Pollitz v. Wabash R.R. Co.

Collin, J.

The action is in behalf of the plaintiff and all other stockholders of the defendant company similarly situated against the company and five of its directors. Each defendant separately answered' the complaint and each answer contained six or more separate defenses. The plaintiff demurred to each separate defense. The Special Term sustained the demurrers as to certain and overruled them as to other separate defenses contained in the answer of the defendants except it sustained them as to all the separate defenses contained in the answer of defendant Hubbard. The Appellate Division, upon the appeals of the plaintiff and defendants, modified the interlocutory judgment of the Special Term by overruling the demurrers as to certain separate defenses which the Special Term condemned. The Appellate Division allowed the plaintiff to appeal to this court and certified the following questions:

“1. Are the second separate and distinct defenses contained in the separate answers of the defendants The Wabash Railroad Company and Henry K. McHarg and the first separate and distinct defenses contained in the separate answers of the defendants Winslow S. Pierce, Thomas II. Hubbard, George J. Gould and John T. Terry, or any of them, sufficient in law upon the face thereof?

“2.

Are the third separate and distinct defense contained in the separate answer of the defendant the Wabash Railroad Company, the third and fourth separate defenses contained in the answer of the defendant Henry K. McHarg, and the second separate and distinct defense contained in the separate answers of the defendants Wins-low S. Pierce, George J. Gould and John T. Terry, or any of them, sufficient in law upon the face thereof ?

*121 “ 3. Are the fourth separate and distinct defense contained in the answer of the defendant the Wabash Railroad Company, the sixth separate defense contained in the answer of the defendant Henry K. McHarg and the third separate and distinct defenses contained in the separate answers of the defendants Winslow S. Pierce, George J. Gould and John T. Terry, or any of them, sufficent in law upon the face thereof % ”

The Appellate Division allowed the defendant Hubbard to appeal to this court and certified the following question: “Is the second separate and distinct defense contained in the separate answer of the defendant Hubbard sufficient in law upon the face thereof ? ”

The complaint alleges, in substance: The plaintiff since June, 1906, has been a stockholder in the defendant company, which was incorporated under the laws of the states of Ohio, Indiana, Michigan, Illinois and Missouri. The defendants George J. Gould, Hubbard, Terry, Pierce and McHarg, with other named parties, constituted a majority of and dominated its board of directors during the years 1903 and 1901. About August, 1901, a prearranged transaction was consummated, as follows: The individual defendants caused the issue to the WabashPittsburg Terminal Railway Company, a corporation (hereinafter designated Pittsburg Company), the directorate of which was controlled by them, of $10,000,000 par value of its common stock in exchange for a like amount of the common stock of the Pittsburg Company. The Pittsburg Company delivered to a syndicate of which some or all of the individual defendants were members $13,100,000 of its first mortgage bonds and $20,000,000 of its second mortgage bonds, par value, and the $10,000,000 of Wabash stock for the consideration of $20,000,000. At that time the bonds were worth and were actually selling in the open market at prices which aggregated about $22,000,000 and the $10,000,000 of Wabash stock was issued to the syndicate as a donation.

*122 The Wabash stock was marketable and valuable; the Pittsburg Company stock was valueless. The complaint alleges that the transaction was a violation of the duties and obligations of the defendants as trustees and of their fiduciary relations to the said defendant corporation and its stockholders, a fraud upon them, unauthorized by law, and ultra vires of the company. It contains excerpts from the existing constitutions or statutes of the incorporating states, in differing phraseology, to the effect that a corporation shall not issue stock or bonds except for money paid, labor done or property actually received and that all fictitious increase of stock or indebtedness shall be void, and alleges that the transaction was in violation thereof; that the $10,000,000 of Wabash stock has been dealt in and become so commingled that it would be impossible to follow it, or distinguish it from other outstanding stock of the company; that the request of the plaintiff to the company to institute this action, made on or about December 29, 1909, was refused; and prays judgment that the defendant company have judgment against the individual defendants for $10,000,000 with interest and that they be compelled to account to the company for their official conduct as officers or directors during the period, and pay to the company the loss it sustained as a result of the wrongful and illegal transactions set forth.

The pith of the action is that the defendant directors caused the company to donate to themselves $10,000,009 or thereabouts of its stock. The plaintiff in his brief denominates it “ a stockholder’s suit brought in behalf of the Wabash Railroad Company against its directors to compel them to account for losses sustained by the corporation through a fraudulent issue of stock of the company for worthless- securities; ” again he says:

“ It is well settled that in any event an action such as is stated in the complaint may be brought in equity by a stockholder on behalf of the corporation, if the corporation refuses to *123 sue. ” The complaint sustains his characterization of the action as equitable, in that it alleges the violation of fiduciary obligations and prays for an accounting.

