# Bookman v. R.J. Reynolds Tobacco Co.

> New Jersey Court of Chancery · July 31, 1946 · 138 N.J. Eq. 312

URL: https://www.frixlaw.com/law-library/cases/3567738

## Case

- **Full name:** Arthur Bookman and Judith W. Bookman v. R.J. Reynolds Tobacco Company
- **Court:** New Jersey Court of Chancery
- **Decided:** July 31, 1946
- **Citations:** 138 N.J. Eq. 312; 37 Backes 312; 48 A.2d 646; 1946 N.J. Ch. LEXIS 42
- **Precedential status:** Published
- **Opinion:** Opinion of the court
- **Judges:** EGAN, V.C.
- **Cited by:** 19 later opinions in the Frix Law Library

## Citator (automated)

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## Opinion text

This is a stockholders' derivative suit instituted by the complainants, Arthur and Judith W. Bookman, Ludwig Lavy, and Mary B. Healey — the last named two being intervenors. The Bookmans each own 100 shares of the new class B common stock of defendant R.J. Reynolds Tobacco Company. Lavy owns 45 shares of the same stock, and Mary B. Healey owns 38 shares of such stock. The complainants all reside in the State of New York. The bill was filed November 14th, 1940. Lavy and a Camillo Weiss filed bills of complaint on April 15th, 1941. After the hearing began and an account of the trial appeared in the newspapers, Weiss advised the court that he had never authorized the institution of a suit against the defendants. His counsel was allowed to withdraw Weiss' name as an intervenor. Mary B. Healey first instituted a derivative suit against the same defendants in the United States District Court for the Western District of North Carolina; that suit was dismissed by the court because some of the alleged causes of action involved the internal affairs of a New Jersey corporation — and for the further reason that this suit, which had been previously commenced, *Page 314
was pending here and awaiting a hearing. Healey v. R.J. Reynolds et al., 48 F. Supp. 207 . Mrs. Healey appealed from the decision, and then filed a petition to intervene in this suit. An order was entered here on April 21st, 1943, granting her application. The individual defendants, all non-residents, voluntarily appeared herein. They were the directors of the corporate defendant at the time suit was started.
The hearing of this suit consumed many months; the testimony covers many thousands of pages; the exhibits are voluminous; and the original and several replying briefs are very extensive. The presentation of the briefs ran into the second year after the final hearing.
In the instant case complainants and intervenors hold 283 shares out of a total of 10,000,000 shares outstanding. They are four stockholders of a total of over 60,000. The defendant company has outstanding 1,000,000 shares of common stock, and 9,000,000 of new class B common stock.
The defendant company was incorporated under the General Corporation Act in 1899. Its general offices and factories are in Winston-Salem, North Carolina. For some time, until approximately May, 1911, it was a partly owned, but independently operated, subsidiary of the American Tobacco Company, when that company was dissolved as a trust in restraint of trade under a decision of the United States Supreme Court. United States v. American Tobacco Co. et al., 221 U.S. 106 ; 55 L.Ed. 663 . As the American Tobacco Company held two-thirds of the Reynolds common stock, which by the terms of the decree of dissolution was distributed to the stockholders of the American, it followed that control of Reynolds passed by the decree into the hands of the stockholders of the American. R.J. Reynolds, his brother, William N. Reynolds, and directors of their choice had been permitted to manage and operate the Reynolds Company while control was owned by the American, but the evidence shows that they were very unhappy in the association and were determined if possible to wrest control from the American Tobacco Company and its stockholders. In fact R.J. Reynolds expressed delight when the tobacco trust was dissolved.
After the dissolution of the trust the American Tobacco Company and the Liggett Myers Tobacco Company adopted *Page 315
bonus by-laws. R.J. Reynolds and W.N. Reynolds considered such by-laws, which gave participation in the profits to only a few of the top officials, as being only partly effective. Between them they devised the by-law hereinafter set forth, which would enable any officer or employee to share in the profits of the business provided he remained as an employee and invested all or a part of his estate in the business. It was designed to be both a spur and an incentive.
At a meeting of the board of directors held August 1st, 1912, the by-law was considered and a special meeting of stockholders was called to be held August 23d 1912, to consider and act upon it. Notice was given to all stockholders which contained the terms of the proposed by-law, and that the profits of the company for the year 1910 were 22.19% of its $7,525,000 capital stock and were taken as a basis because the calculations on businesses and brands for 1910, as shown in the plan submitted to the court by the American Tobacco Company and others, were in fact those upon which the dissolution of the tobacco trust was based. They were also advised that "profits for 1910 served as a basis upon which other companies interested in the dissolution have thus far formulated and adopted by-laws providing funds not exceeding 10% of excess profits for distribution among certain of their officers." At the special meeting the by-law XII (formerly XIII) was adopted without objection in the following form:
"All the Company's officers and employees who have owned its stock and been in its employ for not less than twelve months, may be allowed, in the discretion and at the option of the Board of Directors, beginning with the year 1912, to participate, in proportion to the stock thus owned, in the Company's annual profits which are in excess of the percentage of profits earned during the year 1910, to wit: 22.19%, not exceeding, however, 10% of those profits, in excess of 22.19% of its entire outstanding issue of common stock, taking into account pro rata , any increase or decrease thereof made during the year."
On December 22d 1915, at a meeting of the board of directors, the by-law was amended to read as follows:
"All the Company's officers and employees who have owned its common stock and been in its employ for not less than twelve months, then *Page 316
next preceding, may be allowed, in the discretion and at the option of the Board of Directors, beginning with the year 1912, to participate in proportion to the common stock thus owned, in the Company's annual profits, which are in excess of the percentage of profits earned during the year 1910, to wit: 22.19 per cent, not exceeding, however, ten percent (10%) of those profits in excess of 22.19 per cent of its entire outstanding issue of common stock, taking into account pro rata , any increase or decrease thereof made during the year. The common stock owned by an officer or employee, for the purposes of this By-law, beginning with the year 1916, shall include any stock purchased during the year from an officer or employee or from the personal representative of a deceased officer or employee, provided such stock would have entitled the former owner to participate in proportion thereto, had it been held for the entire twelve months' period."
The bill of complaint charges that this by-law always was and now is invalid; that profits have been distributed under it in excess of the amount permitted by its terms; that there was a misrepresentation to the stockholders of the ratio of earnings to common stock for the year 1910; that excessive participations have been paid through incorrect computation of profits during the years 1912 to 1939, and that the defendant directors by way of participations and fixed salary have received excessive compensation for their services; and, among other things, they ask that the directors be decreed to account to and pay over to the corporation all that had been paid out in participations under this by-law from 1912 to date.
After issue had been joined complainants' accountants were permitted to examine the books of the corporate defendant, and after such examination there was filed an amended bill of complaint in which complainants asserted that the defendant directors had been guilty of breaches of trust in a number of different particulars; that they had wrongfully diverted to their own use funds of the corporate defendant for which they should account; that they had caused the corporation to purchase millions of dollars worth of its own stock for their own uses and purposes for which they should account. The charges will be considered separately, and so far as possible, in order.
It is to be observed that the charges made by the complainants extend from the time of the filing of the bill of *Page 317
complaint in November, 1940, back to August, 1912. When the complainants first sought to introduce evidence as to these old matters, counsel for the defendants objected on the ground that the complainants had no legal right to inquire into matters before they became stockholders of the defendant corporation. At that time I ruled that the evidence would be received subject to the objection of the defendants and that I would finally rule on the question at the conclusion of the case. It is my decision that the complainants, on the authorities stated at the conclusion of this opinion, cannot go back of the date when the complainant Healey bought her first stock in 1927.
In view of the seriousness of the charges made against the directors of the defendant corporation and the long and exhaustive trial, I shall review the various matters put in issue. I find that no breach of trust has been committed by any of the defendant directors at any time. On the contrary, I find that the defendant corporation has been managed with a high degree of fidelity and exceptional skill, and with profit to the stockholders and benefit to the corporation far beyond the expectation that any stockholder could possibly have had when the by-law was adopted in 1912.
At the time of the dissolution of the American Tobacco trust, R.J. Reynolds Tobacco Company in assets and value of sales was about one-third as large as P. Lorillard Company; less than one-fourth the size of Liggett Myers, and had about one-fifth the sales and one-twelfth the assets of the American Tobacco Company (see United States v. American Tobacco Co., 191 Fed. Rep. 412 ). At that time the Reynolds Tobacco Company had no business in cigarettes; it had but 2.73% of the smoking tobacco business of the country, 15.49% of the plug tobacco business of the country, no fine cut tobacco business and no business in cigars, snuff or little cigars. Its chief competitors, the American Tobacco Company, Liggett Myers, and the Lorillard Company had 80% of the cigarette business of the country, about 75% of the smoking tobacco business, 65% of the plug tobacco business, and 80% of the fine cut business.
After the adoption of the above by-law on August 23d *Page 318
1912, the R.J. Reynolds Tobacco Company commenced to grow and expand by leaps and bounds. Its smoking tobacco sales increased by 4,000,000 pounds in 1913 over 1912 and by approximately 4,000,000 pounds in 1914 over the sales in 1913. Chewing tobacco sales in 1913 were over 1,000,000 pounds in excess of those in 1912. In 1913 Reynolds brought out the Camel cigarette. This was known as a burley blend, whereas cigarettes prior thereto had been made chiefly of oriental tobaccos. The company sold over 1,145,000 cigarettes in 1913, over 400,000,000 in 1914, 2,250,000,000 in 1915 and 6,500,000,000 in 1916; its sales of smoking tobacco in 1916 were 33,600,000 pounds as against 18,800,000 in 1912, while its chewing tobacco sales, which were about 36,000,000 pounds in 1912 were over 42,000,000 pounds in 1916.
The rapid expansion of the corporation's business, as above noted, made it necessary in 1917 for the directors to consider the acquisition of new capital. S. Clay Williams, now chairman of the board of directors of the corporation, testified that when he was employed by the corporation as an attorney July 1st, 1917, his first job was to consider ways and means of increasing the company's capital. He said that all possible means were considered and that he was instructed by the directors that under no circumstances should by-law XII be touched or its effect in any way altered, because the management of the company ascribed its remarkable growth from 1912 to that time largely to the incentives and spurs of the by-law.
About this time Mr. Williams saw in the press a report that Bethlehem Steel Company, a New Jersey corporation, had issued a class B common stock, and he thought that solved the Reynolds problem. A draft of an amendment to the company's charter was prepared, considered by the directors and special counsel for the company. It was adopted by the directors, and at a special meeting of the stockholders held after due notice, on November 1st, 1917, the following amendment of the charter was adopted:
"Fourth: The total amount of the authorized capital stock of the corporation is Forty Million Dollars ($40,000,000) divided into Four *Page 319
Hundred Thousand (400,000) shares of the par value of One Hundred Dollars ($100) each, of which total authorized capital stock One Hundred Thousand (100,000) shares amounting at par to Ten Million Dollars ($10,000,000) shall be Common Stock, One Hundred Thousand (100,000) shares amounting at par to Ten Million Dollars ($10,000,000) shall be Class B Common Stock and Two Hundred Thousand (200,000) shares amounting at par to Twenty Million Dollars ($20,000,000) shall be preferred stock, the total amount of which Preferred Stock, at par, issued and outstanding at any time shall not exceed the par value of the total amount of the Common Stock and Class B Common Stock then issued and outstanding.
"That stock known as Common Stock without further designation shall include and consist only of the common stock now issued and outstanding under the prior status of the certificate of incorporation of the Company.
