Case ID: ny-st-rep_47/html/0528-01.html
Source: Caselaw Access Project
Author: {"author": "Follett, Ch. J.", "license": "Public Domain", "url": "https://static.case.law/"}
Date Created: 2024-08-24T03:29:51.129683

Charles E. Skinner, Trustee, App’lt, v. Warren B. Smith et al., Resp’ts.
    
    
      (Court of Appeals, Second Division,
    
    
      Filed October 1, 1892.)
    
    1. Mabufactubing- cobpobatiobs— Tbabsactiobs of tbustees with THEMSELVES.
    The rule that a contract entered into by the trustees of a corporation with themselves, or a transfer of its property to themselves may he set aside, is not broad enough to condemn as void all contracts and transfers executed by a purely private business corporation with or to its trustees in good faith, in case no public or private interest is harmed thereby. Such contracts are not void,but voidable at the election of those who are affected by the fraud.
    
      % Same.
    The individual defendants, being the owners of a patent upon carpet looms, formed a company under the manufacturing act for the purpose of collecting and distributing the royalties, with a nominal capital of §40,000, for which stock was issued to them. Two yéars after defendants concluded to engage in the manufacture of carpets themselves, and retransferred the patent to themselves individually, giving their note for §40,000 increased the capital stock to §600,000, all of which was issued to them, they being credited with $40,000 for the retransfer of the patent, $210,000 to be paid in cash and §350,000 for an unlimited license to the corporation to use the patents upon payment of twenty cents royalty per yard. Held, that the plaintiff as a trustee with knowledge of the whole transaction had no cause of action in favor of himself or any shareholder because neither he nor they have any grievance to .redress.
    •3. Same—Discontinuance.
    A manufacturing company has the right to discontinue its operations when they have become unprofitable for the purpose of protecting shareholders from further loss.
    Appeal from a judgment of the general term of the supreme court of the second department, affirming a judgment dismissing a complaint on *the merits, which was entered on the decision of a special term.
    
      Theron G. Strong, for app’lt; Joseph H. Choate, for resp’ts.
    
      
       Affirming 31 St. Rep., 448.
    
   Follett, Ch. J.

—This action was brought by a trustee of The Smith Moquette Loom Company, pursuant to §§ 1781 and 1782 of the Code of Civil Procedure (which authorize, actions against the officers of corporations, but not against corporations), to set aside alienations of property made or "authorized by the individual defendants to themselves, who were at the time a majority of the trustees of the corporation, and also to compel them to account for all sums and property received under such alienations.

Before considering the facts of this case, it will be well to bring to mind and state one or two of the well settled general rules of law applicable to actions of this class.

A contract entered into by a corporation by the authority or direction of its trustees with, themselves and for their benefit, or a transfer of its property by the authority of the trustees to themselves, may be set aside in case it injures any public interest, or the private interest of any shareholder or creditor, even though the contract or transfer was executed in good faith by the trustees. Duncomb v. N. Y., H. & N. R. R. Co., 84 N. Y., 190. But this rule is not broad enough to condemn as void, on the ground of public policy, all contracts and transfers executed by a purely private business corporation, with or to'its trustees, in good faith, in case no public or private interest is harmed thereby. Such contracts are not void, but voidable at the election of those who are affected by the fraud. Twin-Lick Oil Co. v. Marbury, 91 U. S., 587-589; Thomas v. Brownville, etc., R. R. Co., 109 id., 522-524; Risley v. Indianapolis, B. & W. R. R. Co., 62 N. Y., 240; Barnes v. Brown, 80 id., 527-536; Munson v. S., G. & C. R. R. Co., 103 id., 58-73; 3 St. Rep., 31; Barr v. N. Y., L. R. & W. R. R. Co., 125 N. Y., 263-277; 34 St. Rep., 743.

Whether an action against trustees to prevent them from violating a public duty or to redress a public wrong can be maintained by any party other than “by the attorney general in behalf of the People of the state need not now be determined, for this action is not for the prevention or redress of a public wrong, but for damages for the violation of private rights. The public wrongs mentioned in the third and fourth subdivisions of § 1781 can be prevented or redressed only by an action brought in behalf of the People. Code Civ. Pro., § 1782.

