Mundy Jr, Thomas J

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Boston College Law ReviewVolume 4 | Issue 2 Article 221-1-1963Corporations—Sale of Stock—Condition for theTransfer of Directorship Control.—EssexUniversity Corp. v. YatesThomas J. Mundy JrFollow this and additional works at: http://lawdigitalcommons.bc.edu/bclrPart of the Business Organizations Law CommonsThis Casenotes is brought to you for free and open access by the Law Journals at Digital Commons @ Boston College Law School. It has been acceptedfor inclusion in Boston College Law Review by an authorized administrator of Digital Commons @ Boston College Law School. For more information,please contact nick.szydlowski@bc.edu.Recommended CitationThomas J. Mundy Jr, Corporations—Sale of Stock—Condition for the Transfer of DirectorshipControl.—Essex University Corp. v. Yates, 4 B.C.L. Rev. 421 (1963),http://lawdigitalcommons.bc.edu/bclr/vol4/iss2/22CASE NOTESCorporations—Sale of Stock—Condition for the Transfer of Director-ship Control.—Essex University Corp. v. Yates.1—The defendant, Yates,was president of the board of directors of Republic Pictures Corporation, aNew York corporation having 2,004,190 shares of common stock outstanding.On August 28, 1957 the defendant entered into a contract with JosephHarris, the president of Essex Universal Corporation, whereby Essexagreed to buy and Yates to sell 566,223 shares, or 28.3 per cent of theRepublic stock. The price was eight dollars a share, approximately twodollars above the then market price. A condition was attached to the con-tract whereby the seller would obtain the agreement of the majority of thedirectors of Republic to a process of seriatim resignation, each in turn beingreplaced by the Essex nominee. At the agreed date of performance thedefendant (seller) refused to perform. Essex then brought an action forbreach of contract in the New York Supreme Court, and it was removed tothe United States District Court on the basis of diversity of citizenship.The District Court rendered summary judgment for the defendant on theground that the condition for the transfer of directorship control was in-valid as against public policy. On appeal to the United States Court ofAppeals for the Second Circuit, HELD: The condition for transfer ofdirectors was not, under New York law, per se invalid as against publicpolicy.The court was faced with the difficult question of determining, notwhat the law of New York should be, but what it is. The court recognizedthe fact that there is hardly enough New York authority for an informedprediction of what the New York Court of Appeals would decide on thefacts here presented. In resolving this question the court refers initially tothe early New York Court of Appeals decision of Barnes v. Browne whichheld that the owner of a majority interest may properly, in connection with asale of his shares agree with the buyer to procure the resignation of directorsto facilitate or accelerate the transfer of control by the buyer. Judge Earlstated:[The seller] had the right to sell out all his stock and interestin the corporation . • . and when he ceased to have any interest inthe corporation, it was certainly legitimate and right that he shouldcease to control it. . . It was simply the mode of transferring thecontrol of the corporation to those who by the policy of the lawought to have it, and I am unable to see how any policy of the lawwas violated, or in what way, upon the evidence, any wrong wasthereby done to anyone.While in the Barnes case no term of the contract3 of sale required theseller to effectuate the immediate replacement of directors, as did the con-tract in the present case, the Barnes court stated, "I shall assume that itwas the understanding and a part of the scheme that he should do so." 41 305 F.2d 572 (2d Cir. 1962).2 go N.Y. 527 (1880).a Id. at 537.4 Id. at 536.421BOSTON COLLEGE INDUSTRIAL AND COMMERCIAL LAW REVIEWAs the agreement in Barnes was justified by the rationale that the transfer ofthe directorships was inevitable in a transfer of a majority of the stockand that the parties thus could facilitate the inevitable, the court's relianceon this case implies that today, in a large public issue corporation, a holdingof 28.3 per cent of stock would be tantamount to majority control. Each ofthe three justices wrote a separate opinion. Judge Lombard, in his