"That stock to be known as Class B Common Stock shall include and consist only of the Ten Million Dollars ($10,000,000) of such stock authorized under this amendment. The Class B Common Stock shall have the same rights and privileges as the Common Stock of the corporation except that it shall not have any voting power unless and until the corporation shall fail for ninety (90) days to pay the regular common stock dividend thereon, as due, in which event it shall have the same voting power as the common stock of the company as long as such default shall continue and no longer and except further that it shall not be considered under the Company's plan providing for participation by officers and employees in certain profits of the company."
During the year 1918, the class B common stock was issued for a cash consideration of $10,000,000. Each certificate for class B common stock bore on its face the statement that "it shall not be considered under the Company's plan providing for participation by officers and employees in certain profits of the Company."
After the issuance of the class B common stock the business of the company continued to grow and the profits to accumulate. R.J. Reynolds, the founder of the business, died on July 30th, 1918, and the heavy responsibilities that he had theretofore carried devolved upon the junior executives.
At January 1st, 1920, the capital of the company consisted of $10,000,000 of 7% cumulative preferred stock, $10,000,000 of common stock, $10,000,000 of class B common stock, and over $36,000,000 of surplus (called on the financial statements, Undivided Profits). This surplus gave the management grave concern because while the money was needed in *Page 320
the business there was talk of Congress laying a heavy tax on the undistributed surplus of corporations, and the directors felt that this surplus should be capitalized and retained in the business. The directors accordingly decided that in view of the growth and expansion of the business to recommend to the stockholders changing the class B common stock with limited voting power into a "New Class B" common stock with no voting power, but having all of the other characteristics of the class B common stock that was authorized by the 1917 amendment.
The company in a letter to its stockholders, dated May 1st, 1920, proposed that the par value of all common stock and class B common stock be reduced from $100 to $25 per share; that a 200% stock dividend in the form of New Class B common stock should be paid on all common stock and class B common stock; and that the class B common stock should be exchanged for New Class B common stock, which would differ from the class B common stock only in the reduced par value and the absence of the contingent voting right. The letter requested all holders of class B common stock who were in favor of the proposal to deposit their certificates with the company's transfer agent in exchange for temporary certificates, which would carry a provision under which the company might issue 12 shares of the New Class B common stock in exchange for each share of the class B common stock, provided a sufficient approval of the plan by the holders of class B common stock was indicated, and the common stockholders also approved.
The response of class B common stockholders was so overwhelmingly favorable that the directors, by resolution, submitted the proposal to the holders of the common stock at a special meeting on June 24th, 1920. The proposal was then approved and adopted.
Every share of the class B common stock was exchanged for the New Class B common stock and the 200% stock dividend in the form of New Class B common stock was paid on all the common stock and class B common stock in accordance with the letter of May 1st, 1920, referred to above. *Page 321
PREFERRED.
In April, 1913, the corporate charter was amended at a stockholders meeting to authorize 100,000 shares of 7% cumulative preferred stock of the par value of $100, subject to redemption at the option of the corporation on any dividend date after three years from the issue thereof, at $120 per share and any unpaid accrued dividends. $2,500,000 of this preferred stock was sold to the common stockholders in 1915, and the remainder was sold to stockholders in 1917. An additional $10,000,000 of the preferred stock having been authorized in the amendment of 1917, it was sold to stockholders in 1920.
On September 22d 1925, at a directors meeting, a resolution was adopted to exercise the option to redeem the preferred stock on January 1st, 1926, and to call a special meeting of the stockholders to authorize the redemption. A resolution also was adopted authorizing the officers to purchase all of the preferred stock offered between October 1st and December 18th, 1925, at $120 per share, plus the prorated dividend thereon.
On October 20th, 1925, a special meeting of the stockholders authorized the redemption of the preferred stock, and it was all redeemed as of January 1st, 1926. The premium paid on such redemption in the sum of $4,000,000 was charged against the company's surplus.
One of the charges asserted by the complainants is that this $4,000,000 premium should have been charged against the company's profits for the year in which it was paid and that it was not so charged in order to increase improperly the participation fund under the by-law for the benefit of the directors. Not only was this a capital transaction and so treated by the company's auditors and accountants, but in the company's financial statement for the year 1925, dated January 15th, 1926, and mailed to all stockholders of the company, the following appears: *Page 322
"Net Earnings for the year 1925, after deducting all
charges and expenses of management, and after
making provision for interest, taxes (including
federal and state income taxes), depreciation,
advertising, etc. ................................. $25,221,579.18
DEDUCT
Four quarterly dividends of $1.75 each per share
on Preferred Stock .............................. 1,400,000.00
______________
$23,821,579.18
DEDUCT
Three quarterly dividends of 75c each and one
quarterly dividend of $1.00 per share on Common
Stocks .......................................... 10,400,000.00
______________
Balance carried to Undivided Profits .............. $13,421,579.18
ADD
Undivided Profits December 31, 1924 ............... 29,732,814.48
______________
$43,154,393.66
DEDUCT
Premium paid in redeeming outstanding Preferred
Stock ........................................... 4,000,000.00
______________
Total Undivided Profits December 31, 1925 ........... $39,154,393.66"
It thus will be seen that each and every stockholder was advised under date of January 15th, 1926, nearly fifteen years before this suit was brought, and before any of the complainants became a stockholder, that the premium paid to redeem the preferred stock was charged against surplus and not against the profits for the year. On the authorities hereinafter stated I hold that this treatment of this item has been approved by the stockholders by their acquiescence. Moreover, such treatment was in accordance with the provisions of the Federal Internal Revenue Act and the regulations thereunder.
STOCK DIVIDENDS.
Although the company had paid a 200% stock dividend in 1920 as above stated, net earnings of over $16,000,000 in 1922 and over $20,000,000 in 1923 permitted it to declare *Page 323
and pay on December 22d 1922, a further stock dividend of 33 1/3% in New Class B common stock of the par value of $20,000,000, and after this dividend the common stock issued and outstanding consisted of $10,000,000 of common stock and $70,000,000 of New Class B common stock.
Earnings of the company for the year 1926 had risen to $26,249,403.10, and the undivided profits at December 31st, 1926, aggregated $50,203,796.76. In 1927 the corporation declared a further stock dividend of 25%, which was paid in the form of New Class B common stock to holders of the common stock and New Class B common stock. The par value of this dividend amounted to $20,000,000. The preferred stock having been retired January 1st, 1926, this stock dividend increased the capital of the company to $100,000,000, divided into $10,000,000 par value of common stock and $90,000,000 par value of New Class B common stock.
Two things are to be observed at this point: First, of this $100,000,000 of capital the stockholders had paid into the corporation only $20,000,000 ($10,000,000 for the common stock, and $10,000,000 for the class B common stock, converted as aforesaid into New Class B common stock); second, that the net earnings of the corporation since 1921 had been in excess each year of the total amount paid into the corporation by the stockholders.
The last change in the capital structure of the defendant corporation occurred December 28th, 1928, when at a special meeting of stockholders the par value of the common stock and New Class B common stock was reduced from $25 to $10 per share and the new certificates of $10 par value stock were exchanged for the $25 par value certificates early in 1929.
The company's annual statement for the year 1929 shows that the net earnings of the company for that year were $32,210,521.27. At that time its capital consisted of $100,000,000, and its surplus was $51,579,859.29. Dividends aggregating $25,500,000 were paid to stockholders in the year 1929, which was 1 1/4 times the total capital the stockholders had contributed to the corporation. In fact, dividends aggregating $26,000,000 in 1927, and $26,000,000 in 1928 were paid on the common stock. *Page 324
BY-LAW XII HAVING BEEN ADOPTED BY THE STOCKHOLDERS AND BEING IN SUCCESSFUL OPERATION FOR NEARLY THIRTY YEARS IS VALID.
The charge originally made by complainants that by-law article XII was adopted by a misrepresentation to the stockholders of the ratio of earnings to common stock for the year 1910 was abandoned. Defendants proved that there was no such misrepresentation.
At the time of the adoption of the by-law in 1912 there was no legislative authority for it. Complainants charge that the by-law must be set aside because it authorizes payments to employees based upon no recognized function of employment but solely upon the number of shares of stock held, and they cite in support of their contention Scott v. P. Lorillard Co., 108 N.J. Eq. 153 ; 154 Atl. Rep. 515 ; affirmed, 109 N.J. Eq. 417 ; 157 Atl. Rep. 388 . Complainants also charge that the 1915 amendment to the by-law adopted by the directors but not submitted to a vote of the stockholders is invalid.
Treating the amendment first, I find it valid under the express language of article XIV of the by-laws of the defendant corporation, which provides:
"These by-laws may be altered, amended or repealed by the board of directors by a vote of a majority of all the directors and without the consent or vote of the stockholders."
Moreover, the amendment was for the benefit of the employees as a class and not merely for the benefit of the directors, and cost the other stockholders nothing.
As hereinabove indicated the by-law was adopted at a special meeting of the stockholders on August 23d 1912. At the stockholders meeting no dissenting voice was raised, and the measure was adopted by unanimous vote of the stockholders present after full notice of its provisions. There is a presumption that those who did not appear or vote against the measure assented to the vote of the majority. In re Newark Library, 64 N.J. Law 265 ; 45 Atl. Rep. 622 . The by-law has been in operation since its adoption. The company under *Page 325
it has enjoyed prosperity which is remarkable in its extent. The profit of the defendant company for the year 1912 was $2,899,956.66. For the year 1940 its net profit was $25,548,424.39 after the payment of federal and state taxes on income in the amount of $10,839,723.55.
The number of officers and employees participating in profits for the year 1912 was 27. The number of participants increased almost constantly year by year thereafter, until a high point of 2,177 participants was reached in the year 1928, the number participating in the year 1940 being 2,045. The company now has over 12,000 employees.
During the years 1912 to 1940, inclusive, cash dividends paid on the common and class B common stocks have amounted to over $500,000,000, and stock dividends have been distributed in the amount of $80,000,000.
W.N. Reynolds, formerly president, chairman of the board and chairman of the executive committee of the R.J. Reynolds Tobacco Company, now retired, and who helped his brother, R.J. Reynolds, draw this by-law, and S. Clay Williams, present chairman of the board of directors of the company, both testified that the remarkable growth of the business of the company, and its large profits, have been due to a great extent to the faithful services of the executives and the loyal efforts of the employees, which, they say, have unquestionably been stimulated by the interest which both executives and employees have had in the profits of the corporation.
Mr. Reynolds testified that when the by-law was adopted the Reynolds Company could not afford to pay the high salaries that its competitors were paying, and the bonus plan was devised as the best method of keeping their best men. He said that after employees became stockholders and had their money in the business a great difference in their actions and work was noticeable. He said they took more interest in their work; would not stand for people loafing as they did before; they prevented waste, and he added that in the plant "you could see it work."
Mr. Williams testified that because of the incentives and spurs of the by-law the Reynolds Tobacco Company has become the recognized leader in the tobacco industry; that its *Page 326
officers and employees all the way down the line have from time to time made suggestions which have reduced costs, eliminated waste, and promoted efficiency. He cited many instances where improvements in methods of buying tobacco, manufacturing, shipping and selling have resulted in large savings to the company, most of which have ultimately been adopted by the company's competitors.
In answer to the contentions of complainants, the defendants assert the right of a New Jersey corporation, independent of express statutory authority, to compensate its executives and employees by paying them a share of the corporate profits, thereby making their compensation contingent in whole or in part upon the success of the business. This right of the corporation they say is clear and has long been established. See Rogers v. Hill, 289 U.S. 582 ; Bennett v. Millville Improvement Co., 67 N.J. Law 320 ; 51 Atl. Rep. 706 ; Booth v. Beattie, 95 N.J. Eq. 776 : 123 Atl. Rep. 925 ; Costello v. Thomas Cusack Co., 96 N.J. Eq. 95 ; 124 Atl. Rep. 620 ; Heller v. Boylan, 29 N.Y. Supp.
