noting that in the context of derivative actions, the demand requirement refers to an allegation that “the corporation, on being applied to, refused to prosecute,” and finding plaintiff's demand inadequate where he merely sought payment “of what he deemed he was entitled to, or of a distribution among the stockholders of what he deemed they were entitled to,” because those demands “could have been complied with ... without the bringing of an action”Summary of this case from Cordts-Auth v. Crunk, LLC
Argued March 16, 1899
Decided April 18, 1899
Augustus Van Wyck and James C. Church for appellant. William C. De Witt and William C. Trull for the Brooklyn City Railroad Company, respondent. Julien T. Davies, Charles Francis Stone, William F. Sheehan, Charles A. Collin and Herbert Barry for the Brooklyn Heights Railroad Company, respondent.
For the purpose of this appeal such facts as could properly have been proved under the allegations of the complaint, when supported by reasonable implication and fair intendment, must be accepted as true, and, in connection with the admissions made upon the opening, must be treated as the facts of the case upon which the rights of the parties depend. ( Marie v. Garrison, 83 N.Y. 14; Kley v. Healy, 127 N.Y. 555; Sage v. Culver, 147 N.Y. 241, 245.) The question of primary importance is whether those facts constitute a cause of action against the defendants upon the merits, although due regard must be paid to any technical deficiencies that may exist.
The case presented upon the merits is that of a stockholder in a successful, dividend-paying corporation, with large assets and good prospects, who was compelled by the vote of the directors and the other stockholders, induced by fraud, to surrender a part of his interest in the corporate assets represented by his stock, without any real consideration. The stock owned by the plaintiff made him the equitable owner of an undivided fractional part of the entire assets of the company. ( Burrall v. Bushwick R.R. Co., 75 N.Y. 211, 216; Jermain v. Lake Shore M.S.R. Co., 91 N.Y. 483, 492.)
By the lease he was forced to part with one-tenth of his interest without a corresponding advantage. The lessor company in which he was interested transferred all its rights and property to an irresponsible lessee, with inadequate security, for the privilege of buying back a part only of that property and paying a premium therefor. Leaving out of view for the present the security furnished, and we have the lessor parting with all it had for the right to buy back nine-tenths thereof and pay over $4,000,000 for the bargain. The stockholders got nothing except a part of their own property and paid heavily for the privilege. They parted with property of immense value for stock in a traction company with no assets and without a dollar of paid-up capital, and in addition were compelled to pay $15 for every share given them. The syndicate on the other hand paid nothing for their shares of the par value of $3,000,000, except $15 a share, which every stockholder of the lessor had to pay, in addition to parting with his interest in a paying corporation with $30,000,000 worth of property. The profits of the syndicate in the transaction itself were over $2,000,000, and its prospective profits were nearly $500,000 a year. A solvent and powerful lessor gave every thing it had to an insolvent and weak lessee, and received in payment a part of its own property, paying a premium even for that right. There was no substance to any of the three companies except what was furnished by the lessor, and the scheme, in effect, was to divide up its property and donate a part of it to the syndicate. There was no exchange of properties, but simply a division of the substantial property owned by the lessor. The lessee contributed nothing and the syndicate contributed nothing, except as it paid $15 a share for the stock of the traction company, the same as the stockholders of the lessor were compelled to do. The scheme did not involve a consolidation of two valuable properties, which, by uniting, would be able to earn more at less expense, but it involved a surrender by the lessor of part of its own with nothing to speak of in return. The little railroad, with nominal assets, swallowed the big railroad with assets exceeding $30,000,000, and the traction company, with no assets whatever, swallowed both, and it is claimed that this scheme is not fraudulent as to a protesting stockholder of the road making the sacrifice. None of the three corporations involved had anything to lose except the lessor. One of them had nothing whatever, and another had so little that it is not worth mentioning in comparison with the splendid property successfully managed and paying a great profit that belonged to the lessor. The sham traction company, with no assets whatever, and the dummy lessee, with but trifling assets, had no substance except what they sucked as parasites from the lessor. The traction company got its first assets in the $15 a share paid for its stock by the stockholders of the lessor, and the traction company's promoters got $3,000,000 for $450,000.
But, it is said, the stockholders of the lessor get ten per cent dividends guaranteed and secured for all time in place of the eight per cent they had before. What do they get it out of? Their own property, capable as we must assume of paying fifteen per cent instead of ten. Now we come to the only value furnished by the syndicate, and that is security for the payment of the ten per cent dividends by the deposit of $4,000,000. How long will that last under unsuccessful or dishonest management by trustees incompetent or willing to wreck in order to make money? Security is furnished for less than five years' rental on a lease for nine hundred and ninety-nine years. While the amount of the security seems large in one sense, in fact it is small when the magnitude of the risk is considered. The syndicate received over two and one-half millions of dollars for furnishing a guaranty that a road capable of earning and paying dividends of fifteen per cent would pay dividends of ten per cent. Moreover, the syndicate did not furnish any security whatever except in form, for the substance came from the stockholders of the lessor through their subscriptions to the capital stock of the traction company. The guaranty fund was four millions of dollars, but the subscriptions of the stockholders to the stock of the traction company was more than four millions of dollars. The stockholders of the lessor, therefore, furnished a larger fund than was required for the deposit with the guaranty company, and that this fund was the source of that deposit might have been proved upon the trial under the facts alleged. The syndicate furnished nothing and risked nothing, and its enormous profits were simply contributed by the stockholders of the lessor, the contribution of the plaintiff having been extorted by a two-thirds vote. The scheme in its final analysis took something for nothing, and if not fraudulent upon its face as to a non-assenting stockholder, was fraudulent under the allegations of the complaint.
