to substitute the court's discretion for the discretion of the directors, if that has been honestly and fairly exercised. See 27 A.L.R. 300 to 310; 44 A.L.R. 570, 572, note, and numerous cases cited. The rule is established that directors of a corporation acting as a body in good faith have a right to fix compensation of executive officers for services rendered to the corporation, and that ordinarily their decision as to the amount of compensation is final except where the circumstances show oppression, fraud, abuse, bad faith, or other breach of trust. Wellington Bull Co., Inc. v. Morris, 132 Misc. 509, 230 N.Y.S. 122; affirmed without opinion, First Dept., 226 App.Div. 868, 235 N.Y.S. 906; Seitz v. Union Brass Metal Mfg. Co., 152 Minn. 460, 464, 189 N.W. 586, 587, also reported in 27 A.L.R. 293 (1922); Matthews v. Headley Chocolate Co., 130 Md. 523, 100 A. 645. If clear oppression, bad faith, or other breach of trust is shown, the courts will give redress and determine to what extent the compensation is excessive. But plaintiffs must bring the case within one of the exceptions that are in each case predicated on a breach of legal duty with consequent damage to the corporation."

The confirmed report of Justice Dore's Referee, Frank C. Laughlin, Esq., found ( 155 Misc. page 888, 281 N.Y.S. page 803): "On the main issues with respect to the charges of fraud and bad faith, and as to whether the compensation paid to the senior and some of the junior managing officers was so excessive that it constituted a gift or waste of funds within the principles of law hereinbefore stated, the plaintiffs have adduced no substantial additional evidence on the reference. They have presented some opinion evidence on this subject, but it is of very little, if any, probative force for the reason that it is not predicated on like official positions or services."

As already observed, here, not only was no opinion evidence adduced, but it would be arduous to conjecture opinion evidence on this subject as having any probative value.

Referce Laughlin continued ( 155 Misc. page 889, 281 N.Y.S. page 804): "I am of the opinion and report that the bank and company had authority to adopt the management fund plans and the formula which they did adopt for providing for the management funds. These acts were not only within the powers of the directors of the bank and company, but they were fair and reasonable to the bank and company and their stockholders, and no more than fair to the executives."

Referce Laughlin then concluded this phase of the case by recommending ( 155 Misc. page 891, 281 N.Y.S. page 806): "* * * that none of the defendants should be held liable on the theory that they authorized or permitted the payment of compensation to the executive officers so great as to constitute a gift or waste of the funds of the bank or company."

In the Seitz case, supra, the Court laid down this rule as to when courts will intervene in compensation matters: "If the officers, acting as they do in a fiduciary capacity, fix exorbitant and unreasonable salaries so as to absorb earnings which should go in dividends or remain with the company as surplus, they are not exercising the fidelity which the law requires and a court of equity will give relief at the suit of a minority stockholder by compelling restoration. In determining whether salaries are excessive and unreasonable so that there should be a restoration courts proceed with some caution. An intolerable condition might result if the courts should too lightly undertake the fixing of salaries at the suit of dissatisfied stockholders. An issue as to the reasonable value of the services of officers is easily made. It is not intended that courts shall be called upon to make a yearly audit and adjust salaries."

In Matthews v. Headley Chocolate Company, 130 Md. 523, 535, 100 A. 645, 650, it was said: "The court would not be authorized to substitute its judgment for theirs [directors] as to what are proper salaries, provided they acted in good faith within their powers, and the salaries fixed by them were not clearly excessive."

A telling distinction between excessive and wasteful compensation is made in the recent (1939) case of McQuillen v. National Cash Register Co., D.C.Md., 27 F.Supp. 639, affirmed, 4 Cir., 112 F.2d 877. Quoting Federal District Judge Coleman at 653 of 27 F.Supp.: "It may be conceded that, prima facie, judged by appropriate standards of the worth of the services of any individual for any particular industrial executive position, a salary of $100,000 a year appears to the average person, of average business experience and responsibilities, to be more than liberal compensation. However, courts are not permitted to be controlled by this test any more than by what the average judge, familiar with cases of the present kind, might himself conclude to be adequate compensation. We must distinguish between compensation that is actually wasteful and that which is merely excessive. The former is unlawful, the latter is not. The former is the result of a failure to relate the amount of compensation to the needs of the particular situation by any recognized business practices, honestly, even though unwisely adopted, — namely, the result of bad faith, or of a total neglect of or indifference to such practices. Excessive compensation results from poor judgment, not necessarily from anything else. If the rule were otherwise, the result would be destruction of autonomy in private enterprise to a degree that would render such enterprise no longer private; personal initiative and its just rewards would disappear, and this would undermine the very basis upon which our economic life, with its constitutional guaranties, is founded, and upon which our democratic form of government depends."

In Koplar v. Warner Bros. Pictures, Inc., D.C., 19 F.Supp. 173, the Court rejected the challenge of a stockholder to payments to three Warner brothers under a contract with the Company fixing their compensation at $10.000 a week, plus 90.000 shares of the company's stock, alleged to be worth approximately $12,000,000 in 1928. After litigation ensued and a settlement was effected, Koplar, still dissatisfied, sought to void the settlement.

Federal District Judge Nields of Delaware, held at page 188 of 19 F.Supp.: "In view of the character of the personal services and of the financial assistance, past and future, rendered by the Brothers, the payment was not excessive and did not amount to waste. Salaries of $10,000 a week are matched by salaries paid other top executives in this business. As a matter of morals such payments may be questioned. Directors have the power to award just compensation. That power should be used, not abused. Fair human requirements should set some limits to salaries."

In 1938, eight executives were receiving compensation in excess of $275,000. The Corporation Executive's Living Wage, supra, p. 733. Eugene G. Grace, as director and president of the Bethlehem Steel Corporation, received an average annual bonus from 1918 to 1939 of $814,993; in 1929 his total compensation was $1,635,754. Berendt v. Bethlehem Steel Corp., 108 N.J.Eq. 148, 154 A. 321.

It bears repeating that in nearly every case where compensation was assailed, the fixation was by the directors, whereas here it was by the stockholders themselves. More than that, on at least two occasions the stockholders, even after litigation which exposed the situation here revealed, ratified the payments. Again, the incentive compensation here had a base of $8,222,245.82. Finally, the officers shared 10% of the excess profits, and there was no dissatisfaction by the stockholders as to management, earnings or dividends.

In 1940, Louis B. Mayer received $697,048 as head of Loew's Inc., and Eugene G. Grace was paid $478,144 as president of Bethlehem Steel Corporation. N.Y. Times, May 19, 1941, p. 18.

Contingent fees paid to lawyers is but a variation of the bonus system. In stockholders' actions especially, fees awarded the successful attorneys have been exceedingly large, dependent, of course, upon the benefits produced for the corporation. An examination of some of these awards will indicate that lawyers, as well as executives of industrial corporations, have been the recipients of hardy recompense. An illuminating article on the subject of attorneys' fees in stockholders' derivative actions, by George D. Hornstein, Esq., is found in Columbia Law Review for May, 1939, Vol. XXXIX, No. 5. The following partial table appears therein at page 814:

Resulting Amount of Judge or benefit to counsel fee Referee Title of the Corporation and other Ratio to making case Year compensation benefit award ____________________________________________________________________________________ Adams v. Rockefeller (N.Y.N.H. H.R.R.) 1920 $2,500,000.00 $833,333.33 33 1/3 % Hough, J. Gallin v. Na- tional City Bank 1935 1,844,642.21 472,500.00 25% Dore, J. Bookbinder v. Chase Nat. Bank 1937 2,500,000.00 625,000.00 25% Hammer, J. Benedict v. Seagrave (In- suranceshares Corp. of Del.) 1937 723,500.00 239,605.03 33 1/3 % Valente, J. A consideration of these enormous payments cannot ignore the high toll of the tax collector. Today out of an income of $1,000,000, $717,584 goes for Federal taxes; from an income of $500,000, $330,156 is taken for Federal taxes, and an income of $100,000 is reduced by $43,476 for Federal taxes. And so on. This toll is greatly increased by State taxes. The higher the income, the higher the percentage of tax. So that indirectly the public treasury derives benefit from bountiful payments. That, alone, to be sure, does not justify them. Compensation to Officers and their services:

The challenged compensation received by each officer (except Penn, Taylor and Mower), and a brief reference to the services rendered therefor, will be treated separately. George W. Hill, Sr., President

1929. Salary ............ $ 144,500.00 1930. Salary ........... $ 168,000.00 Bonus ............. 447,870.00 Bonus ............ 842,508.00 _____________ _____________ Total ............. $ 592,370.00 Total ............$1,010,508.00 1931. Salary ............ $ 160,000.00 1932. Salary ........... $ 120,000.00 Bonus ............. 891,570.00 Bonus ............ 705,537.49 _____________ ____________ Total .............$1,051,570.00 Total ............ $ 825,537.49 1933. Salary ............ $ 120,000.00 1934. Salary ........... $ 120,000.00 Bonus ............. 17,042.68 Bonus ............ 167,126.40 _____________ ____________ Total ............. $ 137,042.68 Total ............ $ 287,126.40 1935. Salary ............ $ 120,000.00 1936. Salary ........... $ 120,000.00 Bonus ............. 106,067.95 Bonus ............ 112,284.76 ____________ ____________ Total ............. $ 226,067.95 Total ............ $ 232,284.76 1937. Salary ............ $ 120,000.00 1938. Salary ........... $ 120,000.00 Bonus ............. 260,976.17 Bonus ............ 211,348.72 ____________ ____________ Total ............. $ 380,976.17 Total ............ $ 331,348.72 1939. Salary .................. $ 120,000.00 Bonus ................... 300,299.58 ____________ Total ................... $ 420,299.58 Hill has been president of the Company since 1926. During that period its gross sales increased from approximately $153,000,000 to $267,000,000. Over a billion dollars has been paid in taxes; $358,000,000 has been paid out in dividends to preferred and common stockholders. The preferred and common stock have paid dividends consecutively, and without interruption, 145 and 141 times respectively.

