Case ID: ad_129/html/0036-01.html
Source: Caselaw Access Project
Author: {"author": "Patterson, P. J.: \n      Soott, J. (dissenting):", "license": "Public Domain", "url": "https://static.case.law/"}
Date Created: 2024-08-24T03:29:51.129683

Joseph E. Schwab, Appellant, v. E. G. Potter Company and Others, Respondents.
    First Department,
    December 11, 1908.
    Corporation—increase of capital stock under guise of sale to new corporation formed for that purpose — pleading — complaint stating cause of action for injunction — allegations not constituting defense.
    The complaint of a minority stockholder which in substance alleges that at a meeting the majority stockholders directed the organization of another corporation at the expense of their own corporation and that real estate owned by their corporation should be transferred to the new corporation at an inadequate price in exchange for all its capital stock which the directors were empowered to offer for sale to stockholders on certain terms, and praying that the proposed transaction be enjoined, states a cause of action.
    This, because while an act within the powers of directors and majority stockholders will not be interfered with by the courts in the absence of fraud, the scheme aforesaid is a mere device to increase the capital stock of the corporation without complying with the statute governing such proceeding, and hence the proposed action is ultra vires.
    
    A minority stockholder who does not desire to pay what is in effect a forced assessment by subscribing for the stock of the new corporation in order to preserve his proportionate interest in his corporation, is a party aggrieved and entitled to sue for an injunction.
    
      It is no answer to said complaint to allege that it was necessary to sell the property at a certain sum, or even less, to conserve the interests of the stockholders, that being a mere conclusion.
    Nor is it a defense to allege that an agreement to sell the property pursuant to said resolution was ratified and confirmed by the majority stockholders, for they could not ratify an act which was unlawful.
    Scott and McLaughlin, JJ., dissented, with opinion.
    Appeal by the plaintiff, Joseph E. Schwab, from an interlocutory judgment of the Supreme Court in favor of the defendants, entered in the office of the clerk of the county of Hew York on the 30th day of June, 1908, upon the decision of the court rendered after a trial at the Hew York Special Term, overruling the plaintiff’s demurrer to certain defenses contained in the answer.
    
      Henry H. Abbott, for the appellant.
    
      Robert S. Kristeller, for the respondents.
   Patterson, P. J.:

This appeal is from an interlocutory judgment overruling the plaintiff’s demurrer to the second and third separate defenses contained in the joint answer of the defendants. Those defendants are the E. G. Potter Company, a corporation created and organized under the laws of the State of Hew York (but the nature of its „ business is not disclosed in the pleadings), and Ellis G. Potter, Edward F. Hull and Hiram P. Frear, three of four directors of the company. The plaintiff is a shareholder in the Potter corporation, and he alleges in his complaint that he brings this action on behalf of himself and other stockholders, and its purpose is to procure a judgment restraining the defendant company, its directors and officers from transferring the title and possession of a very valuable piece of real estate belonging to the corporation to another corporation presently to be referred to.

It appears by the complaint that a special meeting of the stockholders of the defendant corporation was held at its office on the 31st day of December, 1907, and at such meeting a resolution was passed, supported by a majority of the stockholders, which provided that the board of directors of the company be authorized, empowered and directed to cause to be organized a corporation, at the expense of the defendant corporation, with a capital of $100,000, with the name of the Library Realty Company, or such other name as might be satisfactory to the officers of the defendant corporation, for the purpose of acquiring the real estate of the defendant corporation, Bo. 477 Fifth avenue, and to accept as the consideration for such conveyance all of the capital stock of the new corporation, and that the board of directors of the defendant corporation be authorized, empowered and directed to transfer to such new corporation such real estate, subject to existing mortgages of $350,000, and to receive in exchange for the equity in the real estate all of the capital stock of the new corporation. And then follows a provision that the board of directors of the defendant corporation are authorized, empowered and directed to offer the $100,000 par value of stock of the new corporation for subscription to the stockholders of the defendant corporation on certain terms.

