# Austrian v. Williams

> District Court, S.D. New York · March 5, 1952 · 103 F. Supp. 64

URL: https://www.frixlaw.com/law-library/cases/1468963

## Case

- **Full name:** AUSTRIAN Et Al. v. WILLIAMS Et Al.
- **Court:** District Court, S.D. New York
- **Decided:** March 5, 1952
- **Citations:** 103 F. Supp. 64
- **Precedential status:** Published
- **Opinion:** Opinion by Weinfeld
- **Judges:** Weinfeld
- **Cited by:** 22 later opinions in the Frix Law Library

## Citator (automated)

- **Red flag:** Reversed on other grounds by Austrian v. Williams, 198 F.2d 697 (1952).
- Negative treatments: 1
- Distinguished by: 0
- Full citator and citing cases: https://www.frixlaw.com/law-library/cases/1468963

## Opinion text

WEINFELD, District Judge
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This case involves the affairs of Central States Electric Corporation, an investment company organized under the laws of Virginia, with its principal place of business in Richmond, Virginia. On February 23, 1942, the Corporation filed in the United States District Court for the Eastern District ■ of Virginia a petition for reorganization under Chapter X’ of the Bankruptcy Act, 11 U.S.C.A. § 501 et seq., which was approved on February 27th, 1942. Messrs. Kent and Wilkinson were appointed trustees and when the latter resigned he was succeeded by Dennis.
Dennis and Kent conducted an investigation under Section 167 of. the Bankruptcy Act and filed a report recommending that no suits be instituted against the officers, directors and the principal stockholder of Central States. The recommendation was approved by the District Court but upon appeal, the -Court of Appeals, Fourth Circuit, reversed and directed a further investigation by disinterested trustees.
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Thereafter, plaintiff Austrian was appointed a third trustee on November 15th, 1944. Messrs. Kent and Dennis resigned in March 1945 and the plaintiff Butcher was appointed as trustee. Austrian and Butcher have since acted as trustees. Following further investigation by them, under Section 16-7 of the Bankruptcy Act, Austrian and Butcher recommended that the present suit be filed and an order was entered by the District Court of Virginia authorizing them to bring this action. This suit was commenced on July 5th, 1945. Jurisdiction was sustained.
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The broad charge made by the plaintiffs is that beginning in 1922 and continuing to the filing of the petition in reorganization in 1942, Harrison Williams, the majority stockholder of Central States, in collaboration with various defendants, engaged in a continuing plan to overreach and loot Central States. Conspiracy charges are included.
Plaintiffs attack a series of transactions as wrongs committed upon Central States by Williams and the defendants or some of them, charging that they overreached Central States in these transactions, converted, wasted, destroyed and wrongfully misappropriated and disposed of its assets, were guilty of breaches of trust, and grossly mismanaged its affairs.
The defendants fall into four categories: (1) Harrison Williams, principal and controlling stockholder of Central States, but not an officer or a director after 1922; (2) directors of Central States and of Williams’ wholly owned companies who passed upon, or participated in, the transactions under attack; (3) directors or partners of other parties to the transactions who were not directors of Central States; and, (4) members of the debtor’s accounting firm. Not all of the defendants are charged with dereliction in all of the transactions; some are involved in only one; others, in a number; the defendant Kilmarx in all but one; and Harrison Williams, in all.
To support the charges of misconduct, the plaintiffs set forth in their complaint thirteen transactions, “A” to “M” inclusive. In the “M” transaction they contend that Williams and a number of other defendants deliberately and fraudulently concealed and kept concealed the damaging facts of transactions “A” to “L” and so conducted themselves as to toll any applicable statute of limitations. At the end of the trial, transactions “F,” “G” and “PI” were dismissed for lack of proof.
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In addition to a denial of the charges, the principal defense is a plea of the statute of limitations.
One of the transactions under attack took place in March 1922, the second in 1927, all others except one in 1929, and one in 1938. Thus, the events under attack cover a span of sixteen years, making it desirable to review in broad outline Central States’ history during that period.
Central States is an investment company whose holdings consisted primarily of stocks in public utility holding companies, which, in turn, held stock in both utility holding and operating companies. Its history falls roughly into four phases. The first began with its organization in 1912, when it acquired the majority of the stock 'of Cleveland Electric Illuminating Company, an operating utility company. It entered its second phase in 1922, when it relinquished its holdings in the Cleveland Electric Illuminating Company and acquired an interest in the North American Company, then engaged principally in investing in securities of public utility holding and operating companies.
During this second- phase of Central States’ history, which continued until late 1928, its principal interest was the investment in the North American Company of which it was the largest single stockholder. By August 1929, Central States owned directly 839,668 shares of North American common stock, 15% of the outstanding ■common stock, and an additional 10% indirect interest through other companies.
Central States’ third phase, which began about September 1928, and continued until the late 1929 market crash, witnessed an era of expansion and of high optimism about electric utilities and their future. Central States increased its capital in September 1928 and again in June of 1929 by the sale of two series of convertible preferred stock.
During this third phase of its existence, Central States participated in the formation of affiliated and subsidiary corporations. These corporations, largely utility holding companies, although some held industrial securities as well, included Ameri
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can Cities Power and Light Corporation formed in October 1928; Electric Shareholdings Corporation organized in March 1929; Shenandoah Corporation formed in July 1929; and Blue Ridge Corporation formed in August 1929. The capital structure of these corporations consisted of preferred as well as common stock. Central States’ investments in these corporations were principally in the common stock, following the pattern of what has been referred to as “leverage,” which gives the equity owner the full benefit of increases in values but which operates adversely when the market goes down.
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The leverage element with its potentiality for rapid gain during a rising market placed these common stocks in great demand during 1928 and 1929. During this period Central States’ investments reached aggregate market values approximating $400,000,-000.
After the break in the market in 1929, the market value of the securities held by Central States diminished severely and Central States entered the fourth phase of its history. Its principal investments then were in North American Company, American Cities, Electric Shareholdings, Shenandoah and Blue Ridge. During the 1930s it disposed of a large part of its holdings in North American and in Electric Shareholdings, its entire interest in Shenandoah, and increased in 1938 its interest in, and acquired a majority of, Blue Ridge common stock. When Central States’ petition for reorganization was filed in 1942, the market value of its assets had declined from a high of approximately $400,000,-000 in 1929 to $1,300,000.
Harrison Williams and Other Directors and Officers of Central States
Harrison Williams, the principal defendant in this action, had organized Central States in 1912 and throughout its history and up to the filing of the petition in reorganization, was intimately associated with the conduct of its affairs and the affairs of its affiliated corporations, and the top personnel of all of them.
Williams’ activity in public utilities began in 1906, when he participated in the organization of the American Gas & Electric Company. Later, he was instrumental in the formation of other light and power companies. He was generally regarded as a person of dominance and prestige in the public utility field, and was credited with the growth and development of the North American Company.
Williams invested in the North American Company shortly after the first World War and was Chairman of its Board of Directors from 1920 to March 24th, 1922, when he resigned. He returned as Chairman of the Board in 1933, and holds that position today.
From March 24th, 1922 to 1942, Williams was neither a director nor officer of Central States. He had been a director and Chairman of the Board, but resigned on March 24th, 1922, the date of the earliest transaction under attack. His stock ownership in Central States and his general prestige and influence reflected his real interest and status.
When Williams organized Central States in 1912 he acquired 27%% of its common stock. At the end of 1922 he owned 64%, which was increased to 96% by the end of 1924, and to 97% in December 1928. Thereafter his stock ownership was reduced, so that in October 1929, it stood at 86% of the common stock, and in December 1929, largely as a result of transaction “J,” at 62% of Central States’ common stock. From 1930 and up to the date of the reorganization petition in 1942, he owned somewhat in excess of 50% of Central States’ common stock at all times.
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During these years Williams also owned or controlled substantially all of the stock of a group of corporations formed by him
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for investment and other purposes, referred to hereafter as Williams’ wholly owned or personal companies. The principal one of these was New Empire Corporation, all of whose stock was owned by him. Williams also owned or controlled, directly or through New Empire, Electric Investment ’Corporation, Federal Utilities, Inc., Utilities Securities Corporation and North American Securities Company, referred to hereinafter as Naseo. All of them had dealings with Central States.
The Board of Directors of Central States in 1929, when most of the transactions took place, was composed of Kilmarx, Fogarty, Freeman, Gruhl, Narlian, Schroeder, Glass, Dame (until May 28th) and Stone (from May 28th). Of all the directors who voted or participated in the transactions, recovery is sought principally against four: Freeman, Fogarty, Stone and Kilmarx. Although named as defendants jurisdiction was not acquired over the other directors due principally to service of process and venue problems
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and in two instances because of death.
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New directors were elected to the Board from time to time between 1929 and 1942. Freeman, Fogarty and Stone resigned by the end of 1934, and of those who constituted the Board in 1929, Schroeder remained until 1937, and Kilmarx was still a director at the time of the trial. Commencing in 1935, a majority of the Board was composed of new directors. Of these, Johnson, McCornack, Eccles and Finney are included as defendants in the “E” transaction which occurred in 1938, and along with Baker and Pardee in the “M” transaction relating to the tolling of the statute of limitations.
Kilmarx first became associated with Central States in 1913 as a junior accountant. He managed Williams’ personal affairs from 1913 to August 1931. He was Williams’ confidential aid. He kept the books and records of Williams’ privately owned corporations, paid his personal bills and had charge of his taxes. These functions were taken over in, 1931 by the defendant Johnson, but Kilmarx continued as director, and from 1934-1938 when the office of President was vacant he was Senior Vice President of Central States and performed the functions of president.
Stone’s association with Central States began in June 1929 when he was elected a director. In July at Williams’ instance, he was elected President, which office he held until 1934. He was also president of Blue Ridge and Shenandoah.
The defendants Freeman and Fogarty were elected directors of Central States on the invitation of Dame, a former president and a director of long standing of Central States and also president of. North American. Freeman served as a director from 1928-1934. He had a broad business background as a partner in Touche, Niven & Co., Certified Public Accountants, and as president of a nationally known corporation. He had made investigations and financial analyses of various corporations for Williams. He had been associated with the North American Company since 1927 as an officer and director and is now its president. Fogarty was a director of Central States from 1926 until 1934 and his principal work was in financing and securities. He had been connected with the North American Company since 1902 and was its president from 1933 to 1939.
Kilmarx, Stone, Fogarty, Freeman and other Central States directors were also directors or officers of one or more Williams’ wholly-owned companies which were parties to a number of transactions with Central States now under attack. Freeman was a director of one Williams’ wholly-owned company; Fogarty of three; Stone was a director of three; and Kilmarx was a director of five, and is the only Central States director named in all transactions but one.
Of the directors named in the “M” transaction relating to the tolling of the statute of limitations, the principal defendant is Johnson, who was first employed by af
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filiates of Central States in 1928 and became a director in 1937 and its president in 1938. Prior thereto, in March 1931, he had succeeded Kilmarx in the management of Williams’ personal affairs and from 1931 to 1944 he was an officer and director of three William’s personal companies.
Management
Central States maintained an office in New York at 60 Broadway from which its main activities were conducted until 1931. Central States, its staff and officers, shared common space with Williams and his personally owned companies.