That Hill is an able, astute, aggressive executive is evident. His business acumen is conceded. Of vast and peculiar experience, he was practically reared in a tobacco atmosphere, his father, the late P.S. Hill, having been an associate of Duke and Cobb. He has worked in virtually every branch of the tobacco business, earning $5 a week in 1904. Many improvements in the business are due to his sagacity and ingenuity. In 1907 he became president of Butler, Butler, Inc., a subsidiary of the old Company, and his stewardship increased its profits manifold. Duke then made him a vice-president of the old Company, in charge of the Cigarette Department. He drummed the trade throughout the Country. On dissolution of the old Company he had the job of competing with the popular brands (particularly Camel) of such contenders as Liggett Meyers, R.J. Reynolds, and Lorillard. When in 1918 it was decided to launch "Lucky Strike" with the slogan "It's Toasted", the business began to ascend. Just how much of the growth is due to Hill's leadership and how much to causes beyond Hill's influence, it is not possible to fathom. At any rate, total cigarette consumption increased from 47,000,000,000 in 1920 to 119,000,000,000 in 1930. That a substantial portion of this increase has been the steadily increasing consumption of cigarettes by women, is patent. It is, nevertheless, not questioned that Hill has steered the Company profitably. Whether he was worth the $4,500,000 paid him between 1926 and 1938 only the stockholders can judge; it was their $4,500,000. Parenthetically, this average of $400,000 a year is no more than the Company pays annually to Messrs. Kay Kyser, and Golenpaul on "Information Please," for weekly radio programs. Charles F. Neiley, Vice-President

1929. Salary ............... $ 48,333.00 1930. Salary .............. $ 50,000.00 Bonus ................ 113,142.00 Bonus .............. 409,495.00 ----------- ----------- Total ................ $163,475.00 Total ............... $459,495.00 1931. Salary ............... $ 50,000.00 Salary .............. $ 50,000.00 Bonus ................ 437,883.00 1932. Bonus .............. 423,332.49 ----------- ----------- Total ................ $487,883.00 Total ............... $473,332.49 1933. Salary ............... $ 50,000.00 1934. Salary .............. $ 50,000.00 Bonus ................ 10,225.61 Bonus ............... 100,275.84 ----------- ----------- Total ................ $ 60,225.61 Total ............... $150,275.84 1935. Salary ............... $ 50,000.00 1936. Salary .............. $ 50,000.00 Bonus ................ 63,640.76 Bonus ............... 67,370.85 ----------- ----------- Total ................ $113,619.76 Total ............... $117,370.85 1937. Salary ............... $ 50,000.00 1938. Salary .............. $ 50,000.00 Bonus ................ 150,583.69 Bonus ............... 120,809.23 ----------- ----------- Total ................ $296,583.69 Total ............... $176,869.23 1939. Salary .................. $ 50,000.00 Bonus ................... 180,179.74 ----------- Total ................... $230,179.74 Since 1931 in full charge of the leaf buying and manufacturing departments, Neiley has been with the Company for forty-one years, and a vice-president since 1929. He is — as of course he must be — expert in the growth, quality and purchase of leaf in a great variety of markets, and in the machinery and processes involved in storing, redrying, steaming and manufacturing. He supervises raw materials and the purchase of all ingredients that go into the manufacture of the Company's products. Purchases are made in seventeen different States, in Cuba, Porto Rico and the Near East. In purchasing leaf, manufacturing needs must be anticipated two or three years in advance. In 1938 alone Neiley's department purchased $52,258,000 of leaf tobacco, and in that year inventory of leaf tobacco carried by the company was $118,314,000. For cigarettes alone, Neiley supervised the purchase of 170,000,000 pounds of tobacco annually. Too, the research department operates under him, and his department has developed many improvements in processes and methods.

The Company's production of over 200,000,000 cigarettes a day is largely Neiley's responsibility as to quality. Nearly 300 brands of manufactured cigarettes and tobaccos are produced in the Company's factories, and the sales value of these products, manufactured under Neiley's supervision, amounted in 1939 to $262,416,000.

In addition, Neiley is entrusted with the maintenance of buildings, machinery and fixtures, having a total cost of more than $33,000,000. His department has 10,400 regular employees and at seasonal periods an additional 10,000. He represents the Company in its labor relations and conducts negotiations with labor unions. That he is a successful negotiator is attested by the fact that the Company has never had a strike. Paul M. Hahn, Vice-President.

1934. Salary ................. $ 50,000.00 1935. Salary .............. $50,000.00 Bonus ................. 100,275.84 Bonus .............. 63,640.76 ----------- ---------- Total ................. $150,275.84 Total .............. $113,640.76 1936. Salary ................. $ 50,000.00 1937. Salary .............. $ 50,000.00 Bonus ................. 67,370.85 Bonus .............. 156,585.69 ----------- ----------- Total ................. $117,370.85 Total .............. $206,585.69 1938. Salary ................. $50,000.00 1939. Salary .............. $ 50,000.00 Bonus ................. 126,809.23 Bonus .............. 180,179.75 ---------- ----------- Total ................. $176,809.23 Total .............. $230,179.75 Before going with the Company, Hahn was a member of the firm of Chadbourne, Stanchfield Levy, the Company's attorneys. As such he came in contact with the Company's officers and attracted their attention. He came to the Company in February, 1931, as a director at a salary of $50,000 a year. In 1932 he became a vice-president but did not participate in incentive compensation until 1935. From February 1, 1931 until his election as a vice-president he was Hill's assistant. Since becoming a vice-president he has on many occasions acted for Hill.

Though trained as a lawyer, Hahn, naturally keen and alert, impressed me with his knowledge of the tobacco business. Seemingly, he is conversant with all its phases. He does not serve as mere decor. He consults about sales and advertising. He supervises the Company's legal representation, as well as the Company's policy and public relations. He makes frequent trips to London in connection with the Company's English subsidiary, J. Wix Sons, Limited, and in 1937 re-organized the management there. Vincent Riggio, Vice-President.

1929. Salary ................. $ 48,333.00 1930. Salary .............. $ 50,000.00 Bonus ................. 115,142.00 Bonus .............. 409,495.00 ----------- ----------- Total ................. $163,475.00 Total .............. $459,495.00 1931. Salary ................. $ 50,000.00 1932. Salary .............. $ 50,000.00 Bonus ................. 437,883.00 Bonus .............. 423,322.49 ----------- ----------- Total ................. $487,883.00 Total .............. $473,322.49 1933. Salary ................. $ 50,000.00 1934. Salary .............. $ 50,000.00 Bonus ................. 10,225.61 Bonus .............. 100,275.84 ----------- ----------- Total ................. $ 60,225.61 Total .............. $150,275.84 1935. Salary ................. $ 50,000.00 1936. Salary .............. $ 50,000.00 Bonus ................. 63,640.76 Bonus .............. 67,370.85 ----------- ----------- Total ................. $113,640.76 Total .............. $117,370.85 1937. Salary ................. $ 50,000.00 1938. Salary .............. $ 50,000.00 Bonus ................. 156,585.69 Bonus .............. 126,809.24 ----------- ----------- Total ................. $206,585.69 Total .............. $176,809.24 1939. Salary ......................... $ 50,000.00 Bonus ......................... 180,179.75 ----------- Total ......................... $230,179.75

This sales manager has lived with the tobacco business for thirty-five years, commencing with Butler-Butler in 1905, and came to the Company in 1911. He has demonstrated remarkable ability as salesman and organizer. There are between 900,000 and 1,000,000 retail tobacco shops scattered throughout the Country, and one of Riggio's myriad duties is to see to it that each of these is visited by the Company's salesman. Riggio himself does considerable traveling, and holds general meetings of his tremendous sales forces. He has so systemized and promoted sales that in 1939 Lucky Strike sales alone yielded $218,542,749, as compared to $47,476,398 in 1922. George W. Hill, Jr., Vice-President.

1938. Salary ................ $ 25,000.00 1939. Salary ............... $ 50,000.00 Bonus ................ 64,273.18 Bonus ............... 180,179.74 ----------- ----------- Total ................ $ 89,273.18 Total ............... $230,179.74 Of all the officers, Hill, Jr., has been the most frequent and hard-hit target of the plaintiffs as regards compensation, chiefly because of his youth (thirty-two) and his somewhat volatile rise with the Company, induced, hint the plaintiffs, by nepotism. Granted that the relationship of father and son has not been harmful to young Hill, and allowing for his youth, it does not follow that the large compensation he has received is waste or spoliation in a legal sense. There is no proof that his position of vice-president in charge of advertising is otiose or that he does not perform valuable work. Indeed, plaintiffs assume that he "is a young man of ability", but suggest that his compensation of $230,179.74 for 1939 was "in part at least, due to the discernment by the father of genius in his son".

Hill, Jr., has been with the Company since 1936. Prior thereto he had no experience whatever in the tobacco business. Upon his graduation from college in 1931 he entered the employ of Phillips Milk of Magnesia Co. at an annual compensation of $2,100; from 1932-35 the Lambert Pharmaceutical Co. paid him $3,000 a year. Admittedly, from $2,100 to $230,179.74 in eight years is quite a spurt. His average weekly salary for 1939 was approximately $4,500.

The Company's advertising budget is $1,000,000 a month. From April, 1936, through October, 1940, the Company spent $58,574,000 in advertising, this under the supervision of young Hill and the Company's advertising consultants Lord Thomas. Hill, Jr., is credited with obtaining "Information Please", and with the working out of the opening of that program, which includes the chant of the auctioneer. "Your Hit Parade" is another of the company's radio programs.

Advertising is the most potent factor in, if not the very life of, selling. The public buys the product it knows; a known product is an advertised product. Even if he is not uncommonly gifted, Hill, Jr., seems to have a flair for advertising; but how much of the Company's prosperity is due to his individual efforts, I am unable to judge. I confess that I have serious misgivings about his services being valued at as high as $230,000 a year. But that is not my problem. I cannot hold that such a sum to a man whose ability and work is not questioned and who has charge of an annual expenditure of $12,000,000 has no relation to the value of the services for which it was given.

By Article XII, the stockholders, who own the Company and whose interests as to compensation are paramount, proposed to the officers: "In 1910 the operating profits of the properties now constituting our company were $8,222,245.82. Now, to induce you to better that figure, 10% of the betterment is to be divided among you as compensation in addition to your fixed salaries".

Decidedly, there is nothing unethical about this proposal. And its legality has been put by the Supreme Court beyond the periphery of debate. Now, does prosperity effect nullification? Is the plan moral and to the interest of the stockholders in lean years, but immoral and subversive in fat times? Just how much prosperity must be achieved to convert the compensation from legitimate to illegitimate? What is the saturation point? Where does adequacy end and waste begin? Under the plan the stockholders prosper with the officers, the increased earnings of the stockholders work increased earnings for the officers. The plan is by no means one-sided; it is largely contingent upon and measured by success. The design of the plan was to induce the profits to mount. As Assistant Professor George T. Washington, writing lucidly under the heading "The Corporation Executive And His Profit-Sharing Contract" The Yale Law Journal, November, 1940, crisply puts it at page 35: "The directors want results for their money; the executive wants a substantial reward for producing the desired results".

Assuming, arguendo, that the compensation should be revised, what yardstick is to be employed? Who or what is to supply the measuring-rod? The conscience of equity? Equity is but another name for human being temporarily judicially robed. He is not omnipotent or omniscient. Can equity be so arrogant as to hold that it knows more about managing this corporation than its stockholders?

