Schmidt v. Magnetic Head Corp.

Gibbons, J. (concurring in part and dissenting in part).

I agree with so much of the opinions of my colleagues as hold that plaintiffs’ causes of action for reformation, rescission and return of indemnification moneys will withstand a motion to dismiss. I also agree that plaintiffs’ cross motions to disqualify defendants’ attorneys and to preliminarily enjoin defendant Magnetic Head Corporation (Magnetic Head) from indemnifying the individual defendants were properly denied. I submit, however, that plaintiffs’ three causes of action for specific performance, construction and breach of contract, all turning on how the shareholders’ agreement is to be interpreted, should not be dismissed.

Before examining the relevant provisions of the shareholders’ agreement, a brief review of basic principles is warranted. To interpret a contract “is to ascertain the substantial intent of the parties” (O’Neil Supply Co. v Petroleum Heat & Power Co., 280 NY 50, 55 ). Absent *167 allegations of fraud or mistake or other circumstances which would allow for reformation or rescission (see Hutchison v Ross, 262 NY 381, 398 ), the relevant intent to be found is not the subjective or real intent of the parties to the agreement, but rather the intent expressed or implied in what they wrote (Mallad Constr. Corp. v County Fed. Sav. & Loan Assn., 32 NY2d 285, 291 ; Raleigh Assoc. v Henry, 302 NY 467, 473 ; see 4 Williston, Contracts [3d ed], §§ 600, 610). Of necessity, then, the focus is on the agreement itself, taking into account express terms and those “ ‘which a reasonable person in the position of the promisee would be justified in understanding were included’ ” (Rowe v Great Atlantic & Pacific Tea Co., 46 NY2d 62, 69 , quoting from 5 Williston, Contracts [rev ed, 1937], § 1293, the substance of which is now in 4 Williston, Contracts [3d ed], § 610B).

Over the years the courts have fashioned various rules of contract interpretation to aid in the task of ascertaining the meaning of an agreement (see, generally, 4 Williston, Contracts [3d ed], §§ 618-630). Several of the rules are pertinent here, including the principles that a writing will be read as a whole, with each part being interpreted with reference to the whole and with no part left meaningless or useless (see Corhill Corp. v S. D. Plants, Inc., 9 NY2d 595 ); that the purpose of the parties must be considered so that the interpretation is consistent with that purpose (Matter of Cromwell Towers Redevelopment Co. v City of Yonkers, 41 NY2d 1 , 6; O’Neil Supply Co. v Petroleum Heat & Power Co., 280 NY 50 , supra); that an interpretation which is fair and reasonable will be preferred over an interpretation which is harsh or unreasonable (Chemung Canal Trust Co. v Montgomery Ward & Co., 4 AD2d 95, 102, affd 4 NY2d 1017 ); that separate instruments, executed at the same time and relating to the same subject matter, should be read together (Matter of Herzog, 301 NY 127 ); and that the circumstances under which the agreement was executed should be considered, if to do so would aid the court in putting itself in the position of the parties to better understand the meaning of the words used (Mallad Constr. Corp. v County Fed. Sav. & Loan Assn., 32 NY2d 285, 292 , supra; 4 Williston, Contracts [3d ed], § 618, pp 716-717, § 629). *168 Furthermore, the language of the contract should not necessarily be taken literally (Spencer v Childs, 1 NY2d 103, 106-107 ). Thus, for example, “[t]o carry out the intention of a contract, words [or grammar] may be transposed, rejected, or supplied, to make its meaning more clear” (Castellano v State of New York, 43 NY2d 909, 911 ; Decker v Carr, 11 App Div 432 , affd 154 NY 764 ; see 4 Williston, Contracts [3d ed], § 619, pp 737-740).

Turning to the case at bar, the particular provision in the shareholders’ agreement which is most at issue, and which is found in paragraph 3, states that “during any period in which Robert J. Schmidt, Jr., and Barbara B. Schmidt, and their associates * * * are the holders of 30% or more of the common shares of the Company the Proxy Holders shall vote the Shares for the election of Herbert J. Schmidt, Jr., Barbara B. Schmidt and James North for election as Directors and for determining the number of directors at not more than nine”. I submit that, giving the plaintiffs and their complaint the benefit of every favorable inference, which we must do since we are considering a motion to dismiss (Rovello v Orofino Realty Co., 40 NY2d 633 ), this particular provision of the contract may be found to mean that the Schmidts and their associates have the right to choose three members on Magnetic Head’s board of directors during the life of the agreement provided that they continue to own 30% or more of the company’s shares. Therefore, I conclude that dismissal of the three causes of action, which pertain directly to the proper interpretation to be placed on the agreement, is improper.