In 1923 Central States entered into a management contract with New Empire Corporation, the top company in the pyramid of the Williams’ personal companies. This arrangement continued until the end of September 1929. Under its terms, New Empire supervised the operation and financing of the business of Central States, and made available “the advice, assistance and service of our entire organization” and “all services required other than such services as [Central States’] officers * * * may otherwise provide for.” New Empire provided all necessary personnel, including officers as designated by the Board of Central States, paid their salaries and all other expenses save directors’ fees. Specifically, with respect to officers, New Empire agreed to supply a president, vice-president, treasurer, secretary and such additional officers as might be elected by Central States’ Board. Prior to election by Central States’ Board of Directors the list of proposed officers would be submitted to Williams for his approval. New Empire also provided all employees, such as clerks, stenographers and operating personnel, offices and all data, records and reports for the keeping of the corporate books, and prepared complete reports of the “operation and management” of Central States.
Williams maintained a personal organization which administered his affairs and those of his privately owned companies. The services furnished by New Empire to Central States under the management contract were performed principally by members of this organization. The officers designated for Central States were employees, officers or directors of various of Williams’ wholly-owned companies or otherwise closely associated with him or his interests. Upon their election as officers of Central States they continued to function in the Williams’ companies or organization, and in some instances, for example, Kilmarx and later Johnson, continued to attend to Williams’ personal affairs while holding office in Central States, New Empire or other affiliated Williams’ companies.
Domination
The plaintiffs’ charges are pegged to a broad claim that Williams was more than just a controlling stockholder — that he dominated Central States in all of its affairs and operations.
Domination must be determined as a fact from all the circumstances, the action and conduct of Williams, of the officers and directors — and not from the mere ownership of controlling stock. Nor may a finding of domination be predicated solely on Williams’ vigorous interest in the affairs and activities of Central States or because his views were considered by the directors. It was not unnatural that owning so vast a percentage of the shares outstanding, representing a value of many millions of dollars, Williams’ views be ascertained and considered.
Upon all the evidence, the Court is convinced that Williams dominated and controlled Central States in all its affairs and operations. The management pattern appraised in the context of his controlling interest compels the conclusion that he was more than just a controlling stockholder. Williams not only had voting control but managerial control as well through New Empire, his wholly-owned corporation. The staff of the Williams’ organization performed all the functions required by Central States. Central States had no personnel of its own. Williams, through New Empire, furnished all the officers of Central States. They were also in the employ of New Empire or the Williams’ organization. Their salaries were paid by New Empire
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or other Williams’ companies. Thus, every man serving Central States as an officer was Williams’ personal designee. Every director of Central States was elected by his votes.
Central States’ business was conducted by an operating group composed of Narlian, Schroeder, Stone and Kilmarx, all closely identified with Williams in one or more of his enterprises. Each was a director or an officer of at least three or more of Williams’ wholly-owned companies. Williams himself was considered by the others as a member of this management group. Although he was neither an officer nor director of Central States after March 1922 he continued to participate actively in its management and operation.
Every important action affecting Central States, including those in which his wholly owned companies were participants, was initiated by Williams or by directors or officers under his immediate supervision and instruction. In most of the transactions Williams, without prior, consultation with Central States’ directors, negotiated and determined on behalf of Central States the basic policy considerations underlying the program, following which the board members invariably gave their pro forma approval. Officers as well as directors carried out the administrative details which implemented the plan or program. He was looked to, as one of the directors described him, as “the real guide.” Reports were made to him daily and constantly and even while abroad he was informed by cable as to major transactions.
Kilmarx, who was president of Central States up to July 1929, when he was succeeded by Stone, described Williams’ decisions as the “equivalent of a direction.” Stone, his successor, referred to Williams as the “key man” who “worked right along with” the officers and directors. Stone, Kilmarx and other officers and directors admitted they attempted to meet Williams’ desires and to carry out his ideas.
Certain officers of Central States who were also directors were granted options to purchase Central States’ stock at prices considerably below the prevailing market under an arrangement that if the options were exercised, the stock was to be supplied by New Empire. Incidentally, this arrangement was approved at the very meeting of the Board at which the Directors approved one of the transactions complained of, one between Central States and a wholly owned Williams’ company.
Another circumstance which points strongly to Williams’ domination of the officers, directors and affairs of Central States, is the destruction of records. When it became known in 1936 that the SEC was investigating investment holding companies, word got around in the Central States organization to destroy all records pertaining to Williams. Thereafter, over an extended time, thousands of files were removed and destroyed. Clerical personnel were directed and assisted by Kilmarx and heads of departments who were also directors of Central States, as well as officers of Williams’ wholly owned companies. The job was completed by the time the SEC investigators arrived. No secondary evidence of the contents of the destroyed records has been supplied other than the suggestion that they contained statistical material, corporate reports and other data, some of which was supplied to Williams in confidence. With one possible exception,
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we do not know whether these records had any direct bearing on the issues in this case but we do know that Williams’ interests were a prime consideration in the purging of the files. The removal of documents bearing reference to Williams was repeated on subsequent occasions.
I draw no adverse inference from the destruction or the removal of Central States’ records with respect to specific transactions, since it would require speculation to infer their contents. However, the action taken in obliterating the records is further evidence of Williams’ power and domination over the directors, officers and employees of Central States.
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A careful appraisal of this record reveals a continued policy of acquiescence by all of the directors and officers of Central States in everything proposed by Williams, including contracts or commitments between his personal companies and Central States. His wish was a command, faithfully executed by officers and directors alike. The record abundantly establishes that their loyalty was to Williams and not to Central States and that Central States was regarded as but another link in the Williams’ chain of companies.
The defendant directors invariably followed Williams’ judgment and their judgment was neither independent nor considered. They yielded to Williams’ dictation and decision and abdicated their responsibilities and obligations to Central States. The plaintiffs have sustained the burden of establishing that Williams was not only the controlling stockholder of Central States but dominated all of its affairs and operations. The plaintiffs also charge defendants with conspiracy, but this they have failed to sustain.
The Law
Before discussing the separate transactions about which the plaintiffs com.plain, it will help to set forth the general principles of law on the basis of which each of these transactions is to be judged and liability determined. These are clearly and emphatically set forth by Mr. Justice Douglas in Pepper v. Litton, 308 U.S. 295 , 60 S.Ct. 238 , 84 L.Ed. 281 , as follows: “A director is a fiduciary. Twin-Lick Oil Co. v. Marbury, 91 U.S. 587, 588 , 23 L.Ed. 328 . So is a dominant or controlling stockholder or group of stockholders. Southern Pacific Co. v. Bogert, 250 U.S. 483, 492 , 39 S.Ct. 533, 537 , 63 L.Ed. 1099 . Their powers are powers in- trust. See Jackson v. Ludeling, 21 Wall. 616, 624 , 22 L.Ed. 492 . Their dealings with the corporation are subjected to rigorous scrutiny and where any of their contracts or engagements with the corporation is challenged the burden is on the director or stockholder not only to prove the good faith of the transaction but also to show its inherent fairness from the viewpoint of the corporation and those interested therein. Geddes v. Anaconda Copper Mining Co., 254 U.S. 590, 599 , 41 S.Ct. 209, 212 , 65 L.Ed. 425 . The essence of the test is whether or not under all the circumstances the transaction carries the earmarks of an arm’s length bargain.” 308 U.S. at pages 306-307, 60 S.Ct. at page 245 .
This statement has been characterized as “perhaps the strongest recent statement of the duties of majority stock interests”. Crawford v. Mexican Petroleum Co. Ltd. of Delaware, 2 Cir., 130 F.2d 359, 361 . The principles are severe, but understandably so. The immunity afforded by the business judgment doctrine,
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under which acts in good faith and in the exercise of an honest judgment conclude the corporation and the stockholders is rooted in the concept of arm’s length bargaining. In the context of domination or control there can be no arm’s length bargaining.
jn the view of Mr. Justice Douglas, the nRe js clearly applicable in the case of either a dominant
or
controlling stockholder. As stated by Mr. Justice Brandeis in Southern Pacific Co. v. Bogert, 250 U.S. 483 , 39 S.Ct. 533 , 63 L.Ed. 1099 , It is the fact of contro1 of the C0fflm0H Property held and exercised, not the particular means ^y which or manner in which the control is exercised, that creates the fiduciary obligati°n- 250 U.S. at page 492 , 39 S.Ct. at 537 .
This standard has been applied by the New York Court of Appeals in Chelrob, Inc., v. Barrett, 293 N.Y. 442 , 57 N.E.2d 825 . The Court held a transaction with a controlling stockholder subject to judicial scrutiny as to its fairness notwithstanding findings that “good faith is established by persuasive evidence”, 293 N.Y. 460 , 57 N.E.2d 834 , the directors acted “honestly and carefully,” 293 N.Y. 451 , 57 N.E.2d 828 , were not “remiss in the performance of their duties”, 293 N.Y. 452 , 57 N.E.2d 830 , and the controlling stockholder “did not usurp the functions of the directors and dominate * * * their actions”. 293 N.Y. at page 460 , 57 N.E.2d at page 834 . But
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since the directors acted in good faith and on the basis of their own considered judgment, the Court of Appeals dismissed the complaint as against them.
Where, however, directors do not act in good faith or with the care and independent responsibility which their status demands, they, too, would be liable. “The relation of the directors to the stockholders is essentially that of trustee and cestui que trust. The directors are bound by all those rules of conscientious fairness, morality, and honesty in purpose which the law imposes as the guides for those who are under the fiduciary obligations and responsibilities. They are held, in official action, to the extreme measure of candor, unselfishness, and good faith. Those principles are rigid, essential, and salutary.” Kavanaugh v. Kavanaugh Knitting Co., 226 N.Y. 185, 193 , 123 N.E. 148, 151 . See also Blaustein v. Pan American Petroleum & Transport Co., 293 N.Y. 281 , 56 N.E.2d 705 .
The test of fairness does not permit of precise definition; it involves a judgment based on all the factors and circumstances. Chief Judge Learned Hand offers some guide in his opinion in Ewen v. Peoria & E. Ry. Co., D.C., 78 F.Supp. 312 , certiorari denied, Income Bondholders of Peoria & E. R. Co. v. New York C. R. Co., 336 U.S. 919 , 69 S.Ct. 642 , 93 L.Ed. 1082 , where he observed that “ ‘whether the proposition submitted would have commended itself to an independent corporation’ ” is very close to the proper test of fairness, and as another approach suggests “whether the actual [transaction] was worse than the [corporation] would have accepted, or could have been forced to accept” had the parties traded at arm’s length, 78 F.Supp. at pages 316, 317.
As to those defendants who were not directors or fiduciaries of Central States, the governing rule is that one who- knowingly joins a fiduciary in an enterprise where the personal interest of the latter is .or may be antagonistic to' his trust, becomes jointly and severally liable with him. Jackson v. Smith, 254 U.S. 586, 589 , 41 S.Ct. 200 , 65 L.Ed. 418 ; also Irving Trust Co. v. Dcutsch, 2 Cir., 73 F.2d 121 . Certiorari denied, Biddle v. Irving Trust Co., 294 U. S. 708 , 55 S.Ct. 405 , 79 L.Ed. 1243 .
The questions of law involved in the defense of the statute of limitations interposed by the defendants in this case will be considered later in this opinion.
Transaction “A”
This transaction revolves about the acquisition by Central States of shares of the common stock of the Shenandoah Corporation upon its organization in July 1929. Recovery is sought not only against Williams, and Fogarty, Freeman, Stone and Kilmarx, directors of Central States, but also against the directors of Goldman Sachs Trading Corporation, the individuals composing the partnership of Goldman, Sachs & Co. and the directors of the Shenandoah Corporation.