(Bell v. Merrifield, 109 N. Y. 202 .) The action is in equity.

The defendants, other than McHarg, heretofore moved for judgment on the pleadings and were defeated.

(Pollitz v. Gould, 202 N. Y. 11 .) The defendant McHarg, unhampered by such prior decision to which he was not a party and invoking the rule that the demurrer to an affirmative defense enables the answering defendant to question the sufficiency of the complaint (Baxter v. McDonnell, 154 N. Y. 432 ), urges that the complaint does not state facts sufficient to constitute a cause of action. His counsel asserts that the stockholders of a corporation may ratify any transaction executed by its board of directors which is not ultra vires of the corporation or a fraud upon the corporation or the minority stockholders; that the transaction alleged was neither ultra vires nor fraudulent; it may, therefore, he urges, be accepted by the stockholders through a majority, and the minority stockholders cannot act for the corporation and cannot maintain this action to repudiate or otherwise question it. The transaction, he asserts, must stand until a repudiation by the corporation or majority stockholders, which must be alleged.

Inasmuch as this appeal requires the consideration of the allegations of the pleadings and not of the facts to be proven under and which may differ from them, it is neither wise nor useful that we should discuss propositions of law or fact not essential to the determinations sought by the questions certified. The proposition that the minority stockholders may not by this action question the acts of the directors, in the absence of the repudiation of them by the majority, rests, avowedly and through principle, upon the claimed facts that the transaction was not ultra vires of the company, or was not fraudulent as to the corporation and, through its effect upon the cor *124 poration, as to the minority stockholders. We think, however, that the facts alleged constructed a fraud as to them. The individual defendants, as directors, occupied the relation of trustees to the corporation and its stockholders, and the obligations of this trusteeship are the basis of ascertaining whether or not their acts, as alleged, were fraudulent. They were the exclusive executive representatives of the corporation and were charged with the administration of its internal affairs and the management and use of its assets. Their corporate acts, within the powers of the corporation, in the lawful and legitimate furtherance of its purposes, in good faith and the exercise of an honest judgment, are valid and conclude the corporation and the stockholders, Questions of policy of management, expediency of contracts or action, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left. solely to their honest and unselfish decision, for their powers therein are without limitation and free from restraint, and the exercise of them for the common and general interests of the corporation may not be questioned, although the results show that what they did was unwise or inexpedient. It is, however, the inflexible rule that they cannot exercise the corporate powers for their private or personal advantage or gain. The law stringently and rigorously forbids to them the use or disposition of the funds or assets of the corporation for their individual enterprises or acquisition, and for any misfeasance or breach of duty or trust resulting in damage to the corporation they are subject to be called to account by the corporation in the appropriate action. These principles, based upon a sound public policy and morality, are so firmly fixed in our jurisprudence that they are not open to discussion and so familiar that authorities declaring them need not be cited.

The issue of the shares of the Wabash Company stock by the individual defendants, as alleged, affected injuriously *125 the interests of the company and the stockholders. It destroyed the potential ability of the corporation to secure, in cash, their value through their future sale or deprived it of the moneys which the sale thereof in the market at that time would have brought. It diminished the proportionate voting power of the outstanding stock and the interests of its holders in the amounts to be declared as dividends and the net assets of the company. The allegations are that the stock then was “of very great actual value” and “could readily have been sold for a very great sum in actual cash.” We must accept the facts as alleged in the complaint with the supporting reasonable and probable inferences, although the statement of them may be partial or perverted. Those facts tend to show, as stated, that the individual defendants, pursuant to a scheme devised by them, caused the shares of stock to be issued and a large part of them delivered to them, through an indirect and circuitous channel upon a consideration grossly inadequate, if not wholly valueless. There is neither allegation nor permissible inference that the stock issued to the Wabash Company gave to it the majority stock or the control of the affairs of the Pittsburg Company, or that the Pittsburg Company owned lines of railroad extending into the city of Pittsburg and other important business centers and that the Wabash Company desired the stock for the purpose of controlling and operating the lines of railroad of the Pittsburg Company in conjunction with its own lines, as the counsel attacking the complaint argues. While we may judicially take cognizance that Pittsburg is a great city, having industrial establishments of perhaps unparalleled magnitude and importance and enormous quantities of freight for shipment, we cannot judicially know, in the absence of their averment by the complaint, that the facts are as counsel argues. The allegations of fact create a cause of action against the individual defendants in that they, as directors, caused to be issued and *126 delivered to themselves without consideration and misappropriated the shares of stock and therein worked a fraud upon the corporation and its stockholders.

