Source: https://supreme.justia.com/cases/federal/us/337/541/
Timestamp: 2019-04-25 13:56:28+00:00

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Justia › US Law › US Case Law › US Supreme Court › Volume 337 › Cohen v. Beneficial Indus. Loan Corp.
1. Under 28 U. S. C. §1291, appeal may be taken from an order of a Federal District Court denying a corporation's motion that the plaintiff in a stockholder's derivative action be required, pursuant to a state statute, to give security for reasonable expenses of the defendants, in connection with the action. Pp. 337 U. S. 545-547.
(a) The matters embraced in such an order are not of such an interlocutory nature as to affect, or to be affected by, a decision on the merits. P. 337 U. S. 546.
(b) The order is appealable because it is a final disposition of a claimed right which is not an ingredient of the cause of action and does not require consideration with it. Pp. 337 U. S. 546-547.
2. A state statute providing that, in any stockholder's derivative action pending at the time of its enactment or thereafter brought, in which the plaintiff's interest as a shareholder is less than 5% of the value of all outstanding shares and has a market value of less than 50,000, he may be required at any stage of the proceeding to give security for the reasonable expenses, including counsel fees, which the corporation may incur or for which it may become liable, does not violate the Federal Constitution. Pp. 337 U. S. 547-555.
(a) The Federal Constitution does not oblige a state to place its litigating and adjudicating processes at the disposal of a plaintiff in a stockholder's derivative suit, at least without imposing standards of responsibility, liability and accountability which it considers will protect the interests he elects himself to represent. Pp. 337 U. S. 547-551.
(b) The statute here involved does not violate the Contract Clause of the Constitution. P. 337 U. S. 551.
(c) For a state to close its courts to this type of litigation if the condition of reasonable security is not met does not violate the Due Process Clause. Pp. 337 U. S. 551-552.
(d) The limitation of the requirement of the statute to stockholders whose interest is less than 5% and has a market value of less than $50,000 does not violate the Equal Protection Clause of the Constitution. Pp. 337 U. S. 552-553.
(e) Assuming that the statute will not be construed as imposing liability for expenses incurred before its enactment, or perhaps before the granting of security in a particular case, the provision making it applicable to actions pending at the time of its enactment does not give it such a retroactive effect as to render it unconstitutional under the Due Process Clause. Pp. 337 U. S. 553-554.
3. That a corporation which was the subject of a stockholder's derivative action in New Jersey was organized under the laws of Delaware does not make inapplicable a New Jersey statute providing that the plaintiff may be required to give security for reasonable expenses of the corporation. Pp. 337 U. S. 554-555.
4. A federal court, having jurisdiction of a stockholder's derivative action only because of diversity of citizenship, must apply a statute of the forum State which makes the plaintiff, if unsuccessful, liable for reasonable expenses, including attorney's fees, of the defense and provides that the corporation may require the plaintiff to give security for their payment as a condition of prosecuting the action. Pp. 337 U. S. 543-545, 337 U. S. 555-557.
(a) A statute which so conditions the stockholder's action cannot be disregarded by the federal court as a mere procedural device. Pp. 337 U. S. 555-556.
(b) A different result is not required by Rule 23 of the Federal Rules of Civil Procedure, since there is no conflict between that rule and the state statute. P. 337 U. S. 556.
170 F. 2d 44, affirmed.
A Federal District Court, having jurisdiction of a stockholder's derivative action solely because of diversity of citizenship, denied a motion to require the plaintiff to post security for reasonable expenses incurred by the defense, as required by a statute of the forum State. 7 F.R.D. 352. The Court of Appeals reversed. 170 F.2d 44. This Court granted certiorari. 336 U. S. 917. Affirmed, p. 337 U. S. 556.
This decision appears to fall in that small class which finally determine claims of right separable from, and collateral to, rights asserted in the action, too important to be denied review and too independent of the cause itself to require that appellate consideration be deferred until the whole case is adjudicated. The Court has long given this provision of the statute this practical, rather than a technical, construction. Bank of Columbia v. Sweeney, 1 Pet. 567, 26 U. S. 569; United States v. River Rouge Improvement Co., 269 U. S. 411, 269 U. S. 414; Cobbledick v. United States, 309 U. S. 323, 309 U. S. 328.
of the cause of action and does not require consideration with it. But we do not mean that every order fixing security is subject to appeal. Here, it is the right to security that presents a serious and unsettled question. If the right were admitted or clear and the order involved only an exercise of discretion as to the amount of security, a matter the statute makes subject to reconsideration from time to time, appealability would present a different question.