Goldman, Sachs & Co., an investment ■banking firm, had long been engaged in the financing of industrial and general business corporations. In 1928 it formed the Goldman Sachs Trading Corporation, hereinafter sometimes referred to as Trading. The partners of Goldman, Sachs & Co. made substantial investments in the stock of Trading and the balance of the stock was sold to the public. Prior to the organization of Shenandoah, Trading’s activities were principally in securities of industrial companies, for which Goldman, Sachs & Co., had acted as bankers.
Early in 1929, John Foster Dulles, senior partner of the law firm representing both Trading and Goldman, Sachs & Co., and Waddill Catchings, senior partner in Goldman Sachs and a director of Trading, conceived the idea of forming an investment company which would enable Trading to participate in public utility securities which were then in great demand, and at the same time make available to the investing public a security of a company dealing in both industrial and utility stocks. Since Trading’s own experience had been limited to industrials, the Trading group wanted to affiliate with a person or group experienced in the light and power field.
Dulles knew Williams, one of the recognized leaders in the utility field, and intro
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duced him to Catchings in June 1929. There ensued a series of almost daily meetings over a period of six weeks between Williams and Catchings, out of which developed the plan for the formation of the Shenandoah Corporation. The corporation was to have the benefit of the combined skill and experience of Goldman Sachs, especially qualified and experienced in industrial investments, and of Williams with his matching competence in the field of utility investments.
All of the major negotiations were conducted by Catchings representing the Trading and Goldman Sachs groups, and Williams who then owned 96% of Central States common stock. It was agreed that the new corporation was to be sponsored jointly by Trading and a company to be designated by Williams. He designated Central States. In substance, Trading and Central States each agreed to exchange $25,000,000 in market values of its stock for a 40% equity in the new company. The 20% balance of the common stock, and all of the preference stock were to be sold to the public. At the time the understanding was reached on July 9th, 1929, Central States stock was selling on the market at $52 and Trading at $105, requiring Central States to deliver to Shenandoah 482,000“ of its shares and Trading to turn over 238,000 of its shares.
The preference stock of Shenandoah to be sold to the public was, in the first instance, to be bought by Central States and Trading and then sold to the public through the bankers, Goldman, Sachs & Co.
In this transaction we are concerned only with the common stock.
Paragraph “Fourth” of the definitive agreement which was not approved until July 24th provided: “Central States will issue or cause to be delivered to the New Company in such names as it may specify 480,770 full-paid and non-assessable shares of the common stock of Central States, as such shares shall be constituted after giving effect to the 200% stock dividend payable July 25, 1929 of which at least 384,616
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shares shall be of original issue and shall pay to the New Company $20,000,000 in cash, together with a sum in cash equal to the accrued dividend on the 500,000 shares of preference stock hereinafter mentioned; Trading will issue and deliver to the New Company in such names as it may specify 238,096 full-paid and non-assessable shares of the capital stock of Trading, all of which shall .be of original issue, and shall pay to the New Company the sum of $20,000,000 in cash, together with a sum in cash equal to the accrued dividend on the 500,000 shares of preference stock hereinafter mentioned. * * * ”
The $20,000,000 cash was to be derived from the $25,000,000 which each, Central States and Trading, expected to receive upon the sale of the preference stock to the public. The net effect of this provision as far as Central States is concerned, was that it was to receive 2 million shares of Shenandoah common, valued at $10 per share, and $5,000,000 cash, a total of $25,-000,000 in value, for 480,770 shares of its common stock.
The charge against the defendants on this transaction centers about the $5,000,000 cash and the delivery to Shenandoah of 96,154 shares of Central States common, not of original issue, but which Central States purchased from Nasco, a Williams wholly owned company.
The contract between Central States and Trading for the formation of Shenandoah was ratified 'by Central States’ Board of Directors on July 24th, 1929. The Board authorized the issuance of 384,616 shares of its unissued common stock. ' At the same meeting the Board also authorized the purchase from Nasco of 96,154 shares of Central States’ common stock at $52 per share, making a total price of $5,000,000. Also approved was an agreement between Central States and Trading, referred to as an equalization agreement, which provided that if upon a reappraisal of the stocks within certain prescribed periods, the ratio of the market prices of the two stocks (Central States at $52 and Trading at $105) at which they were taken in by Shenandoah
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no longer obtained, appropriate adjustment would be made to reestablish it.
Thereafter on August 7th, 1929, the transaction was closed as contemplated under these agreements. Central States received from Goldman, Sachs & Co. $25,-000,000, the proceeds from the public sale of the 500,000 preference shares, $20,000',-000 of which it paid to Shenandoah as required by Paragraph “Fourth” of the contract. The balance of $5,000,000 was paid to Nasco for the 96,154 shares, which, together with the 384,616 shares of original issue totaling 480,770 shares of its common stock, Central States turned over to Shenandoah, and in turn received 2,000,000 shares of Shenandoah common.
The trustees claim that under the contract Central States had the right to deliver to Shenandoah all of the 480,770 shares and to retain the $5,000,000 cash as well as the 2,000,000 shares of Shenandoah. It is charged that Williams, with the connivance of the directors, deprived Central States of the full benefits of its right to perform under the contract. As plaintiffs put it, Williams “carved the juiciest part” of the contract — the cash — for himself and the Central States Board acquiesced and approved it without regard for Central States’ interest.
When the Shenandoah and Nasco contracts were approved on July 24th, the directors who were present and authorized and approved them included Fogarty, Freeman, Kilmarx and Stone. None of them personally profited or benefited from this transaction or from any of the others under attack. Stone had shortly prior to- the transaction been elected president of Central States at Williams’ instance. He was called in towards the very end of the Shenandoah negotiations to work out the mechanics of the plan. It does not appear that he or any other director of Central States actively participated in discussions or decisions on major policy matters.
In view of Williams’ relation to Central States and his domination of its affairs and activities, the court must be satisfied not only as to “the good faith of the transaction but also * * * its inherent fairness from the viewpoint of the corporation and those interested therein.”
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The basic business reason assigned by the directors of Central States for not issuing all of its own shares needed for the Shenandoah transaction was that they regarded it as sound policy for Central States to retain stock as against cash. The primary purpose of the transaction, they say, was to get a 40% equity position in Shenandoah and not the cash. This, Central States received and kept. The $5,000,000 which Central States would have received had it issued the full 480,770 shares instead of the 384,616, would, they claim, under their policy of “Invest and Keep Invested” have been expended at once for other securities. Finally, it is urged that they were confident that Central States common was worth more than its then current market price and they point to the general optimistic attitude prevailing at that time, and the general belief that the period was one of continuing prosperity and increasing values. They cite the fact that the newly issued Shenandoah stock was oversubscribed at $17.50 per share, although the price to Central States was $10, and that the market reached $38 within a few days.
The matters under -consideration must be cast in the period during which they occurred and against the background of facts as they then existed. This was July 1929. The nation was enveloped in a spirit of marked optimism which extended no less to leaders- of industry and finance than it did to the average investor. The steady advance of stocks was assumed by many to reflect a sound economy and continuing prosperity. We know now that it was an era of frenzied finance and wild speculation.
In July 1929 Central States’ directors believed that the market had not reached its limit. Their basic policy was to keep invested — that an inventory of stock was of greater value than cash.
They point to the fact that the price of $52 for Central States common was based on the market price on July 9th, 1929, when the terms of the Shenandoah deal had
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been agreed upon tentatively between Catcliings and Williams; that on July 24th, 1929, when the contract was approved by Central States’ Board, the market price had advanced to $82 per share, and that, accordingly, so long as the stock could be obtained from Williams, through one of his companies, and he was willing to sell at $52, it was not only fair tout signally advantageous to Central States to buy the stock from Nasco instead of using its own 96,-154 shares.
The Court is persuaded that it was the policy of 'Central States to hold securities and not cash, and that at that time it was assumed by most people, however misguided, that security values would keep going up. The continuing rise in the price of Central States stock was fairly cogent proof of a rising market.
It is further contended by plaintiffs that Williams deprived Central States of its corporate opportunity, as distinguished from an invasion of its rights under the contract once it was signed, by injecting himself into the deal and so negotiating it -as to permit him to take a portion of the deal for himself.
The credible evidence establishes that Trading was interested in merging forces with Williams and not primarily Central States. Trading sought association with Williams because of his ability and know-how in the power - and light industries,' which was his special area of prestige and influence in the financial and investment world. Catchings and his group were interested in Williams, the individual, and not in Central States. Central States was merely one of the companies in which Williams had a substantial personal interest and which itself had extensive investments in holding and utility companies.
The importance of Williams personally is demonstrated by his acceptance of membership on the Board of Directors of Shenandoah, — a departure from his fixed policy of not being a director of any company in which he was heavily invested.
This was not a business opportunity which was presented to or belonged to the corporation. In essence, this was Williams’ deal — his opportunity. He was, at the outset, given the right to name any one of the companies which he controlled. As I see the record, he retained for himself 20%, with the rest going to Central States. Williams was free under the facts of this transaction to have handled it entirely for himself. If, in the first instance, he had, out of his vast holdings of Central States common, at that time in excess of 7,000,000 shares, undertaken to deliver to Shenandoah the full 480,770 shares through any of his wholly owned subsidiaries, Central States would have been in no position to complain. There is no evidence that the Goldman Sachs group preferred Central States to any other Williams’ company. It cannot be said, as plaintiffs contend, that Central States was entitled exclusively to participate in the Shenandoah deal. The participation by Williams appears to have been part and parcel of the transaction rather than a last minute contrivance.'
The doctrine of corporate opportunity has been held not to apply where the business opportunity comes to the officer or director or controlling stockholder in his individual capacity and where the opportunity is not essential to the corporation or is one in which it has no interest.
“ ‘where a business opportunity comes to an officer or director in his individual capacity rather than in his official capacity as an officer and director, and the opportunity is one which, because of the nature of the enterprise, is not essential to his corporation, and is one in which the corporation has no interest or expectancy, the officer or director is entitled to treat the opportunity as his own, and the corporation has no interest in it.’ ” Blaustein v. Pan American Petroleum & Transport Co., 263 App.Div. 97, 126 , 31 N.Y.S.2d 934, 962 (1st Dept.), affirmed 293 N.Y. 281 , 56 N.E. 2d 705 , quoting with approval from Loft, Inc., v. Guth, 23 Del.Ch. 138 , 2 A.2d 225 , 238 affirmed 23 Del.Ch. 235 , 5 A.2d 503 .
Upon either theory, that is, the deprivation of corporate opportunity or interference with a corporate right already in be
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ing, the same result is reached. The evidence does not warrant a finding that Williams interfered with a corporate opportunity which belonged to Central States, or, once the contract was signed, that the delivery of the 96,154 shares of stock by Nasco rather than Central States, was under the then existing circumstances unfair.
This conclusion makes it unnecessary to consider the charges made against the directors of Goldman Sachs .Trading Corporation, Shenandoah or the partners of Goldman, Sachs & Co.
In respect of transaction
“A”
all the defendants are entitled to judgment dismissing the complaint upon the merits.
Transaction
“B”
In this transaction it is charged that Williams and other defendants invaded Central States’ contract right to sell 68,423 shares of North American stock and to retain the proceeds of $11,426,641. The plaintiffs also complain about an accompanying interest payment of $34,279.92 made by Central States to the Williams’ companies. Named as defendants, in addition to Williams and directors Stone, Freeman, Fogarty and Kilmarx, are members of the accounting firm of Touche, Niven & Company, who are charged with having made improper entries on the books of Central States in furtherance of Williams’ purpose to overreach Central States in this transaction.