Yes, the Court possess the power to prune these payments, but openness forces the confession that the pruning would be synthetic and artificial rather than analytic or scientific. Whether or not it would be fair and just, is highly dubious. Yet, merely because the problem is perplexing is no reason for eschewing it. It is not timidity, however, which perturbs me. It is finding a rational or just gauge for revising these figures were I inclined to do so. No blueprints are furnished. The elements to be weighed are incalculable; the imponderables, manifold. To act out of whimsy or caprice or arbitrariness would be more than inexact — it would be the precise antithesis of justice; it would be a farce.

If comparisons are to be made, with whose compensation are they to be made — executives? Those connected with the motion picture industry? Radio artists? Justices of the Supreme Court of the United States? The President of the United States? Manifestly, the material at hand is not of adequate plasticity for fashioning into a pattern or standard. Many instances of positive underpayment will come to mind, just as instances of apparent rank overpayment abound. Haplessly, intrinsic worth is not always the criterion. A classic might perhaps produce trifling compensation for its author, whereas a popular novel might yield a titantic fortune. Merit is not always commensurately rewarded, whilst mediocrity sometimes unjustly brings incredibly lavish returns. Nothing is so divergent and contentious and inexplicable as values.

Courts are ill-equipped to solve or even to grapple with these entangled economic problems. Indeed, their solution is not within the juridical province. Courts are concerned that corporations be honestly and fairly operated by its directors, with the observance of the formal requirements of the law; but what is reasonable compensation for its officers is primarily for the stockholders. This does not mean that fiduciaries are to commit waste, or misuse or abuse trust property, with impunity. A just cause will find the Courts at guard and implemented to grant redress. But the stockholder must project a less amorphous plaint than is here presented.

On this branch of the case, I find for the defendants. Yet it does not follow that I affirmatively approve these huge payments. It means that I cannot by any reliable standard find them to be waste or spoliation; it means that I find no valid ground for disapproving what the great majority of stockholders have approved. In the circumstances, if a ceiling for these bonuses is to be erected, the stockholders who built and are responsible for the present structure must be the architects. Finally, it is not amiss to accent the antiseptic policy stressed by Judge Liebell in Winkelman et al. v. General Motors Corporation, D.C.S.D.N.Y. decided August 14, 1940, 39 F.Supp. 826, that: "The duty of the director executives participating in the bonus seems plain — they should be the first to consider unselfishly whether under all the circumstances their bonus allowances are fair and reasonable".

II. Alleged Miscomputations.

Before engaging seriatim the various alleged miscomputations, two vexatious preliminary questions must be resolved.

The first relates to Section 4 of the by-law and involves the conclusiveness of the treasurer's determination; the second affects Section 3 and concerns the sources from which bonus profits are to be calculated.

First:

Section 4 reads: "The declaration of the Treasurer as to the amount of net profits for the year and the sum due anyone hereunder shall be binding and conclusive on all parties, and no one claiming hereunder shall have the right to question the said declaration, or to any examination of the books or accounts of the Company, and nothing herein contained shall give any incumbent of any office any right to claim to continue therein, or any other right except as herein specifically expressed."

This provision does not make the treasurer an arbitrator in the strict sense of the term. Rather, it is in the nature of a contract whereby a designated person is selected merely to make a determination "to avoid a possible controversy"; he does not act as a judge in a quasi-judicial manner settling "a controversy between the parties". The distinction is more substantial than euphemistic. The demarcation was boldly etched in Matter of Fletcher, 237 N.Y. 440, 143 N.E. 248 — recently re-approved in Matter of Stern, 285 N.Y. 239, 242, 33 N.E.2d 689 — where the contract provided for the purchase of corporate stock at a fair value to be determined by three "arbiters". The Court trenchantly said at page 444 of 237 N.Y., at 249 of 143 N.E.:

"It is to be noted at the outset that the contract under consideration does not provide for a determination of damages for which one of the parties may be liable in law; it does not provide for a determination of any question after disagreement of the parties upon that question; it does not attempt to substitute a tribunal created by contract for a court of justice in a dispute which would otherwise be justiciable by the courts. It merely substituted that determination of a particular matter affecting contractual rights, by persons selected by the parties, in place of the determination of that question by the parties themselves in some other manner. If such a provision brings the contract within the application of the Arbitration Law, then it would seem that every contract which provides for an appraisal, a valuation or the determination of any fact affecting contractual rights by one or more persons either named or thereafter to be selected likewise comes within the provisions of that law. * * *

"In order to constitute a submission to arbitration there must be some difference or dispute, either existing or prospective, between the parties and they must intend that it should be determined in a quasi-judicial manner. Therein lies the distinction between an agreement for a valuation and a submission to arbitration, for in the case of a valuation there is not as a rule any difference or dispute between the parties and they intend that the valuer shall without taking evidence or hearing argument, make his valuation according to his own skill, knowledge and experience.' Halsbury, Laws of England, vol. I, p. 440."

Further, 237 N.Y. at 448, 143 N.E. at 251:

"The present contract is not one to settle a controversy between the parties, but is one to avoid a possible controversy by leaving the settlement of a question to third parties; the third parties are not expected to settle the matter in a quasi-judicial manner and it seems to us that it, therefore, does not come within the letter or the spirit of the statute [Arbitration Law]."

The effect of the difference between these two classes of contracts is that in arbitration only fraud, or palpable error tantamount to bad faith, authorizes nullification or rectification of the determination, whereas in the other cases the determination of the designee will be revised and corrected for an erroneous interpretation of the contract. Smith Contracting Co. v. City of New York, 240 N.Y. 491, 148 N.E. 655.

In Uvalde Contracting Co. v. City of New York, First Dept., 160 App. Div. 284, 145 N.Y.S. 604, 606, it was said: "The court excluded much evidence offered by plaintiff, and finally dismissed the complaint upon the ground that the final certificate of the engineer was binding and conclusive upon the contractor unless successfully impeached for fraud, bad faith, or palpable mistake appearing upon the face thereof. There is of course no doubt about this general rule, and so the plaintiff freely concedes. It is not, however, applicable to every case, and the plaintiff's contention is that an equally well-established rule is that the final certificate and determination of the engineer are not binding upon the contractor, where the engineer has attempted to interpret the contract, and has erred in an interpretation based upon the law applicable thereto. The rule for which plaintiff contends has often been enunciated and applied, and perhaps never more satisfactorily than in Burke v. Mayor [of City of New York], 7 App.Div. 128, 40 N.Y.S. 81, which has frequently been cited with approval."

And in Hanssel v. P. Tomasetti Contracting Corporation, Sup., 8 N.Y.S.2d 873, 882, affirmed 257 App.Div. 1031, 13 N.Y.S.2d 565, reversed on other grounds 283 N.Y. 164, 27 N.E.2d 977, it was decided that the Court would not be bound by a computer's erroneous computation based upon an erroneous construction of the contract, but would construe the contract and recompute the amounts in dispute.

The controversial clause there read:

"Article XXIII — Authority of Engineers.

"To prevent all disputes and litigations, the Engineers shall, in all cases, determine the amount and quality of the several kinds of work which are to be paid for under this contract, and they shall determine all questions in relation to said work and the construction thereof, and they shall, in all cases, decide every question which may arise relative to the execution of this contract on the part of the contractor, and their estimates and decisions shall be final, conclusive and binding upon the Contractor, and such estimates and decisions in case any question shall arise, shall be a condition precedent to the right of the Contractor to receive any money under this agreement."

Interpreting the clause, the Court said: "No language could be broader nor give to the engineers greater powers. The Court, however, has applied to that clause the rule of reason and placed upon it certain limitations. The determination of the engineers is final if honestly made in good faith as to a classification of work or materials. But such determination must not be arbitrary or capricious, and the clause never yields to the engineers the judicial power of the Court to interpret the contract."

So, here, the treasurer was bound by Article XII; if he interpreted it erroneously, the Court can review and correct the error. Otherwise, in computing bonuses the treasurer could include profits expressly excluded, or exclude profits definitely included. And Mr. Junius Parker, attorney for Mr. Duke, intimated that Mr. Duke — "the draftsman and sponsor of the by-law" — "did not have in mind that [clause 4] prevented the Company questioning it * * *" (The treasurer's determination). Besides, the defendants' brief correctly states: "Of course the Court must construe the covenant to the extent of deciding what it does not commit to the determination of the arbiter and whether and to what extent his determination is final".

In Jones v. Roberts, 113 App.Div. 285, 98 N.Y.S. 873, affirmed 189 N.Y. 497, 81 N.E. 1167, cited by defendants and stressed on the oral argument, the contract was much broader than the language of Section 4. The Court said at page 294 of 113 App.Div., at page 879 of 98 N.Y.S.: "but we consider the eleventh clause as being so broad, and intended to be so broad, as to confer upon the plaintiff the right to determine at any time how much and what should be regarded as profits of the business; and, as long as that was done in good faith, the defendants are bound by their stipulation".

The element of erroneous interpretation did not enter the Jones case. There the owner of a business permitted three of his clerks to share in the profits. The three had no interest in the capital. The owner "was to be unrestricted in the matter of withdrawals on account of either capital or profits". 113 App.Div. at page 287, 98 N.Y.S. at page 875. The division of profits was left entirely to the owner and he could exclude a sharer any time he saw fit. Patently, the situation here is vastly different. Here, Clause 4 is linked to Clause 3. The profits are defined in the latter and the treasurer could not contrive an interpretation dehors the by-law.

So, Charlton v. Library Bureau, 260 Mass. 1, 156 N.E. 705, likewise cited by defendants, related to the methods of computation by public accountants, rather than to the interpretation of a contract. More, the accountants, though selected by the directors of the company, were not employees, as was the treasurer here.

Decidedly, the Court will not supervise the Company's bookkeeping or be its accountant — accountants differ, as well as lawyers. Nor will the exercise of business judgment be disturbed or reviewed. Where reasonable men might differ, where the determination of the treasurer is debatable or doubtful, the determination should stand. The equivocal domain of maybe-yes, maybe no, will not be tarried in.

Another comment which the facts constrain is that this treasurer could not be an impartial and independent arbiter. Assuming him to be a man of integrity and competence, meticulous independence and absolute impartiality he could hardly exercise. He owed obeisance to those responsible for his retention.

"* * * the courts closely scrutinize the action of an arbitrator whose relat on to one of the parties was such as to naturally influence the judgment even of an honest man". Sweet v. Morrison, 116 N.Y. 19, 27, 22 N.E. 276, 278, 15 Am.St.Rep. 376; In re Friedman, 215 App. Div. 130, 213 N.Y.S. 369; Matter of Knickerbocker Textile Corp. v. Sheila-Lynn, Inc., 172 Misc. 1015, 16 N.Y.S.2d 435.

Still, that clause 4 is not meaningless or sterile, that it cannot and should not be disregarded, that it is entitled to recognition and respect and force — all this is equally apparent.

My conclusion is that Clause 4 is not an arbitration contract and that the computations of the treasurer are "binding and conclusive" only in the absence of (1) fraud, (2) palpable error equivalent to bad faith, and (3) an erroneous interpretation of the contract.

