#### R. M. GAINES v. LONG MANUFACTURING COMPANY, INC., W. R. LONG, JOHN G. LONG, MARY ELLEN FORBES, Individually, and as Stockholders and Directors of LONG MANUFACTURING COMPANY, INC., and J. O. HALL, Secretary and Treasurer of LONG MANUFACTURING COMPANY, INC.

(Filed 31 October, 1951.)

1. Pleadings § 19c—

A demurrer admits the truth of every material fact properly alleged.

2. Same—

A pleading will be liberally construed upon demurrer, giving the pleader every reasonable intendment, and the demurrer will be overruled if the pleading to any extent or in any portion presents facts sufficient to constitute a cause of action.

3. Corporations § 16—

Granting that the stockholders of a corporation have the discretionary power to set aside any part of its earned surplus for working capital, G.S. 55-115, such discretion is not unlimited but must be exercised in good faith and not in arbitrary disregard of the rights of minority stockholders, and courts of equity may grant relief against arbitrary action resulting in injury to minority stockholders, even in the absence of actual fraud, since it amounts in effect to a breach of trust.

4. Same—

Allegations in an action by a minority stockholder alleging that the corporation had a large earned surplus, that the majority stockholders passed a resolution setting aside the entire surplus as working capital and authorizing the issuance of additional stock in a large amount, and that the action was arbitrary and taken for the single purpose of defeating the minority stockholder’s right to dividends and to lessen the book value of his stock and “freeze” him out of his rightful interest in the corporation, together with allegations of fact disclosing that plaintiff had exhausted all efforts to obtain relief from within the corporation, *is held,*sufficient to state a cause of action, and demurrer thereto is properly overruled.

5. Corporations § 10—

A stockholder may maintain an action against the corporation to redress a corporate wrong when he alleges facts sufficient to show that he has exhausted reasonable efforts to obtain relief within the corporate management.

Valentine, J., took no part in the consideration or decision of this case.

Appeal by defendants from *Harris, J.,*at May Term, 1951, of Edge-combe.

Civil action by minority stockholder of corporation for relief against alleged arbitrary manipulation of corporate finances by majority stockholders for the purpose of promoting their own gain, to the detriment of *332the plaintiff, and for writ of *mandamus*to force declaration of dividend, either in stock or in cash, heard upon demurrer to the complaint for failure to state facts sufficient to constitute a cause of action.

From judgment overruling the demurrer, the defendants excepted and appealed.

*Ruarle ■& Ruarle, Joseph O. Mo.ore, Jr., and Battle, Winslow, Merrell <& Taylor for plaintiff, appellee.*

*Henry C. Bourne for defendants, appellants.*

JoiiNSON, J".

The defendants by demurring to the sufficiency of the complaint to state a cause of action admit as true every material fact properly alleged. *Gaines v. Long Manufacturing Company, Inc., post,*340; *Hall v. Dairies, ante,*206; *Bryant v. Ice Co.,*233 N.C. 266, 63 S.E. 2d 547. Under the Code system of pleading which prevails in this jurisdiction, it is settled policy that actions shall be tried upon their merits, and to that end pleadings are construed liberally, with every reasonable intendment being adopted in favor of the pleader, so that a pleading will not be overthrown by a demurrer unless it be ivholly insufficient. “If in any portion of it, or to any extent, it presents facts sufficient to constitute a cause of action, or if facts sufficient for that purpose can be fairly gathered from it, the pleading will stand, ... It must be fatally defective before it will be rejected as insufficient.” *Hoke v. Glenn,*167 N.C. 594, 83 S.E. 807; *S. v. Trust Co.,*192 N.C. 246, 134 S.E. 656.

In substance, the pertinent facts alleged in the complaint are these:

1. That the defendant, Long Manufacturing Company, Inc., was chartered under the laws of North Carolina 13 September, 1946, with an authorized capital stock of 1,000 shares of $100 par value each. The corporation began business with an original paid-in capital of only $1,000, represented by 10 shares of stock. No further stock has ever been issued. The original ten shares are now outstanding. The plaintiff owns two shares, with the remaining eight shares being owned by these defendants, in the proportions as indicated: W. R. Long, six shares;, John G. Long, one share; and Mary Ellen Forbes, one share.

2. The plaintiff paid full value for his two shares of stock and served as Secretary and Treasurer of the corporation from the time of its organization in 1946 until 30 June, 1949, when he resigned, and since that time he has not been an officer of the corporation.