The Shenandoah Corporation was launched with marked success. The public offering of its stock was oversubscribed seven times. This led to the formation of still another company, the Blue Ridge Corporation, sponsored jointly by Central States and Trading. Blue Ridge was to follow the investment program of Shenandoah in industrial and utility stocks. Again, both Williams and Catchings were the principal architects, 'but in this instance there can be no doubt that Williams acted as agent for Central States. The participation by the defendant directors was confined to carrying out the policy decisions reached by Williams and Catchings.
The basic, organization agreement was signed on August 19th, 1929. The capital of Blue Ridge was fixed at $127,500,-000. Shenandoah was to purchase 6,250,-000 shares of the common stock, 86% of the total for $62,500,000. In order to put Shenandoah in funds to acquire the Blue Ridge stock, Central States and Trading each agreed to purchase from Shenandoah 375,000 shares of its common stock for $12,500,000 and 375,000 shares of its $50 par value preference stock for $18,750,000, adding up to $31,250,000 for each, and a total for both of $62,500,000. The closing date was set for September 5th, 1929.
On August 21st, Blue Ridge also entered into agreements with Central States and Trading, under which Blue Ridge agreed to purchase from each various securities at market prices at the close of business on August 17th, 1929. We are concerned only with the Central States agreement. Central States agreed to sell and Blue Ridge agreed to -buy blocks of nine different securities for $35,000,041. One of the blocks consisted of 68,423 shares of North American common stock at $167 per share, totaling $11,426,641. The Board of Directors of Central States at a meeting held on September 3rd, 1929, ratified and approved the sale of the Various securities and authorized the officers to carry out the agreement.
There is a sharp dispute as to when, if at all, Central States delivered the securities to Blue Ridge, which we shall discuss presently. It is not disputed that on September 5th, 1929, the closing date, Central States received from Blue Ridge $35,000,-041, representing the agreed price for the entire package of securities, including the 68,423 shares of North American, and that Stone, as president of Blue Ridge, acknowledged receipt of the securities and Kilmarx, as Treasurer of Central States, acknowledged payment in writing as follows :
“Received of Central States Electric Corporation pursuant to the agreement between us dated August 21, 1929, the following securities of an aggregate value of $35,000,041 in full satisfaction of the ob
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ligations of Central States Electric Corporation under said agreement:
September 5, 1929.
Blue Ridge Corporation
By C. F. Stone
Pres.
“Received of Blue Ridge Corporation $35,009,041. in full payment for the securities listed above. September 5, 1929.
Central States Electric Corporation
By L. E. Kilmarx
V. P.”
There is no other written record, memorandum or entry of any other aspect of the transaction until September 23rd, 1929, when Central States issued .to four Williams’ companies checks totalling $11,426,-641, the exact amount previously received by it for the North American shares, as follows:
These checks were in payment of the 68,423 shares of North American delivered by the Williams companies to Blue Ridge sometime after the closing date, September Sth.
The evidence does not definitely establish when the Williams’ companies delivered the North American shares but at the earliest it was September 23rd;
12
and there is sufficient evidence to support a finding that in fact a substantial number, 18,423 shares, were delivered later, on October 16th, which may account for the fact that a portion of the interest charged against Central States was not paid 'before October 23.
13
The net result was that eventually Williams’ companies, and not Central States, sold the 68,423 shares of North American and received from Central States the purchase price, and in addition the interest payment.
The plaintiffs charge that Central States’ right to sell and retain the proceeds of the sale, with its incidental profit, had been invaded by Williams, who with the acquiescence of the directors appropriated that right for himself. They point out that Central States had 839,000 shares of North American stock and was well able to make the sale; that the price at which Central States was to sell was a good one to it; that Central States was without cash funds to meet its obligation of $31,250,000 to Shenandoah for the purchase of the preference and common stock; that the average cost of North American shares to Central States according to its books, was $11 and with the sale price at $167 it stood to realize a profit of more than $10,650,000; that Williams’ companies in selling the shares realized a profit of $10,727,764.59.
The transaction is defended on various grounds, paralleling substantially those advanced to uphold the “A” transaction. Here, too, it is urged that Central States’ corporate policy and its own interest was to invest and stay invested; that Central States was the largest holder of North American stock (it owned directly and indirectly 25%), which represented its largest single investment, and that it was its fixed policy not only to retain that stock but to increase its North American holdings; that with Williams, instead of Central States, selling the stock of North American, Cen
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tral States indirectly increased its holdings in North American through its interest in Shenandoah which owned in excess of 80% of Blue Ridge; and conversely, had Central States itself made the sale it would have reduced its stake in North American.
The credible evidence is far from convincing that the reasons now advanced to justify the transaction were those which motivated it. The testimony in support of the transaction is weak and unpersuasive. Indeed, the record justifies a holding that the officers of the Williams’ companies, some of whom were also officers and directors of Central States, simply substituted North American stock of the Williams’ companies to accommodate Williams’ personal interests. In so doing, they violated their trust to Central States.
In the Court’s view, the sale by the Williams’ companies was not conceived and undertaken until almost three weeks following the sale by Central States, during which time Central States of course had the proceeds. Interest was not paid on September 23rd, 1929 when Central States paid the $11,426,641 to the four Williams’ companies.
The attempt to justify this transaction on the same basic grounds as those advanced in support of the “A” transaction must fail for there is substantial variance on the facts. The contrast between the circumstances surrounding this transaction “B” and those of the “A” transaction is so marked as to carry its own condemnation of this transaction. In the instant transaction, other than the assertions of those directors who testified on the subject, proof is ’ lacking that delivery of the North American shares by Williams was contemplated either during the negotiations or up to the very time when the delivery was made by the Williams’ companies, no earlier than September 23rd, eighteen days after the Blue Ridge closing.
Here, no single person of the Trading group, Catchings or any other of its representatives, testified as to any knowledge that Williams’ companies, and not Central States, intended to deliver the shares, although the matter of creating a portfolio of securities for Blue Ridge was the subject of extended discussions between representatives of' the two sponsoring groups.
The defense contends that it was always understood by the directors that Williams, and not Central States, would sell the North American stock, and that this was known throughout the negotiations, on August 21st, the date of the letter agreement for the sale of the stock by Central States, and on September 3rd, when the Board of Directors approved the sale. It is significant that despite this claim, no resolution or minute recording that fact or any commitment by Williams was entered in any corporate record. In the “A” transaction the contract between Central States and Nasco was acted upon at the very meeting that the major transaction was approved, and Nasco was firmly bound to make delivery.
Even if the story that it was always intended that the Williams’ companies were to deliver the shares were to be accepted, they were, in the absence of any binding agreement, free to deliver or not to deliver. This put Williams as a fiduciary in an advantageous position to Central States’ disadvantage.
It is no answer to suggest that neither was any entry made in the minutes with respect to other securities which Central States was obligated to sell to Blue Ridge under the letter agreement and which it obtained from other sources. Of the nine blocks of securities to be sold thereunder, Central States did not have six and the directors knew these had to be obtained elsewhere. But it did have the remaining three, including the North American stock. Two of these three Central States delivered out-of its own portfolio holdings, but not the North American, which it had in abundance.
The sale of the securities by Central States was deemed of sufficient importance to require Board action. Yet, revocation of that action is nowhere recorded. The sale by Williams’ companies, instead of Central States, effectively reversed the resolution of the Board. The testimony that during the negotiations Williams indicated he was willing through his companies to furnish the North American stock if Cen
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tral States preferred not to sell and that the directors, after careful consideration, decided to retain the stock and accept Williams’ offer, is not on this record credited.
Considerable testimony was taken on the question of the dates of delivery and transfer of the shares, much of it relating to when, if at all, Central States delivered the shares directly to Blue Ridge.
The defense contends that notwithstanding the receipt signed on September 5th by Stone on behalf of Blue Ridge, acknowledging receipt from Central States of the 68,423 shares, Central States in fact never delivered them on that day or at any other time. It suggests the closing was by means of a due bill — a promise by Central States to deliver at a subsequent date — and that thereafter on September 23rd, the Williams’ companies made good on the due bill by delivering their North American shares. No credible proof was offered that the closing was on the basis of a due bill and the suggestion finds no support in the very considerable testimony which attempted to trace the shares of stock, by whom delivered, and the dates delivered. Stone issued and signed the receipt acknowledging delivery by Central States on September 5th of all the securities, including North American shares. No satisfactory explanation has been offered by Stone or any of the other defendants why he should have acknowledged receipt of the securities when, in fact, they had not been delivered. Even if we were to disregard, which we do not, the testimony of Kilmarx on the subject, who, after some contradictions, convincingly testified after examining certain records, that he was positive that Central States had delivered the securities, the evidence still requires a finding of delivery on September 5th by Central States. Kil-marx testified that all of the securities for which Stone had issued the receipt, were delivered on September 5th, at the time of closing, and that they, including the 68,423 shares’of North American were taken out of the Central States vaults and placed in the Blue Ridge vaults. Kilmarx, at that time, was treasurer of Central States, Blue Ridge and the four Williams’ companies.
As to when the 68,423 shares were returned to Central States, the record is not altogether clear. But Kilmarx related “the practical way” of handling the delivery by the Williams’ companies on September 23rd, or later. His recollection was that he substituted in the vault box of Blue Ridge the 68,423 shares from the Williams’ companies in place of the 68,423 shares which Central States had delivered on September 5th.
The vault records of the Williams’ companies would have shown definitely the various delivery dates but these were reported missing, with the exception of the vault record of New Empire. This vault record shows that New Empire delivered to Blue Ridge 18,423 shares on October 16th, 1929. New Empire received payment from Central States for this number of shares on September 23rd, and Central States also paid interest amounting to $9,229.92 thereon to New Empire on November 13th, 1929.
The Court finds that on September 5th, the closing date, Central States delivered to Blue Ridge its own 68,423 North American shares referred to in the letter agreement of August 21st; that the Williams’ companies delivered to Blue Ridge 68,423 shares of North American of which 18,423 were delivered on October 16th and the remainder no earlier than September 23rd; and that the shares of stock previously delivered by Central States to Blue Ridge were returned to it; that at no time prior to September 23rd was it contemplated that Central States would not make the sale and retain the proceeds thereof and that up to that time the directors who participated gave no consideration to the business reasons which they say impelled their actions, but rather carried out Williams’ purpose in having his companies instead of Central States sell the North American stock — and this in violation of a corporate resolution of the Board of Directors directing the sale by Central States.
The Court concludes, to state it bluntly, that this was simply a case where after Central States sold and made delivery of the stock and received the proceeds of the sale, Williams, whatever his reasons, which
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we need not probe,
14
decided to avail himself of the cash. The funds which belonged to Central States landed in Williams’ companies treasuries on September 23rd. Thus, Central States’ absolute right under its contract with Blue Ridge to receive and retain the $11,426,641 was invaded.
Williams violated his fiduciary obligations to the corporation and imposed upon it a transaction that lacks any acceptable elements of fairness to Central States.
Of the directors, only Kilmarx and Stone appear to have played an active role. In permitting this transaction to take place they were negligent of Central States’ interest and failed to exercise due care. Fo-garty voted only at the board meeting approving the letter agreement of August 21st with Blue Ridge, and there is insufficient evidence upon which to hold him for participation in the events which led to the substitution by Williams’ companies of the North American shares. Freeman was out of the country at the time of the Blue Ridge deal; he was not present at the Board meeting which approved the sale by Central States, and here, too, there are insufficient facts to indicate that he aided Williams in the furtherance of his purpose.