We now turn to the defenses specified in the questions certified. The defenses referred to in the first question certified are substantially or in their material features identical (with an exception hereinafter adverted to) and for the purposes of the present consideration are sufficiently stated as follows: They aver anew and independently of the allegations of the complaint the transactions between the syndicate, the Wabash Company and the Pittsburg Company. They allege as facts that the Pittsburg Company owned and controlled extensive lines of railroad; that its entire capital stock was the $10,000,000 delivered to the Wabash Company and in other facts differ from or add to those of the complaint. They allege that the transaction in its entirety was submitted to and fully considered by the board of directors of the Wabash Company and by direct averment or reasonable inference that the directors acted in good faith and according to their best judgment for the interests of the Wabash Company; that the stock of the Pittsburg Company was equal in value to the stock of the Wabash Company and that the directors violated no duty or committed no breach of trust although the board of directors and the syndicate had members in common. That at a meeting of the stockholders in October, 1904, at which the holders of more than seventy-nine per cent of the stock and seventy-three per cent of the debenture bonds were present or represented the acts of the directors as set forth in those defenses were fully made known and a resolution was thereupon adopted by the unanimous vote of all those stockholders and bondholders approving and confirming them. The counsel for the plaintiff asserts that the facts alleged in these defenses do not constitute a defense.

The transaction set forth in these defenses and by them alleged to have been ratified was neither ultra vires of *127 nor fraudulent as to the Wabash Company. The trans-' action presented by the complaint could not be ratified by a mere majority of the stockholders because it was fraudulent. The direct or indirect misappropriation of assets of the corporation to his own use or benefit by an officer is incapable of being authorized or ratified by a vote or any act or omission of the majority of the stockholders.

(Continental Securities Co.

v. Belmont, 206 N. Y. 7 ;

von Arnim v. American Tube Works, 188 Mass. 515 ;

Russell v. Patterson Co., 232 Penn. St. 113.) The transaction approved and confirmed by the majority of the stockholders, as the defenses allege, was not fraudulent. It was irregular and unlawful because the Wabash Company and the syndicate had members in common. But being intra vires and fair, candid and reasonable, under the allegations of the defenses, it was voidable, not void, and was subject to repudiation or ratification by a duly had vote of the majority of the stockholders. It is true that the corporate powers are vested in and are to be exercised by the board of directors who cannot be controlled by the stockholders in the reasonable and honest exercise and performance of their duties. In the present case the directors, in the exercise of corporate power, issued the stock and executed the transaction. The vice therein was that it violated the rule that directors cannot lawfully enter into a contract in the benefit of which they or one or more of them participate without the knowledge and consent of the stockholders. While the stockholders had not the power or the right to initiate and carry through the transaction or substitute other action in its place, they could say whether or not the corporation would take cognizance of the breach of trust and repudiate the transaction as to the directors and hold them liable for the damage caused. Equity, at least, recognizes the truth that the stockholders are the proprietors of the corporate interests and are ultimately the only beneficiaries thereof and the remedies given the corpora *128 tion are really, though indirectly, for the protection of their rights. They may at each authorized election entirely change the directorate and may at any time keep the directors within the line of faithful administration by an appeal to a court of equity or repudiate their acts which are intra vires of them, but voidable. In case the defendants establish, under the defenses, that the entire proceeding was conducted in good faith and in furtherance of the purposes of and with fairness to the Wabash Company, its result was voidable, not void, and could have been ratified by the stockholders through a duly had majority vote.

(Skinner v. Smith, 134 N. Y. 240 ;

Continental Ins. Co.

v. N. Y. & H. R. R. Co., 187 N. Y.

225, 238; Continental Securities Co.

v. Belmont, 206 N. Y.

7; Hart v. Ogdensburg & L. C. R. R. Co., 89 Hun, 316 ;

Kelley v. Newburyport & A. H. R. R. Co., 141 Mass. 496 ;

Wallace v. Long Island R. R. Co., 12 Hun, 460 ;

Russell v. Patterson Co., 232 Penn. St. 113;

San Diego, Old Town & Pacific Beach R. R. Co.

v. Pacific Beach Co., 112 Cal. 53 .)

The counsel for the plaintiff asserts that the defenses now being considered, other than those in the answers of McHarg and Hubbard, do not aver that the pecuniary interest of the individual defendants in the transaction, arising through their membership in the syndicate was made known to the stockholders at the meeting of October, 1904. All the facts reasonable and fairly inferable from the express allegations are to be deemed averred. They allege that there was submitted for inspection at the meeting the proposition of May, 1904, of the syndicate to the board of directors for the issue of the stock. The proposition involved a matter of magnitude. The syndicate was neither a corporation nor a partnership. The inference that the proposition disclosed those who were making the proposition and were to participate in the matter is reasonable.

The defenses referred to in the second question certified *129 are likewise substantially identical and allege in sufficient form and in effect that all the stockholders of the Wabash Company, including the plaintiff, had, prior to the commencement of the action, acquiesced in the transaction as averred in the defenses referred to in the first question certified.