2d 653.
See, also, Foster v. C.O. Howes Co., 119 N.E. Rep. 356 ; Sequin v. Plano, 160 Wn. 421 ; 295 Pac. Rep. 179 .
The statute, chapter 175 of the Laws of 1920 , as amended by chapter 192 of the Laws of 1932, P.L. p. 321 , which, in substance, is re-enacted in R.S. 14:9-1 to 14:9-5 , removes any doubt as to the validity of the by-law.
The statute as amended in 1932 provides as follows:
"1. Any stock corporation * * * may * * * carry out a plan * * * for any * * * of the following purposes * * *
"(b) The participation by all or any of its employees and those actively engaged in the conduct of its business in the profits of the corporate enterprise or any branch or division thereof. The participation may be based upon length or nature of service, amount of compensation paid or shares owned , or upon such other basis as may be selected for the purpose and may be in cash or by the delivery of shares of its capital stock held by it, or issued or purchased by it for the purpose. Any such share in the profits shall be regarded as part of the legitimate expenses of the corporation." (Italics mine.)
"4. * * * A resolution or by-law heretofore adopted or approved by a majority vote of the stockholders of a corporation entitled to vote thereon shall be valid from the time of such adoption or approval to the extent it contains terms which might be embodied in a plan or plans authorized by this act, as amended." *Page 327
The legislature has thus given approval to the by-law in question which plainly comes within the provisions of the 1932 amendment. The by-law, with its amendment, seems to have found no protestant among the company's stockholders until this suit was instituted in November, 1940, and it stood unassailed for a period of more than 28 years. The complainants having purchased their stock after this by-law had been in effect for many years cannot successfully attack it. Epstein v. Schenck, 35 N.Y. Supp. 2d 969; Pfister v. Gerwig ( S.Ct., Ind., 1890 ), 23 N.E. Rep. 1041.
The case of Scott v. P. Lorillard Co., supra , is distinguishable from this case. In the Lorillard Case the directors proposed an amendment to the by-laws of the corporation, which provided that the treasurer of the company should:
"* * * pay and distribute an amount of such net profits equal in the aggregate to five per cent. (5%) thereof to and among those officers and employees of the company who have both been in the employ and owned common stock of the company as hereinafter stated as an extra dividend upon and in the proportion among such officers and employees of such shares of common stock thus owned by them respectively."
Sixteen stockholders who severally owned 7,413 shares of the common stock of the company joined in a bill to restrain the company from submitting this proposed amendment to its stockholders. The case was decided in April, 1931, prior to the enactment of chapter 192 of the Session Laws of 1932, which specifically authorizes the adoption of a by-law providing for a distribution of profits to officers and employees of a corporation on the basis of shares owned by such officers and employees. The court determined that in the absence of such statutory authority there was no warrant for the payment of an extra dividend on stock owned by officers and employees which was not also payable pro rata to other owners of the same class of stock.
One difference therefore, between the Lorillard Case and the case at bar is that ever since the enactment of the 1932 act, a by-law of the kind under consideration in the instant case has been expressly authorized by statute, while, as above stated, at the time the Lorillard Case was decided no statutory *Page 328
authority existed for such a by-law. Moreover, in the Lorillard Case the court restrained the taking of a vote on a proposal to amend the by-laws, while in this case the attack is upon a by-law which was voted by the stockholders without objection and has been in operation continuously for nearly 30 years without any objection by any stockholder, during which time, as will hereafter appear, officers and employees of the Reynolds Company on the faith of the by-law have invested large sums of money in the common, participating stock of the defendant company, paying from 1 1/4 to 2 1/2 times what the B stocks sold for, thereby acquiring rights which cannot be ignored.
THE COMPLAINT THAT THE BONUS BASE SHOULD BE ON THE TOTAL OF THE COMMON PLUS TOTAL B STOCKS RATHER THAN THE COMMON STOCK ALONE.
Mr. Williams testified that when in 1917 additional capital was required, it could have been obtained on short term bank loans, long term debentures, by the sale of additional preferred stock or additional common stock. The directors, after he called to their attention the Bethlehem Steel Company's class B common stock, decided to raise the additional capital through the issuance of a class of stock having the general characteristics of common stock but having such additional qualifications and characteristics as not to change the application or results of the by-law which would follow an increase in the amount of stock on which participations should be payable, or by enlarging the capital base on which 22.19% would have to be earned before participations could be paid. This was five years after the stockholders had adopted by-law XII and its worth to the company and the stockholders had been proved. Undoubtedly many of the stockholders who had approved the by-law in 1912 voted on the 1917 amendment of the charter.
Subsequent events have shown that the management contemplated a wide distribution of the participating stock among the employees. The participation base would not have been widened by raising new capital through bank loans, *Page 329
debentures or preferred stock. There was submitted by management to the stockholders an amendment to the certificate of incorporation which expressly stated the differences between the common stock and the class B common stock. This amendment said:
"That stock known as Common Stock without further designation shall include and consist only of the Common Stock now issued and outstanding under the prior status of the Certificate of Incorporation of the Company.
"That stock to be known as Class B Common Stock shall consist only of the Ten Million Dollars ($10,000,000) of such stock authorized under this amendment. The Class B Common Stock shall have the same rights and privileges as the Common Stock of the corporation, except that it shall not have any voting power unless and until the corporation shall fail for ninety (90) days to pay the regular common stock dividend thereon, as due, in which event it shall have the same voting power as the Common Stock of the Company, as long as such default shall continue and no longer, and except further that it shall not be considered under the Company's plan providing for participation by officers and employees in certain profits of the Company."
The adoption by the stockholders of this amendment in 1917 was nothing less than a definition or description by the stockholders of this company of its several classes of stock. This amendment was adopted by a vote of over 91% of the common stock then issued and outstanding.
All of the certificates for the class B common stock; all of the warrants for exchange of the class B common stock into New Class B common stock in 1920; all the certificates of New Class B common stock; and all of the shares of common stock issued after the B stocks were authorized have had printed on the face thereof the statement that the Class B common stock and the New Class B common stock respectively "shall not be considered under the Company's plan providing for participation by officers and employees in certain profits of the Company."
The certificates of stock of the complainants and intervenors were marked as exhibits and this phrase appears on the face of their certificates.
This phrase has been carried forward into each of the amendments of the company's charter. The 1920 amendment *Page 330
referred to the common stock as "Ten Million Dollars ($10,000,000) of Common Stock (to be known as `Common Stock' without further designation)" and defined and described the New Class B common stock as in the 1917 amendment.
Counsel for the defendants in their brief state that the complainants have failed to show how the profits distributable under the by-law can be determined in accordance with their claim without considering either the Class B stock or the New Class B stock. This argument is unanswerable. The very essence of complainants' contention is that no distribution could be lawfully made under the by-law without considering the Class B and New Class B stock, whereas the amendments which created this stock both expressly provided that the stock should not be so considered.
Ever since 1918 the directors, many of whom are now dead, have construed common stock as used in the by-law to mean the class of common stock that was authorized by the charter in 1912, when the by-law was adopted. They have construed the class B common stock and the New Class B common stock to be a new class of stock. Such a class is permitted by section 18 of the Corporation Act, as amended in 1901, which reads as follows:
"Every corporation organized under this act shall have power to create two or more kinds of stock, of such classes, with such designations, preferences and voting powers or restrictions or qualifications thereof as shall be stated and expressed in the certificate of incorporation or in any certificate of amendment thereof, * * *."
This act was in effect when the amendment of 1917 was adopted.
I find that the action of the directors, and their construction of the by-laws and the charter of the defendant company was correct, and that they were justified in not considering the class B common stock and New Class B common stock when annually they considered the question of participations.
The answer to the criticism of the complainants that the board of directors did not give full and complete information to the stockholders regarding the amount of participations paid in each year and to whom such participations were paid *Page 331
seems to me to be that this was a function of management. Some corporations give their stockholders very full information about every phase of the business; other corporations do not. The stockholders have a right to call on the officers for any information they may wish. The failure to give such information as that referred to does not constitute either fraud or breach of trust.
THE W.N. REYNOLDS SPECIAL ACCOUNTS.
The accountants for the complainants who examined the books of the R.J. Reynolds Tobacco Company after issue on the original bill was joined, testified that they discovered between 1920 and 1933, inclusive, the defendant maintained a number of accounts bearing the name "W.N. Reynolds." W.N. Reynolds, as above stated, had gone into the business with his brother R.J. Reynolds long before it was incorporated, and in 1920 he was president of the company.
The accountants discovered some ten or fifteen of these special accounts, and because each bore the name of one of the defendant directors who had been the company president they scrutinized with care all the entries in all these accounts. They discovered that on or about January 18th, 1923, the company purchased 4,000 shares of its Class B common stock for $191,912.50 and another block of 1,000 of such shares for $49,000. These amounts were charged to the special account. The account showed that between January and April, 1923, these 5,000 shares of B stock were all sold on the Stock Exchange at a profit, the profit on the 4,000 shares being $48,557.87 and the profit on the 1,000 shares being $9,597.94, and that the company issued checks for these amounts to the defendant, W.N. Reynolds, a director, personally.
The accountants also discovered and testified to payments made to New York brokers for stock in the company that had been purchased in the name of an account entitled "James A. Gray Employees' Account," and to other brokers in payment for common stock bought in a personal account of S. Clay Williams when he was president. *Page 332
It is unnecessary here to detail all of the very numerous transactions that were covered by the testimony of complainants' accountants on the one hand and that were explained in great detail, item by item, by Mr. Reynolds, Mr. Williams and Mr. Gray. Suffice it to say by way of preface that although many of these transactions went back as long as 20 years, and although many of the corporation's records supporting the books were destroyed years before this suit was brought under a standing company instruction to destroy records after a certain number of years, the defendants produced before me evidence so clear and convincing of the bona fides of every transaction that I hold that there was no fraud or breach of trust whatsoever.
A very large part of the time devoted to the trial and to the briefs concerned these special accounts because they were in the name of the company's president and a director. The facts that were developed are not in dispute. The complainants seek by the inferences they draw from undisputed facts and by serious charges of fraud, bad faith, self-dealing and by misleading terms to fasten liability upon the directors, which I find to be not justified in any respect. On all the evidence I find not a single instance of fraud or breach of trust on the part of any director.
When by-law XII was adopted, 27 officers and employees owned 19,140 shares of the company's common stock. Over 66,000 shares having been in the hands of American Tobacco stockholders, principally its officers and directors who controlled the tobacco trust, by 1920 the number of officer and employee participants was only 161, and they held 100,196 shares of the $25 par stock.
It is alleged that R.J. Reynolds in his lifetime personally helped a number of employees to buy stock and financed their purchases. In the period between 1912 and 1920 the company itself purchased some shares of its common stock and allotted these shares to employees, who paid for them part cash and the balance by a note secured by the stock. All of such notes bore interest at the market rate. In fact, on October 5th, 1912, six weeks after the by-law was adopted, the board of directors passed a resolution authorizing the treasurer to make *Page 333
loans to employees but not exceeding the book value of the stock given a security. This was perhaps the origin of the attempt to get the company's voting stock away from the stockholders of the American Tobacco Company.