3. The defendants W. R. Long, John G. Long, and Mary Ellen Forbes (who are brothers and sister) constitute the present board of directors of the corporation. They were elected at the 8 January, 1951, annual meeting of the stockholders. At the meeting of the board of directors held the same day, *W.*R. Long was elected President; John G. Long was *333elected Vice-President; and J. 0. Hall (although being neither a director nor a stockholder) was elected Secretary and Treasurer of the corporation.

4. The corporation has prospered from its inception: for the fiscal year ending 31 October, 1947, the first year of operations, net profits after all taxes were $193,707.62; for the year ending 31 October, 1948, net profits after taxes amounted to $32,142.57; for the year ending 31 October, 1949, net profits after taxes were $19,317.43; and for the year ending 31 October, 1950, net profits after taxes were $50,367.05.

At the end of the fiscal year 31 Octoberj 1950, the corporation had current assets of $352,130.24, including cash on hand in banks of $146,124.92. At that time the corporation had paid-in capital and earned surplus of $296,387.47 “and was amply solvent and was not in need of any additional operating capital”; that at the time of the commencement of this suit the financial condition of the corporation was substantially the same as on 31 October, 1950.

5. At the 8 January, 1951, annual meeting of the stockholders of the corporation two resolutions “were introduced by the defendant John G. Long and carried by the votes of the defendants *~W.*R. Long, John G. Long and Mary Ellen Forbes, over the protest(s) of the plaintiff, who was present and voted his 2 shares of stock against said resolutions.”

The first resolution recites that whereas the books of the corporation show as of 31 October, 1950, an earned surplus of $295,387.47, nevertheless the corporation “is badly in need of additional working capital to carry on its business.” And, thereupon, the resolution directs the payment from earned surplus of a dividend of six per centum on the outstanding capital stock to stockholders of record as of 8 January, 1951 (amounting in all to $60.00), with further direction “that the remaining part of the surplus fund in the amount of $295,327.47 is hereby fixed and designated by the stockholders as working capital of said corporation.”

The second resolution recites in substance that the defendant corporation at its inception and during subsequent years was and has been short of working capital and that funds for capital investment and operations were advanced by V. R. Long, trading as Long Supply Company, and subsequently Long Supply Company, Inc., and that on 31 October, 1950, these advances to the defendant corporation amounted to $100,338.06. The resolution further recites that the remaining unissued authorized capital stock of the defendant corporation should be issued and sold for the purpose of paying off this indebtedness due Long Supply Company, Inc. And, thereupon, the resolution directs that the remaining 990 shares of unissued capital stock be issued and sold at not less than $100 per-share, and that the indebtedness due the Long Supply Company, Inc., be-paid out of the proceeds. The resolution further directs that each stock-*334bolder of the defendant corporation shall be entitled to subscribe for 99 shares of the new stock for each share owned as of 8 January, 1951, and that each stockholder be allowed to subscribe and pay for the new stock at $100 per share. The resolution contains a forfeiture provision providing in effect that a failure on the part of any stockholder, his heirs or assigns, to exercise this pre-emptive right on or before 10 o’clock a.m., 10 February, 1951, shall work a forfeiture or waiver of the right to subscribe for such additional stock, with the directors being authorized to make sale of such remaining stock.

6. That after the adoption of the aforesaid resolutions at the 8 January, 1951, meeting of the stockholders of the corporation, the plaintiff, by written communications delivered by special delivery, U. S. Mail, on or about 26 February, 1951, to W. E. Long, President of the defendant corporation, and to all of the other directors of the corporation, demanded that a meeting of the stockholders be called immediately, as allowed by the By-laws, to consider rescission of the former action of the stockholders in undertaking to set aside as working capital the entire earned surplus of the corporation, and further to consider the declaration of dividends in accordance with a proposed, or alternate, resolution to be submitted to the meeting by the plaintiff, copies of which proposed, and alternate, resolutions were transmitted to each director with the written demand for call of a stockholders meeting. The proposed resolutions are incorporated in the complaint. They contain the following recitals:

> “Wheeeas, it is desirable that the corporation’s debt to Long Manufacturing Company of $100,338.06 as of October 31, 1950, be paid;

> “AND Whereas the payment thereof out of earned surplus will leave a surplus of $195,049.41 as of the same date;