Second:

Next pressing for solution is the sources of the net profits subject to distribution as bonuses.

The base is $8,222,245.82 — "the estimated amount of such net profits earned during 1910 by the businesses that now belong to the Company" — that is, the businesses allocated to the Company by the 1911 decree of dissolution. Under Section I the treasurer is to ascertain the "net profits as hereinafter defined * * *".

The definition appears in Section 3 and contains two parts.

"Net profits are:

"(A) the net earnings made by the Company in its business as a manufacturer and seller of tobacco and its products after deducting all expenses and losses."

Now, what is the purport of the phrase "in its business as a manufacturer and seller of tobacco and its products" — descriptive or limitive? The defendants argue that the words but describe the business, the plaintiffs just as confidently maintain that they have a more fundamental connotation.

Just why it was expedient or advisable to describe the business in the definitive clause, I cannot fathom. Preceding these words the Company is referred to simply as the Company — which suffices. Unless the addendum — "in its business as a manufacturer and seller of tobacco and its products" — has a definite, purposeful significance, it is utterly superfluous. As a part of the Company's organic law (its constitution), Article XII was carefully drawn, every word was designed to serve a purpose (to define or restrict a right), surplusage was not suffered.

I think there is affinity between the disputed words and the profits in which officers share — the officers were to share in the profits of the Company's tobacco business; they were to be excluded from profits otherwise derived. This is borne out by Exhibit 3, p. 40, which shows how the base figure of $8,222,245 was arrived at.

The total profits, tobacco and incidental, for the year 1910 amounted to the sum of.. $14,530,563.71 deducting earnings from investment securities based on year 1910..................... 3,160,753.89 leaves, earnings from sale and manufacture of tobacco, based on year 1910............ 11,369,809.82 and deducting Dividends on Outstanding Preferred Stock, as required by the By Law 3,147,564.00 leaves a balance of exactly (the base figure)........................................ 8,222,245.82 This base figure of $8,222,245.82, it is manifest, includes only the 1910 earnings of the Company in its tobacco business, and excludes all incidental income. It is this figure, so derived, which must be augmented in order that the officers might get 10% of the increment.

The $3,160,753.89 was not part of the betterment — it was not earned from the sale and manufacture of tobacco — hence the officers were excluded from participation therein. I do not perceive why subsequent years should not be treated likewise. It is the best and surest guide we have. Obviously, it was never intended that all the earnings, from whatever source, should be pumped into the reservoir for tapping by the officers. The defendants themselves, in another connection, accurately expounded the by-law when they said: "The profit-sharing rate is to be computed only on profits from the part of the business most affected by management in excess of such profits the year before the adoption of the by-law, after providing for the dividends on the Preferred Stock." Ex.CU, p. 48.

I hold that the profits of the Company to be shared by the officers are restricted to such as were earned in the business of manufacture and sale of tobacco.

"(B) * * * to which profits shall be added, or from which profits shall be deducted, as the case may be, the Company's proportion (based on its stock holdings) of the net profits or losses for the year of its subsidiary companies engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars * * *."

Thus, profits from subsidiaries not "engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars" are excluded from the computation. This is as clear as clear can be. The annoying controversy arising out of this particular restrictive phrase revolves around the term "subsidiary". The Company has four subsidiaries — concededly not engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars — which the defendants insist are not subsidiaries in the sense that their earnings are excludable. The four are, American Suppliers, Inc., American Tobacco Company of Pacific Coast, American Tobacco Company of the Orient, De Mauduit Paper Corporation of New York.

The disposition of $1,175,000 — to say nothing of future large sums — turns upon the decision of whether the profits from these four subsidiaries are includable or excludable for bonus purposes. The treasurer held them includable, and the officers have been participating therein.

American Suppliers, Inc., is engaged in the purchase, treatment and sale of domestic leaf tobacco.

American Tobacco Company of the Pacific Coast was engaged in the business of distributing the products of the Company in the far West until its dissolution in December, 1939.

American Tobacco Company of the Orient is engaged in the business of the purchase, treatment and sale of Turkish leaf tobacco.

De Mauduit Paper Corporation of New York is engaged exclusively in the purchasing and importing of cigarette paper from France for resale.

The defendants reason that these four were not separate legal entities when the by-law was adopted, that they were but departments of the Company, that their subsequent incorporation was contrived as tax-saving devices, and that, accordingly, they are still "considered" by the treasurer and other officers as "departments" of the Company and not as "subsidiaries".

Unfortunately for the defendants, the constricted issue here is whether these four companies are subsidiaries, not why they are subsidiaries. Each of these corporations issued its capital stock for good and valid consideration consisting of the transfer to it of legal title to assets; each kept its own books and records; each had its own employees, filed its own tax returns, and entered into its own contracts. The annual reports to stockholders refer to them as subsidiaries. True, the Company's officers dominate and direct these subsidiaries; but that is so in every case of parent company and offspring. The reasons which motivated the incorporation of these companies are not decisive or even germane. The language of the by-law is perfectly plain. Once start probing motives — despite the clarity of the language — and the quest will most likely run amuck.

American Suppliers, Inc., was the Company's leaf department for about eighteen years before incorporation. It was created to save taxes, and is conducted substantially the same under incorporation as before.

The American Tobacco Company of the Pacific Coast was the fifth sales division of the Company, and it too, came into being as a tax-saving device

The Orient Company operates like the American Suppliers, except that it is engaged only in the purchase of Turkish leaf. Here again, the design was to save taxes.

The De Mauduit Paper Corporation, importing cigarette paper from the Company's factory in France, was given corporate form to effect a saving in custom duties.

The defendants make a persuasive argument for including the profits from these four companies. They were includable anterior to their incorporation, and, plead the defendants, they should not be held excludable merely because they were incorporated to save money.

The answer to this is four-fold:

First, they are subsidiaries.

Second, virtually all subsidiaries are money-saving contrivances to escape or restrict taxation, to limit liability to property of the subsidiary, to immunize the parent for the derelictions of its offspring. Save for a few exceptions presently to be noted, a subsidiary does not lose its characteristics as such by sheer virtue of the motives which inspired its creation.

Professor Ballantine's Corporation Law and Practice states, at 896, that one of the primary motives for organizing a subsidiary is "To lessen taxes and to avoid excessive fees and taxation upon a large authorized capital stock for the privilege of doing business in other states."

Furthermore:

"The use of subsidiary corporations. During recent years, there has been an extensive development in the use of subsidiary corporations which may be employed as a means of expansion of the business and to accomplish various purposes. Some of these purposes may be enumerated as follows:

"* * * (2) To limit liability as to risky departments or branches of the business, either in contract or tort;

"* * * (6) To keep various departments of its business distinct, * * *".

Here, therefore, it was the officers' duty to save money for their Company even though the savings was to their personal disadvantage.

Third, the plain language of Article XII was a caveat to the officers concerning their rights; it put them on notice as to the character and extent of the profits in which they were to participate.

Fourth, the officers were not and are not remediless; recourse could and can be had by amending the by-law as authorized by Section 5, which provides: "Section 5. This By-Law may be modified or repealed only by the action of the stockholders of the Company and not by the directors."

Defendants produced considerable testimony in support of their strong thesis that it was never intended to exclude these "departments" from the purview of the by-law; they urge that to give the word subsidiary a strict and literal interpretation would operate not only contrary to intention but unjustly and unfairly, if not harshly. They invoke the incandescent words of Mr. Justice Holmes in Towne v. Eisner, 245 U.S. 418, 425, 38 S.Ct. 158, 159, 62 L.Ed. 372, L.R.A. 1918D, 254, that: "A word is not a crystal, transparent and unchanged, it is the skin of a living thought and may vary greatly in color and content according to the circumstances and the time in which it is used".

To be sure, there are instances where, for reasons of equity, Courts — recognizing the aphorism that "the letter killeth but the spirit giveth life" — penetrate the externals to reach the substance and reality behind. The facade often belies the interior. Yes, intent governs. But a more puissant doctrine is that the Court must presume that when language is unambiguous it expresses the intent. Otherwise the parol evidence rule is headed for devastation. True, a rigid and tenacious cleavage to the parol evidence rule not infrequently operates unjustly. Yet that is the course of virtually all salutary rules. A weapon of defense is often misused to commit offense. A tested rule should not be jettisoned just because it is susceptible of abuse. Hardly any rule is impervious to mistreatment. Experience teaches us, however, that greater safety lies in our adherence to the rule. "The life of the law", the knowing Mr. Justice Holmes wisely said, "has not been logic; it has been experience". To venture beyond the certain and safe frontiers of the writing is to grope in the zone of uncertainty and hazard. The defendants tell us with infinite and not altogether unimpressive assurance what Mr. Duke long ago intended. But the stockholders — what did they intend? Their intention, I apprehend, is impregnably ensconced within the visible borders of Article XII. Their citadel, too, must be saved from corrosive interpretation.

It is, I think, an unwarranted reflection upon the acumen and skill and foresight of the sponsor and draftsmen of Article XII to suggest that they neglected to express, or did not know how to express, what was in their minds. We must assume, therefore, that the by-law truly reflects their intention.

"Courts should not give to the agreement of parties, under such conditions [where the words are clear], a meaning which it would prefer or which it may think the parties intended. Intention is to be found in the language used. It is the only sure guide." Matter of Loew's Buffalo Theatres, 233 N.Y. 495, 501, 135 N.E. 862, 864.

"Deeply imbedded in the judicial decisions of every common-law jurisdiction is the rule that the terms of a written agreement cannot be varied by parol and that in construing the agreement `it is not the real intent but the intent expressed or apparent in the writing which is sought.' 2 Williston on Contracts, § 610". Hutchison v. Ross, 262 N.Y. 381, 398, 187 N.E. 65, 72, 89 A.L.R. 1007.

"So far as the evidence tends to show not the meaning of the writing but an intention wholly unexpressed in the writing, it is irrelevant". Williston on Contracts, Revised Ed., Vol. 3, Sec. 629.

The alter ego theory, advanced by the defendants, does not fit into this mold.

To detect and punish the real and responsible culprit the Court will ignore semblances and snatch off the corporate disguise. Thus (1) where the subsidiary has been formed for the purpose of cheating, defrauding or accomplishing indirectly or by circumvention a prohibited act (Booth v. Bunce, 33 N.Y. 139, 88 Am.Dec. 372), or (2) where no fraud or illicit motive is involved in the formation of the subsidiary or its operation, but where some one is attempting to fasten onto the parent a liability for the act of the subsidiary (Berkey v. Third Ave. Ry. Co., 244 N.Y. 84, 155 N.E. 58, 50 A.L.R. 599), or (3) where an attempt is made to subject the parent corporation to the service of process or liability under tax statutes, in a jurisdiction where it is allegedly operating through a subsidiary (Society Milion Athena, Inc., v. National Bank of Greece, 166 Misc. 190, 2 N.Y.S.2d 155, affirmed, 253 App.Div. 650, 3 N.Y.S.2d 677) — in these and cognate instances (the Court brushes aside the fictional, though legal), separate existence of the subsidiary and reaches out for the answerable offender. The present case, however, does not come within any of these categories.