It appears that after the death of R.J. Reynolds there was no one in the company who had the financial ability personally to finance the purchase of the company's common stock for employees. When the large stockholders who had received their stock through the American Tobacco Company were approached and asked to sell their stock, they declined to do so because they wanted to retain their investment in the company and did not want to pay income taxes on the difference between the cost of the stock to them and its then market value, which was very high. A change in the income tax law permitted a tax free exchange of one class of stock for another class of stock in the same corporation. This statute afforded an opportunity for the company or an employee to purchase the Class B common stock and later the New Class B common stock and exchange it for the common stock which participated under the by-law.
Since very large blocks of the Reynolds common stock were held by a number of different persons, many of whom had been directors of the tobacco trust, the directors decided that the only way the purposes of the by-law could completely be served and the common stock secured from the American Tobacco Company group for distribution to a large number of employees, was for the company itself to acquire the common stock and distribute it to employees. The company, accordingly, in 1920, commenced the purchase of common stock for sale to employees and the purchase of New Class B common stock to be used for exchange for common stock, which common stock would then be sold to employees.
In the first few years its practice was to make distributions to the employees as soon as possible after the stock was acquired. Because there was a delay between the time the money was laid out for the common stock purchased or the B stock purchased for exchange and the date when the common stock was sold to employees, the company made a practice of charging interest at bank rates on all moneys laid out to *Page 334
acquire such stock. Employees were required to pay part of the purchase price in cash but were permitted to give the company their notes, secured by the stock but not in excess of its book value.
This interest was paid to the company as part of the cost of the employee's stock. The defendants say that interest was charged to these special accounts in order that no employee would have the use of the company's money for his benefit without paying for it, and in order that the stock might be resold at a price which would include every item of expense to the company, less dividends, the price being fixed as though the employee had bought the stock at the time the company bought it but had not paid for it until it was allocated to him; that when the stock was sold the interest was collected, and was a receipt of the company. Being considered an item of earning, such interest was included in the company's profits in every year. The total of employees' notes was carried on the company's books and its annual statements in "Other Accounts Receivable." In the first few years after 1920, such amounts were true receivables because the company held the employees' notes secured by the stock not wholly paid for.
Complainants charge that this interest was improperly credited to the earnings account because the employee was given credit for any intervening dividends, but I feel that the officers were justified in treating the interest as earnings on the company's money invested, and having been collected from the employees the stockholders were entitled to have it treated as income, particularly since the whole idea of the management was to distribute the stock to the employees just as though they had acquired it the moment the company acquired it.
Complainants' accountants discovered in their analysis of the W.N. Reynolds Special Accounts on defendant's books, several transfers of blocks of B shares from one special account to another. Every one of these transfers was explained to my complete satisfaction.
One transfer was of 2,526 shares of B stock from the company's investment account to a W.N. Reynolds Special Account on August 20th, 1924. It was recorded as sold at *Page 335
approximately $68.50 per share, and complainants say the market price that day was $77 per share, as a result of which they claim the selling price was approximately $24,000 less than the market price.
Mr. Gray, who handled the transaction, explained that early in June, 1924, the company decided to sell some of its investment stock. At the same time the company was engaged in acquiring B stock to exchange for common stock for resale to employees. To avoid paying a broker's commission for selling the investment stock and then paying another brokerage commission to buy a like number of shares, the stock was simply transferred from the investment account to the special account at the market at the time the matter was arranged. The B stock placed in the special account was exchanged for common stock. Mr. Gray testified that the market at the time the transaction was arranged was the price at which the stock was entered in the account.
All the facts and circumstances support Mr. Gray's explanation of this transaction. The common stock that was received for these 2,526 B shares was transferred between November 5th and November 29th, 1924, to 248 employees.
Complainants criticize a purchase of 700 B shares on May 3d 1928, at $91,000; the recording of that purchase in an investment account and the subsequent transfer of those shares two weeks later to Account No. 2 at $92,487.50, an increase of $1,487.50.
Mr. Gray explained that the 700 B shares were purchased originally as an investment in the company's own stock. They were transferred to the No. 2 Account to exchange for common stock at the then market, which, in the meantime, had advanced about $2 per share. He explained that the transfer was made to avoid selling the 700 B shares on the market from the investment account and buying the same number of shares for the employees' stock purchase account and paying brokerage commissions both ways. The common stock received for these 700 B shares in exchange was practically all disposed of before the end of 1928 to employees.
While, as above stated, the W.N. Reynolds special accounts were primarily used for the purposes above mentioned, the *Page 336
defendants say they were also used for other proper corporate purposes.
The accounts were kept under the direction of Mr. James A. Gray. Mr. Gray, prior to coming with the company on January 1st, 1920, had been a banker. He had been president of the North Carolina Bankers Association, and had been a state senator. He used the special accounts not only for the purposes above mentioned, but in some instances he segregated in a special account a particular block of stock bought for investment, or a particular block of stock for trade, and even used a W.N. Reynolds Special Account to record the purchase of a site for the company's office building in Winston-Salem. The money for this purchase was paid over to real estate brokers and the amount set up in a W.N. Reynolds special account. After the site was acquired in the name of the company, the special account was closed.
Another like transaction occurred in 1927, when the company desired to purchase a tobacco foil manufacturing company located at that time in Richmond, Virginia. The tobacco company made a contract with the three individuals who owned the stock of the foil company to purchase the stock, and to erect for the company a foil plant in Winston-Salem, and operate it for the company. The purchase price was paid in installments, at intervals, pending the completion and operation of the plant. As the payments were made, they were charged to one of the Reynolds special accounts, and carried in the financial statement as "Other Accounts Receivable." This transaction did not represent a true receivable, but represented the amount paid by the company for the stock of the tobacco foil company. These operations, it is alleged, caused no loss to the company, and it seems were a convenient method of keeping account of the money in use until the transaction was completed and then transferred to its proper permanent account.
The checks to W.N. Reynolds referred to at the beginning of this heading relating to the special accounts were fully and convincingly explained by Mr. W.N. Reynolds, Mr. Williams and Mr. Gray. The transaction occurred in 1923 when the company was offering two shares of New Class B common *Page 337
stock for one share of common stock. Craig, Kent and Fleshman, who together owned 5,600 shares of the common stock, refused to trade on the two-for-one basis. Mr. Williams testified that Mr. Reynolds, "who is quite a horse trader," called on Craig, Kent and Fleshman to try to induce them to go along with the management and trade their stock, and in the course of his negotiations he said that if they would trade their stock on the two-for-one basis he would buy them 5,000 shares of B stock and hold it for as long as a year, giving them the privilege of ordering it sold at any time; would only charge them interest on the cost of the stock, would give them any profit if the shares were sold and he personally would stand the loss if the stock went down. Reynolds' proposition was accepted.
The 5,600 shares of their common stock were distributed with 8,552 other shares to 612 employees, none of whom was a director. When the stock went up Craig, Kent and Fleshman asked Mr. Reynolds to sell it. The company sold the stock and gave Mr. Reynolds its checks for the profit less interest on the company's money that had been invested in the meantime in the B stock. Mr. Reynolds deposited the company's checks in his personal account. He thereupon immediately drew and delivered his own checks to Kent, Craig and Fleshman for their respective shares of the profit, not letting them know that the company had bought the stock. Mr. Reynolds, however, had guaranteed the company personally against any loss. The testimony of the defendants was supported by the documents and bank records.
Since no director gained by this transaction and the company sustained no loss, but on the contrary received interest on the money for the short time it was outstanding, there is no liability on the part of the defendants in this connection. Furthermore, it is another of the transactions that occurred long before any of the complainants became a stockholder.
As to the charge that payments were made to New York brokers for stock purchased in the accounts of Mr. Gray and Mr. Williams as above mentioned, the evidence discloses that every purchase of company stock through these accounts was carefully segregated by these gentlemen from any business of *Page 338
their own, payment for the particular stock was made to the broker and the stock purchased was delivered immediately to the company and put in the name of the company's nominee.
Complainants criticize the purchase by the company of 45,000 shares of New Class B common stock early in 1929 to trade for Mr. Lasater's 36,000 shares of common stock.
Mr. Williams testified that Mr. Lasater had been with the company 54 years and was in charge of the manufacturing department of the company. Early in 1929 Lasater was very ill. Following his recovery he stated to Bowman Gray, president of the company, that he had in mind to retire at the end of 1929, and wanted the company to place his shares of common stock with the employees. An exchange was arranged with him on the basis of 1 1/4 shares of B stock for his common stock. The company bought 45,000 shares of B stock in the market to exchange for Mr. Lasater's 36,000 shares of common stock and charged the cost to Reynolds Special Account No. 2.
In the fall of 1929 Mr. Lasater's principal assistant died and he then announced his decision to remain with the company. The 45,000 shares of B stock which had been purchased by the company for the Lasater exchange were then transferred from the No. 2 account to an investment account known as Reynolds Special No. 2B. These 45,000 shares so transferred to the investment account were part of the shares which were sold in the years 1930 to 1933, inclusive, which produced a profit for the stockholders in excess of $5,000,000, as hereafter mentioned.
The defendant Gray in explaining the reason for the company purchasing on the market 45,000 shares of New Class B common stock specifically to make the exchange with Lasater when it had more than that number of shares in the investment account (that were part of a block of stock purchased years before from the United Retail Cigar Stores purchase), testified that the shares of United stock stood on the books of the company at about $8 per share, and that to have used 45,000 shares of this low cost stock for the exchange with Lasater would have made the common stock acquired by the company from him stand on its books at about $10 per share; *Page 339
and "it would have been manifestly unfair to the stockholders of the company for us to have sold the United stock to the employees where only $8 a share was being realized from the B stock; whereas, we could have sold it, and did sell it, at the market and otherwise in later years and realized a handsome profit for the general stockholders on that United stock."
I think the defendants' explanation of the purchase of the 45,000 shares of the New Class B common stock to trade for the Lasater stock, bears the impress of truth, and I do not find, in the circumstance, room for censure.
Answering complainants' counsel's reference to the transfer on December 31st, 1929, of 10,400 shares of New Class B common stock from W.N. Reynolds Special Account No. 7E, which was then used as an investment account, to W.N. Reynolds Special Account No. 2, the defendants say it was made at cost. During the following year 1,400 shares out of the 10,400 shares of B stock were used for exchange purposes, and during this same year the balance of 9,000 shares were retransferred to the investment account at the same price per share at which they had been transferred from the investment account the year before to the special account. These transfers were of company owned stock from one account to another. The common stock which was received in exchange for the 1,400 shares of B stock was not sold by the company but ultimately went into the Insurance and Retirement Fund. The company neither gained nor lost anything by either of these transfers.
The defendants take the position that it was proper to use the special accounts to keep stock for employees separate from stock bought for investment, and that the number of employee stockholders was greatly increased by the company's purchases and resale of common stock.
I believe the officers and directors defendants, in the opening and operation of the special accounts, acted in entire good faith; and I believe their conduct in the circumstances was free of any improper and wrongful intent.
By 1933 the special accounts apparently had served their purpose and they were all closed out without loss to the company, but to its great advantage. *Page 340
Control of the company had been removed from the stockholders of its principal competitor; the officers and employees of the corporation owned 651,703 shares of its voting stock, and from the participation fund of approximately 10% of the annual profits they were paying for 200,000 shares of common stock in the Insurance and Retirement Investment Fund which is relieving the other stockholders of contributing anything for employee retirement, health and insurance benefits, as will hereafter appear.
THE ALLEGED PAYMENT OF PARTICIPATIONS TO PERSONS NOT ENTITLED THERETO UNDER THE BY-LAW.
