Zisook, S. P.

English

Chicago-Kent College of Law

Chicago-Kent Law Review Volume 35 Issue 2 Article 6 April 1957 Corporations - Actions between Shareholders and Officers or Agents - Whether Personal Recovery by Former Shareholder Is Allowable in Actions against Officer for Misappropriation of Corporate Assets S. P. Zisook Follow this and additional works at: https://scholarship.kentlaw.iit.edu/cklawreview  Part of the Law Commons Recommended Citation S. P. Zisook, Corporations - Actions between Shareholders and Officers or Agents - Whether Personal Recovery by Former Shareholder Is Allowable in Actions against Officer for Misappropriation of Corporate Assets, 35 Chi.-Kent L. Rev. 136 (1957). Available at: https://scholarship.kentlaw.iit.edu/cklawreview/vol35/iss2/6 This Notes is brought to you for free and open access by Scholarly Commons @ IIT Chicago-Kent College of Law. It has been accepted for inclusion in Chicago-Kent Law Review by an authorized editor of Scholarly Commons @ IIT Chicago-Kent College of Law. For more information, please contact jwenger@kentlaw.iit.edu, ebarney@kentlaw.iit.edu. CHICAGO-KENT LAW REVIEWA possible solution to the problem in the instant case was given in thecase of Furst v. Brady,9 where the deceased non-resident motorist carriedan insurance policy which protected him from loss due to his automobileaccident. The court there treated the policy as an asset in the state wherethe suit was brought and allowed recovery against an ancillary administra-tor. In the case at hand, the deceased had a similar policy, and the claim-ants attempted to have an ancillary administrator appointed for purposesof reaching this policy to satisfy their claims in their home state. Thecourt did not allow this appointment, and refused to treat the policy asan asset in the state where suit was brought, thereby turning away fromthe above suggested solution.The increasing use of automobiles and accidents connected therewithseems to point to the necessity of a new concept in the law, especially sincethe more violent the accident the greater the chance of death for those in-volved. Therefore, the frequency of these deaths will give rise to more andmore actions similar to the instant case. The legislature of Ohio, appre-ciating these facts and recognizing the need for conferring such jurisdic-tion, has followed the modern trend and passed an amendment to its so-called substituted service statute and personal representatives of deceasednon-resident motorists may now be served in that manner.'0 The mostsalient aspect of this case lies in the fact that the legislature recognizedthe inadequacy in its state law and immediately stepped into the breachand remedied the situation.N. A. ZIMMERMANCORPORATIONs-ACTIoNs BETwEEN SHAREHOLDERS AND OFFICERS ORAGENTs-W =ETERm PERSONAL RECOVERY BY FORMER SHAREHOLDER ISALLOWABLE IN ACTIONS AGAINST OFFICER FOR MISAPPROPRIATION Or COR-PoRATE AssETs-The United States Court of Appeals for the Ninth Circuitwas recently faced with the problem of whether a former shareholdermight be allowed an individual recovery against an officer of the corpo-ration in the case of Watson v. Button.' Therein, the former owner ofone-half of the corporate stock brought an action against the former gen-1939, Art. 56, § 186.189; Mich. Stat. Ann., 1949 Cum. Supp., § 9.2103; Neb. Rev. Stat.1943, Vol. 2, Ch. 25, Art. 5, § 25-530 as amended in 1949; Thompson's Laws N. Y.,1945 Supp., Vehicle and Traffic Law, § 52, p. 725; Wis. Stats. 1949, Ch. 85 § 85.05(3).The constitutionality of these statutes has been upheld in such cases as: Plopa v.DuPre, 327 Mich. 606, 42 N. W. (2d) 777 (1950); Leighton v. Roper, 300 N. Y. 434,91 N. E. (2d) 876 (1950).9375 Ill. 425, 31 N. E. (2d) 606 (1940), noted in 19 CMCAGo-KENT L,&w R~wew293.10 Legislative Acts and Joint Resolutions of the State of Ohio, 1955-56, p. 49.1235 F. (2d) 235 (1956).DISCUSSION OF RECENT DECISIONSeral manager, who had owned the balance of the stock, to recover theamount misappropriated by the defendant prior to the sale of the entirecorporate stock to its present owners.2 The district court awarded a per-sonal judgment for the total amount of the defalcation to the plaintiff andthe reviewing court affirmed when it concluded that an individual recoveryis allowable, as an exception to the general rule, where the parties arejointly responsible for the corporation's liabilities resulting from suchmisappropriations, and the rights of creditors and other shareholders arenot prejudiced.3Generally, the individual shareholders have no separate and inde-pendent right of action for injuries suffered by the corporation whichmerely result in the depreciation of the value of their stock. 