Acquiescence as a defense has, speaking generally, a dual nature. It may, upon the one hand, rest upon the principle of ratification, and may be denominated implied ratification, or it may, upon the other hand, rest upon the principle of estoppel, and may be denominated equitable estoppel. The former principle underlies it when the conduct of a plaintiff, relating to the transaction or matter complained of by him, subsequent to the rise of it, justifies and supports the normal and reasonable conclusion that he, by his assent thereto or acquiescence therein, has accepted and adopted it. His ratification is implied through his acquiescence instead of expressed by positive and distinct action or language.

(Arnot v. Union Salt Co., 186 N. Y. 501 ;

San Diego, O. T. & D. B. R. R. Co.

v. Pacific Beach Co., 112 Cal. 53 .) The latter principle underlies it when a plaintiff against whom it is invoked remained silent or inactive when there was the opportunity and the duty to speak or act.

(Rothschild v. Title Guarantee & Trust Co., 204 N. Y. 458 ;

Sheldon H. B. Co.

v. Eickemeyer H. B. M. Co., 90 N. Y. 607 .) The substantive facts alleged in the defenses under consideration are those alleged in the defenses referred to in the first question certified, and may in case the proof upon the trial fails to establish express ratification, constitute acquiescence in and the adoption of the transaction, although they do not constitute an equitable estoppel between the Wabash Company and the individual defendants. The arguments of the plaintiff’s counsel against the sufficiency of the defenses are met by what has been said in regard to the defense of ratification.

The defense alleged in the defenses referred to in the *130 third question certified is that the plaintiff has been guilty of such laches that he is not entitled to maintain the action or have relief from the court. The counsel for the plaintiff argues that the defense is not properly or sufficiently pleaded. We hold the contrary. Knowledge on the part of the plaintiff of the essential facts constituting the alleged wrong, the opportunity for seeking and enforcing the remedy and prolonged delay in doing so, are shown.

Laches, however, is not a bar to the cause of action alleged. The plaintiff, in behalf of the corporation, is seeking to enforce in equity a legal right, to wit, the right of the corporation to recover from the individual defendants the damages resulting from their misuse of its assets. The favor or the discretion of the court is not appealed to, as was the fact in Groesbeck v. Morgan ( 206 N. Y. 385 ) which was an action for specific performance by a vendee against the vendor wherein we held that laches was a defense independent of the statute of limitations. In the present case resort is had to equitable jurisdiction for the purpose of ascertaining through an accounting the sum of damages. In Coit v. Campbell ( 82 N. Y. 509, 514 ) Judge Rapallo, writing for the court, said: “It is a well-established principle of equity, that where there is a discretion to bar a right on the ground of delay, the courts will, in the exercise of that discretion, use the Statute of Limitations as a rule to guide their action. (Mitford’s Equity Pleadings, 293, 318.) Of course, this principle applies only to cases where the relief asked relates t.o a matter of right, and not to applications to the favor of the court, or for its indulgence in cases of default or excusable neglect. These cases are purely discretionary, and any loches which may to the courts seem sufficient, is cause for denying relief.” The alleged cause of action is barred by the statute of limitations applicable to it, and not by laches.

(Coil v. Campbell, 82 N. Y. 509 ;

Brinckerhoff v. Bostwick, 99 N. Y. 185 .)

*131 The question certified in the order permitting the defendant Hubbard to appeal requires the further determination as to whether he has sufficiently pleaded the defense of ratification. The defense, as pleaded, alleges the facts constituting the transaction between the Wabash Company, the Pittsburg Company and the syndicate (which thereunder was voidable, not fraudulent), the ratification of the acts of the directors at the stockholders’ meeting of October, 1904, and that subsequent to those matters “ the plaintiff with full knowledge thereof ratified and confirmed the same.” The plaintiff asserts that “to say merely that a person has ratified is to allege a general conclusion which the pleader draws from undisclosed facts or inferences.” Ratification is a conclusion of fact and not a conclusion of law. The evidence or the facts establishing a fact entering into a cause of action or a defense need not be pleaded. The defense is, therefore, sufficiently pleaded.

(Carter v. Pomeroy, 30 Ind. 438 .)

The order should be modified by sustaining the demurrers of the plaintiff to each of the defenses mentioned in the third question certified, and by overruling the demurrer of the plaintiff to the second separate and distinct defense contained in the separate answer of the defendant Hubbard, and as so modified affirmed, without costs to any party. The questions should be answered: Each of the defenses named in the first and second questions certified and the defense in the question certified upon the appeal of the defendant Hubbard is sufficient in law upon the face thereof. Each of the defenses named in the third question certified is insufficient in law upon the face thereof.