It is further alleged in the complaint that the capital stock of the defendant corporation consists of 3,500 shares of the par value of $100 each, of which 3,000 shares have been issued and 500 remain unissued; that the resolution above referred to was passed at the stockholders’ meeting by a vote of 2,450 shares in favor and 550 shares opposed; that the plaintiff is an original incorporator of the defendant corporation and owns 100 shares of stock, for which he paid the sum of $10,000; that at the stockholders’ meeting there was delivered to the several stockholders of the defendant corporation a statement of its assets and liabilities; that in the statement of assets, which was prepared by a firm of public accountants, the real property was valued at $498,000, which is $48,000 in excess of the sum for which it was proposed to sell the same to the new corporation ; that the plaintiff has recently had the said property appraised by competent appraisers, and its value has been by them stated to be $525,000, and he believes that the property is actually of that value, which is $75,000 in excess of the price at which it is proposed to convey it to the contemplated new corporation. Plaintiff then sets forth that he is unwilling to subscribe to stock in the new corporation, and that if the proposed plan is carried into effect, he and those similarly situated will be deprived as stockholders of the defendant corporation of all right and interest in the real estate, “ and the title to said real property will be wrongfully and illegally transferred from the E. G. Potter Company to the said proposed new corporation and to the stockholders thereof at a low and inadequate valuation, and that the completion of the plan proposed in the said resolution * * * will deprive the plaintiff and the other minority stockholders who are unwilling to subscribe to the stock of said new corporation of their interest as stockholders of the E. G-. Potter Company in said property by force and without adequate compensation.” It is further alleged in the complaint that the carrying out of the plan referred to will compel the plaintiff and other dissenting stockholders to pay what is in effect a forced assessment of thirty-three and one-third per cent upon the par value of the capital stock owned by them respectively under penalty of being deprived of their proportionate interest in said real property for an arbitrarily fixed and inadequate valuation. And it is further alleged “that said plan is in all respects unjust and illegal and calculated to injuriously affect the rights of and damage the stockholders of said company who are unwilling or unable to subscribe and pay for the stock of said new corporation to be organized pursuant to the said resolution.”

The defendants jointly answered the complaint and, after certain admissions and denials, set up for a further and separate defense that the agreement to sell the real estate of the company was entered into only after mature deliberation by the directors and officers of the defendant company, and that in their judgment the price at which the property was to be sold was adequate and proper; and further, as a second separate defense, that it was necessary to sell the property at said sum of $450,000, or even less, if said price could not have been obtained, to conserve the interests of the stockholders of the defendant company; and further, as a third separate defense, that the agreement to sell the property pursuant to the resolution referred to in the complaint was ratified and confirmed by stockholders representing over two-thirds of the capital stock of the company.

The learned judge at Special Term, in determining the issue of law raised by the demurrer, did not pass upon the sufficiency of either of the separate defenses, but, searching the record for the first fault in pleading, he examined the complaint and reached the conclusion that it was defective in that it did not state a cause of action, and, therefore, the demurrer was overruled. This conclusion was arrived at on the theory that the transaction set forth in the complaint was nothing more or less than a sale by the defendant corporation of some of its property, capital stock of another corporation to be received as the consideration, and that the acts of which the plaintiff complains were simply those of administration of the affairs of a corporation, with which the court would not interfere at the suit of a discontented minority stockholder.

If that were all that is involved in this action, according to the allegations of the complaint, there would be no difficulty in sustaining this interlocutory judgment, for it is beyond controversy that an act clearly within the powers of the board of directors of a corporation and of the majority of its stockholders will not be interfered with, in the absence of fraud, for the business of the corporation must be conducted by itself and not by the courts. Gamble v. Queens County Water Co. (123 N. Y. 91); Continental Ins. Co v. N. Y. & H. R. R. Co. (103 App. Div. 282; 187 N. Y. 225); Colby v. Equitable Trust Co. (124 App. Div. 262), and other cases that might be cited, plainly indicate the established rule of law on that subject. But it is evident from the allegations of this complaint and from the inferences that fairly may be drawn from such allegations that what was in the contemplation of the directors and majority stockholders of the defendant corporation was not to have that corporation make an actual sale of the real estate to another corporation and receive shares of stock as the consideration therefor, but to resort to a device by which to increase its capital by dismembering itself and organizing another corporation of which it should be the only stockholder, and thus evade the provisions of the statute relating to the increase of the capital stock of a corporation. The defendant corporation, by the resolution, is authorized and directed to create a new corporation at the expense of the old one. What it is to do, therefore, is to be a corporate act done in its capacity as a corporation. Instead of increasing its capital stock in the manner provided by law, it is to separate its assets, deliver one portion of them to its own creature, capitalize that portion at a fixed valuation, and receive back all the shares of stock issued by its creature; and there that transaction really ends. Affording an opportunity to the stockholders of the old corporation to subscribe to the stock of the new one is merely an offer to them to buy from the old corporation this new stock after it comes into the possession of the old corporation. I am unable to find authority for such action as that taken at this stockholders’ meeting. What was done thereat and what the directors of the defendant corporation were instructed to do, are things beyond the power of that corporation. A corporation cannot split itself up into two or more independent corporate entities. The minority stockholders are aggrieved; and if the view I have taken of this transaction is the correct one, it cannot be contended successfully that the minority stockholders may not maintain a suit to enjoin the ultra vires acts of their corporation. It is no answer to say that the plaintiff and other minority stockholders are not injured. Manifestly, they may be injured.