4 Rather, thewrong is said to be primarily against the corporation, and incidentallyagainst the owners. A suit to redress such a wrong must instead be broughtby the corporation or by a shareholder in a derivative suit on behalf of thecorporation. 5Any judgment obtained by reason of such wrongs is an asset of thecorporation which inures first to the benefit of creditors,5 and secondly tothe shareholders. This rule is based on the principle that where such aninjury occurs, each shareholder suffers relatively in proportion to thenumber of shares he owns, and each will be made whole if the corporationobtains restitution or compensation from the wrongdoer. 6 Since it is usu-ally conceded that the corporation has a cause of action, direct relief tothe shareholders might double the defendant's liability7 and, if recoveryshould be denied the corporation, the conduct of its business and rightsof its creditors might be jeopardized." The single action in favor of thecorporation is also said to be more convenient than the multiplicity of suits2 In July of 1954, all of the stock was sold to third parties. Defendant secured, aspart of the sale, an agreement from the purchasers to release and discharge himfrom any claims and demands existing against him in favor of the corporation, thusprecluding an action by the corporation or its present shareholders to enforce thecorporate cause of action.3 The court expressly stated that the plaintiff cannot bring a derivative actionsince he is no longer a shareholder. However, the court treated this case as a de-rivative action, and concluded that it falls within an exception to the general rulesof recovery applicable in stockholders' derivative suits.4 Smith v. Hurd, 12 Metc. (Mass.) 371 (1847), Is the leading case.5 Green v. Victor Talking Machine Co., 24 F. (2d) 378 (1928) ; Smith v. Hurd,12 Metc. (Mass.) 371 (1847) ; Massachusetts v. Davis, 140 Tex. 398, 168 S. W. (2d)216 (1942).6 Massachusetts v. Davis, 140 Tex. 398, 168 S. W. (2d) 216 (1942) ; see also thenote in 40 Calif. L. Rev. 127 (1952).7 White v. First National Bank, 252 Pa. 205, 97 A. 403 (1916).8 Dorah v. Pensicot County Bank, 213 Mo. App. 541, 256 S. W. 560 (1923) ; Beeberv. Wilson, 285 Pa. 312, 131 A. 854 (1926).CHICAGO-KENT LAW REVIEWwhich might result from a recognition of direct liability to the share-holders.9This general rule is not affected by the mere fact that the complainingshareholder owns all, or substantially all of the stock, 10 or that the defend-ant acted with malice toward the individual shareholder, since the ill willof a wrongdoer toward a stockholder and his motive in wrongdoing doesnot change his liability for injuries which remain injuries to the corpora-tion rather than to the individual shareholder."This rule is not universal, however. The courts have recognized atleast three situations which raise possible exceptions to the general rule.The first of these situations arises where the individual has parted withhis shares, without knowledge of the prior wrongful misappropriation ofcorporate assets by the directors. It has been held that the individual couldrecover from the directors the amount by which the misappropriation hadreduced the value of his prior shareholdings. 