The plaintiffs also- seek to hold members of the firm of Touche, Niven & Company, accountants for 'Central States. The charge'against these defendants is that in furtherance of Williams’ design to overreach Central States and in violation of their obligations and in complete subservience to his wishes, and with full knowledge of Central States’ right to sell the North American stock to Blue Ridge and to retain the proceeds of the sale, they made or permitted entries on the books of Central States, the effect of which was to make it appear, contrary to fact, that Williams’ companies and not Central States were the sellers of the stock.
These defendants, in addition to accounting services, performed bookkeeping services for Central States and had possession of its books of original entry wherein entries were made from records usually delivered to them by messenger. Minutes and other corporate records were also available to the accountants.
They also acted in the same capacity for Federal Utilities, .Electric Investment and Utilities Securities, three of the four Williams’ companies which received payments from Central States for the North American Company stock. Here, too, Touche Niven performed bookkeeping and auditing functions and kept the books at its office, making the entries from records sent over by the companies.
To establish their claim, plaintiffs rely upon certain erasures and alterations in Central States’ books. An original entry in the journal indicated there was due to Central States a total of $35,000,041 for the securities sold under the letter agreement of August 21st and itemized separately each security listed and the sales price thereof, including the 68,423 shares of North American stock for $11,426,641. The words “North American common” were removed by ink eradicator and “Sundry Debtors” substituted. On another page of the journal, in connection with these shares, the words “Accounts Receivable” were similarly erased, and the words “Sundry Debtors” inserted. The substituted entries reflected a sale of the North American shares by somebody other than Central States.
Plaintiffs rely upon the original entries and the changes, as well as other entries and omissions, to substantiate their charges, offering no other proof. They contend that the accountants, through their representative who made the entries on the books, knew of the contract for the sale by Central States of the 68,423 shares of North American, and of the approval of the sale by the directors; also that they knew of the subsequent delivery of the shares on September 5th by Central States to Blue Ridge and the receipt by Central States of the proceeds of the sale, and.that Central States had thereafter paid the proceeds to the Williams’ companies on Septémber 23rd, before the Williams’ companies de
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livered any of the stock, and that notwithstanding, and without authorization by Central States’ Board permitting any variance, the Touche Niven representative made the entries and t'he changes which concealed the true facts and made it appear that Central States was not the vendor of the stock.
The Touche Niven representative who made the entries in question is dead. The plaintiffs stipulated that if the defendants of the Touche Niven group were called, they would testify that as members of the firm they had no knowledge of any instructions by any officer or director of Central States or by Harrison Williams on how or what entries to make in Central States’ books of account; that insofar as they have any knowledge or information, the entries were made in good faith and not for the purpose of any personal advantage to Williams at the expense of Central States.
A certified public accountant who testified as an expert for the defendants stated that the entries were made in accordance with accepted principles of accounting, that they reflected the transaction as it was consummated and that the entries as they now appear on the books reflect a state of balance.
There is no proof that the defendants or their representative, now deceased, who made the entries, knowingly aided the plan to have the Williams’ companies, instead of Central States, deliver the stock. The mere fact that there is an erasure does not give rise to knowledge of or participation in any wrongful purpose. Erasures in books of account and alterations to correct errors are common occurrences. The testimony of the expert that without the corrections the books would have been out of balance, was not rebutted.
The record does not sustain the serious charge made against the Touche Niven defendants and they are entitled to judgment dismissing the complaint upon the merits.
There remains the question of the nature of the relief to be granted.
The plaintiffs claim rescission and a right to be restored to their original position. They seek the sums of $11,426,641 and the interest item, $34,279.92 with appropriate interest, and tender the return to Williams and his four wholly owned companies of 68,423 shares of North American Company common stock and all the dividends and benefits received incident to ownership thereof from September 1929 to the date hereof.
The defendant Williams resists rescission on the ground that not he, but four of his wholly owned companies were parties to the transaction here condemned. Three, New Empire, Electric • Investment and Federal Utilities, were served with process, but on moti.on the action was dismissed against each for improper venue. The fourth, Utilities Securities, has been dissolved and as to it the motion to dismiss was granted on the ground that it was not amenable to suit. Consequently, he argues that since the Court does not have jurisdiction of the corporations, the transactions to which they were parties cannot be cancelled or rescinded, nor may a constructive trust be impressed as he, Williams, did not acquire legal title to any of the property now sought by the plaintiffs.
In my opinion these factors do not bar the plaintiffs from obtaining in this action an undoing of the transfers of cash and the shares of North American stock. Williams’ domination of Central States and the four corporations which received the cash was complete. He used the four corporations as agents for the transaction of part of his own business, thus making himself responsible for their acts. Rapid Transit Subway Construction Company v. City of New York, 259 N.Y. 472, 488 , 182 N.E. 145 . Even were domination not so complete, considerations of “honesty and justice” may compel a Court to decide the same way. 259 N.Y. at page 489 , 182 N.E. at page 150 ; Hollander v. Henry, 2d Cir., 186 F.2d 582, 584 , certiorari denied 341 U. S. 949 , 71 S.Ct. 1017 , 95 L.Ed. 1373 .
The “B” transaction was carried out on Williams’ instructions and for his personal benefit. Had he caused shares from his personal portfolio to be transferred to Central States and the cash transferred from Central States into his personal bank account, no questions would be presented.
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What actually occurred, in view of the pattern of Williams’ operations, was in substance the same. Each and every one of the four corporations, one hundred per cent owned or controlled by him, was the instrumentality by which he effected his purpose.
15
To Williams at the time of the transaction neither the particular source of the securities nor the particular recipient of the cash was material, provided both were under his control and acted on his instructions and for his benefit. Receipt of the cash by his personal corporations was the equivalent of receipt by him, and in this sense they were his pockets. The way in which the payments by Central States were made without formal regard as to which company delivered what number of shares indicates the manner in which Williams operated the financial affairs of ■his personal companies and his complete power to direct the transfer of cash in the manner best suited to his decisions.
16
Williams is before the Court. To allow the absence of the pocket corporations to bar relief requiring Williams to restore the cash over which he had absolute power of disposition would be an unwarranted frustration of equity’s power to correct injustice, and this, on the formal basis of the particular disposition of the funds and source of securities selected by Williams, although the selection had no materiality in the transaction itself. The language of Chief Judge Lehman in Rapid Transit Subway Construction Company v. City of New York, supra, 259 N.Y. 488 , 182 N.E. 150 , summarizing two decisions of the Supreme Court
17
is appropriate to the situation at bar.
“ *
* * the stockholder did not merely use its control of the corporation in the normal and usual manner, but used the corporation as an agent for the transaction of part of the stockholder’s business. * * * liability rested, not upon a disregard of the independent personality of the corporation, but upon the principle of
respondeat superior
applicable even where the agent is a natural person.”
I conclude that rescission may be had against Williams. The plaintiffs are entitled in respect of this transaction “B” to a decree against him directing the return by Williams of the sums of $11,426,-641 with interest thereon from the 23rd day of September 1929, and of the interest payments totalling $34,279.92 with interest from the dates the interest payments were made upon the return of 68,423 shares of North American Company common stock, and all the dividends and benefits received incident to ownership thereof from September 1929 to date.
The enforcement of this decree against Williams should result in complete restora
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tion and render unnecessary the determination of the amount of damages for which the defendants Williams, Stone and Kil-marx are liable on this transaction. If there is a failure of complete restoration, plaintiffs may apply to this Court for assessment of damages or such other and further relief against defendants Williams, Stone and Kilmarx as may be appropriate in the circumstances.
The disposition herein is subject to a consideration of, the defense of the statute of limitations which is hereafter discussed.
Transaction “C”, “D” & “L”
Stock Dividend Policy and Dealer Distribution Program
Preliminary to a consideration of transactions “C,” “D” and “L,” reference has to be made to the stock dividend policy and a closely related activity, Nasco’s so-called dealer distribution program from which, in some measure, these transactions stem,
Stock Dividend Policy
Central States’ dividend policy was patterned after and tied in with that of North American company whose stock constituted Central States’ principal activity in the second phase of its history.
North American was the top holding company of a vast system of operating and holding companies in the public utility field. Its activities included the financing of affiliated companies. In order to increase capacity and earnings, these companies required heavy capital investments. In 1923 North American adopted a policy of paying common stock dividends in stock instead of in cash. The essential purpose of the program was to enable it to plough earnings back into operating subsidiary companies, making available funds for construction, plant and equipment. It was in effect a policy of self financing which reduced the need to obtain, from either bankers or through the public offering of securities, the cash required for expansion programs. This, at the same time eliminated the usual underwriting or financing costs. Under this “self financing” program, from 1923 to 1933, out of a total of roughly $185,000,000 available for dividends on its common stock, North American paid a cash dividend on only one occasion, in 1923, in the year the program was inaugurated — in the amount of $1,-200,000. Otherwise it paid stock dividends of 2%'% or 1/40 of a share quarterly. Thus, in that period approximately $184,-000,000 was made available to operating subsidiaries.
North American’s dividend policy presented problems to its stockholders. Since Central States’ largest single investment was in the North American company, the receipt of stock dividends instead of cash largely influenced its own dividend policy. It, in turn, issued stock instead of cash dividends. The program was carried over to the two series of convertible preference stock issued by Central States in 1928 and 1929 through the inclusion of optional dividend features, under which the holder was required to give notice if he wanted the cash, otherwise the dividend was paid in stock. American Cities Power and Light Corporation and Electric Shareholdings, when organized as part of Central States’ expansion prpgram, also adopted the stock dividend program.
(a) Purpose of Dealer Distribution
The North American stock dividend policy, of course, also affected its stockholders other than Central States. There were those" who wanted cash and accordingly sold the stock dividends on the market Without a market, the stock dividend program could not have been continued. In order to maintain and stabilize the market, Williams, in 1923 when the stock dividend policy was first initiated, through his wholly owned New Empire Corporation, organized Nasco. The distribution program undertaken by Nasco was intended to maintain a ready market for the sale of dividend stock and to broaden the list of North American stockholders. As compensation for this service, North American paid Nasco $150,000 per year.
Broadening the market, according to the testimony, meant increasing the number of stockholders and widening the geographical area of distribution, acquainting security dealers with the stock, spreading information about the company and its plans,
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and increasing acceptance of the stock generally. The number of North American stockholders increased from several thousand to forty thousand all over the United States. Profits made by stockholders upon the sale of their stock dividends naturally influenced the marketability ol future issues. As a result of the dealer distribution program, Central States, as a stockholder of North American, could either retain the stock dividends and increase its investment, or at its option, sell the stock in an available and stabilized market.
(b) Method of Distribution
Nasco used investment dealers throughout the country to sell the shares to institutional and individual investors. To encourage the sale of the stock to investors who would retain the securities, Nasco paid dealers an extra commission on sales to purchasers who held on to the stock for a certain length of time. Dealers . telephoned or wired orders to Nasco who filled them by delivery of the stock at the price of the last sale on the Exchange on the day the order was received. The demand was met either from an inventory which Nasco sought to maintain or by purchases on the Exchange, and generally these were kept in line with the dealer demand for the stock. The process has been referred to as buying on the market and selling off the market.
(c) Distribution of American Cities, Central States and Electric Shareholdings stock.
We have already noted that the dividend policies of Central States, American Cities and Electric Shareholdings were patterned after North American. Their stock dividend policy and the conversion feature of their preferred stocks and debentures also required a similar dealer distribution program for their common stocks.
Nasco’s activities in North American stock were discontinued in 1928. Thereafter, it distributed the common stock of American Cities and, beginning in 1929, the common stocks of Central States and Electric Shareholdings. As owner of 80% of the Class B common stock of American Cities, Central States was receiving common stock dividends on 1,600,000 shares and was vitally interested in having a ready and broad market. It was also desirable for other stockholders to have a market.