Complainants also charge that participation payments were made under the by-law XII to persons not entitled thereto. The by-law as originally adopted provided that officers and employees of the company participate in the company's annual profits only if they "owned its common stock and had been in its employ for not less than twelve months, then next preceding." The by-law as amended in the year 1915 provided that the ownership prerequisite would be satisfied if the stock was purchased during the year from an officer or employee, or from the personal representative of a deceased officer or employee, provided the former owner would have been entitled to participate had he held the stock for the entire twelve months' period.
They charge that after the adoption of the by-law the directors and officers improperly adopted a practice of having the company allocate and sell its common shares to officers and employees and allowing the purchasers to participate thereon under by-law XII at the end of the year during which they purchased the shares, even though such stock was not acquired from an employee.
The defendants insist that the corporation was not injured by the decision of the officers that employees allotted stock after the year end, acquired by the company for them before January 1st, might participate for the year. They say that *Page 341
this plan helped to secure a wide distribution of the common stock of the company among its employees and it speeded up placing them under the incentive of the by-law and spurred their interest in the company. Mr. James A. Gray, president of the company, testified:
"When we first started in 1920 (to accumulate stock) my recollection is that we made distributions during the year. That is to say, if we acquired some stock in July, 1920, we would try to allocate that and complete the sale of it by, say, September or October. That was true in a number of other instances throughout the years, that if we acquired a block early enough in the year a good-sized block, we would distribute it promptly.
"On the other hand, a great deal of the purchasing throughout the years was done late in the year. It was the natural thing for a stockholder considering selling his stock to delay the sale as long as he could, hoping the market was going up, and we found that a great many of those people would not give us their decisions. Many of this old American Tobacco Company group and other old stockholders would not give us their decisions until late in the year; and therefore when we purchased such a large part of the stock right up to the last minute on December 31st, we found it was impractical to make an intelligent allocation day by day at the end of the year as we were securing it for two reasons. First, as explained yesterday afternoon, we did not know the total number of shares that we would have to allocate, intelligently allocate, against the orders in hand; second, the price that we were paying for each lot, even if it was a half a dollar a share difference for a hundred shares or 500 shares as contrasted to a purchase the day before of a larger amount at a lower price — each fraction on each individual purchase changed the average for the entire block, and in order to let all employees purchase at the same price it was necessary to wait until the entire accumulations would come in at the end of the year and then get an average on the entire amount and allocate it promptly after January 1st."
This allocation, Mr. Gray said, at cost plus interest and less dividends, gave the employees the stock at the price "just *Page 342
as if he had owned it from the day the company first bought it."
The defendants state that the distribution of the stock to the employees who had ordered it was delayed for the convenience of the company in order that it might make a fair allocation of the stock at the same price to each employee; and it construed the by-law as permitting the employees who, because of the necessary delay on the part of the company in distributing this stock, had not actually received it until shortly after the commencement of the year, to participate for that year as equitable owners of the stock. This plan appears to have been followed throughout the years as to all employees.
Likewise, the company consistently carried into its "Other Accounts Receivable" account not only the amount owing on employee notes but also the total amount invested in the special account which carried the common stock not yet distributed to employees, and paid for. The reason given for this was that until 1928 or 1929 the stock had been paid for by the time the annual statement was mailed to stockholders and it was then a true receivable. In the meantime, it was a potential receivable. No stockholder was harmed by this treatment and it was approved by Ernst Ernst, the company's disinterested accountants.
The complainants contend improper payments of participations were made to officers and employees who were not record owners for the full twelve months, and condemn the alleged practice of the company in considering an employee an owner of common stock within the meaning of the by-law from the date when he made a firm contract for its purchase.
The defendants argue that an employee who had entered into a binding contract to buy stock had the same incentive as though he had become the record owner; that if he had the beneficial ownership in stock he had the same incentive as though he had legal title thereto, and a much greater incentive than if he had the legal title with no beneficial interest. They contend that for many purposes, a person who has a binding contract to purchase stock is regarded as the owner of such stock. I fully agree with the defendants' contention — a person having an equitable interest under our *Page 343
legal system is entitled to such benefits as that interest demands. The decisions of our courts are to that effect and the following cases sustain it.
In Masholie v. River Edge Estates, Inc., 129 N.J. Eq. 228 ; 19 Atl. Rep. 2d 27 , this court said:
"It is my opinion that the judgment, or decree, obtained by the complainant ( Exhibit C-2 ), directing the specific performance of the agreement concerning the ownership of the stock between the complainant and Daniel J. Salvatore, places the equitable title of the stock in the complainant from June, 1935, when the contract was made, notwithstanding the fact that the judgment, or decree, awarding the title to the stock to this complainant was entered approximately five years later."
In O'Connor v. International Silver Co., 68 N.J. Eq. 67 ; 59 Atl. Rep. 321 ; affirmed, 68 N.J. Eq. 680 ; 62 Atl. Rep. 408 ,
Vice-Chancellor Pitney, in sustaining the right of the complainant to sue as a stockholder, notwithstanding the fact that he was not a stockholder of record, said in part:
"The status of the holder by legal assignment of a certificate of stock which has not been transferred on the books of the company is in some respects better than that of a real estate owner whose deed is unrecorded, because, in the absence of actual notice, the grantor of such a deed may make a good title to a purchaser in good faith for value."
And also,
"I am unable to perceive why a clear title to the shares of stock, with the immediate right to have the stock transferred on the books of the company, does not give the owner a right to the ear of this court to protect his interest in the corporation and its management."
In Cook v. Sterling Electric Co., 118 Fed. Rep. 45 , the court said:
"It is claimed that, whatever may be the equitable rights of the defendants under the agreement, the legal title is in the complainant, and that the oral agreement cannot be set up as a defense, and that the defendants should file a bill setting up their equitable rights, and compel a transfer of the legal title. It suffices to say that this contention overlooks *Page 344
the fact that this is a suit in a court of equity, where, in matters within its jurisdiction, an equitable title is as good as a legal title as to all parties affected by such equity. It cannot be maintained in a court of equity that a party holding the equitable title will be denied his equitable rights by the holder of the naked legal title. In such a case the holder of the legal title stands, in a court of equity, as a mere trustee for the use and benefit of the owner of the equitable title or estate. It certainly would be against conscience to permit a complainant, while holding the consideration for the oral agreement of sale, to pursue the defendants as wrongdoers." (Italics mine.)
In Cushing v. Blake, 30 N.J. Eq. 689 , Mr. Justice Depue, speaking for the Court of Errors and Appeals, said: "The doctrine of courts of equity is that equitable estates are considered, to all intents and purposes, as legal estates."
Complainants further charge that only officers and directors were given the advantage of participating on stock equitably owned before the year end but transferred to them of record after the first of the year. Mr. Gray completely answered this contention as follows:
"In all instances, employees were regarded as holders of common stock from the date that such employees made a contract to purchase the stock, without regard to the date when the stock was actually transferred into the names of such employees on the transfer records of the company. Also, where the company, pursuant to its general practice, purchased stock during any year for distribution to employees and distributed the stock to such employees shortly after the beginning of the following year, such employees were regarded as owning the stock from the beginning of such year.
"Q. Now, can you give instances of the application of that interpretation of the by-law as applied to employees of the company? A. I produce a list showing for the period from June 4th, 1920, to April 23d 1925, every distribution of stock of any consequence with the exception of the Duke distribution, which has already been put in the record, of stock to employees under the program that I have just outlined; and I call attention to the fact that the first several *Page 345
distributions listed on the front page of this proposed exhibit are distinctly described as non-participating for that year, meaning that the stock was bought, in this first transaction, prior to June 14th, 1920, from four brokerage concerns. Therefore that stock was not entitled to participation for that year, because it had not been held during the entire year by an employee. Therefore the first distribution of 1,299 shares are described as non-participating for 1920. The same description applies to the next three lots. The next distribution on the front sheet, transferred on October 14th, 1920 — * * * Was to four employees of the company of a total of 1,508 shares, which shares were allowed to participate for the year 1920 because they were transferred from the name of Joseph M. Babcock, a nominee of the company, and had been owned prior to January 1st, 1920. I do not think it necessary to go any further in describing this proposed exhibit as each page describes on its face the lots that were participating for respective years and the lots that were non-participating for the respective years."
It appears that transfers of 28,464 shares of stock acquired from the Duke interests were made to 1,214 employees, all of whom participated on the stock for the year 1926, although the stock was not in their names of record at the beginning of the year. Among those employees there were three directors to whom 2,289 shares were transferred. They having an interest considered to be equitable, as above expressed, were entitled to the benefits accruing as hereinabove observed.
Complainants assert that S. Clay Williams, now chairman of the defendant's board of directors, was improperly permitted to participate for the year 1926 on 13,000 shares of common stock that were acquired for the company by Mr. W.N. Reynolds from Thomas Fortune Ryan, one of the former directors of the American Tobacco trust. The facts of this transaction appear to be as follows:
A number of unsuccessful attempts had been made to acquire Mr. Ryan's stock. In 1925 the company had acquired a large block of stock from the Estate of J.B. Duke and others associated with Mr. Duke in the American Tobacco trust. The allocation of that stock was made by W.N. Reynolds, *Page 346
chairman of the board, Bowman Gray, then president, and James A. Gray, vice-president in charge of the company's finances. None of this stock had been allotted to Mr. Williams, who was rising in importance in the company.
In December Mr. Reynolds telegraphed Mr. Ryan at his home in Virginia asking if he would grant Mr. Williams an interview, and he sent Mr. Williams to see Mr. Ryan and try to negotiate a trade of B stock for common stock. After an all-day conference, Mr. Williams negotiated an agreement in which Mr. Ryan agreed to exchange his 14,900 shares of Reynolds common stock for 19,021 shares of New Class B stock, upon Mr. Reynold's personal guaranty against Ryan having to pay any income tax on the exchange. Upon his return to Winston-Salem and reporting the trade, Mr. Williams was advised by his superiors that he could have all or any part of the Ryan stock. He elected to take 13,000 shares and the remainder were taken by five other employees, no one of whom was a director. Williams owned sufficient B stock to exchange for his 13,000 shares of the Ryan stock, but part of it was in his safe deposit box, part was pledged to banks and the remainder to brokers, not all paid for. On December 30th or 31st, Williams advised the company's agent in charge of the participation records that he had acquired 13,000 of the Ryan stock.
I find that the transaction with Mr. Ryan was fully arranged before December 31st, as evidenced by letters and telegrams which are in evidence. The exchange of certificates with Mr. Ryan was made in New York on February 10th, 1926, to suit Ryan's convenience, who insisted that the New Class B certificates be registered in his name before he would deliver over his certificates for the common stock. As a matter of convenience Mr. Williams and the others to whom were allotted the Ryan stock, delivered their certificates for B stock to Mr. James A. Gray, excepting such certificates as Williams had pledged to banks and brokers. Williams arranged that the banks and brokers would deliver the B certificates which they held in exchange for common certificates, and the proper authorizations and agreements were delivered to Mr. Gray to put the transaction through. *Page 347
Mr. Gray, to facilitate putting the exchange through with Mr. Ryan, after being fully secured as above mentioned by the B shares, agreements and documents from Williams and the others who were to get the Ryan shares, ordered the company's transfer agent to transfer into the name of Thomas F. Ryan 19,021 B shares owned by the company and registered in the name of its nominee. These were delivered to Mr. Ryan against the receipt from him of the 14,900 shares of common stock. These 14,900 shares of common stock were distributed to Williams and the other employees and to Williams' bankers and brokers, and the B shares that stood in the nominee's name were replaced by the B shares that came from Williams and the other employees.