12 In these instances, theformer shareholder has been given a personal right of action on the theorythat the misappropriation has wrongfully affected him in a manner dif-ferent from its effect on the shareholders generally in that he has beenfraudulently induced or coerced into selling his shares.' sAnother situation in which an individual recovery has been allowedis where it appears that the injury to the shareholder resulted from theviolation of some special relationship, fiduciary or contractual, owed theshareholder by the wrongdoer. In these instances, although the corpora-tion also may have a cause of action growing out of the same wrong,the injury has its origin in circumstances independent of the plaintiff'sstatus as a shareholder, and he may maintain an action in his own right9 Wells v. Dane, 101 Me. 67, 63 A. 324 (1905).10 L. J. Sigl Inc. v. Bresnahan, 216 App. Div. 634, 215 N. Y. S. 735 (1926) (98%owership by plaintiff) ; Lockhart v. Moore, 25 Tenn. App. 456, 159 S. W. (2d) 438(1941) (complete ownership of stock) ; Stinnett v. Paramount-Famous Lasky Corp.,Tex. Com. App., 37 S. W. (2d) 145 (1931) (all but one share held by plaintiff).11 Boatright v. Steinite Radio Corp., 46 F. (2d) 385 (1931); Green v. VictorTalking Machine Co., 24 F. (2d) 378 (1928) ; Shenberg v. DeGarmo, 61 Cal. App. 326,143 P. (2d) 74 (1943) ; Compare Stidham v. State Bank, 126 Kans. 336, 268 P. 106(1928), where recovery was allowed a bank shareholder for slander of the bankalleged to have been uttered for the purpose of ruining the plaintiff among others.12 Backus v. Kirsh, 264 Mich. 73, 249 N. W. 469 (1933) ; Coronado DevelopmentCorp. v. Milliken, 175 Misc. 1, 22 N. Y. S. (2d) 670 (1940) ; Von Au v. Magenheimer,126 App. Div. 257, 110 N. Y. S. 629 (1908); Stinnett v. Paramount-Famous LaskyCorp., Tex. Com. App., 37 S. W. (2d) 145 (1931).Is See note 9, ante, and see Wells v. Dane, 101 Me. 67, 63 A. 324 (1905), where-in the court said, "That a shareholder has parted with his stock does not deprivehim of his right to sue ... directors who have unlawfully taken advantage of theirposition to his detriment."DISCUSSION OF RECENT DECISIONSin addition to the corporate right of action. 14  Thus, for example, in-dividual recovery has been awarded where the shareholder was a decedent'sestate, and the defendant its unfaithful administrator,15 or where thedirector was a pledgee of the plaintiff's shares.' 6At this point, it is important to note that the preceding two situa-tions have dealt with the circumstances under which a direct cause of actionin the shareholder will be enforced in addition to the corporate right ofaction. In these instances, although the cause of action may have arisenout of the transaction whereby the shareholder acquired his stock, or outof other circumstances dependent on the fact that he owns the stock, heacts in his individual capacity rather than on behalf of the corpora-tion; he is personally a party to a contract, or an individual victim ofa tortious injury. 17 It is clear that he has an individual right of action,and the suit brought by him would not constitute a derivative suit.' s Inthe true stockholders derivative suit, the plaintiff is merely an instigatormoving the court to action in behalf of the corporation.19 Thus it canreadily be seen that these instances, referred to as "exceptions", arenot really exceptions at all, but a recognition of the individual's separateand independent cause of action.There does exist, however, a true exception to the general rule. Incertain instances, where rights of creditors are not concerned, some courtshave granted a personal judgment in favor of the complaining share-holder, in lieu of recovery by the corporation, for such injuries whereit appeared that the wrongdoers themselves owned a majority of the14 Camp v. Gress, 250 U. S. 308, 39 S. Ct. 478, 63 L. Ed. 997 (1919) ; Blazer v.Black, 196 F. (2d) 139 (1951) ; Cutting v. Bryan, 30 F. (2d) 754 (1929) ; ChaseNational Bank v. Sayles, 30 F. (2d) 178 (1927) , Hammer v. Werner, 239 App. Div.38, 265 N. Y. S. 172 (1933) ; Kono v. Roeth, 237 App. Div. 252, 260 N. Y. S. 662(1932) ; Blakeslee v. Sottile, 118 Misc. 513, 194 N. Y. S. 752 (1922) ; General RubberCo. v. Benedict, 215 N. Y. 18, 109 N. E. 96 (1915) ; Vierling v. Baxter, 293 Pa. 52,141 A. 728 (1928) ; Porter v. Healy, 244 Pa. 427, 91 A. 428 (1914) ; Cullum v. GeneralMotors Acceptance Corp., Tex. Civ. App., 115 S. W. (2d) 1196 (1938).15 Matter of Auditore, 249 N. Y. 335, 164 N. E. 242 (1928), wherein it was heldthat an administrator of a stockholder's estate was liable in damages to the estatefor reducing the value of the stock because of his violation of trust by taking andapplying to his own use all assets of the corporation of which he was also a director,and that a judgment for