Transactions “C,” “D” and “L” must be considered against this background of the stock dividend policy and the dealer distribution program.
Transaction “C”
Late in 1928, Central States purchased 1,600,000 shares of the American Cities Class B stock representing an 80% equity interest in American Cities. From November 1928 to October 31st, 1929, Nasco bought and sold American Cities “B” stock in very substantial amounts.
On October 31st, 1929, Nasco was long 57,879 shares of the “B” stock at an average cost of $36 per share, involving a loss of $636,000 which increased to $800,000 when dealers returned an additional 12,316 shares because of cancellations or defaults. As a result- of this and other losses, Williams decided sometime prior to October 31, 1929, to discontinue Nasco.
The defendants contend that effective October 31st, 1929, Nasco transferred to Central States its. long position of 57,879 shares of American Cities “B” at the market price that day, $25 per share; that with respect to the unknown number of shares yet to be returned by dealers, these were also to be taken over at the same price of $25 per share. The transaction is sought to be justified on the ground that upon Nas-co’s discontinuance of the dealer distribution program it was in Central States’ interest, as the largest holder of American Cities “B,” to continue the dealer distribution activities without hiatus — and the justification is based upon the various reasons assigned for the dealer distribution program.
The plaintiffs claim that the purchase was foisted by Nasco upon Central States at a price of $25 per share by selling them “as of October 31, 1929,” when the market price on December 3rd, the day the directors authorized the transaction, was $18; that it was handled “as of October 31, 1929,” to relieve Nasco of part of the $800,000 loss.
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In fact, the plaintiffs argue that this was an alternative plan to an abandoned plan to have Central States absorb the entire loss.
The fundamental issue is the fairness of the transaction, and the narrower factual issue is whether the purchase of these shares was made on October 31st, 1929, or on or about December 3rd, 1929, and then handled as of October 31st, 1929.
The arrangements for the takeover of Nasco position were made orally by Williams and officers and directors of Central States, principally Stone, its President. The takeover was authorized by Central States’ directors at a Board meeting held on December 3rd, 1929. Of the- eight directors who voted for its adoption, only Stone, Freeman, Fogarty and Kilmarx are named with Williams as defendants in this transaction. The resolution reads:
“After a statement of explanation by the President, on motion duly made and seconded it was unanimously
“Resolved, that the action of the officers in behalf of this Corporation in taking over from North American Securities Company its position in the matter of B stock of American 'Cities Power & Light Corporation (i. e., stock on hand and stock re-deliverable to it upon sales not consummated) as of October 31, 1929, at market price of $25 as of that date, be and it hereby is approved.”
Kilmarx was then Treasurer and a director of Central States, Nasco and American Cities, as well as a director and officer of other Williams’ wholly owned companies. Stone was President and director of Central States and a director of three wholly owned Williams’ companies. Every other director who voted for the resolution was also a director of one or more wholly owned Williams companies.
On December 4th, the day following the Board resolution, Kilmarx issued a purchase ticket dated “12/4/29 as of 10/31/29” indicating the purchase by Central States from Nasco of 57,879 shares of American Cities “B” at $25 per share for $1,446,999.-48. This was entered on Central States’ purchase book. No purchase slip was issued for the 12,316 shares (those returned by the dealers) but an entry was. made in Central States’ purchase book indicating a purchase from Nasco at $25 per share for $307,900. The two entries total 70,195 shares, purchased by Central States from Nasco for $1,754,899.48. Central States made payment by crediting Nasco’s loan account with that amount.
The explanation of the transaction comes principally from Kilmarx and Stone. The matter of the takeover and the terms was the subject of discussions between Williams and Stone subsequent to October 31st, and extending up to the date of the resolution. A final decision was reached by them in early December, at which time Kilmarx was first advised of it.
Drawing the most favorable inference from Kilmarx’ testimony, it is to the following effect: that there was a commitment made by Central States to buy a block of American Cities “B” stock, which left open the number of shares and the price to be paid for them. These were not determined until early December.
With such essential terms as the numbei of shares and the price undetermined, the arrangement could hardly have been a valid contract. But separate and apart from this, the Court is of the view that this arrangement, effective as of a prior date, which required Central States to buy the shares at $7 over the market price prevailing on December 3rd, the date the directors approved, the transaction, must be condemned.
The first documentary reference to the takeover-is in the minutes of the December 3rd Board meeting.
Stone, whose testimony was also relied on to support defendant’s position, was far from definite. He could not recall the explanation which he made to the Board of Directors as noted in the minutes of December 3rd; nor when he had the discussions with Williams relating to the takeover except that they took place some time after Williams indicated he planned to discontinue Nasco’s operations and the distribution of the American Cities “B.” He had no recollection that the transaction was made effective as of a prior date but relat
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ed the transaction to the discontinuance of the Nasco operations the date of which he also did not recall. Williams did not recall the transaction and nothing occurred during the trial to refresh his memory.
The evidence establishes that no definitive conclusion was reached until about December 3rd.
In addition to the takeover authorized, by the resolution, defendants rely on the activities in the American Cities “B” stock after October 31st. These relate to purchases and sales during November. The defendants point to entries of purchase and sales of the “B” stock for the month of November in Central States’ books as indication that Central States, commencing on November 1st, regarded itself as owner of the shares and did, in fact, take over the account by exercising rights of ownership. Central States’ trading account for November contains an opening entry showing the receipt of 57,880 shares of American Cities “B” on November 1st, and thereafter almost daily entries of purchases and sales out of that account. But the evidence establishes that Nasco, and not Central States, made the purchases and sales during that month.
The Nasco purchase and sales sheets for the month of November 1929 record the very purchases and sales of American Cities “B” which ultimately were recorded in Central States’ purchase book and the Central States trading account. Under Central States’ normal bookkeeping procedure, individual slips would have been issued for each purchase and sale transaction. Contrary to this usual procedure, no individual sales or purchase slips were made or issued by Central States in connection with American Cities “B” stock transactions in the month of November. But on December 4th a Central States summary sales and a summary purchase slip, reflecting the combined total of the individual purchases and sales during November, were issued by Kil-marx. Each was dated “12/4/29 as of 11/ 31/29” (sic) and each summarizes respectively the total sales and purchases of American Cities “B” made during the month of November by Nasco.
The defendants claim that the mechanics of the transfer of the book entries and the issuance of the summary slips and other related facts sustain their position that Central States took over the account as of October 31st, 1929. But the inference is equally permissible, in fact on this record more compelling, that the purchases and sales during November were, in fact, Nas-co’s; that it, Nasco, was still actively engaged in dealer distribution throughout the entire month; and that the transfer to the books of Central States carried out the decision reached at the end of November or early December and approved by the Board on December 3rd. This explains a single summary purchase and a single summary sales slip executed in the early part of December following the November transactions, contrary to Central States’ usual procedure.
The defendants place great store on Williams’ intention to discontinue Nasco, and specifically urge two items in this connection. One is the legal change of name of Nasco on October 29th, to permit the incorporation of a new company, to be known as New Nasco, in which Goldman Sachs Trading and Central States were to be equally interested, for the purpose of engaging in dealer distribution activities. The New Nasco was incorporated on October 29th, the same day that old Nasco’s name was changed to Columbia Utilities. Second, there is the basic agreement amongst Central States, Goldman Sachs Trading, the old Nasco and New Nasco, executed on January 1st, 1930, which contains a “Whereas” clause reading: “Whereas, the business of distributing securities has been carried on in the name and for the account of North American Securities since October 29, 1929 * * Separate and apart from the self-serving nature of the “Whereas” clause, made long after October 31st, the New Nasco did not begin its activities at the earliest until January 1st, 1930. New Nasco was delayed by a survey of Blue Sky Laws, which was not completed by counsel until November 20th. The plan for the formation of a New Nasco sponsored jointly by Goldman Sachs and Central States was first contemplated in
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the late summer of 1929 and it is unlikely that pending activities by the newly formed Nasco, Williams would have abruptly discontinued the 'old Nasco.
There are other circumstances which indicate that the takeover was effective the date of its authorization by the Board and not prior thereto.
The Treasurer’s report, signed by Kil-marx, for the period from October 31st to November 27th, which normally reflected the acquisition and disposition of the stock during the period of the report, omitted any reference to the acquisition of the 57,879 shares. Nor is there any reference in the report to purchases and sales by Central States of American Cities “B” stock in the month of November, those finally recorded by means of the summary sales and purchase slip. It is true that the accountants issued a tentative report as of November 30th, showing the acquisition of the 57,879 shares and also the result of the purchase and sales transactions for the month of November, carried on by Nasco allegedly for Central States, but the force of this is weakened when it is pointed out that it was forwarded to Central States on December 3rd. No satisfactory explanation has been offered why the takeover is as of October 31st and the action of the Board on December 3rd, 1929. Stone, when specifically asked to account for the lapse of time, had no explanation.
The fact that the resolution of the directors authorizes the takeover of the Nasco position “as of 10/31/29” instead of referring to an agreement made on October 31st, 1929; the purchase slip for the acquisition of the 57,879 shares on December 4th, again “as of October 31st”; the summary sales and the summary purchase slips each dated “12/4/29 as of 11/31/29” (sic) covering sales and purchases admittedly made by Nasco in November; the transfer of the November transactions at the end of November or early December from the books of Nasco to Central States; the omission in the Treasurer’s report of November 27th of the 57,879 shares, then in Central States’ portfolio
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with the precise amount having been known since at least October 31st; the fact that the New Nasco did not begin operations until January 1st, 1930; all lead to the conclusion that no agreement was made on or prior to October 31st either to take over the then known 57,-879 shares or the unknown number in the hands of dealers at the $25 market price prevailing that day, and that Nasco did not discontinue its activities until the end of November or early December 1929, and that no arrangement for any taking over was made prior to the period between November 27th and December 3rd.
On the evidence before me, I do not find it unfair to Central States for Central States to have taken over Nasco’s position in American Cities. Central States’ large holdings would appear to have dictated that course in its own interests. But the terms of the takeover were unfair to Central States.
When the deal was fixed by the action of Central States’ Board the market price was $18 per share and the approval of .the transaction as of a prior date gave Williams an unfair edge and advantage of $7 a share based on market price — let alone — the actual price Nasco might have received if in December
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Nasco had tried to market elsewhere so large a block of American Cities stock.
It is no answer to suggest, as the defendants argue, that Nasco’s activities were of benefit to Central States. Nasco was engaged in a private enterprise, and was not acting as agent for Central States. Whatever latitude Central States might have had in dealing with unaffiliated third parties, and however free a corporation.may be in an arm’s length transaction to take into account considerations not legally binding which may prompt it to be generous or “fair,” in dealing with a controlling stockholder who dominated its affairs and activities, such a corporation cannot act with the same freedom. This precluded Central States from paying on a deal made in December the higher price which prevailed in October.
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In participating in and passing upon and ratifying the transaction, the defendant-directors, Kilmarx, Stone, Freeman and Fogarty, acting under the domination of Williams, failed to exercise due care or prudence in the discharge of their responsibilities to Central States and acted contrary to the interests of Central States and are, therefore, jointly and severally liable with Williams.
Plaintiffs are entitled to recovery against them on this transaction in the sum of $491,-365, being at the rate of $7.00 per share, with interest from the 4th day of December 1929, subject, however, to consideration of the defense of statute of limitations.