opinion,applied a "practical-certainty" test. He said that if, at the trial level, itcould be found that a certain percentage of shares would in fact amountto control then the condition in the contract would be valid. Judge Clarkhowever felt that twenty-eight per cent equals control and this should notbe an issue at the trial level. Judge Friendly, while disagreeing with therationale of Lombard and Clark, stated that, "although [Barnes] dealtwith the sale of a majority interest, I am unable to find any real indicationthat the doctrine there announced has been thus limited . . . to indicate thatNew York would not apply the [Barnes] doctrine to a case where a stock-holder conditioned a sale on his causing the resignation of a majority of thedirectors and the election of the purchaser's nominees." 5Although it may be true that the New York courts have not specificallyoverruled Barnes v. Brown, there are strong inferences that the 1880 doc-trine is outmoded due to the evolution of corporate law and theory.The early conventional approach of the Barnes court and of the deci-sions relying thereon(' was to regard controlling shares as an ordinary assetwhich corporate managers may buy and sell with the same freedom which thelaw permits with respect to other kinds of property.? This approach ispredicated upon the notion that the corporation—the collective body ofshareholders—is a separate legal entity, an artificial personality, to whoman officer, a director or a controlling shareholder owes his sole duty. Itfollowed as a necessary corollary that the controlling shareholder was nota fiduciary of and owed no duty to the outside shareholders as individualswhen he sold his stock to strangers.8 Therefore, (under this conventionalapproach) the controlling shareholder could sell to any person, at any timeand at any price. 9An examination of the recent New York cases will disclose a currenttrend in the law to prevent abuse of power on the sale of control. Thesecases show that the conventional approach of the Barnes court, whichwas used as authority by the present court in reaching its decision, hasnot only been generally discredited, but has been by implication discarded.The Supreme Court of New York, in the case of Ballantine v. Ferretti,5 305 F.2d at 582.Roosevelt v. Hamblin, 199 Mass. 127, 85 N.E. 98 (1908); San Remo CopperMining Co. v. Moneuse, 149 App. Div. 26, 133 N.Y. Supp. 509 (1912).7 Jennings, Trading in Corporate Control, 44 Calif. L. Rev. 1, 5 (1956); Hill, TheSale of Controlling Shares, 70 Harv. L. Rev. 986 (1957).8 Jennings, supra note 7, at 6.Roosevelt v. Hamblin, supra note 6; Levy v. Feinberg, 29 N.Y.S.2d 550 (Sup.Ct. 1941), rev'd sub nom., Levy v. Armstrong Beverage Corp., 265 App. Div. 208, 38N.Y.S.2d 517 (1942) ; Stanton v. Schenck, 140 Misc, 621, 251 N.Y. Supp. 221 (Sup. Ct.1931). But see Fremont v. Stone, 42 Barb. 169 (N.Y. Sup. Ct. 1864), where theprinciple is qualified to the extent that the directorate may not be turned over topersons who there is reason to believe will loot the corporation.422CASE NOTESsaid in effect: Though a corporation may, under certain circumstances, pay orpermit [a] third party to pay some consideration to some officers anddirectors to induce them to resign, sale of control by those standing in [a]fiduciary relation to the corporation may be wrongful even though [the]corporation does not complain.10 In the 1941 case of Gerdes v. Reynolds,"which Judge Lombard distinguished in that it "did no more than hold con-trolling shareholders who sold out to persons whose intentions they hadreason to suspect to an accounting, after the fact," 12 the court stated,in seeming contradiction to Judge Lombard's interpretation, thatOfficers and directors always and necessarily stand in a fiduciaryrelation to the corporation and to its stockholders. . . . They un-doubtedly may free themselves of that fiduciary relationship byceasing to be officers and directors, but their right to resign,although sometimes stated with seeming absoluteness is qualifiedby their fiduciary obligation to others. . . Neither can they ac-cept pay in any form or guise, direct or devious, for their ownresignation or for the election for others in their place. . . . [S]ucha contract cannot be made a vehicle for a violation of any fiduciarycluty.laIn the Gerdes case, the liability of the four directors who sold their stock,resigned and placed the buyer's candidates in control of the directorshipwas asserted against them on two grounds. First, "that the sale of stock,accompanied by their resignations and the election of their successorsnominated by the purchaser, was itself an illegal transaction because inviolation of fiduciary duties owed to the corporation and the holders of itsdebentures and its preferred stock and its minority common stockholders.""