Since this order may be reviewed on appeal, the petition in No. 512, whereby the corporation asserts the right to compel security by mandamus, is dismissed.
Petitioners deny the validity of the statute under both Federal and New Jersey Constitutions. The latter question is ultimately for the state courts, and since they have made no contrary determination, we shall presume in the circumstances of this case that the statute conforms with the State constitution.
Federal Constitutional questions we must consider, because a federal court would not give effect, in either a diversity or nondiversity case, to a state statute that violates the Constitution of the United States.
were lax, and were not self-enforcing, and stockholders, in face of gravest abuses, were singularly impotent in obtaining redress of abuses of trust.
Equity came to the relief of the stockholder, who had no standing to bring civil action at law against faithless directors and managers. Equity, however, allowed him to step into the corporation's shoes and to seek in its right the restitution he could not demand in his own. It required him first to demand that the corporation vindicate its own rights, but when, as was usual, those who perpetrated the wrongs also were able to obstruct any remedy, equity would hear and adjudge the corporation's cause through its stockholder with the corporation as a defendant, albeit a rather nominal one. This remedy, born of stockholder helplessness, was long the chief regulator of corporate management, and has afforded no small incentive to avoid at least grosser forms of betrayal of stockholders' interests. It is argued, and not without reason, that, without it, there would be little practical check on such abuses.
Unfortunately, the remedy itself provided opportunity for abuse which was not neglected. Suits sometimes were brought not to redress real wrongs, but to realize upon their nuisance value. They were bought off by secret settlements in which any wrongs to the general body of share owners were compounded by the suing stockholder, who was mollified by payments from corporate assets. These litigations were aptly characterized in professional slang as "strike suits." And it was said that these suits were more commonly brought by small and irresponsible than by large stockholders, because the former put less to risk, and a small interest was more often within the capacity and readiness of management to compromise than a large one.
and redressed, on the other. The Legislature of New Jersey, like that of other states, [Footnote 2] considered them sufficient to warrant some remedial measures.
The very nature of the stockholder's derivative action makes it one in the regulation of which the legislature of a state has wide powers. Whatever theory one may hold as to the nature of the corporate entity, it remains a wholly artificial creation whose internal relations between management and stockholders are dependent upon state law and may be subject to most complete and penetrating regulation, either by public authority or by some form of stockholder action. Directors and managers, if not technically trustees, occupy positions of a fiduciary nature, and nothing in the Federal Constitution prohibits a state from imposing on them the strictest measure of responsibility, liability and accountability, either as a condition of assuming office or as a consequence of holding it.
representative, at least without imposing standards of responsibility, liability and accountability which it considers will protect the interests he elects himself to represent. It is not without significance that this Court has found it necessary long ago, in the Equity Rules [Footnote 3] and now in the Federal Rules of Civil Procedure, [Footnote 4] to impose procedural regulations of the class action not applicable to any other. We conclude that the state has plenary power over this type of litigation.
highest wisdom or provide the best conceivable remedies. Nor can legislation be set aside by courts because of the fact, if it be such, that it has been sponsored and promoted by those who advantage from it. [Footnote 6] In dealing with such difficult and controversial subjects, only experience will verify or disclose weaknesses and defects of any policy and teach lessons which may be applied by amendment. Within the area of constitutionality, the states should not be restrained from devising experiments, even those we might think dubious, in the effort to preserve the maximum good which equity sought in creating the derivative stockholder's action and at the same time to eliminate as much as possible its defects and evils.
It is said that this statute transgresses the Due Process Clause, Amend. 14, by being "arbitrary, capricious and unreasonable;" the Equal Protection Clause by singling out small stockholders to burden most heavily; that it violates the Contract Clause, art. 1, § 10, cl. 1, and that its application to pending litigation renders it unconstitutionally retroactive.
The contention that this statute violates the Contract Clause of the Constitution is one in which we see not the slightest merit. Plaintiff's suit is entertained by equity largely because he had no contract rights on which to base an action at law, and hence none which is impaired by this legislation.
that it is inadequate or to decrease if it is proved to be excessive. A state may set the terms on which it will permit litigations in its courts. No type of litigation is more susceptible of regulation than that of a fiduciary nature. And it cannot seriously be said that a state makes such unreasonable use of its power as to violate the Constitution when it provides liability and security for payment of reasonable expenses if a litigation of this character is adjudged to be unsustainable. It is urged that such a requirement will foreclose resort by most stockholders to the only available judicial remedy for the protection of their rights. Of course, to require security for the payment of any kind of costs or the necessity for bearing any kind of expense of litigation has a deterring effect. But we deal with power, not wisdom, and we think, notwithstanding this tendency, it is within the power of a state to close its courts to this type of litigation if the condition of reasonable security is not met.