Transaction “D”
This transaction relates to purchases and sales by Central States, of its own convertible preferred stock. Plaintiffs claim that the purpose of this operation was to maintain the market price of Central States common for the benefit of Williams, who was then engaged through Nasco in buying on the market and distributing through dealers large quantities of Central States common. They seek to recover from Williams and Freeman, Fogarty, Kilmarx and Stone, directors at the time of the transaction, the sum of $9,055,426.56 (the net amount expended by Central States). The defendants assert that the purchases were made for valid purposes and in Central States’ own interest.
■ Commencing in 1928, when Central States embarked upon the expansion program, the third phase of its activity, it sold two issues of convertible preferred stock known as the 1928 and 1929 series respectively. The provisions of the two series were substantially the same. The stock was convertible into common. In March 1929 (before the issuance of the 1929 series) Central States paid a 100% stock dividend on its common, and in June 1929 (after the issuance of the 1929 series) it paid a 200% common stock dividend. The conversion feature of the preferred stock contained an adjustment formula which gave effect to the common stock dividends.
The two series contained other features in addition to the conversion privilege. Each share of preferred was redeemable at Central States’ option at $110 on thirty days’ notice, but the shareholder for a period of twenty-five days after the notice of redemption, had the power to convert into common. The preferred stock also provided for quarterly dividends in common stock, or at the option of the holder, in cash, at the annual rate of $6.
The right of conversion into common stock created a definite price relationship between the two stocks. Generally, the price of the preferred stock would rise to the market level of the common available upon the conversion. When the prices of the stocks were in balance it was considered parity. However, the correlation was not exact and at times the preferred stocks sold at prices below their common stock equivalent or parity price. At other times, when preferred was bought in volume in anticipation of a rise in the common stock, the preferred stock sold at more than their common stock equivalent. It is apparent that when the preferred sold below the market value of the- common stock available under the conversion feature, there was an advantage in converting.
As the market price of the common increased, the dividend return to the holder of the preferred increased, and his conversion privilege had greater value.
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The lag of the preferred below the level of its common stock equivalent — parity— created an opportunity for professional arbitragers. They would buy the preferred and simultaneously sell the common short. They would then convert the preferred into common and make delivery of the common stock received upon the conversion. The profit to the arbitragers was the dif
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ference between the price paid by them for the preferred and the amount received by them upon the sale of the common.
An obvious result of conversions, whether by professional arbitragers or preferred stockholders who sought to benefit by the price differential whenever the preferred sold below its common equivalent, was to throw additional shares of Central States common stock upon the market. This is the nub of the plaintiffs’ contention. They argue that Central States was compelled to undertake the purchase of substantial amounts of its convertible preferred stock to protect Williams who, through Nasco, was engaged in extensive trading operations in the common stock of Central States.
It was Williams, who instructed and authorized Kilmarx to undertake and supervise the program. The repurchasing program had not been authorized in advance by the directors but they knew of the daily transactions and the treasurer’s reports revealed the pertinent facts.
By July of 1929, Central States had outstanding 110,000 shares of its 1928 series of convertible preferred and 115,500 shares of its 1929 series. Central States began to deal in the convertible preferred in February 1929, and its activities continued until the end of October 1929. During this period it purchased 48,380 shares and sold 25,633 of the 1928 series, and purchased 33,400 shares and sold 4,968 of the 1929 series. The net purchases of both series amounted to 51,179 shares at a net cost to Central States of $9,055,426.56, the amount sought to be recovered from Williams and the directors.
During the same period that Central States was purchasing and selling its preferred stock, Williams, through Nasco, was purchasing on the market and selling off the market through the dealer distribution system Central States common. Nasco’s concentrated activities in Central States common coincided generally with Central States’ operation in preferred, particularly in June and July of 1929, the peak period of activity for both. Williams, directly or indirectly, in his market operation in the year 1929, purchased over $32,000,000 of Central States common and distributed over $27,-000,000, with heaviest purchases and sales from May to October.
In June and July 1929, the market price of Central States common had risen from $25 to $80 per share, reflecting an increase in the market value of Williams’ holdings by almost $400,000,000.
Kilmarx, who was in charge of the day to day operations, bought the convertible stock only when the market price was under the equivalent price of the common stock. The purchases, coinciding with the rise in the market price of the common, prevented the common from being sold short against the conversion which would follow.
Central States, however, did not confine its activity solely to purchases; it also sold, but only when the price of the preferred was equal to or higher than the price of the equivalent common. In fact, Central States was here engaged in a sort of reverse arbitrage. When the preferred was over parity, there was no danger of conversion. Kilmarx conceded that had not the preferred gone over parity, the convertible stock purchased by it would have been retained by Central States and there would have been no trading activity — just purchases.
Central States’ trading activities from May through August 1929, resulted in a profit on consummated transactions of more than $1,700,000. This was wiped out by the market crash in October. Central States then had a balance of 51,179 shares on hand. Eventually, the cost of the 51,179 shares was written down to the par value of $100 each and the difference was charged to capital surplus which resulted from the transaction described under “J.”
Plaintiffs contend that the operation was not in the interest of Central States, and that the purchases involved the use of Central States funds- and facilities for Williams’ benefit and his personal purposes. They point to the fact that during the time Central States was buying and selling the preferred stock, it did not buy any oi its common stock and, hence, the activity had no corporate purpose for the protection
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of Central States. They reject the contention that one of the purposes of the transaction was to retire the preferred thereby making available additional common stock for future sales at a higher price. They also seek to mitigate the force of the defendants’ argument that the preferred was purchased for retirement by showing that the defendants made no attempt to retire another issue of preferred, also redeemable, but without a right of conversion.
The defendants contend that the purchases were made for valid business reasons in Central States’ interest; that the purchases both protected the corporation against arbitrage activities and at the same time Central States made and sought to make a profit by buying and selling.
In essence, these are the reasons advanced :
1. A profit purpose through the trading activity; 2. Profit prospects on both common and preferred based upon general optimistic attitude and the bull market; (a) it was desirable to retain (by preventing conversions) as much of the common stock as possible for future sales at higher market values; (b) it was desirable to purchase the preferred for future market sales, again in the belief that the market would continue to rise; 3. Protection of the corporation against professional arbitragers. It is claimed that their short selling resulted’ in an erratic market which was detrimental to the corporation because it impaired its prestige and endangered future prospects for the issuance of securities which were then contemplated as part of the expansion program. Investors, it is claimed, looked with more favor on stocks which were fairly stable.
So much for the business reasons relied upon by the defendants. But they also seek to rebut the plaintiffs’ arguments and bolster their own position by pointing out that even if the 51,000 shares had been converted, it could have had no significant effect upon Williams’ holdings or Nasco’s dealer distribution program. The common stock equivalent of 51,000 preferred shares upon conversion was approximately 185,000 shares, and the daily purchases of the preferred were not substantial enough in relation to the total outstanding stock in the market to have made any appreciable difference. Furthermore, Nasco was buying on the market to supply heavy dealers’ demands and was generally paying a price higher than that at which the dealers’ orders were placed. Consequently, they say, a lower, rather than a higher, market price and a greater, rather than lesser, supply of common on the market was to Williams’ interest. They also rely upon the fact that there were very substantial conversions in 1929 — 464,241 shares of common stock were issued on conversion. In addition, it is argued that the resales by Central States of the convertible previously repurchased again placed these shares on the market with the conversion privilege. All these are urged as negativing the charge that the purchasing program was intended for Williams’ benefit.
Several of the reasons now relied upon by the defendants were not advanced when Williams, Stone and Kilmarx testified before the SEC in 1937. The trading profit purpose seems to have been urged for the first time upon this trial and so, too, the suggestion that because of the prevailing optimism about the market there was likelihood of future profit by retaining the common shares which would have been released upon conversion, for future sales in a higher market. At the SEC hearing Williams claimed that the purpose was to prevent arbitrage and conversions, although it may well be that he did not fully develop the underlying reasons.
Assuming that the original purpose was principally to prevent conversions and that Williams necessarily benefited, the Court may not ignore the contemporaneous facts of the transactions in considering the fairness of the program to Central States, and whether or not Central States was overreached. First, the fact is that the corporation did trade in the stock. Out of the total of 81,780 shares purchased of both series, it resold 30,601 shares, leaving the balance of 51,179 shares, the subject of this action. To the extent that it sold 30,-601 shares, it made possible conversions into common, although it must be acknowl
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edged that with the parity price of the preferred at or in excess of the common at the time of such sales, there was no likelihood of immediate conversion. Nor may the fact be ignored that as a result of its trading operations in a comparatively short time, from May to August 1929, a profit of $1,700,000 was realized which, to be sure, was completely dissipated by the collapse of the market in October 1929. Nor may we disregard the fact that prior to the crash and during the period of the purchase of the preferred, the market value at all times exceeded the net cost — and at one point in August 1929, by more than $6,200,000.
Weighing these facts against the claim that the basic purpose of the transaction was to benefit Williams at the expense of Central States by preventing conversions to avoid the dumping of common stock on the market, the Court is not satisfied that, upon the entire case, such is the fact. That Williams may have been an incidental beneficiary of the 'purchases does not, in and of itself, justify a finding that the program was unfair to Central States or reflected a breach of trust by fiduciaries.
The evidence establishes that through the years Central States, by reason of its stock dividend policy, was justified in seeking to maintain a stable market so that investors would be free to dispose of stock dividends received by them in a normal rather than in an irregular and erratic market. Also, the maintenance of a favorable climate for future issues contemplated under the expansion program represents a legitimate corporate purpose. Under the circumstances, the prevention of arbitragers’ activities which tended to create a hectic market, would appear to be in the interests of Central States. This record does not justify a finding that the reason for the program was to advantage Williams at the expense of Central States or that the program was not undertaken in the interests of Central States.
The defendants are entitled to judgment dismissing the complaint upon the merits.
Transaction “L”
This transaction relates to the sale by Central States to Nasco of 40,000 shares of North American Company stock at $46.-13928 per share. The lowest market price on the day of sale was $50 per share. Plaintiffs seek to recover the difference of $154,428.80. Those named in this transaction, in addition to Williams, are Fogarty and Kilmarx.
During 1927, Nasco’s dealer distribution activities were confined to North American common stock. To maintain an inventory position to meet dealers’ demands, Nasco, from January to May 23rd, 1927, borrowed from Central States 60,000 shares of North American common. It had returned 20,000 shares and owed Central States a balance of 40,000 shares. These are the subject matter of this transaction. At the time of this transaction, Nasco was oversold by 80,000 shares and needed stock to cover its short position. Instead of returning the balance of the shares due to Central States, Central States on May 21st, 1927 sold to Nasco the 40,000 shares at $46.13928, the net price at which Nasco had sold the North American stock after taking into account purchases and sales. The lowest price on the market for North American common on that day was $50. Central States’ journal records the sale, as well as a book profit of $419,011.75 on the sale, as follows: “To record as of May 21, 1927 sale of and profit on 40,000 shs. North American Company Common Stock at an average price of $46.13928 per share as per statement on file. Approved by directors at meeting held on June 7, 1927.”
The minutes of the Board meeting on June 7th, 1927, recite (1) that Nasco “through their dealer distribution, had sold during the period to May 21, 1927, in excess of 40,000 shares of the Common Stock of the North American Company, at an average price of $46.13928 per share, in accordance with statement submitted”; (2) that Central States had advanced North American Company stock, in excess of 40,-000 shares since January 1927; and (3) “it being necessary to realize on its (Central’s) stock holding for the Company’s corporate purposes” it was “Resolved, that the Central States Electric Corporation adopt the sale of such 40,000 shares of North American Company Common Stock as set forth
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above, at a net price of $46.13928 per share as its action.”