the corporation against such director for misappropriationof funds was no bar to proceedings against him as administrator for the resultingloss in value of decedent's stock.16 Ritchie v. McMullen, 79 F. 522 (1897).17 See Berlack, "Stockholders' Suits: A Possible Substitute", 35 Mich. L. Rev.597 (1937).'s See 18 C. J. S.. Corporation, § 559, p. 1272; Fletcher, Cyclopedia of Corpora-tions, Vol. 13, § 5921.19 See cases cited In note 5, ante.CHICAGO-KENT LAW REVIEWcorporate stock, 2° or where the majority of the shareholders assentedto the alleged misconduct.2 1 In all such cases, the courts have, as a shortcut to justice, directed the payment to the objecting shareholder of hisproportionate share of the amount found to be due to the corporation,on the theory that where substantially all other shareholders were defend-ants, or in pari delicto with them, to allow them the benefits resultingfrom a judgment in favor of the corporation would be to violate the"clean hands" doctrine. Some courts, however, have rejected this theoryon the ground that to permit the defendants to retain part of the funds,in proportion to the stock of ratifying shareholder, would tend to en-courage fraud, and would, in effect, permit ratification of illegal acts.22The court, in the instant case, apparently felt that a former share-holder, who parted with his shares without knowledge of the prior mis-appropriation of corporate assets by the directors, may recover personallywhere the rights of creditors or other shareholders are not prejudiced.This apparent limitation upon the individual's right of recovery seemsquite unnecessary in this type of situation. As has been pointed outpreviously, 23 in these instances, the plaintiff is suing in his individualcapacity and not on behalf of the corporation, thereby obviating anypossible objections a corporate creditor might raise to a personal re-covery by the shareholder. The court could more properly have decidedthe instant case by recognizing the plaintiff's individual cause of actionagainst the errant director 24 instead of erroneously treating the problemas an exception to the general rule.S. P. ZISooK20 Di Tomasso v. Loverro, 250 App. Div. 206, 293 N. Y. S. 912 (1937) ; Eaton v.Robinson, 19 R. I. 146, 32 A. 339 (1895) ; Joyce v. Congdon, 114 Wash. 239, 195 P.29 (1921).21 Matthews v. Headley Chocolate Co., 130 Md. 523i 100 A. 645 (1917). See alsoFletcher, Cyclopedia of Corporations, Vol. 13, § 6028.22 Keenan v. Eshelman, 23 Del. Ch. 234, 2 A. (2d) 904 (1938), 120 A. L. R. 227;Miller v. Crown Perfumery Co., 125 App. Div. 881, 110 N. Y. S. 806 (1908) ; Bailliev. Columbia Gold Mining Co., 86 Ore. 1, 166 P. 965 (1917) : see Fletcher, Cyclopediaof Corporations, Vol. 13, § 6028; and note in 23 Minn. L. Rev. 973. Of particularimportance to the Illinois practitioner is the fact that the law in this state is farfrom well settled. In Brown v. DeYoung, 167 Ill. 549, 47 N. E. 863 (1897), thecourt treated the misappropriated money as a fund out of which dividends shouldbe declared, and awarded the innocent shareholders their proportionate share of theamount due to the corporation. In Chicago Macaroni Manufacturing Co. v. Bog-giano, 202 Ill. 312, 67 N. E. 17 (1903), and in Voorhees v. Mason, 245 Ill. 256, 91N. E. 1056 (1910), the court refused to follow the rule announced in the DeYoungcase. However, it appears that the facts of the latter cases differ from those ofthe former in that the rights of creditors might have been prejudiced in theBoggiano and the Voorhees cases if an individual recovery by the shareholders hadbeen allowed; however, in the DeYoung case, the creditors were adequately pro-tected by existing corporate assets.23 See notes 9 and 10, ante.24 See note 10, ante.

Corporations - Actions between Shareholders and Officers or Agents - Whether Personal Recovery by Former Shareholder Is Allowable in Actions against Officer for Misappropriation of Corporate Assets

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Corporations - Actions between Shareholders and Officers or Agents - Whether Personal Recovery by Former Shareholder Is Allowable in Actions against Officer for Misappropriation of Corporate Assets

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