based upon the percentage or market value of the stock alleged to be injured by the wrongs, is an unconstitutional one. Where any classification is based on a percentage or an amount, it is necessarily somewhat arbitrary. It is difficult to say of many lines drawn by legislation that they give those just above and those just below the line a perfectly equal protection. A taxpayer with $10,000.01 of income does not think it is equality to tax him at a different rate than one who has $9,999.99, or to require returns from one just above and not from one just below a certain figure. It is difficult to say that a stockholder who has 49.99% of a company's stock should be unable to elect any representative to its Board of Directors. while one who owns 50.01% may name the entire Board. If there is power, as we think there is, to draw a line based on considerations of proportion or amount, it is a rare case, of which this is not one, that a constitutional objection may be made to the particular point which the legislature has chosen.
before one or the other of these periods. We would not, for the purpose of considering constitutionality, construe the statute in absence of a state decision to impose liability for events before its enactment. On this basis, its alleged retroactivity amounts only to a stay of further proceedings unless and until security is furnished for expense incurred in the future, and does not extend either to destruction of an existing cause of action or to creation of a new liability for past events.
The mere fact that a statute applies to a civil action retrospectively does not render it unconstitutional. Blount v. Windley, 95 U. S. 173, 95 U. S. 180; Western Union Telegraph Co. v. Louisville & N.R.Co., 258 U. S. 13; Chase Securities Corp. v. Donaldson, 325 U. S. 304. Looking upon the statute as we have indicated, its retroactive effect, if any, is certainly less drastic and prejudicial than that held not to be unconstitutional in these decisions. We do not find in the bare statute any such retroactive effect as renders it unconstitutional under the Due Process Clause, and of course we express no opinion as to the effect of an application other than we have indicated.
It is also contended that this statute may not be applied in this case because the cause of action derives from a Delaware corporation, and hence Delaware law governs it. But it is the plaintiff who has brought the case in New Jersey. The trial will very likely involve questions of conflict of laws as to which the law of New Jersey will apply, Klaxon Co. v. Stentor Electric Mfg. Co., 313 U. S. 487; Griffin v. McCoach, 313 U. S. 498, and perhaps questions of full faith and credit. These are not before us now. A plaintiff cannot avail himself of the New Jersey forum and at the same time escape the terms on which it is made available, if the law is applicable to a federal court sitting in that State, which we later consider.
a valid law of that State, and the question remains as to whether it must be applied by federal courts in that State to suits brought therein on diversity grounds.
"The laws of the several states, except where the Constitution or treaties of the United States or Acts of Congress otherwise require or provide, shall be regarded as rules of decision in civil actions in the courts of the United States, in cases where they apply."
This Court, in Erie R. Co. v. Tompkins, 304 U. S. 64, held that judicial decisions are laws of the states within its meaning. But Erie R. Co. v. Tompkins and its progeny have wrought a more far-reaching change in the relation of state and federal courts and the application of state law in the latter whereby in diversity cases the federal court administers the state system of law in all except details related to its own conduct of business. Guaranty Trust Co. v. York, 326 U. S. 99. The only substantial argument that this New Jersey statute is not applicable here is that its provisions are mere rules of procedure, rather than rules of substantive law.
the Act did was to create this liability, it would clearly be substantive. But this new liability would be without meaning and value in many cases if it resulted in nothing but a judgment for expenses at or after the end of the case. Therefore, a procedure is prescribed by which the liability is insured by entitling the corporate defendant to a bond of indemnity before the outlay is incurred. We do not think a statute which so conditions the stockholder's action can be disregarded by the federal court as a mere procedural device.
It is urged, however, that Federal Rule of Civil Procedure No. 23 deals with plaintiff's right to maintain such an action in federal court, and that therefore the subject is recognized as procedural, and the federal rule alone prevails. Rule 23 requires the stockholder's complaint to be verified by oath and to show that the plaintiff was a stockholder at the time of the transaction of which he complains or that his share thereafter devolved upon him by operation of law. In other words, the federal court will not permit itself to be used to litigate a purchased grievance or become a party to speculation in wrongs done to corporations. It also requires a showing that an action is not a collusive one to confer jurisdiction, and to set forth the facts showing that the plaintiff has endeavored to obtain his remedy through the corporation itself. It further provides that the class action shall not be dismissed or compromised without approval of the court, with notice to the members of the class. These provisions neither create nor exempt from liabilities, but require complete disclosure to the court and notice to the parties in interest. None conflict with the statute in question, and all may be observed by a federal court, even if not applicable in state court.