Complainants charge that this was an improper transaction in that Williams had use of company funds and property and that the company ran the risk of a large loss should Williams die or should a creditor have attached his interest in the Ryan stock.
The evidence indicates that the transaction involved no use of the funds of the company and no speculation by Williams: nothing belonging to the company appears to have been placed under the control of Williams; and no obligation was incurred by the company except the obligation to deal faithfully with securities belonging to Williams which at all times were under the control of the company until the entire transaction had been completed.
Complainants further charge Williams was improperly allowed to participate on these 13,000 shares of Ryan stock for the year 1926. He was allowed to participate on it just as every other employee was permitted to participate on stock equitably acquired in 1925. Moreover, the decision to allow him to participate in the fund was made by the other directors, whose share in the participation fund was reduced materially by allowing the 13,000 Williams' shares to participate. It would have been to their selfish interest to deny Williams the right to participate in 1926 on these shares. Their decision cost the non-participating stockholders nothing whatsoever. I can find nothing improper in the actions of Mr. Williams or any other director in this connection. Incidentally, *Page 348
the complainants do not charge that the company improperly paid participation to the half dozen other employees who acquired 1,000 shares of the Ryan stock.
Complainants also charge that Mr. Williams improperly was allowed to participate on 500 shares for the year 1924 that were transferred to his name of record January 5th, 1924. Mr. Williams proved to my entire satisfaction that he became the equitable owner of this stock in 1923, having arranged to buy it from the R.J. Reynolds Memorial Auditorium Commission. He built up his bank balance December 31st, 1923, to pay for the stock pursuant to his agreement to purchase, and on January 1st, 1924, issued his check for the price. He did not know until the Commission made delivery that the certificate was registered in the name of Kathryn S. Johnston and had been endorsed by her over to the Commission.
I find that Mr. Williams acquired the equitable title to this stock in December, 1923, and it was not improper for the directors to permit him to participate on such stock for the year 1924. Moreover, these are some of the transactions occurring long before the complainants became stockholders of the defendant corporation and of which they have no right to complain.
The complainants contend that the payments to Gordon Gray under the by-law were improper. They contend he was not an employee of the company and notwithstanding, was permitted to participate under the by-law for the years 1936 to 1941 inclusive by reason of his inheritance of 2.005 shares of Class A stock.
The defendants challenge the correctness of the complainants' assertion that Gordon Gray inherited a single share of common stock from his father, Bowman Gray, former president of the company. Gordon Gray is a lawyer, and was a member of the law firm of Manly, Hendren Wemble, which firm for many years has been local counsel for the defendant corporation, and participated as a partner in the retainer paid by the company. Because of the character of the work he did for the R.J. Reynolds Tobacco Company, and because he was a stockholder, Mr. Williams, chairman of the board, *Page 349
suggested to the board of directors that he be added to the list of those entitled to participation under the by-law.
As early as 1917 the company decided with respect to its attorneys "who were under continuous employment by the company — that is, on fixed annual retainer, or monthly retainer — and we ruled that under the by-law an attorney for the company attached to it in its employ by the year was entitled to participate." Mr. Williams testified that: "there were certain lines of work that Mr. Gray performed for the company. There were certain other lines of work that another member of the firm [Manly, Hendren
Wemble] performed for the company."
It appears that Gordon Gray left the above law firm and became a publisher; Mr. Williams said, "We made an arrangement with him under which he was paid a retainer to keep an eye out for certain public relations questions of R.J. Reynolds Tobacco Company" on which he worked with Mr. Williams from time to time.
The defendants contend that it was a matter of business administration for the directors to decide whether or not these gentlemen, including Gordon Gray, were employees of the company within the meaning of the by-law. They knew better than anyone else whether it was to the advantage of the company and its stockholders to consider these attorneys as employees of the company and allow them to participate on their common stock and thus tie them in more closely than otherwise might have been possible with the interest of the company and its welfare. The testimony indicates that Gordon Gray was a company employee within the meaning of the by-law.
See Turner v. American Metal Co., 50 N.Y. Supp. 2d 800 , which said of the power of the board of directors:
"They were the exclusive executive representatives of the corporation and were charged with the administration of its internal affairs and the management and use of its assets. Their corporate acts were within the power of the corporation and the lawful and legitimate furtherance of its purposes in good faith and the exercise of an honest judgment are valid and conclude the corporation and the stockholders. Questions *Page 350
of policy, of management, expediency, of contract or actions, adequacy of consideration, lawful appropriation of corporate funds to advance corporate interests, are left solely to their unselfish and honest decision."
It appears to me that there is no liability attaching to the aforesaid transaction. The officers and directors appear to have acted in good faith, for the benefit of the stockholders and the company. I believe they exercised an honest judgment and betrayed no trust.
THE COMPANY'S INVESTMENT IN ITS OWN SHARES.
From time to time the company made investments of its surplus funds in its own New Class B common stock. The defendants contend that such investments were all made for proper corporate purposes, and resulted not only in large profits when such stock was sold but also the receipt meanwhile of a larger return on the money invested than could have been secured in any other proper investment.
The board of directors of the defendant company treated the profits realized on the sale of investment stock as well as the dividends thereon as part of the "Annual Profits" of the company within the meaning of the by-law. The complainants contend that when the corporation bought its own stock it ceased to be outstanding; that it was dead; that profits realized on the sale of such shares was not an item of earnings, and that the payment of dividends by the company to itself was merely putting money from one pocket into another. Hence they say it was improper for defendants to include the profits and dividends in the annual profits of the company, and that the directors must account for all of the participations paid on such profits and dividends.
Complainants also contend that purchases by the company of large blocks of its New Class B common stock between 1929 and 1932 were made to protect the investment of directors in the shares of the company and were not made for proper corporate purposes. *Page 351
The defendants, on the other hand, have proved to my entire satisfaction that in each instance the directors caused the company to purchase these shares for what they believed to be a proper corporate purpose. The net result of these purchases were profits in excess of $8,000,000.
The defendants further assert that by July, 1933, the company had sold the last of its own shares held in its investment account; that for several years it advised the stockholders in its annual reports of the purchase and sale of its shares, the profit it was making and that the profit and dividends were being added to the company's earnings, and that no stockholder complained until the Bookman bill of complaint was filed in November, 1940.
The first purchase made by the company of its own shares was the United Cigar Stores purchase. The United Retail Stores Corporation had acquired 86,800 shares of the company's New Class B common stock. This company, being in the retail tobacco business and holding this block of stock, let the rumor spread that it could sell tobacco products at cost because of the dividends it was receiving on a big block of Reynolds stock. When this rumor reached the company in Winston-Salem through its sales force, Mr. W.N. Reynolds, president of the company, went to New York to see Mr. Whelan to try to induce him to stop the circulation of these rumors.
When he entered Mr. Whelan's office by appointment, Mr. Whelan, before Reynolds could mention the rumors, asked Mr. Reynolds if he would buy the stock. Mr. Reynolds asked for and received an option to buy the entire block of stock at about $33.74 per share.
Mr. Reynolds took this option to C.D. Barney Company, brokers in New York, and asked them to take it off his hands without profit and distribute the stock. At that time the stock was not listed on any exchange and was traded in over the counter. A junior partner, John W. Hanes, was in favor of taking over the option, but Mr. Harding, head of the firm, declined to take the whole or any part of it.
Mr. Reynolds then went to Bernhard, Scholle Company, another brokerage house, and offered the option to them without *Page 352
profit to himself. That company said they would take 10,000 of the shares provided Mr. Reynolds, Messrs. Bowman Gray, James Gray and Williams would take a substantial block.
Mr. Reynolds then telephoned to Mrs. R.J. Reynolds thinking she might take a large block, but she only would agree to take 5,000 shares. On his way back to Winston-Salem Mr. Reynolds says he got the idea that since the stock was being bought to protect the business of the company, it might be proper for the company to take so much of the stock as he could not sell to individuals. He was able to dispose of all but 64,000 shares of this block of stock, Bernhard, Scholle Company taking 10,000, Mrs. Johnston (formerly Mrs. Reynolds) taking 5,000 shares, S. Clay Williams taking 2,050 shares, and the company placing the remainder with other officers.
On December 1st, 1921, the directors unanimously adopted the following resolution:
"Resolved, That it is for the best interests of R.J. Reynolds Tobacco Company to purchase the 64,000 shares of its New Class B common stock now owned by the United Cigar Stores Company and offered at $33.7332257 per share, interest on purchase price at 6 per cent to be paid from last dividend date to conclusion of purchase, same amounting to $0.3605283 per share.
"Resolved, further, that the Treasurer be and he is hereby authorized and instructed to make purchase of this 64,000 shares of this Company's New Class B Common Stock on the basis above stated, and upon delivery of certificates representing the stock to make payment of both the purchase price and the interest from the funds of the Company, and pending further instruction from the President or Board of Directors, to carry said stock in the name of such person as shall be denominated by the President for that purpose."
Mr. Williams, who at the time was in the law department and not a director, had advised the directors after examining the authorities that it was proper for the company to make this purchase of stock.
The company instructed one of its New York banks to pay United Cigar Stores for the entire block of stock, and upon its receipt to deliver 5,000 shares to Mrs. Johnston against her check, 10,000 shares to Bernhard, Scholle Company *Page 353
against its check. Mr. Williams paid for his stock partly in cash and partly with a note to the company secured by the stock, which note was promptly paid with interest.
This purchase proved over the years to have been extremely profitable. Complainants now charge that Mr. Williams was wrongfully allowed to purchase the above mentioned 2,050 shares and that he should account for the profit realized thereon, and that in fact the entire block was purchased by the company.
It seems to me that this explanation of the transaction given by Mr. Gray is conclusive:
"Mr. Reynolds had made every effort he knew how to make to sell stock and he hadn't succeeded in selling more than the difference between 64,000 shares and the total block, which as I recall was 86,800 shares. In other words, the company was buying what he had not succeeded in personally selling.
" Q. That is, that takes into account the 2,162 shares which were purchased for exchange for common? A. I was considering that as well because it was being exchanged for common and the common itself was resold to employees for cash or bills receivable.
" Q. Now, Mr. Gray, what was the primary purpose of the company in buying this 64,000 shares of United stock? A. To get it away from United Retail Stores Corporation."
The defendants say that the fact that the company originally paid to United Cigar Stores Corporation the consideration for the whole block was merely for convenience in closing the transaction. The stock, other than that sold to Bernhard, Scholle Company and Mrs. Johnston, was delivered to the company and did not come into the possession of the employees until it had been paid for, except that a part of the purchase price of Williams' stock was paid by his note, which was secured by collateral, in accordance with a resolution of the board of directors. This note subsequently was paid in full. These transactions seem to have been conducted in a proper and business-like manner.
Complainants charge the defendants with liability for the sale of 20,000 shares of the above mentioned United stock pursuant to the following option: *Page 354
"Winston-Salem, N.C. January 9, 1922.
Mr. John W. Hanes, C.D. Barney Co., 15 Broad Street, New York City.
Dear Sir: —
This letter will serve as a confirmation of recent conversation to effect that we hereby give you and your associates an option on twenty thousand (20,000) shares of R.J. Reynolds Tobacco Co., New Class `B' Common Stock, at a price per share of $33.75, plus accrued dividend at the rate of dividend last declared prior to the exercise of such part of the above mentioned option as at that time is availed of, said option to be in effect on and after the listing of said shares on the New York Stock Exchange, and to expire at the end of eighteen months from date of listing on the New York Stock Exchange, provided, however, that should the `pool' hereinafter mentioned be liquidated prior to eighteen months after the listing of the stock on the New York Stock Exchange, then this option shall expire at the time of the liquidation of said `pool.'