What private interest was injured or imperiled by the transfer of the patent from the corporation to the individual defendants ? Creditors were not injured by the acts complained of, for there were none, so far as the record shows, between the time when the corporation was organized and the date when this action was begun, except as the individual defendants became such by reason of advances made. The only private rights or interest alleged to have been impaired or jeopardized are those of share holders. Who were the share holders, and when and how did they become such ?

January 16, 1877, letters patent numbered 186,374, werq issued by the United States to Alexander Smith, for an improvement in carpet looms, which was assigned on December 12, 1878, by his executors, to the following named persons, and in the following proportions : One-half to Warren B. Smith, one-fourth tq William F. Cochran and one-fourth to Eva S. Cochran, which assignments were duly recorded in the United States patent office December 14, 1878. Warren B. Smith and Eva S. Cochran are brother and sister, the children of Alexander Smith, and William F. Cochran is the husband of said Eva S. Cochran.

December 13, 1878, The Smith Moquette Loom Company was incorporated pursuant to chapter 40 ofxthe Laws of 1848, and the acts amendatory thereof and supplementary thereto, with a capital stock of $40,000 divided into four hundred shares of the par value of $100 each. The purpose of the formation of the corporation was stated in the certificate as follows: “ That the objects for which the said company is formed are the manufacture and selling of carpets, and transacting of all business necessary for and incident to the manufacture and sale of carpets and the development and introduction of the Smith Moquette Loom, and other inventions relating to the manufacture of carpets, and the issuing licenses and collecting royalties for the use of such inventions.”

December 24, 1878, said three assignees of said patent assigned their interests therein to The Smith Moquette Loom Company, in consideration of, and in payment for, the above mentioned shares of stock issued by that corporation to them. January 20, 1879, these assignments were duly recorded in the United States Patent office. These assignments were subject to a license granted February 1, 1877, by the original patentee, Alexander Smith, to Alexander Smith Son’s Carpet Company, by which that company acquired the right to use 100 looms upon the payment of twenty cents royalty for every yard of carpet made on them.

Upon the organization of the corporation, Warren B. Smith became the owner of two hundred shares of its stock, William F. Cochran and Eva S. Cochran of one hundred shares each, which they continued to own until November 18th, 1880, when the capital stock of the corporation was increased to $600,000..

The court found in respect to the transfer from the individual defendants to the corporation as follows : “ That the original transfer of the invention and patent by the individual defendants to the company for forty thousand dollars was made by them without any regard to its actual value, which was many times greater than the sum, and solely as a convenient mode of holding and enjoying title to the same, and to the royalties to be derived therefrom for their exclusive benefit as the sole owners thereof.”

“ Eighth.—That the said defendants, Warren B. Smith, William F. Cochran and Eva S. Cochran, being the sole stockholders and trustees of said company, carried on the business of said company until the fall of 1880 upon the original plan, to wit: the collection of royalties under licenses issued under said patent, during which period a large amount of royalties was collected and divided between them, and that during such period no manufacturing was carried on by said company.”

Ninth. That in the fall of 1880 the demand for Moquette carpets was large and the future prospects of manufacturing were encouraging, and the said defendants concluded that it would be advantageous for them that said company should engage in such manufacturing business, and, as they were unwilling to part with the exclusive ownership of said patent and invention, that said patent should be transferred to themselves individually at the same nominal figure at which they had transferred it to the company, and that to enable the company to go into manufacturing, erect the necessary buildings, buy machinery and to manufacture, its capital stock should be increased to $600,000, all of which should be issued to themselves, forty thousand for that amount of money to be paid by them for the re-transfer of the patent, and in lieu of the four hundred shares originally issued to them, which were to be surrendered. Two hundred and ten thousand dollars "of that amount to be paid in cash by them, and the residue of $350,000 for an unlimited license to use the patents upon payment of the same rate of royalty paid by the Alexander Smith & Sons’ Carpet Company, viz.: twenty cents per yard.”