The by-law does not specify present subsidiaries and exclude future — the comprehensive term "subsidiaries" is employed. Adequate valid or cogent reason for re-wording the Article fails to emerge. The treasurer's treatment of the American Cigarette Cigar Company — which the defendants endorse (noted in C infra) — contributes formidable encouragement to this concept of the by-law.

I hold, therefore, that inasmuch as the above four companies are subsidiaries, their profits are excludable from the compass of incentive compensation.

These observations lead to this formula: As to the Company itself only a part of its profits is includable in the bonus base; as to the subsidiaries all the profits are includable, once a given subsidiary brings itself within the by-law definition, that is, engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars. Stated differently: Profits of the Company can be included if they are earned in the business of "tobacco and its products", but subsidiaries can be included only if they manufacture and sell certain tobacco products.

Now, applying the above formula to the alleged miscomputations:

(a) The dividend of $61,584.53 received from the Company's French subsidiary, Societe Anonyme Des Papeteries de Mauduit in 1934, should have been excluded from bonus computation. Engaged in manufacturing cigarette paper for sale, neither the profits, losses nor dividends are includable in bonus income.

(b) For like reasons, the inclusion of dividends paid to the Company on its stockholdings in Durham and South Carolina Railroad Company was an erroneous interpretation of the by-law.

(c) In their insistence that the profits from the American Cigarette Cigar Co. be excluded from bonus computation, the plaintiffs antagonize and reverse their position that the by-law is free from ambiguity and that its plain language constitutes a mandate which must be heeded.

Formerly this subsidiary was the American Cigar Company and for about 24 years after the adoption of Article XII was engaged directly or through its subsidiaries in the cigar business. In March, 1932 the American Cigar Company leased its entire cigar business to its parent, the Company, at an annual rental of $1,800,000, and its subsidiaries continued the manufacture of cigars. The Company's investment in this subsidiary is $14,000,000. Up to November, 1936, all the substantial earnings of the Cigar Company were excluded from the bonus plan because it did not manufacture and sell smoking tobacco, chewing tobacco, cigarettes or little cigars. On November 1, 1936 the Company leased the Pall Mall cigarette to the American Cigar Company and the name of that subsidiary was then changed to American Cigarette Cigar Company. Thereby, the earnings of the newly-garbed subsidiary, averaging more than $100,000 a year, became within the orbit of the bonus definition.

The plaintiffs charge that this plan was a transparent ruse by the officers to divert more bonus income into their pockets. In construing Article XII the plaintiffs plead for literalness, cleave to the precise language, and disdain all attempts at interpretation by showing intent and motive. But when they arrive at this transaction they urge the alleged impurity of the officer's motives.

The plaintiff's position on this point collides with their general position that "once a subsidiary meets the definition of includability, all of its profits from whatever source must be included (in proportion to the stockholdings of the Company in the subsidiary)."

Surely, if it is equitable to exclude the profits from a former department of the Company once it is incorporated and becomes a subsidiary in the narrow sense of the term, a fortiori; it is equitable to include the profits from a subsidiary when it becomes engaged in the manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars, even though such subsidiary was formerly disqualified because it did not engage in such business. Both cases meet the dogmatic terms of the by-law. What is much more, the defendants' warm and unqualified approval of the treasurer's management of this significant item, lends sturdy support, I think, to my reading of the by-law.

The evidence fails to convince me that the officers were induced to market Pall Malls under the aegis of the American Cigarette Cigar Company instead of the American Tobacco Company by the illicit motives plaintiffs ascribe to them.

It was decided to exploit Pall Mall as a quality cigarette, and to distribute it on what is known as a "control" basis. Under this basis selected jobbers are licensed to sell only within a defined territory as distinguished from selling to all jobbers with the right to distribute in any territory — which is known as an "open" basis. The American Cigar Company was a recognized and popular cigar company known to operate on a "control" basis. Exploitation of Pall Mall through this Company, argue the defendants, served three distinct purposes: First, it permitted the ultilization of the numerous contacts of the American Cigarette Cigar Company in the cigar business. Second, the exploitation of Pall Malls by the Company would engender ill will amongst the Company's numerous customers — and this undesirable effect would be avoided by exploitation through the American Cigarette Cigar Company. And, third, the exploitation of Pall Mall by the Company would interfere with its concentration upon Lucky Strike, and that it was desirable, if not essential, to put a "new crowd" on the production of the Pall Mall cigarette.

Whether these reasons were sound and justified, is not for the Court to judge. The Court cannot hold that the directors exercised poor business judgment in marketing Pall Malls through a subsidiary. It would be a temerity for the Court to reverse the directors on this essentially business policy. The charge that the shift was made because of the bonusmindedness of the defendants — to enfold a once excludable subsidiary technically within the wordage of the bonus by-law — is not sustained. The proofs rather support the defendants' attitude that the lease was made in absolute good faith purely for business reasons.

One of the concrete profitable results has been a tax saving of some $290,000 a year. After the making of the lease the rental of $1,800,000, paid by the parent under the lease, was deducted as an expense, so that from 1932 to 1939 the officers suffered a reduction in income subject to bonus of a total of $13,932,463.71. The system evolved for exploiting Pall Mall has been successful. As a Turkish cigarette Pall Mall had become practically dormant, due to the change in taste for blended cigarettes. Accordingly, the brand was changed into an American blended elongated cigarette. Pall Malls sell for a somewhat higher price than Luckies, Camels and Chesterfields. The "control" system has worked advantageously; seemingly the officers' judgment with respect to this venture has on the whole found vindication in the good results.

The defendants, who had the onus of proof as to this phase of the case (Pepper v. Litton, 308 U.S. 295, 306, 60 S.Ct. 238, 84 L. Ed. 281) successfully carried the burden.

(d) So much of the American Cigarette Cigar Company earnings as were represented by dividends received by it on stock of the Company should be excluded. They are not earnings. The effect of inclusion is to receive double compensation, one when the profits were made by the Company, and again when such profits were paid to the American Cigarette Cigar Company in the form of dividends and then re-included in bonusable income. The duplication was admitted by the Treasurer, E.A. Harvey, and after 1936 the item was excluded.

(e) The alleged failure to deduct depreciation in computing earnings of the American Cigarette Cigar Company was purely a matter of accounting method, and the treasurer's determination will not be disturbed. His treatment of this item was approved, if not suggested, by Deloitte, Plender, Griffiths Co., as well as by Lybrand, Ross Bros. Montgomery, two eminent firms of accountants. The treatment of amortization of the leased assets by the Cigar Company would seem to be correct.

(f) Nor do I find any warrant for interfering with the treasurer's determination concerning J. Wix Sons, Ltd., the Company's English subsidiary, engaged in the manufacture and sale of cigarettes in England. If earnings were substituted for the dividends, no overpayment would result.

(g) As to dividends collected by J. Wix Sons, Ltd. on shares of the Company, from 1932 to 1938, inclusive, they should be excluded on the principle discussed in connection with American Cigarette Cigar Company (d) hereof.

(h) The plaint arising out of the 1936 special reserve, relating to J. Wix Sons, Ltd., is ill-founded. The reserve was merely a segregation of surplus as a reserve for contingencies; no loss was recognized.

(i) The next disputed item relates to dividends on treasury shares of the Company for 1932 and 1933. Thereafter the practice of including these dividends in bonus computation was discontinued. Inasmuch as the inclusion in income of dividends on treasury shares admittedly effects the payment of a double bonus, it was improper.

(j) On January 17, 1936, the Company contracted to sell, as of December 31, 1935, its subsidiary, Tin Decorating Company of Baltimore, which resulted in the inclusion of the sum of $1,338,678.29 for bonus purposes, that being the profit alleged to be realized upon the dissolution of the Company. Bonuses thereon amounted to $101,986.60. Inasmuch as the profits of the subsidiary were excludable, the plaintiffs urge that the profits realized from the sale of the subsidiary were like-wise excludable. For two years the treasurer excluded this item, then his successor revised the figures by including it. My opinion is that the inclusion was not justified. Discussing this question, Asst. Professor George T. Washington, in The Yale Law Journal, supra, deftly says at 52, 53: "Quite apart from any express clause on the subject, however, a strong argument can be made for interpreting the ordinary reference to `net earnings' in bonus contracts as applying only to operating earnings. The purpose of the contract is to give the executive a share in earnings produced by his own efforts, and it may well be urged that any intention to give him a share in capital gains or other income not derived from the normal operation of the business must be stated in the most explicit terms. Suppose, for example, that the corporation receives an attractive offer for the purchase of its interest in an important subsidiary. If the executive knows that he is to share in whatever capital gain is realized by the corporation upon the sale, he will be strongly tempted to approve the proposition even though the corporation would then be faced with the problem of finding an equally advantageous investment for its funds. As the corporation is not in the business of buying and selling its investments in subsidiaries, there appears no reason for allowing the executive to share in any profit so derived."

(k) The inclusion of "other dividends and interest", aggregating $110,685.58 was not authorized by the by-law and should be excluded.

(1) The same is true of "other income", totaling $6,756.56.

(m) The inclusion of "net income" on sales of securities, amounting to $27,857.78 was erroneous.

(n) The treasurer's treatment of the item concerning the retirement of preferred stock of American Cigar Company will not be molested. I cannot hold that the treasurer in this connection palpably erred or that he misinterpreted the contract. He most certainly was not guilty of fraud or bad faith. The question is whether or not there was an actual as distinguished from a bookkeeping loss. The treatment accorded the transaction, it would seem was a tax-saving stratagem. Of course if this was a real loss, it should have been deducted from the bonus computation. And if there was, or will be, an ultimate actual loss to the stockholders, there was, or will be, a corresponding loss for bonus-computing purposes. As already observed, our concern is not with matters of accounting. Unless and until a loss is actually sustained, no deduction should be made. However, stockholders and officers should occupy a parity; there is to be no discrimination. The Company cannot simultaneously blow hot for its officers and cold for its stockholders.

(o) What has just been written about (n) applies with equal force to the $250,000 reserve for investment in S.M. Frank Company. I cannot perceive that an actual loss was suffered, and the plaintiffs' expert is not in complete disagreement with this view.

(p) I am unable to perceive that a loss was sustained in connection with the commutation of the lease with Tobacco Products Corporation. The obligation fixed in 1923 was refinanced in 1935 at a lower rate of interest, the Company appreciably benefiting by the transaction. The plaintiffs say that the directors should have had an appraisal made of the brands in question at the time of the commutation. But this was a matter of business judgment which Messrs. Lybrand, Ross Bros. Montgomery approved and certified. These accountants did not deem an appraisal proper or necessary. I find no warrant for holding that they were wrong.