This brings us to the consideration of the demurrer to the second and third separate defenses above adverted to. I think the demurrer was well taken. The second defense is that “ it was necessary to sell the property at said sum of $450,000, or even less, if said price could not have been obtained, to conserve the interests of the stockholders of the defendant company.” This statement of a defense presents no fact from which it could be inferred that a sale of the property was necessary; it is merely a conclusion of the pleader as to such necessity. As to the third alleged separate defense, namely, that the agreement to sell the property pursuant to the resolution stated in the complaint was ratified and confirmed by stockholders representing over two-thirds of the capital stock of the company — that does not constitute a defense, for the plaintiff stands upon the illegality of the original action of the stockholders ; and if that is radically unlawful, the question of ratification is not involved in the controversy. Beside which, it is not made to appear in the answer that any agreement has actually been made to sell the property'pursuant to the resolution.

I am of opinion that the interlocutory judgment should be reversed, with costs, and the demurrer to the separate defenses sustained, with costs, with leave to the defendants to amend their answer on payment of costs in this court and in the court below.

Laughlin and Houghton, JJ., concurred; McLaughlin and Scott, JJ., dissented.

Soott, J. (dissenting):

The plaintiff appeals from an interlocutory judgment overruling his demurrer to two separate defenses contained in the answer. The court below searching the record for the first error in pleading held that the complaint did not state a cause of action, and upon the principle that a bad answer is good enough for a bad complaint, overruled the demurrer. The sufficiency of the complaint "is, therefore, called in question by this appeal. The complaint alleges that the defendant E. G. Potter Company is a domestic corporation with an authorized capital stock of $350,000, of which only $300,000 has been issued. The plaintiff is a minority stockholder. Among the assets of the company is a piece of real property in the city of New York, upon which there is a mortgage of $350,000. On December 31, 1907, at a meeting of the stockholders of the corporation, a resolution was adopted by a stock vote, the holders of 2,450 shares voting in favor of it, and the owners of 550 shares (among whom was this plaintiff) voting against it. The resolution is as follows:

Resol/oed: That the Board of Directors of this Company be and they hereby are authorized, empowered and directed to cause to be organized a corporation at the expense of this Company under the Laws of the State of New York, with a capital stock of $100,000, with the name ‘ Library Realty Company/ or such other name as may be satisfactory to the officers of this Company, for the purpose of acquiring the real estate of this Company, No. 477 Fifth Avenue, in consideration of the issuance to this Company of all the capital stock of said new corporation ; and further
“ Hesol/oed: That the Board of Directors be and they hereby are authorized, empowered and directed to transfer to said new corporation when formed the equity in the real estate of this Company known as 477 Fifth Avenue, subject to the existing mortgage thereon, amounting to $350,000, and to receive in exchange for said equity in said real estate all the capital stock of said new corporation to be formed, viz., capital stock of the par value of $100,000; and further
Hesol/oed: That the Board of Directors of this Company be and they hereby are authorized, empowered and directed to cause the said $100,000 par value of stock of said new corporation when acquired by this Company to be offered by proper notice to the stockholders of this Company for subscription at /par, each stockholder of this Company to have the right to subscribe for an amount of the stock of the new corporation at par equal to one-third of the par value of said stockholder’s holdings of this Company, each stockholder not wishing to subscribe to have the right to assign his rights to so subscribe, and, in the event of failure of any stockholder or his assignee to so subscribe, his rights to subscribe to terminate and the Company to have the right to receive subscriptions for all or any part of such unsubscribed for stock in the new corporation from stockholders of this Company or from outside parties, the time in which to subscribe to be limited as the directors may deem best, and the said subscriptions to be ¡laid in cash as follows :
“ 25 per cent of the subscription on or before the day on which the right to subscribe terminates ; 25 per cent 'of the subscription five months after such date; 25 per cent of the subscription ten months after such date ; 25 per cent of the subscription fourteen months after such date; and further
“ Resolved: That the Board of Directors be and they hereby are authorized, empowered and directed to do or cause to be done all acts that may be necessary, convenient or desirable in order to carry out the foregoing resolutions and to properly safeguard the rights of this Company and of the subscribers to the stock of the new Company.”