September 23, 1880, the corporation acquired the right to increase its capital stock to $600,000. That increase was effected as follows: The individual defendants paid $250,000 in cash for 2,500 shares, and they granted to the corporation an unlimited license to manufacture under the patent for 3,500 shares and the: payment of a royalty of twenty cents per yard, which made up the full amount of the capital stock. At this time no person had anjf interest in the corporation, or in the patent, except these individual defendants. From the date of the organization of the corporation to November 18, 1880, when the capital stock was-increased, no business was transacted by it except the granting of licenses for the use of the patents and collecting royalties for the same. Among other rights granted by the corporation was one on the 17th of April, 1879, to the Hartford Carpet Company, by which it acquired the right, in consideration of $62,000, to use sixty-two looms upon the payment of a royalty of twenty cents per yard for every yard manufactured on the looms.

In respect to the increase, the court found: “ That at the time of the said re-transfer of said patent and invention the value thereof had not materially changed, and that said re-transfer at the same price at which the same had been conveyed to the company was made by the defendants without regard to its actual value, in good faith, in the belief that they had the legal right to cause said re-transfer to be made by said company on the terms on which it was made, without any design or intent to injure or defraud any person who might thereafter .become the holder of any of the increased stock to be issued by the company, and that no such person or any person was injured or defrauded thereby.”

“ That the unlimited license to manufacture under said patent upon payment of a royalty of twenty cents per yard was necessary for the manufacturing business of said Smith Moquette Loom Company, and was not an inadequate consideration for the amount of thirty-five hundred shares of its capital stock then issued therefor to the said defendants Warren B. Smith, William F. Cochran and Eva S. Cochran, according to their belief and expectation at that time as to the manufacturing possible to be done by said company, and the issue thereof for that consideration was made by them in good faith and with no intent to defraud said company or any future holder of stock therein."

November 18, 1880, a certificate, No. one, for three thousand shares was issued to Smith. A certificate, No. two, for fifteen hundred shares was issued to William F. Cochran, and a certificate, No. three, for fifteen hundred shares to Eva S. Cochran. These shares they continued to hold until March 31, 1881, during which said period said three persons were the only trustees of the corporation.

At some time prior to March 31, 1881, Charles E. Skinner and Eugene Tymeson had received from the United States -letters patent for improved machinery for the manufacture of tufted or pile fabrics, which were numbered respectively 233, 290 and 233, 291,- and, as they claimed, had invented five other improvements in looms for weaving tufted fabrics, for which patents had not been obtained. On the 31st of March, 1881, Skinner and Tymeson agreed to assign to the Smith Moquette Loom Company said patents already issued and also such patents for improved looms as they should thereafter obtain, in consideration of one thousand shares of the stock of the corporation which were on that day assigned to them ; 500 to Skinner and 500 to Tymeson. Warren B. Smith assigning 500, and Mr. and Mrs. Cochran 250 each. Afterwards, Skinner and Tymeson made formal assignments of the patents granted to them.

The court found in respect to this purchase as follows; Twenty-fifth. “ That the said plaintiff and Tymeson, at and before the time they assigned said patents to said Moquette Loom Company, and took an assignment of said certificates of stock, had knowledge that said Loom Company did not own the Smith Moquette Loom patent aforesaid, but had only a right or license to use the same upon payment of a royalty, and that said patent, had been transferred to the original owners, to wit: said individual defendants.”

Twenty-sixth. “ That the negotiations for the purchase of said! Tymeson and Skinner patents were conducted between the plaintiff and the defendant Smith, and that the said defendant informed the plaintiff, before the same were closed, that the Smith Moquette Loom patent had been reassigned to the owners, to wit: himself. Mr. and Mrs. Cochran; that the capital stock had been increased to $600,000; and that it had all been issued to said defendants, who were to put in $250,000 in cash, and that the company was to have a license to manufacture upon a royalty of twenty cents, a yard.”

Twenty-seventh. “That no misrepresentations were made to said plaintiff or Tymeson to induce them to assign their patents or accept any stock.”

September 16, 1881, the individual defendants sold one thousand shares of their stock to John Sloane, to whom certificates were issued therefor.

November 19, 1881, the number of trustees of the corporation was duly increased from three to six, and John Sloane, Halcyon Skinner and Frank T. Holder were then elected as such additional trustees. Since that date said persons have continued to-be trustees, except, March 15,1884, Charles E. Skinner was elected in the place of Halcyon Skinner, since which date he has continued to be a trustee.