(q) Rogers v. Hill [ 289 U.S. 582, 53 S.Ct. 734, 77 L.Ed. 1385, 88 A.L.R. 744], held that — "Compensation to an officer for his services constitutes a part of operating expenses deductible from earnings in order to ascertain net profits. It is immaterial whether such compensation is a fixed salary or depends in whole or in part upon earnings."

In Gallin, supra, 152 Misc. 703, 273 N.Y.S. 113, Mr. Justice Dore said: "* * * compensation, contingent upon net earnings, is a cost of the enterprise * * *".

And in Assistant Professor Washington's Yale Law Journal Article just alluded to, he says at page 51: "A similar problem, but one of much more difficulty, arises when the corporation employs more than one executive on a percentage compensation basis. The question here is whether the compensation of any one executive should be computed as a percentage of the net earnings remaining after the compensation payable to the other executives has been deducted as an expense. If the contract with any single executive fails to provide that the percentage compensation payable to the other executives shall not be deducted as an expense, it is doubtless necessary that this deduction be made, despite difficulties in making the computation. Usage varies as to deducting all or any part of the executive's own compensation. It would seem that only his fixed salary should be deducted."

It would seem necessary, therefore, to deduct as an operating expense compensation paid to these officers "in order to ascertain net profits". But the participants' own bonus need not be deducted as an expense. This does not compel, as the defendants appear to argue, a reduction of the percentage. The bonuses, of course, are reduced, because the operating expenses are increased. But the 10% remains intact. A formula which would depreciate the 10% is not authorized, and, hence, will not be countenanced.

Summarizing the findings under this heading II:

1. Profits from the four subsidiaries, American Suppliers, Inc., American Tobacco Company of the Pacific Coast, American Tobacco Company of the Orient, and the De Mauduit Paper Corporation of New York, are eliminated from the bonus computation as subsidiaries not ever engaged in the business of the "manufacture and sale of smoking tobacco, chewing tobacco, cigarettes or little cigars." The erroneous payments under this subdivision amount to $1,715,000.

2. Bonuses on the $61,584.53 dividend received from the subsidiary Societe Anonym Des Papeteries de Mauduit — amounting to $5,234.69 — are to be restored to the Company.

3. The $2,142.82 paid on the dividends from the Durham South Carolina Railroad Company is to be returned to the Company.

4. The $11,635.36 paid on the dividends received from the American Cigarette Cigar Company is to be returned to the Company.

5. The $11,469.33 paid on dividends collected by J. Wix Sons, Ltd. on shares of the Company is to be restored to the Company.

6. The payment of $25,264.64 representing dividends on treasury shares of the Company, is to be restored to the Company.

7. The payment of $101,986.60, profit on dissolution of Tin Decorating Company of Baltimore is to be restored to the Company.

8. Payments of $110,685.58, "other dividends and interest"; $6,756.65, "other income"; and $27,857.78, "net profit on sales of securities", are to be refunded to the company.

9. Bonus compensation, except as to the participant, is to be computed and deducted. (The parties should agree on this adjustment.)

10. Exclusive of the immediately preceding item, the total under this heading which the recipient defendants are ordered to refund to the Company is $2,018,033.44.

11. All other alleged miscomputations are resolved in favor of the treasurer's determination.

III. The Equitable Allocation of the $375,000 to Chadbourne, Stanchfield Levy in Connection with the Rogers Litigation.

From May 8, 1931, to July 27, 1933, the Company paid Chadbourne, Stanchfield Levy $615,000 for legal services. Of this, $370,000 was allocated to the Rogers litigation, and out of the $370,000 Chadbourne, Stanchfield Levy paid counsel, including John W. Davis and Nathan L. Miller. After conferences between Hahn and George W. Whiteside of the Chadbourne firm, it was arranged that of the $370,000 the Company pay $276,000 or about 75%, the balance to be absorbed by the directors and minor employees, the directors paying 11% and the minor employees 14%. The Company eventually received $98,836 made up as follows:

Hill. Sr. ........................ $14,705 Pena Estate ...................... 8,823 Neiley ........................... 8,823 Riggio ........................... 8,823 ________ $41,176 Group of minor executives............................. 52,660 ________ Total: ............................ $93,836.

The plaintiffs make no claim that the bills for the legal services were in any way unreasonable or excessive. The services were, concede the plaintiffs, able and extensive. They do contend that such services were rendered on behalf and for the benefit of the directors, and that, therefore, the directors should pay.

I agree with the plaintiffs that the Company was not as much interested in defending the Rogers litigation as were the defendants. Indeed, except for certain comparatively minor interests, the Company's stake and that of the plaintiff were identical. In a larger sense the Company was the plaintiff inasmuch as the derivative actions were prosecuted in its behalf. It became a defendant only because the directors refused to bring the suits.

The applicable rule is expressed in Apfel v. Auditore, 223 App.Div. 457, 228 N.Y.S. 489, affirmed, 250 N.Y. 600, 166 N.E. 339, as follows: "The administratrix of Joseph Auditore, charging Frank Auditore with waste of corporate funds and other misconduct as an officer and director of these corporations, brought a representative stockholders' action. The corporations were made nominal defendants. Frank Auditore retained the plaintiff's firm as attorneys for himself and the corporations. * * * We regard it as inequitable that the corporations should be called upon to pay for the defense of this action, brought for their benefit and resulting in a judgment in favor of the plaintiff as a representative of the corporate interests. The amount of the plaintiff's recovery against the corporations should be limited to the value of the labor of entering a nominal appearance for the corporations and formally appearing for them."

In Monahan v. Kenny, 248 App.Div. 159, 288 N.Y.S. 323, 324, where an attorney requested that his fee be fixed for defending a stockholder's action which charged misappropriation of funds, it was said: "The corporation was merely a nominal party defendant to the action. It was in reality a plaintiff. Its interests were in direct conflict with those of the individual defendants in control of the corporation. * * * Under the aforesaid circumstances, there clearly is no liability on the part of the corporation for the fees of the attorney for services rendered to the individual defendants. As a necessary corollary, it follows that the corporation is not chargeable with the expense of determining the fee payable by the individual defendants to their attorney."

The circumstance that the litigation was settled is of no consequence. The settlement was for a substantial amount. There is authority for the principle that even had the defendants been exonerated the corporation should not be saddled with the expense of defense, except insofar as the stake of the corporation was concerned. Griesse v. Lang, 37 Ohio App. 553, 175 N.E. 222; New York Dock Co., Inc., v. McCollum, 173 Misc. 106, 16 N.Y.S.2d 844.

From the above references to the Rogers litigation it is obvious that the Company did not have such a substantial interest in defeating the litigation as to pay 75 per cent. of the expenses incurred.

Very true, Rogers attacked the validity of the by-law, and the Company had an interest in defending it, but after the Supreme Court upheld its legality there was no further occasion for the Company to defend it. Furthermore, only one of the four actions involved the legality of the bonus plan. Certainly the defense of the stock bonus was for the benefit of the directors, not the Company. The Company, too, was interested in defending the stock employee's plan, approved 99 9/10% of the shareholders in July, 1938, which case went to the Supreme Court. Rogers v. Guaranty Trust Company of New York, supra.

Judge Leibell, in the proceeding which sought to nullify the settlement, Rogers v. Hill, D.C., 34 F.Supp. 358, pointedly said at page 369: "The argument is also advanced that the decree of dismissal should be vacated because the corporation should have had, at the time the terms of settlement were discussed, an attorney, other than the law firm that was also acting for the director defendants. If the corporation itself were dealing with the director defendants and if it were not otherwise represented in the negotiation of the settlement, there might be something to this contention. The corporation was a nominal defendant. It would have been the plaintiff if it had complied with the demand Rogers made that the corporation bring suit, before he instituted his shareholder's action. The owner of the primary right, the corporation, refused to enforce that right, so Rogers, a shareholder, a member of the class that possessed the secondary right, brought his derivative action against the directors. In the negotiations for the settlement of the issues raised by the pleadings in the various actions, he represented the corporation. Meighan v. American Grass Twine Co., 2 Cir., 154 F. 346, 347. The corporation was properly and necessarily represented by him. He controlled the action."

To the extent, therefore, of defending the Company's real and legitimate interest, payment should come from the Company. Godley v. Crandall Godley Co., 181 App.Div. 75, 168 N.Y.S. 251, affirmed, 227 N.Y. 656, 126 N.E. 908; Kirby v. Schenck, ___ Misc. ___, 25 N.Y.S.2d 431, Pecora, J.

Manifestly, the separation of these services cannot be achieved with mathematical precision. A readjustment, therefore, cannot be made with equitable exactitude. It is equally manifest, however, that the Company has paid more than its just share of the expense. This is not intended as a criticism of those responsible for the allocation; they misjudged, I think, the respective stakes. The individual defendants in the Rogers cases will be directed to reimburse the Company an additional $150,000.

IV. The Liability of Hill, Sr., and Hahn for the $250,000 Loan from Lord Thomas.

This vexatious transaction has been the source of considerable misfortune. From it stems the dire consequences to a former Judge of the United States Circuit Court of Appeals and to a lawyer of lofty position at the bar.

During the pendency of the appeals in the United States Circuit Court of Appeals in two of the Rogers cases, a loan of $250,000 was made by Lord Thomas, through its head, Albert D. Lasker, to James J. Sullivan, a business associate of former Judge Manton. Concededly, the greater part of the proceeds of the loan found its way into the treasury of corporations in which the former judge was interested. The American Tobacco Company was Lord Thomas' largest and most remunerative client. In 1931 alone the business it handled for the Company amounted to approximately $19,000,000.

The plaintiffs contend that the loan — which was never repaid, and which is now barred by the statute of limitations — was for the personal benefit of Hill, Sr. and Hahn. Lasker somewhat supports the theory that he made the loan at the instance and suggestion of Hahn, and that he looked to Hahn and Hill, Sr., to see to it that it was repaid. Sullivan executed his note for the $250,000 and deposited 15,604 shares of the National Cellulose Corporation, of which he was President, as collateral. Subsequently, the appeals were decided by the Circuit Court of Appeals in favor of the defendants, Judge Manton writing the prevailing opinion and Judge Swan dissenting.