It is understood by both you, your associates and ourselves that this option is given exclusively for the purpose of assisting you and your associates to form and operate a `pool' to `protect' the shares of New Class `B' Common Stock of R.J. Reynolds Tobacco Company on the New York Stock Exchange after listing, and that it is understood that the option will be exercised only when and as needed in the operation of said `pool.'
Yours very truly,
(Signed personally by W.N. Reynolds, S. Clay Williams, James A. Gray and Bowman Gray.)"
I believe the testimony given by the defendants and find that this was a company option. Williams testified that the purpose of giving the option was to protect the stock on the New York Stock Exchange if and when it should be listed, and to secure a wider distribution of the stock. He said:
"We were bringing the stocks of R.J. Reynolds Tobacco Company to New York and putting them on the New York Stock Exchange for trading by any and all comers who saw fit to trade therein. We knew very little about it. Our advice had been from other people familiar with the listing of industrial shares on the Exchange that it was quite a hazardous sport for industrial management to list its company's shares on the New York Stock Exchange without having some brokers in New York not only familiar with the shares of *Page 355
that particular corporation, their values, their earning capacity, and the management of the company, but having that broker directly interested in those shares. It was in the service of that deficiency of status that Reynolds had in New York prior to the listing of its stock that this option was given."
Mr. Gray testified:
"As I recall it, the financial statement was published on March 6th, 1922, and we promptly thereafter made application to list the shares, and the shares were admitted to list about March 16th, 1922. It was important that, before the shares were listed on the exchange, the sponsorship should be arranged. The sponsors, in turn, had taken the position — I am speaking now of C.D. Barney Company — that, if they accepted this sponsorship, they would want an option on some stock, for a double purpose: First, to have some stock to sell to other people who might be interested in becoming stockholders of the company, which was the primary purpose. One of our primary purposes in listing was to broaden the stockholder list.
"Secondly, they felt that they should have an option so that, if they were going to support the stock in the event of a short raid and probably assume a loss in such protection, they should have an option at a price slightly below the market so that they would have an opportunity to at least recoup any losses they might sustain in protecting the stock in a short raid.
"It was important that this option be given them prior to the actual listing, in order that they could organize the sponsoring group.
"You will recall that the exhibit which you have just shown me refers to their proposed organization of a pool.
"I would like to stop in my main recital long enough to say that I did not have any interest in that pool and, to the best of my knowledge and belief, no director of R.J. Reynolds Tobacco Company had any interest in that pool. I was invited into the pool, but I declined to enter into it because I did not want to be in the position of profiting from any operation in the company's interests. *Page 356
"Going back to the main point, the option was given them, and they had an opportunity to get the pool organized and ready to operate at the time we listed the stock about two months later. When the option was signed by the four of us individually, it will be recalled that, in the month previous thereto, the company had purchased the 64,000 shares of United stock as a temporary investment. The market on the stock in early January was only slightly above the cost of the United stock the month before. As it was important for the sponsoring group to have an option slightly below the market, the contrast between the cost of the United stock to us and the market price at that time was about two points, which enabled us to give the sponsors an option slightly below the market and at the same time not below the cost of our stock. As a matter of fact, as I recall it, the United stock stood on our books at 33.74, with a possible fraction, and we gave the option to Barney at 33.75, or, in stock exchange terminology, 33 3/4, approximately one cent above the cost of the stock to us the month before."
When asked why the option was not signed by the company rather than the four individuals, Mr. Gray testified:
"In our opinion, it was not a proper thing for an option to be outstanding in the street in New York signed in the name of R.J. Reynolds Tobacco Company, and the four of us individually agreed to sign the option individually, with the distinct understanding that the 20,000 shares, if taken by Barney, were to be 20,000 shares of the United block."
The option itself shows that it was given for this purpose. It was to be availed of on and after the listing of the shares on the New York Stock Exchange. Its purpose apparently was "to protect the shares of New Class B common stock of R.J. Reynolds Tobacco Company on the New York Stock Exchange after listing."
The option price was the cost per share to the company of United stock which it had acquired in December, 1921, plus 1c per share. The option was given in January instead of in March, when the stock was listed, because it was necessary for C.D. Barney
Company to make their arrangements to perform their duties under the option agreement. *Page 357
Mr. Williams testified that it was the understanding of fellow officers and directors that the corporation was to furnish the stock and that it did furnish the stock under the option.
Mr. Gray testified that so far as he was concerned he did not have at the time 5,000 shares of B stock which would have been his proportion of stock to furnish under the option if it had been an individual option instead of a company option.
At a meeting of the board of directors held on March 2d 1922, the following resolutions were adopted:
"Resolved, that application be made to the New York Stock Exchange for the listing of the $10,000,000 of Common Stock, the $50,000,000 of New Class B Common Stock, and the $20,000,000 of Preferred Stock of this corporation, and that James A. Gray, Vice President, be designated by the corporation to appear before the Committee on Stock List of said Exchange, with authority to make such changes in said application, or in any agreements relative thereto as may be necessary to conform with requirements for listing."
"Resolved, that the President be, and he is hereby, from the time of the Company's acquisition of said stock, clothed with authority to sell for the company, whenever he sees fit and at such price or prices, not below cost, as he deems proper, any part or all of the New Class B Common Stock of the Company purchased by the Company during December, 1921."
Mr. Williams testified that at this meeting and prior to the adoption of these resolutions, the board of directors in his presence was informed, "that in connection with the listing of the stock on the New York Stock Exchange, all of the advices that we had had from officials of the Exchange and other persons was to the effect that it would not be advisable to list that stock on the Exchange with as few stockholders and as limited distribution as we had at that time, except as in connection with the listing we arranged for something that might be called a sponsorship for the stock, which did not do anything particularly with respect to it except to carry an interest in it, watch its course, and be sure it was not ill-treated or suffered unwarranted experiences on the Exchange. It was further expressed that the Barney brokerage house, which had carried an intensive interest and quite an extensive activity in Reynolds Tobacco stock for a number of years *Page 358
theretofore, was probably the appropriate and proper, the most effective sponsor for that stock."
The class B common stock authorized in 1917 was sold to stockholders one-half, or 50,000 shares, on April 1st, 1918, at par. Seventeen shares of the 50,000 shares offered were not subscribed for by stockholders, but they were issued, apparently by order of one of the officers now deceased, to Mr. Orr, secretary of R.J. Reynolds.
On July 1st, 1918, when the second lot of 50,000 shares of B stock were issued, 21 2/3 shares were not subscribed for by stockholders, and these shares were issued to Mr. Orr. By virtue of its ownership of the 17 shares above mentioned, the company had the right to subscribe for 5 2/3 shares on July 1st. These 44 1/3 shares were issued to Mr. Orr, the cost being absorbed by undivided profits. The one-third share was sold on August 10th, 1918, for $33.34. The 44 shares were treated by the company as shares which had been issued.
When the transaction occurred only two of the present defendants were directors of the company, and it does not appear that they had knowledge of it, nor does it appear that those who subsequently became directors had knowledge of the fact that this stock was not actually issued until it was later sold by the company. The transaction has all the appearances of being, and I believe it was, an honest one. When the shares were eventually sold, the company received $35,090.46, which is indicative of a beneficial corporate transaction. This profit over the subscription price of those shares was included in the company's profits, and being so included it followed that participation was paid thereon.
Complainants charge that this was a capital transaction and the inclusion in the profits was wrongful and a breach of trust. It occurred many years ago, long before complainants purchased any stock, and I find no taint of wrong or breach of trust involved in it.
The next large purchase by the corporation of its New Class B common stock for investment purposes occurred in 1928. The testimony shows that the sale of the Lucky Strike cigarettes of American Tobacco Company was increasing by leaps and bounds. Camel sales were declining. Luckies sold *Page 359
to distributors on a slightly better basis than Camels, and American accordingly had more money available to advertise and push Luckies than Reynolds did. The management thereupon cut the price of Camels in order to force American to reduce its price, which would leave it with less funds available for advertising.
Following this price cut large blocks of the Reynolds B stock were dumped on the New York Stock Exchange. The directors met and agreed individually and severally to invest about $8,000,000 in the B shares. They placed their orders separately through different brokers. After their purchases had been made large blocks of New Class B stock owned by Mrs. J.B. Duke, widow of the former head of the tobacco trust, were shown by the company's transfer sheets to have been sold on the market.
The directors concluded that a raid on the Reynolds stock was in process. Whereupon the directors passed a resolution at a special meeting, authorizing the company to purchase 44,000 shares, which cost $5,000,000. The directors personally had purchased 62,200 at a cost of $8,209,000.
These purchases accomplished their purpose. Before the end of the year all the 44,000 shares the company had bought had been sold, with a net profit to the company of $1,091,129.50, or 20% on the money invested. The directors by the year end had sold only 18,200 of the shares they had bought.
Complainants charge that most of the directors who bought these 62,200 shares bought them on margin from banks or brokers, and that when they induced the company to purchase its 44,000 shares it did so to protect the directors' investment and help bolster up the stock and keep it from going further down.
According to the testimony, the officers and directors of the defendant viewed with alarm the increase in the sale of Lucky Strikes and the decrease in the sale of Camels. They cut the price of Camels from $6.40 to $6.00 per thousand. Mr. Williams said that Reynolds was in a terrific business battle and that it was the most dangerous threat the company had ever run into. *Page 360
Had the directors gone into this matter as a speculation, it is to be assumed that they would wait until the Reynolds B stock had gone away down rather than attempt to plug it immediately after the price cut. Their purchases were at considerably higher prices than the company's purchases. Had they intended to profit at company expense, it is to be assumed they would have sold their shares first and after they received a profit would have sold the company's shares.
That they permitted the company to get out first at a profit of over a million dollars and make a profit of 20% on the money invested, while they retained their stock and realized only a 7 or 9% advance on what they sold, indicates the high purposes of the directors. That was no breach of trust.
The complainants charge that in December, 1928, a group of Reynolds directors and officers entered into a syndicate agreement with C.D. Barney Company to speculate in the B stock of the company, and that the company bought some of its investment stock from the syndicate in the fall of 1929.
The defendants' explanation of the Chas. D. Barney Company syndicate agreement is as follows: Late in the year 1928, John W. Hanes of Chas. D. Barney Company, represented to Mr. Williams that although the Tobacco Company had a very fine record, good earnings and a high rate of dividends, it had not been recognized for its real value among investors generally. It then had outstanding 10,000,000 shares of B stock, less than 6,000 stockholders, and 2,000,000 shares of its B stock were in brokers' hands. Chas. D. Barney Company had for some years been interested in tobacco stocks and particularly in stock of the R.J. Reynolds Tobacco Company. Barney proposed to form a syndicate for the purpose of bringing the stock to the attention of investors generally.
Mr. Hanes inquired of Mr. Williams as to whether some of the directors would take an interest in the syndicate. The Tobacco Company was interested in enlarging its stockholder list because it recognized the danger inherent in a large number of shares outstanding in the hands of a comparatively small number of stockholders. They believed that the syndicate would be helpful in enlarging the stockholder list. Mr. *Page 361
Gray testified that he believed the syndicate could do a constructive thing in broadening the stockholder list. It was proposed by Hanes to secure participations for 1,000,000 shares. Eight of the directors of the R.J. Reynolds Tobacco Company took less than a 15% interest in this syndicate.