> “And Whereas the payment of cash dividends in the sum of $25,000 would leave remaining a working capital of $122,600 (cash, receivables and inventories of $233,400 against current liabilities of $110,800, a ratio of more than 2 to 1) ;

> “And Whereas such working capital is sufficient for the needs of the business;

> “And Whereas the resolution adopted January 8, 1951, directing the issuance of $99,000 in new stock for cash was improvident, and its execution would result in over-capitalizing the business, and leaving large funds idle a good part of each year, and would further result in the destruction of a major part of the interest in the corporation of any stockholder not exercising his pre-emptive right to subscribe to the new stock;”

The proposed resolution then resolves and directs:

> “(1) That so much of the resolution of January 8, 1951, as sets aside $295,327.47 as working capital be rescinded.

> *335“(2) That the officers and directors are directed to pay a dividend of two thousand four hundred ninety-four per cent (2,494%) on the outstanding stock, from earned surplus, to stockholders of record January 8, 1951, amounting to $24,940.00, in addition to the $60 in dividends declared January 8, 1951.

> “(3) That the debt of Long Supply Company be paid out of the $146,000 cash on hand October 31, 1950.

> “(4) That $122,600 be set aside as working capital.

> “(5) That the resolution of January 8, 1951, directing the issuance of new stock, 990 shares for $99,000 cash, be, and the same is hereby rescinded.”

The alternate resolution proposed by the plaintiff for consideration on failure of the adoption of the foregoing proposed resolution, provides :

> “(1) That the resolution of January 8, 1951, directing the issuance of 990 shares of new stock for $99,000 cash be rescinded.

> “(2) That the directors proceed to increase the authorized capital stock to 4,000 shares of $100 par value each.

> “(3) That a stock dividend of $295,000 be then declared, out of earned surplus, making the capital $296,000 consisting of 2960 shares.

> “(4) That if additional working capital then be found necessary, the directors be authorized to issue and sell 1,000 new shares for $100 cash each, to the stockholders of record according to their pre-emptive rights, or on their waiver, to other persons.”

*1.*That the officers and directors of the corporation have failed to consider the foregoing resolutions and proposals of the plaintiff, and “they have failed to call a meeting for the purpose of considering the resolutions and plaintiff has exhausted his remedies within the corporation and is without adequate remedy, save only a Court of Equity.”

8. That the “defendants have failed and refused to declare dividends from the . . . profits of the corporation save only the . . . dividend totaling $60.00 as purportedly declared at the meeting of said corporation on January 8,1951; that the resolutions of January 8, 1951, attempting to set aside the entire surplus as working capital was not adopted in good faith, but arbitrarily and fraudulently for the single purpose of defeating plaintiff’s statutory right to dividends; that the payment of a dividend as demanded would not impair either the capital stock of the corporation, paid in and outstanding, or any working capital legally fixed pursuant to the provisions of the laws of North Carolina.”

9. That “the defendants have resolved to and are threatening to issue additional capital common stock in the corporation in the amount of $99,000; that if said stock is issued plaintiff is unable financially to purchase the portion of said stock which, in accordance with said resolution, would be tendered to plaintiff, and in the event that said additional *336stock is issued by defendants before the declaration of a dividend or some proper distribution of the enormous profits of defendant corporation, either in cash dividend, stock dividend, or otherwise, the plaintiff will be irreparably damaged in that, after the issuance of such additional stock, plaintiff would be entitled to share in said profits only to the extent of 2/10 of 1%, whereas plaintiff is rightfully entitled to share in said profits and ownership of said business to the extent of 20%.”

10. That “the action of the defendants in ignoring the requests of the plaintiff for some proper distribution of the profits of the defendant corporation and the threatened action of the defendants in undertaking to issue additional stock for the purpose of rendering valueless the right of the plaintiff to participate in any distribution of the profits of the defendant corporation are arbitrary, unlawful, and in violation of legal duties owed by the defendants to the plaintiff; that the stock of the plaintiff represents 20% of the net worth of said defendant corporation, and regardless of the enormous profits made by the defendant corporation, . . . the defendants have arbitrarily and unlawfully failed, neglected, and refused to pay out the accumulated profits of said corporation, and . . . that said defendants are willfully and deliberately failing to pay dividends, and are operating said business for their own gain and advantage and for the purpose of rendering the stock of the plaintiff valueless and to the great loss and damage of the plaintiff, and with the deliberate intent of ‘freezing out’ plaintiff from his ownership in said corporation.”