There is some difference between Lasker's version of the transaction and that of Hahn, the latter affirming that he interceded at the instance of the late Thomas L. Chadbourne. But no matter which version is credited, I am unable to perceive how or upon what theory Hill, Sr. or Hahn are personally responsible for the loan. Indubitably, the defendants in the Rogers cases — temporarily at least — benefited by the reversal in the Circuit Court. Even so, why should Hill, Sr. and Hahn pay? The prophylactic rule that if a fiduciary misuses his trust for his own interests, he is accountable to the cestui for the gains, is too ingrained for accentuation. Meinhard v. Salmon, 249 N.Y. 458, 164 N.E. 545, 62 A.L.R. 1; Ashman v. Miller, 6 Cir., 101 F.2d 85, 91; Dutton v. Willner, 52 N.Y. 312, 319; Guth v. Loft, Inc., Del.Sup., 5 A.2d 503; Irving Trust Co. v. Deutsch, 2 Cir., 73 F.2d 121, certiorari denied, 294 U.S. 708, 55 S.Ct. 405, 79 L.Ed. 1243.

The plaintiffs correctly declare that "the paramount duty of a director is to champion the interests of his corporation." But that basic and salubrious doctrine is remote to this situation.

In the disciplinary proceedings to which Hahn was a party, (In re Levy, D.C., 30 F.Supp. 317) Federal Judge Knox found as a fact that: "Hahn acted as an intermediary of Chadbourne and Levy in the making of the loan to Sullivan and did not act either in his own interest or in the interest of the American Tobacco Company or any of its officers or directors."

Here, then, we have a square holding by the knowledgeable, scrupulous and rigidly independent judge who made an incisive inquiry into the facts, that the loan was not made to Hill or Hahn. Though Levy was punished, Hahn was exonerated. With this unequivocal finding that the Sullivan loan was not made in Hahn's interest or in the interest of the Tobacco Company or any of its officers or directors, the plaintiffs' insistence to the contrary is jejune. The Appellate Division's opinion that "some of the other principals in this transaction are not without blame" (Matter of Louis S. Levy, 260 App.Div. 722, 728, 23 N.Y.S.2d 414, 419) lends no assuagement to the plaintiffs' theory.

From this loan the Company suffered no pecuniary loss; Hill and Hahn acquired no pecuniary benefits. The Company, too, had a stake in the litigation, and such appeasement as Hill and Hahn derived from Judge Manton's favorable rulings was soon cancelled by the Supreme Court. What is more, all those enriched lost more permanently than they ephemerally gained. No matter how venal the fateful transaction is viewed, it has not been satisfactorily established that Hill, Sr. or Hahn gained anything by virtue of their fiduciary positions for which they are accountable to the Company in equity.

Finding no basis for differing with Judge Knox's conclusion, the claim is rejected.

V. The Effect of Ratification.

It cannot be repeated too often that this Company belongs to its stockholders and that it is they who are paying the officers.

Not only did the stockholders fix the compensation formula, but on at least two occasions they ratified the formula, even after the compensation was attacked as bounties. Thus, in 1930 Hill, Sr., received $1,010,508, and in 1931 $1,057,570. Rogers' suits were commenced around this time. Rogers v. Hill was argued in the Supreme Court on May 1, 1933, and decided May 29, 1933. On April 5, 1933, the employee stock subscription plan was voted, by which time the stockholders had received detailed information relative to compensation and benefits received by officers, directors and employees, from 1921 to the end of 1932. Nevertheless, the directors were overwhelmingly re-elected and the stockholders expressly approved the allotments (except that of Hill, which he relinquished).

Again, in April, 1940, after all the publicity attending the Rogers litigation, and its settlement, and following the proceedings before Judge Leibell, the stockholders refused to increase the base or to reduce the officers' compensation. The vote against the change was 2,193,481 shares against 74,571, making the ratification 96.7 of the shares represented. It may be that the meeting was "a battle of proxies, not of wits," (Berendt v. Bethlehem Steel Corp., 108 N.J.Eq. 148, 151, 154 A. 321, 322), but it is strong indication that the vast majority of stockholders are satisfied. Granting that "the majority * * * have no power to give away corporate property against the protest of the minority" (Rogers v. Hill, 289 U.S. at pages 591, 592, 53 S.Ct. at page 735, 77 L.Ed. 1385, 88 A.L.R. 744), the acquiescence of the overwhelming majority is a persuasive influence in the consideration of the equities.

VI. The Statute of Limitations.

The plaintiffs contend for the ten year statute of limitations, (Civil Practice Act, § 53); the defendants, for the six (§ 48). The first of these consolidated actions was commenced February 8, 1939.

After Brinckerhoff v. Bostwick, 88 N.Y. 52, was decided in 1882, it was generally thought that the ten year statute of limitations governed stockholders' derivative actions. The rationale was that corporate assets constituted a trust fund. This thought was somewhat shaken by O'Brien v. Fitzgerald, 143 N.Y. 377, 38 N.E. 371; Mason v. Henry, 152 N.Y. 529, 46 N.E. 837, and Dykman v. Keeney, 154 N.Y. 483, 48 N.E. 894. Confusion ensued, some adhering to the trust fund doctrine, others distinguishing between the adequacy and inadequacy of the legal remedy. Potter v. Walker, 276 N.Y. 15, 11 N.E.2d 335, 1937, essayed a clarification. There the Court of Appeals held, first, that irrespective of the nature of the right the ten year statute was applicable where the legal remedy was inadequate. It said at pages 25, 26 of 276 N.Y., at page 337 of 11 N.E.2d: "In respect to those causes of action by which is sought to recover profits received by directors by reason of wrongful acts, an action at law would not afford adequate relief. * * * The Appellate Division is therefore clearly right in applying the ten-year statute of limitations as to such causes of action."

The Court then proceeded to shatter the notion that a derivative action was necessarily always equitable in nature, by announcing a second rule as follows ( 276 N.Y. at page 26, 11 N.E.2d at page 337): "Those causes of action, however, which are based merely upon negligence of two of the directors who are not alleged to have participated in the receipt of any wrongful profits at the expense of the corporation, require the application of a different rule. * * * If the remedy were invoked directly by the corporation or a receiver, a common-law action for damages would lie. It would be adequate and, consequently, equitable relief would be unnecessary."

The Court added: "To the extent that an accounting is necessary, the right and the remedy must necessarily be of an equitable nature."

This last observation has caused some bafflement. Thus, in John Dunlop's Sons, Inc., v. Dunlop, 259 App.Div. 233, 18 N.Y.S.2d 818 (affirmed 285 N.Y. 333, 34 N.E.2d 344), which reversed 172 Misc. 66, 14 N.Y.S.2d 452, the Appellate Division, finding no justification for an accounting, held the six year statute applicable, without commenting, however, on the trial court's holding that legal remedy would not have been as "complete, as effective and as adequate as the equitable remedy".

The correct rule would seem to be that the ten year statute is applicable where the law affords an inadequate remedy, whether the basic right sued upon be legal or equitable. This means that in a derivative action if the corporation had an adequate legal remedy, the stockholder — suing for the corporation — would likewise be deemed to have a legal remedy, and the statute to be applied would be the one applicable to the legal action.

As was said in noteworthy Keys v. Leopold, 241 N.Y. 189, 149 N.E. 828, 829: "The mere fact that this is an action for an accounting is not determinative of this question. When a legal and an equitable remedy exist as to the same subject-matter, the latter is under the control of the same statutory bar as the former." But the legal remedy must, as observed, be adequate. Falk v. Hoffman, 233 N.Y. 199, 135 N.E. 243.

Cwerdinski v. Bent, 256 App.Div. 612, 11 N.Y.S.2d 208, affirmed 281 N.Y. 782, 24 N.E.2d 475, relied upon by the defendants as compelling the application of the six year statute hereto, does not, in my opinion, fit this case. Rogers v. Hill, supra [ 289 U.S. 582, 53 S.Ct. 735, 77 L.Ed. 1385, 88 A.L.R. 744], authorizes an "investigation in equity". At law the by-law might be asserted as a defense to excessiveness. In the Cwerdinski case the corporation had an adequate legal remedy for money had and received because the excessive compensation constituted a breach of the express terms of a written contract. Here, however, although the express terms of the written contract (the by-law) grants the full compensation paid, the payments will be scrutinized in equity to determine if waste and spoliation has been committed. In the Cwerdinski case [ 256 App.Div. 612, 11 N.Y.S.2d 210], the first cause of action sought "to compel the parties who were the recipients of the bonuses to return to the corporation the difference between the sums actually received by them and the amounts which should have been paid under the bonus plan". Thus, there the yardstick was circumscribed — it was legal and not plastic — the contract here is more clastic and controlled more by considerations of equity and good conscience than by contract or legal principles.

Certainly, as regards the action for scaling down the bonuses, the ten year statute applies.

As to the action for miscomputation, while the Cwerdinski case presented no "factual complexity * * * such as would require an accounting in a court of equity", this case abounds in factual complexities. "Thus there is clearly no remedy at law comparable to that available in equity (Holland v. Grote, 193 N.Y. 262, 86 N.E. 30), and, therefore, the period of limitation which would bar an action at law does not reduce the period which ordinarily limits a suit in equity. Hanover Fire Ins. Co. v. Morse Dry Dock Repair Co., 270 N.Y. 86, 200 N.E. 589". Hearn 45 St. Corp. v. Jano, 283 N.Y. 139, 145, 27 N.E.2d 814, 817, 128 A.L.R. 1285. In the Dunlop case, too, the legal remedy for money had and received was adequate.

Present here, however, are ingredients absent in the Cwerdinski and Dunlop cases. Of course, if simple overpayment were the only element involved, the six year limitation would control. Davis v. Cohn, 256 App.Div. 905, 9 N.Y.S.2d 881; Frank v. Carlisle, 261 App.Div. 13, 23 N.Y.S.2d 849; Goldstein v. Tri-Continental Corp., 282 N.Y. 21, 24 N.E.2d 728. But equitable considerations attend this case which only equity can appropriately and completely balance and administer.

At all events, virtually the whole of the controversy revolving around the statute of limitations issue has been rendered academic because, first, as to excessive bonuses, the defendants are prevailing, and second, as to miscomputations plaintiffs concede that "no demand is made and no recovery is sought by the plaintiffs herein for any miscomputations or payments in violation of the provisions of the by-law beyond the six year period". Bijur brief, p. 28.

Although I do not by any means deem the question wholly free from doubt, my conclusion is that the ten year statute of limitations applies to the entire case.^_

_ See Contemporary Law Pamphlets, 1941 Series I, number 32. "The New York Statute of Limitations Applicable to Actions in Equity Based on Legal Rights", George A. Spiegelberg, Esq., published by N.Y.U. School of Law.

VII. The Liability of Non-Recipient Directors.

The plaintiffs assert that the non-recipient directors are liable equally with recipient directors for breach of their fiduciary duty in failing to supervise the computations of the Treasurer's Department. The least they should have done, say the plaintiffs, was to employ a firm of outside auditors to check the computations. Epstein v. Schenck,¹ January 20, 1939; Gallin, supra.