It is very clear, we think, that under these facts as found, that, is, knowledge on the part of plaintiff, and of all the shareholders,, that the original patent had been assigned to the individual defendants, and an unlimited license granted to the corporation to» manufacture carpets for $350,000, payable in the shares of the-corporation, that this plaintiff as a trustee has no cause of action; in favor of himself or of any shareholder because neither he nor they have any grievance to redress.

The court further finds the corporation went on and erected manufactories and engaged in and continued in the business o£ manufacturing carpets until about February 1, 1883, at which, time the individual defendants had advanced $384,627.40. There-does not seem to have been any dispute about the validity of this-indebtedness. It was found upon examination that the business-was being done at a loss, and thereupon it was resolved by the-trustees that the stock on hand should be sold, the manufactoriesleased, and the sums due to the individual defendants secured by mortgages upon the realty and personalty of the corporation.. More than two-thirds of the shareholders consented to the execution of these mortgages, and they were executed accordingly.

" Fifteen months afterwards, nothing having been paid upon the mortgages, they were foreclosed and the property covered by them purchased by Warren B. Smith. The court found in respect to stopping the manufacture of goods, the leasing of the property and the execution of the mortgages, as follows : ■ Thirty-third. “ That the said defendants and Mr. Sloane voted for said resolutions in good faith, believing that there was no other way to save the Moquette Company and its stockholder^ from further loss, and that the acts and proceedings therein directed were for the best interests of said company and its stockholders, and such also was the fact, and the defendants in passing the said resolutions did not intend to injure or defraud the plaintiff as a stockholder of said company, and did not, in fact, injure or defraud him.”

Thirty-fourth. “ That said resolutions so adopted by the board of trustees were necessary and proper, and were for the best interest of said company and its stockholders, and no better or other arrangement to save said company and its stockholders from further loss was practicable.”

It should have been stated that John Sloane testified that when he purchased his one thousand shares that the patent had been transferred by the corporation to Warren B. Smith and William F. and Eva S. Cochran.

• November 29, 1880, two hundred and fifty shares were in form transferred by Smith and the Cochrans to Frank T. Holden, to enable him to become a trustee, but he never had any real interest in them. No persons other than these mentioned ever held any of the shares of the corporation.

As before stated, this action is not brought to redress a public wrong. There is no finding that the transfer of the patent from the corporation to the individual defendants, and the issuance of $350,000 in stock for the license, were in contemplation of thereafter selling shares to the public, or to this plaintiff, who, as well as Tymeson, purchased with full knowledge of all the facts.

This case falls within the principle stated in Kent v. Quicksilver Mining Co., 78 N. Y., 159, where it was said: “In the applieacation of the doctrine of ultra vires, it is to be borne in mind that it has two phases; one where the public is concerned; one where the question is between the corporate body and the stockholders in it, or between it and its stockholders and third parties dealing with it and through it with them. When the public is concerned to restrain a corporation within the limit of the power given to it by its charter, an assent by the stockholders to the use of unauthorized power by the corporate body will be of no avail. When it is a question of the right of a stockholder to restrain the corporate body within its express or incidental powers, the stockholder may in many cases be denied on the ground of his express assent, or his intelligent though tacit consent to the corporate action. If there be a departure from statutory direction, which is to be considered merely a breach of trust to be restrained by a stockholder, it is pertinent to consider what has been his conduct in regard thereto. A corporation may do acts which affect the public to its harm, inasmuch as they are per se illegal, or are malum prohibitum. Then no assent of stockholders can validate them. It may do acts not thus illegal, though there is want oí power to do them, which affect only the interest of the stockholders. They may be made good by the assent of the stockholders, so that strangers to the stockholders dealing in good faith-with the corporation will be protected in a reliance upon those; acts.”

The right of a manufacturing company to discontinue its operations when they have become unprofitable, for the purpose of protecting shareholders from further loss, does not admit we think of doubt. Treadwell v. Salisbury Mfg. Co., 7 Gray, 395; Hancock v. Holbrook, 9 Fed. Rep., 353; Boston R. R. v. N. Y. R. R., 13 R. I., 263; Morawetz Corp., §§ 413 et seq.; 1004; Buford v. Keokuk Packet Co., 69 Mo., 611.

The judgment should be affirmed, with costs.

All concur.