It does not appear that the directors had anything to do with the management of the syndicate. Eight directors, some now deceased, joined in the syndicate arrangement and gave Barney options on their stock for distribution through the syndicate. They, the defendants say, had a large part of this stock which they had bought at the time the price of Camel cigarettes was reduced in the spring of 1928, and which they had refrained from selling; and while they hoped to dispose of this stock and to make a profit, they were also actuated by their desire to promote the interest of the company by securing a wider distribution of the stock among the public generally. In no single instance, the defendants maintain, did Chas. D. Barney Company consult the Reynolds directors whether they should buy or sell. Barney gave no information whatsoever as to the operations of the syndicate to a Reynolds director. It was released from the several option agreements given by the eight Reynolds directors October 17th, 1929. The syndicate operated at a loss and the directors instead of profiting thereby sustained heavy losses.
Both Mr. Williams and Mr. Gray testified that they knew nothing about two accounts that were revealed when complainants took the depositions of a representative of Chas. D. Barney Company. These accounts were known as No. 8000 Account and Reynolds Sales Account No. 1. It was not established that the company ever purchased any stock from a director.
Mr. Williams testified that the stock which he received from the syndicate was worth "definitely less than the price at which it was charged out to me under the dissolution of the syndicate."
The final purchase by the company of its New Class B common stock for investment occurred at the time of the market crash in 1929. That year the company was enjoying great prosperity. Camel cigarette sales were up over *Page 362
600,000,000 from those of 1928; it had a large inventory of leaf tobacco, and its profits were the best it had ever had. When the market broke the company had surplus funds consisting of $12,000,000 in cash and $17,000,000 in government securities, with no immediate prospect of needing them in the business. The return on government securities was then about 3%. The company had paid three quarterly dividends of 60 cents a share and contemplated paying 75 cents a share at the year end.
At the September, 1929, dividend date the company had only 9,136 B stockholders, who held a total of 10,000,000 shares of the company's stock. Twenty-three per cent. of the stock, or 2,000,000 shares, were in brokers' hands. While Camel cigarettes had for many years been the leading cigarette in the country, yet the Lucky Strike cigarette of American Tobacco Company had been outselling it in 1928 and was outselling it in 1929, although the Camel sales were rapidly increasing.
The management of the company felt that the break in the market was temporary and did not envision that it was the beginning of a long depression. They felt that the stock of the company, which had been selling above $70 per share in 1929, was in a precarious position and they were fearful of the effects of a serious raid on the stock, which at that time was a not infrequent occurrence in the market. Accordingly the directors decided to invest so much of the company's surplus funds as might be necessary in the stock at $50 per share, believing that the returns would be double what they were receiving on government bonds and expecting that the stock would stabilize itself above $50 per share.
With proper directors' resolutions the management purchased all the stock that was offered in the market at $50 per share for two weeks beginning October 29th. On the night of November 13th, on the advice of its brokers, the company put in a scale order for a certain number of shares at prices scaling down from 50 through 39 and lower. This order was filled down to 39 at the opening of the market on November 14th. Thereafter the company made no purchases until October, 1930. The stock rose from 39 through 48 in 1929, in *Page 363
which time the company sold part of the stock it had acquired and continued selling until the market broke again in the fall of 1930.
The company's financial statement at December 31st, 1929, shows on the asset side: "Investments in Non-competitive companies,c., $19,601,594.77."
The investment in non-competitive companies shown on the December 31st, 1930, statement was $9,455,147.02, with a footnote which read:
"Consisting almost entirely of company's own stock at which the investment is below market price at December 31st, 1930."
The letter to stockholders which carried this statement, dated January 14th, 1931, said:
"As noted in the statement, the Company holds shares of its own stock which are carried at a figure less than market price at December 31, 1930, and which represent employment of surplus cash at a far greater yield than could be obtained from any equivalent high-grade security. During the past year the Company sold a block of the shares previously acquired and the profit from the sale was applied in reduction of the cost of the shares still held. No part of the earnings shown in the Treasurer's report for the year was derived from the sale of stock."
On January 13th, 1932, the company's president, Mr. Williams, wrote a letter to the stockholders, in which he, among other things, said:
"Net current assets at December 31, 1931, amounted to $128,242,251.20. In addition to this, as noted on the statement, the Company has an investment in shares of its own stock at a figure which is less than market price at December 31, 1931. This investment, somewhat larger than that at the close of the preceding year, produces a very attractive yield as compared to what could be obtained from any equivalent high-grade security in which surplus cash funds could be placed. No part of the earnings shown in the Treasurer's report for the year was derived from the sale of stock."
With the letter was enclosed the company's financial statement which showed investment in non-competitive companies at $13,413,287.26 with a footnote stating that it consisted almost entirely of company's own stock in which the investment was below market price at December 31st, 1931. *Page 364
Mr. Williams, on January 12th, 1933, wrote a letter to all the stockholders, in which appears the following:
"As noted on the statement, the Company has an investment in shares of its own stock somewhat larger than a year ago, which produces a very attractive yield as compared to what could be obtained from any equivalent high-grade security in which surplus cash could be placed. No part of the earnings shown in the Treasurer's report for the year was derived from the sale of stock and, as formerly, the income from such stock is included in dividends on investments."
This letter accompanies the financial statement for December 31st, 1932, which showed investments in non-competitive companies, c., at $18,329,443.10, with a footnote stating "including 585,000 shares company's own stock — $18,208,641.83."
On January 11th, 1934, Mr. Williams, as president, wrote a letter to all the stockholders of the company, in which he enclosed the financial statement of the company as of December 31st, 1933, in which he said:
"Net earnings for the year 1933 were $21,153,721.50, or $2.11 per share, compared with $33,674,800.28 or $3.36 per share for 1932. Cash dividends of $30,000,000, or $3.00 per share, were paid in 1933. The earnings for the year 1933 include an item of $5,003,597.93, representing profit from disposal of company's investment in its own Class B shares, which was announced through the press in July, as well as dividends received on such shares before disposition."
The foregoing exhibits show that the stockholders had full information of the fact that the company had a large investment in B stock; that the dividends on that stock were substantial and were included in the profits of the company; that during the year 1933 the stock had been sold at a profit, which was also included in the net earnings.
While complainants' counsel charge that the individual defendants were guilty of breaches of trust because they bought and sold B stock in the market and because the company at various times also bought and sold B stock, they do not claim that the company sustained any loss. The undisputed evidence shows that the company on its purchases and sales of B stock realized the following profits:
1928 ........................... $1,271,023.19
1929 ........................... 436,581.21
1930-1933 ...................... 5,003,597.93
*Page 365
The total profits that the company realized on the purchase and sale of its own investment stock between 1923 and 1933 amounted to $8,388,386.67. The participation paid officers and employees thereon was 10% thereof, or $838,838.67, of which complainants say the directors, living and dead, personally received $449,568.66. The estates of the deceased directors have been distributed; several who were directors have resigned and are not parties to this suit, and other directors who are parties did not take office until after some or all of these distributions of participations were made.
In addition to this profit the return on the money invested in defendants' shares was in excess of 7.81% on the amount invested as against a return on government securities for the period of about 2 1/2%. Moreover, at the end of the year 1933, after the defendant had sold all of its investment stock, the number of B stockholders had increased to 43,040 as compared with 9,136 in September, 1929, and by the time the bill was filed in this case the number of stockholders was in excess of 60,000.
I agree with the contention of the defendants that the corporation was within its rights in purchasing this stock.
In Chapman v. Iron Clad Rheostat Co., 62 N.J. Law 497 ; 41 Atl. Rep. 690 , Mr. Justice Dixon, speaking for the Supreme Court, said:
"This question, as it turns on common law principles, seems not to have been judicially decided in New Jersey, nor need it now be, for the provisions of our Corporation Act ( Pamph. L. 1896 p. 277 ), by which (section 20) the shares of stock in every corporation are declared to be personal property, and (section 1) every corporation is vested with power to purchase such personal estate as the purposes of the corporation shall require, except (section 3) certain designated sorts of personal property, which do not embrace shares of its own capital stock, coupled with those provisions which recognize the power of corporations to own shares of their own capital stock (sections 29, 38), plainly imply a legislative grant of the necessary power in all cases where the purposes of the corporation require it."
See Berger v. U.S. Steel Corp., 63 N.J. Eq. 809 ; 53 *Page 366 Atl. Rep. 68 , wherein Mr. Justice Van Syckel, speaking for the Court of Errors and Appeals, said:
"There is no provision in the Corporation Act, or in the charter of the company, to support the proposition that purchases of its stock cannot be made by it on credit.
"On the contrary, as has been shown, the company has power to buy its own shares and that power is given to it in the same terms and as broadly as the granted authority to purchase other personal property. No limitation is, in this respect, placed upon it which does not apply equally to the purchase of all other property."
The complainants argue that "although the defendants treated these transactions as profit when they dealt with payments of bonuses to themselves and others, the defendants took an opposite view when they made the company's tax return and litigated the tax question in the courts."
The defendants challenge the statement and cite Helvering v. R.J. Reynolds, 306 U.S. 110 , wherein it appears that the company returned the profit made in 1929 in "other items of non-taxable income" as "profit on R.J.R. stock." Mr. Justice Roberts in that case, among other things, said:
"During 1929 the company sold shares acquired in that and prior years for a sum which exceeded cost by $286,581.21, which amount was entered in the books as a cash item and added to surplus. In its income tax return for 1929, the company listed this gain under the caption `other items of non-taxable income' as `profit R.J.R. stock.'"
The Treasury regulations prior to 1934 provided:
"If * * * the corporation purchases any of its stock and holds it as Treasury stock, the sale of such stock will be considered a capital transaction and the proceeds of such sale will be treated as capital and will not constitute income of the corporation. A corporation realizes no gain or loss from the purchase or sale of its own stock."
However, on May 2d 1934, this regulation was amended by the Treasury Department to read:
"Where a corporation deals in its own shares as it might in the shares of another corporation, the resulting gain or loss is to be computed in the same manner as though the corporation were dealing in the shares of another." *Page 367
The defendants further direct attention to the court's remarks in Helvering v. R.J. Reynolds, supra , which appear as follows:
"Since the legislative approval of existing regulations by re-enactment of the statutory provision to which they appertain gives such regulations the force of law, we think that Congress did not intend to authorize the Treasury to repeal the rule of law that existed during the period for which the tax is imposed."
The defendants say that because of the amendment of the regulation in 1934, the Commissioner of Internal Revenue determined a deficiency in the tax paid by the corporation for 1929 which led to the controversy above mentioned; and that the Supreme Court pointed out that the regulation in effect in 1929 had been in effect for many years; that meanwhile Congress had several times amended the Revenue Law without expressly changing the regulations. The regulation in effect in 1929 served no purpose except to determine taxable income under the Internal Revenue Laws.
The case of Heller v. Boylan, supra , is distinguished from the instant case by the fact that the only profits, a percentage of which was distributable under the by-law of the American Tobacco Company were "the net earnings made by the company in its business as a manufacturer and seller of tobacco and its products, after deducting all expenses and losses." The decision was based upon the court's construction of a by-law, the language of which was different from the by-law in the instant case, which permits participation on the "annual profits of the company," which I construe to mean from whatever source they are derived.
The case of Winkleman v. General Motors Corp., 44 F. Supp. 960 ,
cited by the complainants, involved the consideration of three bonus plans of the General Motors Corporation. The court considered the contention that the profits received by the corporation as dividends on stock owned by it in General Motors management corporation should have been excluded in so far as those profits resulted from dividends received by the management corporation on General Motors stock held by it. The court held that these profits were *Page 368
properly included. Its determination was based, in part, upon the fact that the management corporation w

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/3567738. Public record. Not legal advice.