1 No opinion for publication.

Generally, of course, directors cannot escape responsibility by pleading disavowal of knowledge of wrongdoing. Walker v. Man, 142 Misc. 277, 253 N.Y.S. 458. Their "obligation is that which ordinarily prudent and diligent men would exercise under the same or similar circumstances * * *. The question of negligence is ultimately one of fact to be determined under all the circumstances in each particular case". Gallin, supra, 152 Misc. at page 685, 273 N.Y.S. at page 94.

"What may be negligence in one case may not be want of ordinary care in another * * *." Briggs v. Spaulding, 141 U.S. 132, 11 S.Ct. 924, 931, 35 L.Ed. 662.

"If nothing has come to the knowledge to awaken suspicion that something is going wrong, ordinary attention to the affairs of the institution is sufficient. If, upon the other hand, directors know, or by the exercise of ordinary care should have known, any facts which would awaken suspicion and put a prudent man on his guard, then a degree of care commensurate with the evil to be avoided is required, and a want of that care makes them responsible". Rankin v. Cooper, 8 Cir., 149 F. 1010, 1013; Kavanaugh v. Kavanaugh Knitting Co., 226 N.Y. 185, 123 N.E. 148; Continental Securities Co. v. Belmont, 206 N.Y. 7, 99 N.E. 138, 51 L.R.A., N.S., 112, Ann.Cas. 1914A, 777; Pollitz v. Wabash R.R. Co., 207 N.Y. 113, 100 N.E. 721.

Applying these general principles to this situation, I am unable to subscribe to the plaintiffs' notion that these non-recipient directors are responsible for the miscomputations of the treasurer. Inasmuch as the by-law empowered the treasurer to make the computations, and made his determination final, inasmuch as the treasurer's computations remained unchallenged for a number of years, inasmuch as the by-law was the creature of the stockholders and not of the directors, and, finally, since the stockholders ratified what the treasurer did, I cannot hold that the non-recipient directors failed to act with reasonable care and prudence. The non-recipient directors had no more reason or occasion for suspecting that the treasurer was overpaying recipient officers than they had for suspecting that any subordinate was being overpaid under a written or verbal contract.

In the Gallin and Epstein cases the directors were charged with the responsibility of administering the incentive compensation plan. Here, it bears reiteration, the stockholders conferred that duty upon the treasurer. As a precaution — to fend such controversies as this litigation mirrors — it would have been prudent to engage independent auditors to check the treasurer's computations, but omission to do so was not, in the circumstances, actionable negligence.

I hold that no cause of action affecting miscomputations has been established against non-recipient directors.

Summary.

To recapitulate:

1. The incentive compensation payments remain undisturbed.

2. The recipient defendants are to restore to the Company $2,018,033.44, representing the total overpayments due to the treasurer's misinterpretation of Article XII. Objections to all other payments as miscomputations are overruled.

3. The defendants here who occupied similar status in the Rogers litigation shall contribute pro rata an additional $150,000 in connection with the legal expenses arising out of that litigation.

4. Neither Hill, Sr., nor Hahn is accountable to the Company for the $250,000 Lord Thomas loan to Sullivan.

5. Ratification by the stockholders has not validated what has been held herein to be wrong.

6. The ten year statute of limitations governs the entire case.

7. Save for the $150,000, specified in item 3, only the recipient officers are liable for the restorations herein ordered.

8. The grand total for which judgment is to be entered is $2,168,033.44, plus such sums calculated to be restored under (q) of II hereof.

The judgment should provide for proper allocations and adjustments in accordance with the amounts received, and counsel should endeavor to agree thereon, as well as on the method and time of payment. Perhaps a plan can be formulated whereby the payments will extend over a period of years, to be deducted from future bonuses or salaries.

This opinion has essayed a coverage — though comparatively brief — of all the points involved. Hence, findings of fact and conclusions of law can easily be dispensed with as unnecessary. This opinion should suffice as a decision. If the parties desire, notwithstanding, to settle findings and conclusions, let them do so on or before June 7, 1941. Otherwise, settle judgment in accordance herewith by such date.

The motions are disposed of as herein indicated, with appropriate exceptions.

Thirty days stay; sixty days to make a case.

Concluding, the Court is exceedingly grateful to counsel for their valuable aid and congenial co-operation. The approximately 2,500 pages of testimony, the legion of exhibits, and more than 500 pages of briefs, give only a modicum of indication of the task they had. This task they have discharged with exceptional fidelity. The case was prepared with rare care, and ably tried and orally argued, and the briefs — on which the Court has drawn freely — were skilful and impressive.

On Rehearing.

Communications from counsel will be treated as informal applications for reargument of several phases of the case.

It is unfortunate that counsel did not confer together, since it is abundantly evident that some of the apparent differences are susceptible of adjustment. I felt, and still feel, that adjustment can be achieved if counsel are less ceremonious about the responsibility for assuming the initiative.

As a prelude to taking up the items concerning which reargument is sought, and responding to counsel's expression of reluctance to burden the Court with these applications, it is perhaps superfluous to state that the aim is to achieve just and correct conclusions. To knowingly commit an injustice or deliberately perpetuate an error is not in consonance with a worthy administration of justice.

The Plaintiffs' Reargument Requests.

1. Excessive incentive compensation.

If the plaintiffs think that the incentive bonus payments were left undisturbed because I deemed the burden of proof on plaintiffs, and that plaintiffs failed to discharge the burden, then plaintiffs have misread or misconceived that part of the opinion. Inasmuch as all the proofs were in, I did not regard the burden of proof as the pivotal point. The issue was decided on the merits, and not because of the technical failure of proof, or the absence of proof which manifestly could not affect the result. All the plaintiffs now say on this segment, was weighed in reaching the finality that the bonus payments would not be trimmed. I still think that the burden of proof was with the plaintiffs. The officers received 10% of the profits under a contract, just as any employee. The stockholders — not the recipient officers — openly and duly fixed the method and amount. This is vastly different "from matters where a fiduciary deals with its cestui at a profit". Blaustein v. Pan American Petroleum Transport Co., 174 Misc. 601, 21 N.Y.S.2d 651, 727. I found for the defendants on this aspect of the case not because of the burden of proof question, but wholly apart from it. Nothing the plaintiffs now say prompts me to recede from the finding.

2. American Cigarette Cigar Co.

The plaintiffs shed no additional light on this point. Of course, "if the Pall Mall lease was executed in bad faith for the purpose of inflating bonuses, a Court of equity will not permit such a device to accomplish its improper objective even though the subsidiary would appear to meet the literal test of the by-law". But, after scrutinizing the conduct of the officers, I was not persuaded, and am not now persuaded, that the Pall Mall lease was executed in bad faith and with an improper design. The main opinion agrees with the plaintiffs that the burden of justification rested upon the defendants. They carried that burden to my satisfaction. The circumstances that in exploiting Pall Mall the "control" basis has been abandoned, does not alter my opinion concerning the causes which animated the original decision. The abandonment, too, was the exercise of business discretion, with which I am loath to disagree because the facts, as I perceive them, do not warrant disagreement.

The Defendants' Reargument Requests.

a. The Statute of Limitations.

Expressing grave doubt as to whether the ten or six year statute of limitations applied, I inclined toward the former, at the same time giving the view that the entire subject was academic inasmuch as no claim went outside or beyond six years. The defendants feel — and not wholly without justification — that the dictum (and it was dictum) that the ten year statute applied to the entire case might seriously affect other pending or future cognate litigation.

Certainly it was not intended to control or affect other litigation — pending, potential, or future. The opinion obviously recognized — as, of course, it was obliged to recognize — the rule of such cases as Dunlop's Sons, Inc. v. Dunlop, 259 App.Div. 233, 18 N.Y.S.2d 818, affirmed, 285 N.Y. 333, 34 N.E.2d 344; Cwerdinski v. Bent, 256 App.Div. 612, 11 N.Y.S.2d 208; Id., 281 N.Y. 782, 24 N.E.2d 475; Davis v. Cohn, 256 App.Div. 905, 9 N.Y.S.2d 881; and Goldstein v. Tri-Continental Corp., 282 N.Y. 21, 24 N.E.2d 728.

Inasmuch, therefore, as the ten year statute was rendered academic, that part of the opinion which held such limitation applicable is recalled.

The plaintiffs' offer to introduce the figures for 1940 is denied.

b. The $150,000 item arising from the Rogers litigation.

This is one of the items concerning which counsel might have conferred. Manifestly, it was not intended that this assessment should fall upon all the defendants equally. Only those now before the Court, and who were before the Court in the Rogers litigation, are to be, or legally could be, affected. But in addition to Hill, Sr., Neiley and Riggio, three others were and are defendants — Boylan, Reuter and Harkrader. Unless the parties agree otherwise, Hill is to contribute 16% of the $150,000, and the remaining five just named, 9% each.

The plaintiffs' theory that the repayment of this $150,000 should be assessed jointly and severally against all of the defendants who knowingly acquiesced in this improper expenditure of corporate funds, is alien to this situation. It is, therefore, rejected. Furthermore, the plaintiffs' suggestion that at the very least, the defendants Hill and Hahn "should be held jointly and severally liable for the full loss of $150,000" is unsound and meritless.

c. Deducting bonus payments as a Company expense.

The Court intended to hold that inasmuch as bonus is part of salary, both should be treated together, in the same way, and both deducted as an expense incurred in operation. Perhaps the addendum that "the participant's own bonus need not be deducted as an expense" will lead to confusion, and, moreover, create a different base, whereas, as defendants suggest, "under the by-law there is plainly to be only one base common to them all".

I cannot subscribe to the defendants' contention that under the by-law profits are defined as "including the sums to be paid as bonus", and that, accordingly, "such sums cannot at the same time be excluded from profits as an operating expense". To repeat: Bonus should be considered a part of compensation, same as salary, and as an operating expense. This is the sum of the ruling.

d. As to the year 1933.

The plaintiffs' "consent that the recovery for the year 1933 shall be limited to the sum of $37,493.90, that being the total bonus paid in that year", should resolve the controversy anent this year.

e. Wix dividends on Tobacco Company stock.

The defendants are correct in stating that in calculating the controversial Wix earnings, the dividends received by Wix on shares of American Tobacco stock owned by it, were excluded. Therefore subdivision g of the main opinion is so revised as to eliminate the $11,469.33 item. The reason for this revision is found in subdivision f. Thus, g will be compatible with f.

f. Interest.

In the circumstances, no interest prior to the entry of judgment will be allowed.

g. Deferred payments.

Here again, the desirability of a conference among the attorneys is demonstrated. The Court suggested that the payments required to be made under the judgment, extend "over a period of years, to be deducted from future bonuses or salaries". But, in the absence of agreement, the Court's power to defer payment beyond thirty days is extremely doubtful. Sec. 614, Civil Practice Act.

The other figures in the main opinion are revised to conform hereto. All figures subject to verification.

Once more, the parties are entreated to make an earnest effort to compose such differences as are susceptible of co-operative adjustment.

All papers must be in by June 20, 1941.