It is distinctly alleged that the scheme of leasing the road was unlawful, and that the intent and effect thereof on the part of the stockholders of the lessor, who designed, approved and carried the same into effect, was to injure and defraud the stockholders of that company. The motive and object of the stockholders who approved the lease by their votes are charged to have been furtive and evil, and the effect of their action injurious and fraudulent. The method of accomplishing the fraud was set forth, and the complaint, which was amplified somewhat by the opening, asserted that the syndicate, composed in part of directors of the lessor, and in control of both lessor and lessee when the lease was made, devised and executed a plan to take away property of the stockholders and give it to third persons. While the complaint is not as definite as it might be, so far as appears, there was no motion made by the defendants to make it more definite or certain. No bill of particulars was called for, nor was further information sought by any of the methods authorized by the settled practice. When a party goes to trial upon a loose pleading without any effort to have it made more definite, he can make no lawful complaint if under the general allegations all facts fairly covered thereby are admitted in evidence against him. We think that under the allegations of the complaint before us every fact bearing upon the intention of the stockholders who approved the lease to defraud the minority stockholders could have properly been received.
As a general rule courts have nothing to do with the internal management of business corporations. Whatever may lawfully be done by the directors or stockholders, acting through majorities prescribed by law, must of necessity be submitted to by the minority, for corporations can be conducted upon no other basis. All questions within the scope of the corporate powers which relate to the policy of administration, to the expediency of proposed measures, or to the consideration of contracts, provided it is not so grossly inadequate as to be evidence of fraud, are beyond the province of the courts. The minority directors or stockholders cannot come into court upon allegations of a want of judgment or lack of efficiency on the part of the majority and change the course of administration. Corporate elections furnish the only remedy for internal dissensions, as the majority must rule so long as it keeps within the powers conferred by the charter.
To these general rules, however, there are some exceptions, and the most important is that founded on fraud. While courts cannot compel directors or stockholders, proceeding by the vote of a majority, to act wisely, they can compel them to act honestly, or undo their work if they act otherwise. Where a majority of the directors, or stockholders, or both, acting in bad faith, carry into effect a scheme which, even if lawful upon its face, is intended to circumvent the minority stockholders and defraud them out of their legal rights, the courts interfere and remedy the wrong. Action on the part of directors or stockholders, pursuant to a fraudulent scheme designed to injure the other stockholders, will sustain an action by the corporation, or, if it refuses to act, by a stockholder in its stead for the benefit of all the injured stockholders. ( Leslie v. Lorillard, 110 N.Y. 519, 535; Gamble v. Queens County Water Co., 123 N.Y. 91; Sage v. Culver, 147 N.Y. 245; Farmers' Loan Trust Co. v. N.Y. N. Ry. Co., 150 N.Y. 410; Hawes v. Oakland, 104 U.S. 450.) When a contract founded in fraud is executed by the directors with a third party upon the express approval of a required number of stockholders, with the intention on the part of all concerned to defraud the non-assenting stockholders, and the scheme will naturally result in serious injury to them or to the corporation, a court of equity will set aside the fraudulent transaction and compel the delinquent parties to account. Such is the case before us as we interpret the complaint.
The right of action, however, belongs to the corporation, and should be brought by it as plaintiff, but when it will not bring the suit itself, an aggrieved stockholder, after due demand and a refusal, or unreasonable neglect to proceed, may bring it in his own name upon making the corporation a party defendant. ( Greaves v. Gauge, 69 N.Y. 154.) Such an action is not for the benefit of the plaintiff alone, but is representative in character and for the benefit of himself and all other stockholders similarly situated. In the case last cited it was held that, when a stockholder brings an action of the kind under consideration, the complaint should allege that the corporation, on being applied to, refused to prosecute, and that this averment constitutes an essential element of the cause of action. The complaint before us does not set forth a demand that the corporation should bring an action to annul the lease. The plaintiff alleges that, as a stockholder of the Brooklyn City Railroad Company, he demanded his share of the proceeds of operating the road over and above the ten per cent paid to him under the lease; that he notified the directors and officers that the lease was unlawful and injured the stockholders, and demanded a distribution among them of all the profits and receipts arising from the operation of the road without regard to the lease. He follows this with the further allegation that such distribution necessarily involved such action on the part of the officers and directors as would effect the annulling of the lease. This did not meet the requirements of the situation, because no demand was made that the corporation bring an action to annul the lease. The demand was either of a payment to the plaintiff of what he deemed he was entitled to, or of a distribution among the stockholders of what he deemed they were entitled to. These demands might have been complied with simply by the payment of money without the bringing of an action. They were not necessarily inconsistent with the continuance of the lease. He was not entitled to what he demanded, and he made no demand of what he was entitled to. Non constat if he had made a proper demand this action would have been unnecessary, as the corporation would have done its duty by suing to annul the lease, for it does not appear that it is still under such control as to make a demand useless, as held in Sage v. Culver ( supra). The averments relating to the subject of demand are not aided by the allegation that the distribution demanded involved such action as would effect the annulling of the lease, for that was not a fact, but an argument or legal conclusion which does not warrant the introduction of evidence.
We agree with the learned judges of the Appellate Division that the demand was insufficient to meet the requirements of law and for that reason we affirm their judgment.
All concur (PARKER, Ch. J., BARTLETT and HAIGHT, JJ., on the ground that the demand to bring the action was insufficient to meet the requirements of the law), except GRAY. J., not sitting.
Judgment affirmed, with costs.