We see no reason why the policy stated in Guaranty Trust Co. v. York, 326 U. S. 99, should not apply.
We hold that the New Jersey statute applies in federal courts, and that the District Court erred in declining to fix the amount of indemnity reasonably to be exacted as a condition of further prosecution of the suit.
* Together with No. 512, Beneficial Industrial Loan Corp. v. Smith, United States District Judge, et al., also on certiorari to the same Court.
"1. In any action instituted or maintained in the right of any domestic or foreign corporation by the holder or holders of shares, or of voting trust certificates representing shares, of such corporation having a total par value or stated capital value of less than five percentum (5%) of the aggregate par value or stated capital value of all the outstanding shares of such corporation's stock of every class . . . unless the shares or voting trust certificates held by such holder or holders have a market value in excess of fifty thousand dollars ($50,000.00), the corporation in whose right such action is brought shall be entitled, at any stage of the proceeding before final judgment, to require the complainant or complainants to give security for the reasonable expenses, including counsel fees, which may be incurred by it in connection with such action and by the other parties defendant in connection therewith for which it may become subject pursuant to law, its certificate of incorporation, its by-laws or under equitable principles, to which the corporation shall have recourse in such amount as the court having jurisdiction shall determine upon the termination of such action. The amount of such security may thereafter, from time to time, be increased or decreased in the discretion of the court having jurisdiction of such action upon showing that the security provided has or may become inadequate or is excessive."
"2. In any action, suit or proceeding brought or maintained in the right of a domestic or foreign corporation by the holder or holders of shares, or of voting trust certificates representing shares, of such corporation, it must be made to appear that the complainant was a shareholder or the holder of a voting trust certificate at the time of the transaction of which he complains or that his share or voting trust certificate thereafter devolved upon him by operation of law."
"3. This act shall take effect immediately, and shall apply to all such actions, suits or proceedings now pending in which no final judgment has been entered, and to all future actions, suits and proceedings."
See § 61-b, New York General Corporation Law, Consol.Laws, c. 23; 12 Pa. Stat.Ann. § 1322; c. 989, Laws of Maryland, 1945; Wisconsin Stat. § 180.13 (1945).
Old Equity Rule 94, 104 U.S. ix; Equity Rule 27, 226 U.S. 649, 656.
See Hornstein, Problems of Procedure is Stockholders' Derivative Suits, 42 Col.L.R. 574; Hornstein, Directors' Expenses in Stockholders' Suits, 43 id. 301; Koessler, The Stockholder's Suit: A Comparative View, 46 id. 238; Hornstein, New Aspects of Stockholders' Derivative Suits, 47 id. 1; Carson, Current Phases of Derivative Actions Against Directors, 40 Mich.L.R. 1125; P. E. Jackson, Reorganization of the Corporate Concept and the Effect of Section 61-b of the New York General Corporation Law, A5 Am.Bankr.Rev. 323; Carson, Further Phases of Derivative Actions Against Directors, 29 Cornell L.Q. 431; House, Stockholders' Suits And the Coudert-Mitchell Laws, 20 N.Y.U.L.Q.Rev. 377; Hornstein, The Death Knell of Stockholders' Derivative Suits in New York, 32 California L.R. 123; Zlinkoff, The American Investor And the Constitutionality of Section 61-b of the New York General Corporation Law, 54 Yale L.J. 352. See Douglas, Directors Who Do Not Direct, 47 Harv.L.R. 1305.
Daniel v. Family Security Life Insurance Co., 336 U. S. 220.
MR. JUSTICE DOUGLAS, with whom MR. JUSTICE FRANKFURTER concurs, dissenting in part.
The cause of action on which this suit is brought is a derivative one. Though it belongs to the corporation, the stockholders are entitled under state law to enforce it. The measure of the cause of action is the claim which the corporation has against the alleged wrongdoers. This New Jersey statute does not add one iota to, nor subtract one iota from, that cause of action. It merely prescribes the method by which stockholders may enforce it. Each state has numerous regulations governing the institution of suits in its courts. They may favor the litigation or they may affect it adversely. But they do not fall under the principle of Erie R. Co. v. Tompkins, 304 U. S. 64, unless they define, qualify or delimit the cause of action or otherwise relate to it.
This New Jersey statute, like statutes governing security for costs, regulates only the procedure for instituting a particular cause of action, and hence need not be applied in this diversity suit in the federal court. Rule 23 of the Federal Rules of Civil Procedure defines that procedure for the federal courts.
I am in accord with the dissenting opinion of MR. JUSTICE DOUGLAS in this case. I also agree with the dissenting views of MR. JUSTICE JACKSON in No. 465, Woods v.