The plaintiff alleges that the real estate in question is carried on the books of the corporation at a valuation of $498,000 or $48,000 more than the price at which it is proposed to sell it, and that he has been informed by competent and reputable real estate dealers that said property is worth $525,000 or $75,000 more than it is proposed to sell it for. It is not alleged that the defendant corporation is insolvent, or that it is other than a solvent going concern. The relief sought is that the defendants be restrained from carrying out the proposed sale, which is alleged to be favored by the directors of the corporation, a majority of whom have expressed their intention to carry it out unless restrained. The plaintiff professes to see in the proposed plan and method of sale a covert attempt to levy indirectly upon his stock an assessment under penalty of losing a proportionate share of his interest in the assets of the company. We do not so understand it. On the contrary, we find nothing more in the proposed plan than a purpose to sell the real estate of the corporation for $100,000 in cash, with an equal opportunity to each stockholder to participate in the purchase, if he desires to do so, in the proportion in which he holds stock in the defendant corporation. If the proposed sale were to be one outright for the sum of $100,000 in cash it would be perfectly plain that the complaint does not state sufficient facts to justify the interposition of the court. As has been said, there is no allegation of insolvency ; it does not appear that the sale of the real estate will prevent the corporation from pursuing its usual business, and there is no allegation of fraud. All that is charged is that the price is inadequate, if, indeed, the vague and uncertain allegation of the complaint can fairly be said to be an allegation of inadequacy. But mere inadequacy of price, uncoupled with fraud or ultra vires, or unless it is so apparent as to compel the inference of fraud, is not sufficient to justify the court in interfering with the action of the directors and the majority stockholders. (Gamble v. Queens County Water Co., 123 N. Y. 91; Continental Ins. Co. v. N. Y. & H. R. R. Co., 103 App. Div. 282; 187 N. Y. 225; Hennessy v. Muhleman, 40 App. Div. 175 ; Colby v. Equitable Trust Co., 124 id. 262.) We think that it may, therefore, he safely said that if the proposition had been to sell the real estate to some stranger for • $100,000 in cash, the insufficiency of the allegations of the complaint to support the demand for an injunction to prevent the sale would be so obvious that no debatable question would be presented. Such a sale would not waste the assets of the corporation, or lessen the value of plaintiff’s interest in these assets. It would simply transform an item of real estate assets to one of cash assets. Precisely this result will be arrived at by carrying out the plan approved by the directors and stockholders. The corporation will part with this particular piece of real property, and in exchange therefor will receive $100,000 in cash, so that when the transaction is completed the assets represented by the capital stock will be of precisely the same value, and will consist of precisely the same class of property that would be the case if the real estate had been sold outright to a stranger. So the plaintiff will be left in the same position, and his stock will be of the same value, if the plan be carried out, as it would be in case of an outright sale. The method devised for bringing about this result seems to us to be not only unobjectionable, but really one very advantageous to the present stockholders. It may be that the real estate has a considerable prospective value, the advantage of which would be lost to the present stockholders by an outright sale to a stranger. By the proposed plan each stockholder is afforded an opportunity to become a purchaser, and to participate in the prospective increase in value, but he is under no obligation so to do. If he declines, he will be, in no worse position than he would be if the property were to be sold outright. Indeed, so far as concerns the value of his stock and the assets represented by it, he will be in precisely the same position. If he thinks that the property is now worth more than it is proposed to sell it for, or that it will presently increase in value, he can participate proportionately in the expected enhancement in value. We find nothing alleged which is unfair to the minority stockholders, or beyond the power of the corporation, or which implies fraud or bad faith on the part of the directors and the majority stockholders.

The judgment appealed from should, therefore, be affirmed, with costs.

HoLaughlin, J., concurred.

Judgment reversed, with costs, and demurrer sustained, with costs, with leave to defendants to amend on payment of costs.