(Emphasis supplied.) The second reason for finding liability (i.e., holding,controlling shareholders who sold out to persons whose intentions they hadreason to suspect to an accounting, after the fact) was the sole reasonstated by Judge Lombard upon which he based his interpretation of the case.Even granting Judge Lombard's interpretation, there exists at the minimuma very strong inference that such a sale of directorship is illegal as abreach of fiduciary duty to the corporation and to the other stockholders.The modern viewpoint, consistent with these recent New York cases,indicates that, when majority stockholders have in fact assumed the manage-ment of the corporation, they stand in a fiduciary relation to the minority. 15While they may resign, this right is qualified by their fiduciary obligation10 28 N.Y.S.2d 668, 680 (Sup. Ct. 1941).11 28 N.Y.S.2d 622 (Sup. Ct. 1941)." 305 F.2d at 577.13 Gerdes v. Reynolds, supra note 11, at 651-52.14 Id. at 649.15 Southern Pac. Co. v. Bogert, 250 U.S. 483, 491 (1919); B]austein v. Pan Am.Petroleum & Transp. Co., 174 Misc. 601, 665, 690, 21 N.Y.S.2d 651, 711, 733 (1940);Cleary v. Higley, 154 Misc. 158, 168-69, 277 N.Y. Supp. 63, 76, afrd, 246 App. Div.698, 284 N.Y. Supp. 989 (1934); Farmer's Loan & Trust Co. v. N.Y. & No. R.R. Co.,150 N.Y. 410, 430-31, 44 N.E. 1043, 1048-49 (1896); Hornstein, Corporation Law &Practice § 366 (1959); Berle & Means, The Modern Corporation & Private Property243 (1932).423BOSTON COLLEGE INDUSTRIAL AND COMMERCIAL LAW REVIEWto others." Recent cases hold that a seller, who is a director and a dom-inant stockholder stands in a fiduciary relationship to the corporation andto the minority stockholders as beneficiaries thereof. 17 The cases are imposinga strictly fiduciary capacity on the directors, in effect making their officea trust."In the fairly recent case of Benson v. Braun the New York SupremeCourt stated that "It appears similarly probable that the sellers expected orassumed that their resignations would be requested. Such expectations orassumptions cannot be equated with the bartering of corporate officeswhich the law forbids."'In recent commentary on the subject, the corporate asset theory,first advanced by Berle, has been emphasized. 2° The claim is "that anypremium paid for a majority block of stock is paid by the purchaserbecause the shares carry `control'; the purchaser is 'buying power and notstock ....' [Thus] 'the power going with the control is an asset which belongsonly to the corporation....' "21While the 1880 case of Barnes v. Brown was a Court of Appeals decisionand the three New York cases mentioned above 22 were lower court decisions,it seems apparently clear that, while Barnes has not been overruled, thetheory upon which its decision was based has passed from the prevailingconcept of corporate law. 23 The directors are placed in office by the stock-16 O'Neil v. City of Port Jervis, 253 N.Y. 423, 430, 171 N.E. 694, 696 (1930);Lattin, The Law of Corporations § 13 (1959); Jennings, supra note 7, at 9.17 Pepper v. Litton, 308 U.S. 295 (1939); Southern Pac. Co. v. Bogert, 250 U.S.483 (1919).18 Perlman v, Feldman, 219 F.2d 173 (2d Cir.), cert. denied, 349 U.S. 952 (1955);Hill v. Nisbet, 100 Ind. 341, 353 (1885); Stratis v. Anderson, 254 Mass. 536, 150 N.E.832 (1926).19 8 Misc. 2d 67, 71, 155 N.Y.S.2d 622, 627 (Sup. Ct. 1956).29 Berle & Means, The Modern Corporation & Private Property 244 (1932).21 Jennings, supra note 7, at 9.22 Supra notes 10, 11 & 19.23 The federal courts, in deciding a question of state law, are not necessarily boundby an early decision of the state's highest court where subsequent inferior state courtdecisions have consistently refused to be so bound. In Bernhardt v. Polygraphic Co.of America, 350 U.S. 198 (1955), faced in a diversity case with a question apparentlysettled by a 1910 decision of the state's highest court, the Court conformed to theearly decision. However, in a