Upon the allegations of the complaint, the plaintiff prays judgment, among other things, “that the defendants be commanded and directed to declare and pay out among the stockholders of Long Manufacturing Company, Inc., the whole of the accumulated profits of said corporation, or such part thereof as the court shall find should be so declared, either in cash or by way of a stock dividend as provided by the resolutions proposed by the plaintiff . . ., and in accordance with the provisions of G.S. 55-115 and other pertinent laws of North Carolina.”

Here, then, the defendants by demurrer test the legal sufficiency of the foregoing allegations to state a cause of action. They set up and rely upon the provisions of G.S. 55-115, which read as follows:

> “The directors of every corporation created under this chapter shall, in January of each year, unless some specific time for that purpose is fixed in its charter, or bylaws, and in that case at the time so fixed, after reserving, over and above its capital stock paid in, as a working capital for the corporation, whatever sum has been fixed by the stockholders, declare a dividend among its stockholders of the whole of its accumulated profits exceeding the amount reserved, and pay it to the stockholders on demand. The corporation may, in its certificate of incorporation or *337bylaws, give tbe directors power to fix tbe amount to be reserved as working capital.”

Tbe defendants contend it affirmatively appears from tbe complaint tbat in accordance witb tbis statute tbe entire surplus of $295,327.47, after tbe payment of a 6% dividend, was duly and properly reserved and set aside as working capital, and tbat therefore there remains no surplus out of which dividends may be legally declared, and, tbis being so, tbat tbe complaint fails to state facts sufficient to constitute a cause of action.

But there is more to it than tbat. Conceding, as we may, tbat under tbe general law, including tbe foregoing statute, tbe controlling authorities of a corporation necessarily are clothed witb broad discretionary powers in fixing tbe amount to be reserved and set aside as working capital from accumulated corporate profits, and conceding further tbat in tbe exercise of tbis discretion, corporate management, acting in good faith and witb due regard for tbe affairs of tbe corporation as a whole and the welfare of its stockholders, may treat and deal witb accumulated profits or earned surplus in a wide variety of ways: it may withhold tbe profits from tbe payment of dividends in whole or in part, so as to provide for tbe retirement of debts, or to build up additional capital, either on a temporary basis or by transfer to tbe permanent capital account by means of a stock dividend, or it may invest tbe surplus earnings in better-ments and corporate expansion. However, tbis discretion is not an unlimited one. It must not be abused. Tbe controlling management must act in good faith and not in arbitrary disregard of tbe rights of tbe minority stockholders. Tbe controlling corporate authorities will not be permitted to use their powers arbitrarily or oppressively by refusing to declare a dividend where net profits and tbe character of tbe business clearly warrant it. Accordingly, if it be made to appear tbat tbe controlling management is acting in bad faith, for their own gain and advantage, in oppressive disregard of tbe rights of minority stockholders, in a manner amounting in effect to a breach of trust, even though no actual fraud be shown, a court of equity may be invoked to break tbe shackles of any such oppressive control. See *Amick v. Coble,*222 N.C. 484, 23 S.E. 2d 854; *Mitchell v. Realty Co.,*169 N.C. 516, 86 S.E. 358; *White v. Kincaid,*149 N.C. 415, 63 S.E. 109; 13 Am. Jur., Corporations, Sections 422, 423 and 708; Annotations: 55 A.L.R. 8, p. 44 *et seq.;*76 A.L.R. 885; 109 A.L.R. 1381; *Gaines v. Long Manufacturing Co., post,*340; *Anderson v. W. J. Dyer & Bro.,*94 Minn. 30, 101 N.W. 1061; *Star Publishing Co. v. Ball,*192 Ind. 158, 134 N.E. 285; *Mulcahy v. Hibernia Savings & Loan Soc.,*144 Cal. 219, 77 P. 910; *Wilson v. American Ice Co.,*206 Fed. 736.