Interstate Realty Co., ante, p. 337 U. S. 538, decided today. And I have noted my dissent in Ragan v. Merchants Transfer & Warehouse Co., ante, p. 337 U. S. 530, also decided today.
Without undertaking to discuss each case in detail, I think the three decisions, taken together, demonstrate the extreme extent to which the Court is going in submitting the control of diversity litigation in the federal courts to the states, rather than to Congress, where it properly belongs. This is done in the guise of applying the rule of Erie R. Co. v. Tompkins, 304 U. S. 64. But, in my opinion, it was never the purpose of that decision to put such matters as those involved here outside the power of Congress to regulate, and to confer that authority exclusively upon the states.
What is being applied is a gloss on the Erie rule, not the rule itself. That case held that federal courts in diversity cases must apply state law, decisional as well as statutory, in determining matters of substantive law, in particular and apart from procedural limitations upon its assertion -- whether a cause of action exists. I accept that view generally and insofar as it involves a wise rule of administration for the federal courts, though I have grave doubt that it has any solid constitutional foundation.
been put upon the Erie ruling by later decisions, e.g., Guaranty Trust Co. v. York, 326 U. S. 99, which, in my opinion, is being applied to extend the Erie ruling far beyond its original purpose or intent and, in my judgment, with consequences and implications seriously impairing Congress' power, within its proper sphere of action, to control this type of litigation in the federal courts.
The accepted dichotomy is the familiar "procedural-substantive" one. This, of course, is a subject of endless discussion, which hardly needs to be repeated here. Suffice it to say that actually, in many situations, procedure and substance are so interwoven that rational separation becomes well nigh impossible. But, even so, this fact cannot dispense with the necessity of making a distinction. For, as the matter stands, it is Congress which has the power to govern the procedure of the federal courts in diversity cases and the states which have that power over matters clearly substantive in nature. Judges therefore cannot escape making the division. And they must make it where the two constituent elements are Siamese twins, as well as where they are not twins or even blood brothers. The real question is not whether the separation shall be made, but how it shall be made, whether mechanically by reference to whether the state courts' doors are open or closed, or by a consideration of the policies which close them and their relation to accommodating the policy of the Erie rule with Congress' power to govern the incidents of litigation in diversity suits.
a diversity suit in Pennsylvania or New York.* It is another, in my view, to require a bond for costs or for payment of the opposing party's expenses and attorney's fees in the event the claimant is unsuccessful. Whether or not the latter is conceived as creating a new substantive right, it is too close to controlling the incidents of the litigation, rather than its outcome, to be identified with the former. It is a matter which, in my opinion, lies within Congress' control for diversity cases, not one for state control or to be governed by the fact that the state shuts the doors of its courts unless the state requirements concerning such incidents of litigation are complied with.
"that the plaintiff was a shareholder at the time of the transaction of which he complains or that his share thereafter devolved on him by operation of law. . . ."
For, in any strict and abstract sense, that provision would seem to be as much a "substantive" one as the New Jersey requirements for bond, etc. And, if so, then it would seem highly doubtful, on any automatic or mechanical application of the substantive-procedural dichotomy, that either Congress or this Court could create such a limitation on diversity litigation, since, as a substantive matter, this would be for the states to control. See 3 Moore, Federal Practice (2d Ed.) 3493-3506.
For myself, I have no doubt of the validity of Rule 23 or of the power of Congress to enact such a rule, even though it has a substantive aspect. Notwithstanding that aspect, the rule is too closely related to procedural and other matters affecting litigation in the federal courts for me to conceive of its invalidity. So also, in the present cases, I think the state regulations, though each may be regarded as having a substantive aspect, are too closely related to the modes and methods of conducting litigation in the federal courts to be capable of displacing Congress' power or regulation in those respects or the federal courts' power to hear and determine the respective controversies.
Accordingly I would reverse the judgments in the Cohen and Ragan cases and affirm that in the Woods case.
"a citizen of Pennsylvania . . . in the federal court for Southern New York, which had jurisdiction because the company is a corporation of that State."
304 U.S. at 304 U. S. 69 (emphasis added). Accordingly, as Erie is now construed, the issue on remand should have been what law a New York state court would have applied to the Pennsylvania tort. But the sole issue determined on remand was the applicable Pennsylvania law, without mention of the probable attitude of the New York courts. Tompkins v. Erie R. Co., 2 Cir., 98 F.2d 49. It was not until after Justice Brandeis had retired that this Court held that federal district courts were required to follow local conflict of laws doctrine in the resolution of diversity cases. Klaxon Co. v. Stentor Electric Mfg. Co., 313 U. S. 487.

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