concurring opinion, Mr. Justice Frankfurter suggestedthat a federal court might declare that the Vermont court if faced with the questionat this time might reach a conclusion contrary to the 1910 decision. He argued quiteforcefully that "the 1910 decision should not foreclose consideration by the federaldistiict court of the question, and that the Court should attempt to decide what theVermont court would do if faced with the question at this time." 350 U.S. at 211.Cf. Mason v. American Emery Wheel Works, 241 F.2d 906, 908 (1st Cir. 1957).In the present case the court seemed unwilling to go beyond the 1880 decision ofthe New York Court of Appeals and the theory upon which it was based. JudgeFriendly notes the solution to such a problem adopted in Florida, where the SupremeCourt of Florida may answer questions of state law certified to it by the federalappellate courts. Fla. Rev. Stat. § 25.031 (1959); Rule 4.61 of the Supreme Court ofFlorida. In the absence of such an available procedure, the abstention of federal courtson questions of state law is limited to areas of sovereign prerogative, Louisiana Power& Light Co. v. City of Thibodaux, 360 U.S. 25 (1959), and uninterpreted state statutes,the constitutionality of which is doubtful, Leiter Minerals, Inc. v. United States, 352U.S. 220 (1957).424CASE NOTESholders and a duty—a fiduciary relationship—flows down not only tothe controlling shareholders but to all the stockholders. A sale of thedirectorships is a sale of a corporate asset and, considered as a breach of thefiduciary duty of these sellers, as directors, should not be countenanced bythe law.The trend of law today seems to be toward regarding managementcontrol as a corporate asset in which all shareholders have an equitableinterest and in which they are entitled to share. On this basis the Barnesdoctrine and the decision in the present case represent an outmoded view."Judge Friendly's opinion in the present case is indicative of the modernapproach to the director's increased fiduciary obligations:. . . developments over the past decades seem to me to show thatsuch a clause violates basic principles of corporate democracy. . .A mass seriatim resignation directed by a selling stockholder, andthe filling of vacancies by his henchmen at the dictation of a pur-chaser and without any consideration of the character of thelatter's nominees, are beyond what the stockholders contemplatedor should have been expected to contemplate. . . . A special meet-ing of stockholders to replace a board may always be called, andthere could be no objection to making the closing of a purchasecontingent on the results of such an election. 25THOMAS J. MUNDY, JR.Corporations—Stockholder's Rights—Inspection of the Corporate StockLedger.—Trans World Airlines, Inc. v. State of Del. ex rel. Porterie.'—Petitioner, owner of record of one hundred shares of TWA stock, was refusedpermission by TWA to inspect its stock ledger. Its refusal was predicatedon the contention that the petitioner was acting solely in behalf of HowardHughes' interests which were being sued by TWA in another jurisdictionin connection with certain loans made to TWA. The airline further contendedthat the inspection was sought for the purpose of soliciting stockholdersupport for a resolution instigated by Hughes via the petitioner, recom-mending that it assist Hughes in prosecuting claims against certain !endinginstitutions. Such action by TWA's management would result in an aban-donment of its claims against Hughes, which TWA asserts would be inimicalto the corporation. The Superior Court of Delaware granted a writ ofmandamus permitting a qualified inspection of TWA's stock ledger. On24 Berle, "Control" In Corporate Law, 58 Colum. L. Rev. 1212, 1217 (1958):A third point of contact is the practically universal prohibition of contractsby directors to resign, tciting Gerdes case] . . . . The vice therefore of adirector's contract to resign . . . at bottom rests not on the fact that such actionis based on personal motives but on the simple fact that the control functionis being abused. The thrust is quite simply, that directorships may not bebought and sold.25 305 F.2d at 581.I — Del. —, 183 A.2d 174 (1962).425

Corporations—Sale of Stock—Condition for the Transfer of Directorship Control.—Essex University Corp. v. Yates

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