In *Anderson v. W. J. Dyer Bro., supra,*tbe action was instituted by a minority stockholder against tbe majority stockholders, alleging a course of conduct, including tbe withholding of dividends, amounting in *338effect to a conspiracy to deprive tbe plaintiff of bis stock. Tbe defendants demurred to tbe complaint for failure to state a cause of action. Tbe demurrer was overruled. Tbis was affirmed on appeal, with tbe Minnesota Court making these observations:

“While it is true that tbe courts cannot ordinarily compel a corporation to declare a dividend at tbe suit of a minority stockholder, yet it is not to be doubted that where dividends are withheld for an unlawful purpose —to deprive a particular stockholder of bis rights — he may have tbe aid of equity for adequate protection. It appears in tbis complaint that tbe earnings and surplus of tbe company amounted to more than $70,000, upon an authorized capital of $50,000; that a portion of tbe capital stock has not been issued, and that tbe failure and refusal to declare a dividend is for tbe purpose of defrauding plaintiff; . . . Under such circumstances, it is too plain to admit of doubt, as held by tbe trial court, that these facts entitled plaintiff to some relief.” (94 Minn. p. 35.)

In 13 Am. Jur., Corporations, Sec. 423, p. 475, it is stated:

> “Tbe devolution of unlimited power imposes on tbe holders of tbe majority of tbe stock a correlative duty, tbe duty of a fiduciary or agent, to tbe holders of tbe minority of tbe stock, who can act only through them • — tbe duty to exercise good faith, care, and diligence to make tbe property of tbe corporation produce the largest possible amount, to protect tbe interests of tbe holders of the minority of tbe stock, and to secure and pay over to them their just proportion of tbe income and of tbe proceeds of tbe corporate property.”

It is further stated in 13 Am. Jur., Corporations, Sec. 708, as follows:

> “It is well settled that in a proper case a court of equity has jurisdiction to compel tbe declaration and payment of corporate dividends wrongfully withheld from minority stockholders. . . .

> “While a strong case must be made to justify such relief and while tbe court will not generally infringe upon the discretion vested in tbe corporation and its officers, where tbe right to a corporate dividend is clear, a court of equity will interfere to compel tbe directors to declare it. . . . Some courts have declared that fraud or bad faith is necessary in order to warrant such relief, but according to the weight of authority courts of equity may also compel tbe declaration of dividends in extreme cases of arbitrary, oppressive, or wrongful conduct amounting in effect to a breach of trust, even though no actual fraud is shown.”

In tbe instant case tbe gravamen of tbe plaintiff’s complaint is that: “tbe resolutions of January 8, 1951, attempting to set aside tbe entire surplus as working capital of $295,327.47 . . . was not adopted in good faith, but arbitrarily and fraudulently for tbe single purpose of defeating plaintiff’s statutory right to dividends, . . . and that tbe defendants have arbitrarily and unlawfully failed, . . . and refused to pay out tbe *339accumulated profits . . . and are willfully and deliberately failing to pay dividends, and are operating said business for tbeir own gain and advantage . . . for tbe purpose of rendering tbe stock of tbe plaintiff valueless . . . and with tbe deliberate intent of ‘freezing out’ plaintiff from bis ownership in said corporation.”

These allegations put to test tbe validity of tbe resolution of 8 January, 1951. If tbe allegations be true, no valid corporate action has been taken, and tbe earned surplus of tbe corporation does not stand set aside as working capital. These allegations would seem to be sufficient to afford tbe plaintiff an opportunity to be beard, — a chance to produce bis proofs and see if be can make good bis charges. *Amick v. Coble, supra*(222 N.C. 484).

As a general rule, a stockholder may not maintain suit against tbe corporation to redress a corporate wrong unless and until be has exhausted reasonable efforts in seeking relief within tbe corporation; and, ordinarily, be is required to allege in bis complaint that be has sought, but has been unable to obtain, correction of tbe wrongs complained of by tbe controlling authorities of tbe corporation, or show facts excusing such demand. See *Winstead v. Hearne,*173 N.C. 606, bot. p. 611, 92 S.E. 613; 13 Am. Jur., Corporations, Sec. 454, p. 500. Here, it would seem that tbe plaintiff has alleged in detail sufficient efforts to obtain relief, before suit, from within tbe corporate management.

¥e have not overlooked tbe decision in *Steele v. Cotton Mills,*231 N.C. 636, 58 S.E. 2d 620, cited and relied upon by tbe defendants. That case, however, is distinguishable. There it was not made to appear that at tbe time of tbe commencement of tbe action funds were available for tbe payment of dividends, as is specifically alleged in tbe instant case.

For tbe reasons given, tbe judgment below overruling tbe demurrer is

Affirmed.

VALENTINE, J., took no part in the consideration or decision of this case.