The statement referred to in the resolution was prepared by the accountants based upon all the sales and purchases made by Nasco of North American stock. Following the computations appears the legend, “Of the above stock 40,000 shares sold for the account of Central States Electric Corporation.”
Plaintiffs point to this last item and also to a preliminary draft of a resolution not used, which contains similar language, as another attempt to hold Central States as principal (as in “C” Transaction). There can be no question upon this record that the distribution was at all times carried on by Nasco for its own account. The defendants make no contention to the contrary.
The simple issue here is whether a sale imposed by a fiduciary upon a beneficiary requiring it to sell at less than the market value may be considered fair.
The defendants seek to justify the transaction on the ground that Nasco, having suffered heavy losses in the dealer distribution of North American, contemplated discontinuing its activities and that it was to Central States’ interest as the largest holder of North American common that such activities be continued. Accordingly, they urge that as an inducement to Nasco the sale at the price below the market was, under the circumstances, fair. Parenthetically, it is observed that it was the pi'oposed discontinuance at the end of October 1929 of Nasco’s activities which was the asserted justification for the takeover of the 70,000 shares of. American Cities “B” on December 4, 1929 “as of October 31st,” discussed under Transaction “C.” But this was May 1927.
There is a complete absence of credible evidence in the record to support this contention. Central States was entitled to the return of either the balance of the 40,000 shares of North American stock owing to it from Nasco or payment therefor at the market price on May 21st. It is true that Central States was interested in a stabilized and broadened market and that a wider distribution of the stock was to its advantage. But the irrefutable fact is that the dealer distribution activity of Nasco was essentially for its own account. That Central States was an incidental beneficiary of Nasco’s activities does not justify depriving Central States of the fair market price of the stock on the day the common directorship compelled it to sell below the market. North American Company and other Williams’ companies were just as much interested in the dealer distribution activity. The distribution here was of North American Company stock and the North American Company would appear to have been a more direct beneficiary; its interest is evident from the fact that North American contributed to Nasco $150,000 per year to support its activities. Taking defendants’ contention at face, there is no proof of any commitment or agreement on the part of Nasco to continue the stabilizing activities.
There is apparent contradiction between the positions taken by the defendants in this and in the “B” transaction. Here the defense’s position is the reverse of that urged in that transaction. It was there contended that Central States’ basic policy was to retain the North American stock and to extend its holdings, although it had debts and found it necessary to sell debentures amounting to $25,000,000 as well as other securities to raise cash required for investment in the Blue Ridge Corporation. Here, too, we are dealing with North American. We find Central States selling 40,000 shares of North American below the market to Williams, and recording on the minutes that it was necessary “to realize on its stock holdings for the Company’s corporate purposes.” Whatever may have been the reason for the sale, it appears that the consideration was not adequate. Ged-des v. Anaconda, 254 U.S. 590, 599 , 41 S.Ct. 209 , 65 L.Ed. 425 . The directors’ duty was to obtain the best possible price for the stock. The transaction does not ■ have the fairness required of a trade between Central States and its controlling and dominating stockholder.
In participating in and passing upon and ratifying the transaction, the defendant-directors Fogarty and Kilmarx, acting un
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der the domination of Williams, failed to exercise due care or prudence in the discharge of their responsibilities to Central States and acted contrary to the interests of Central States and are, therefore, jointly and severally liable with Williams.
Plaintiffs are entitled to recovery against them on this transaction in the sum of $154,428.80 with interest from the 21st day of May, 1927,' subject, however, to consideration of the defense of statute of limitations.
Transaction “E”
This transaction took place during the fourth phase of Central States’ affairs, when its principal activity was the ownership of stock in other companies such as the North American Company, American Cities Power and Light Corporation, Blue Ridge and Electric Shareholdings. Recovery is sought against Williams and Kilmarx, Johnson, McCornack, Eccles ■ and Finney who were directors at the time of the transaction.
In 1938, when the registration provisions of the Public Utility Holding Company Act had been held constitutional,
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Central States owned directly, and indirectly through wholly owned or affiliated companies, 16% of the common stock of the North American Company. To avoid being subject to the registration requirements of the Act, Central States decided to reduce its holdings in North American to below 10%. To achieve that result it was necessary for Central States to dispose of a substantial part of its stock in Electric Shareholdings which owned considerable North American stock and also, for American Cities to sell some of its North American stock.
On November 18th, 1938, Central States and American Cities agreed with Tri-Con-tinental Corporation and Selected Industries Incorporated that, insofar as Central States was concerned, Central States was to exchange 594,432 shares of Electric Shareholdings common for 891,648 shares of Blue Ridge common, the exchange being at the rate of one share of Electric Shareholdings for one and one-half shares of Blue Ridge. A concurrent and another intended result of the exchange was that •stock control of Blue Ridge was transferred to Central States and stock control of Electric Shareholdings was transferred to the Tri-Continental group.
Central States did not exchange all of its stock in Electric Shareholdings and the reason assigned is that the amount was limited by the number of shares of Blue Ridge which Tri-Continental and Selected Industries had available for exchange.
The transaction with Tri-Continental is not questioned. What is attacked is another transaction made on the same day between Central States and New Empire Corporation and Onondaga Corporation,
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two of Williams’ wholly owned corporations. Central States exchanged with those companies a total of 23,400 shares of Blue Ridge for 15,600 shares of Electric Shareholdings. The rate of exchange was the same as in the deal with Tri-Continental. Both transactions were approved by the directors at a Board meeting on November 21st, 1938.
The gist of plaintiffs’ charge is that' Central States’ corporate policy, as evidenced by its contract with Tri-Continental, was to dispose ■ of Electric Shareholdings and acquire Blue Ridge; that at or about the same time, inconsistently with the purposes of the Tri-Continental deal, Central States was forced by Williams to give up Blue Ridge and acquire Electric Shareholdings. The motive ascribed for this alleged reversal of policy is that it was to relieve the Williams’ companies of their Electric Shareholdings since Williams did not want to be placed in minority position with TriContinental, which, as a result of the transaction would acquire control of Electric Shareholdings.
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The defendants assert that tax saving reasons in the interest of Central States motivated the exchange with the Williams’ companies. It appears that for some time prior .to the transaction, Central States had been purchasing its own debentures at a discount and retiring them. The question as to whether the difference between the face amounts of the debentures and the prices paid for them constituted taxable income to Central States was not free from doubt and defendants claim that it was desirable, pending clarification of the issue, for Central States to establish counterbalancing tax losses.
Johnson, then a director of Central States and soon to be its President, and also a director of a number of Williams’ wholly owned companies knew that the Williams companies held stock of Electric Shareholdings. In an effort to avoid the possible tax consequences of the debenture retirement program, Johnson suggested the exchange with the Williams’ companies. His plan was that the 15,600 Williams’ Electric Shareholdings stock be included in the block transferred by Central States to Tri-Continental, thereby enabling Central States to retain an additional 15,-600 of its highest tax base stock, of its remaining Electric Shareholdings for sale against possible taxable profit resulting from the debenture purchase program. This is the principal justification for the exchange with Williams.
Plaintiffs urge that the tax saving motive is -sheer afterthought, and as potent evidence that Johnson’s story is contrived, rely upon the fact that the certificates of stock acquired from the Williams’ companies were not included as part of the total exchanged with Tri-Continental — an essential element if the tax consideration was in fact the reason. Johnson attributes this to the failure of his subordinates in Central States’ accounting department to follow his specific instructions, which he assumed without checkup, would be faithfully executed.
If, in fact, the tax program was the motivating consideration for the exchange .with Williams, it must be conceded that it was in Central States’ interest. Thus, the determination of the issue in this transaction turns on acceptance or rejection of the testimony supporting the justification for the directors’ actions.
Johnson’s oral version of what he intended to accomplish receives some support from a contemporaneous document in his handwriting. Johnson prepared for the directors statements showing which blocks of stock were available for delivery to Tri-Continental .and which were to be delivered, and calculated the resultant loss upon the exchange. The calculations indicated various blocks of stock and their cost basis. Included in the computation are the 15,600 shares acquired from the Williams’ companies. That the tax matter generally was under consideration is further evidenced by a memorandum sent by Johnson the day following the transaction, November 19th, 1938, to the tax counsel representing Central States.
The record satisfies me that a principal factor in the exchange between Central States and the Williams’ companies was the tax offset program and so it cannot be considered unfair to Central States. The Williams’ companies obtained no tax or market advantage from the sale of the Electric Shareholdings stock to Central States. Marketwise, this transaction offered no advantage to Williams. The market price of Electric Shareholdings, for a considerable time after the transaction, was higher than the value Williams received through the exchange for Blue Ridge.
I find .that the transaction was in the interests of, and was not unfair to, -'Central States. The defendants are entitled to judgment as to this cause of action.
Transaction “I”
In this transaction the plaintiffs charge that a retroactive modification of the New Empire management contract compelled Central States to pay an additional $102,328.44 after it had already paid and fully discharged its obligation under the contract. Named as defendants in addition to Williams, -are directors Kilmarx, Stone, Fogarty and Freeman.
Under the management contract made in February 1923, New Empire undertook to
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supervise Central States’ business, to make available its entire organization and to render all required services to Central States. By an amended agreement, Central States was to pay $18,000 per annum in monthly installments of $1,500. The contract permitted either party to terminate it upon thirty days’ notice. No such notice was given by Central States or New Empire at any time. The payments were made regularly until the end of December 1928 and no issue arises up to that time.
Commencing January 1929 and through September 1929, Central States' continued to make the regular monthly payments of $1,500 each to New Empire. In June 1929, the defendant Stone entered Central States’ employ and was elected President at a salary of $50,000 per year. His salary of $4,166.66 each month from June through September 1929, was paid by Central States, although New Empire under the management contract was obligated to “furnish at our (New Empire) expense a President * * * ” and other officers. On October 8th, 1929, after these salary payments had been made, the Executive Committee of the Board of Directors of Central States by corporate resolution approved the following arrangement: “The President reported that arrangements had been made under which indirect administrative overhead expenses incurred for the common benefit of this Corporation and several of its associated companies shall be shared by the several companies in proportion to the amount of their respective resources as adjusted from time to time by the officers, in their discretion, to give effect to variations in the value of assets and to exclude inter-company holdings. He further stated that this arrangement was being made retroactive to January 1, 1929.”
The controversy centers about this resolution and its retroactive provision.
After the passage of the resolution, Central States paid $85,661.79 to New Empire as its share of the “arrangement” for the first nine months of 1929. Recovery is sought of this sum and also the four salary payments to Stone, in all, $102,328.44. The claim covers only ‘the period for which the arrangement was retroactive, January 1st, 1929 to September 30th, 1929. Plaintiffs contend that the payments were without consideration since Central States had the right to performance by New Empire of its obligation under the unexpired and uncancelled contract, that Central States had paid in full its commitment under the contract, and that the retroactive provision foisting upon Central States additional payments beyond its commitment was unfair to it and a breach of fiduciary obligation by defendants to 'Central States and was made solely in New Empire’s interest and at the expense of Central States.
Upon the trial, counsel representing two defendant-directors acknowledged that the issue was one of retroactivity but urged ■that the transaction was fair in view of New Empire’s increased expense. Counsel for Williams dissented, urging that two contracts were in effect: (1) a quasi-contractual obligation for additional services, not contemplated under the original agreement, and that the retroactivity referred only to this item, and (2) the express contract, the management contract, of 1923.
The position finally urged by the defendants is (1) a quas

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/1468963. Public record. Not legal advice.