Keeping the already discussed general principles of contract law in mind, it is clear that the shareholders’ agreement was executed within the context of the merger of MCP Corporation into Magnetic Head. The Schmidts’ interest in MCP and the relative size and value of the two companies prior to the merger were apparently such that, were it not for the temporary relinquishment of voting rights established by the shareholders’ agreement, the Schmidts would have gained control of the merged corporation, Magnetic Head. Thus, in effect, MCP would have taken over Magnetic Head, and not vice versa. To prevent this from happening, and to keep Mr. Rockwell and his *169 group from being placed in a vulnerable position within Magnetic Head, the shareholders’ agreement was entered into, whereby the Schmidts relinquished their voting power in Magnetic Head to three proxy holders for as long as Mr. Rockwell was engaged in the management of the company. However, apparently the Schmidts did not totally capitulate, giving away all control. A quid pro quo was arranged, whereby a maximum term of 10 years was placed on the life of the shareholders’ agreement, and whereby, while the agreement was in effect, the Schmidts retained some measure of control of the policy making apparatus of the corporation. This was achieved by allowing one of the three proxy holders to be a Schmidt designee, and through the provision which limits the size of the board of directors and which states that Mr. and Mrs. Schmidt, along with North, the Schmidts’ attorney, would be on the board of directors. The purpose of the agreement was not, as maintained by my colleagues in the majority, simply to create a proxy system of voting. The proxy system is only the means to effect a greater purpose, which was to create and maintain a delicate balance of power within Magnetic Head for so long as Mr. Rockwell was managing the company, for up to 10 years.

The majority’s interpretation of the agreement may well throw this balance askew. According to its view, since the agreement specifies that the proxy holders will vote for “Herbert J. Schmidt, Jr., Barbara B. Schmidt and James North” as directors, the proxy holders are not compelled to vote in any certain way if any of the positions occupied by Mr. Schmidt, his wife or North, become vacant. This means that if Mrs. Schmidt, for example, no longer wishes to bear any responsibilities on the board, perhaps because of sickness or other reason, she and her husband cannot designate her successor. In other words, if the Schmidts want to have any voice in the making of policy for Magnetic Head during the life of the agreement, they personally must retain their positions on the board. Not only do they lack control over the position previously occupied by North, but they lack control over their own positions. The theoretical possibility, of course, is that through retirement, sickness or what have you, the owners of the Schmidts’ shares in *170 Magnetic Head may have no voice on the board of directors, despite owning almost 50% of the corporation. Such a result is hardly consistent with the purpose of maintaining the balance of power which the shareholders’ agreement was designed to achieve.

All this is simply to say that taking into account the circumstances of the merger, the apparent position of the primary actors in the merger, the purpose of the shareholders’ agreement, and reading the agreement as a whole, it might properly be concluded that the Schmidts have the authority to designate North’s successor. The Schmidts’ authority might be considered implied in fact, such that, while the agreement does not expressly set forth who should nominate North’s replacement, a reasonable person would nevertheless conclude that the Schmidts possessed that power (cf. Sutton v East Riv. Sav. Bank, 55 NY2d 550, 555-556 ; Morlee Sales Corp. v Manufacturers Trust Co., 9 NY2d 16, 20 ). Alternatively, it might be concluded that the provision in paragraph 3, which speaks about the Schmidts owning at least 30% of the shares and Mr. and Mrs. Schmidt and North being on the board, should not be taken literally. Rather, this provision may manifest an intent whereby, so long as the Schmidts or their successors own at least 30% of Magnetic Head, they can designate who should occupy three positions on a board of directors made up of no more than nine persons.

Up until now I have not considered the possibility of extrinsic evidence, and its effect on how the agreement should be interpreted. Plaintiffs’ second cause of action, for construction, specifically alleges that the agreement is ambiguous. Much has been said in the parties’ briefs on appeal concerning the question of ambiguity and the use to be made of extrinsic evidence to establish intent. The rule is well established, and is really but a corollary to the axiom that intent is to be gleaned from the instrument itself, that extrinsic evidence is inadmissible to vary, alter or contradict a contract which is complete, unambiguous, valid and unaffected by fraud, duress, mistake or illegality (see, generally, Richardson, Evidence [Prince, 10th ed], §§ 601-632). However, where a contract is not integrated or is only partially integrated, parol evidence which is not *171 contradictory to what has been written is admissible to complete the writing (Fogelson v Rackfay Constr. Co., 300 NY 334 ; Smith v Slocum, 71 AD2d 1058 ). Similarly, parol evidence is, of course, admissible to clarify any ambiguity in what has been expressed (67 Wall St. Co. v Franklin Nat. Bank, 37 NY2d 245, 248-249 ).

I do not seek to quarrel with the majority’s contention that an omission in a contract should not be considered an ambiguity allowing for extrinsic proof. I submit that an omission which cannot be filled by implication may not be remedied through extrinsic proof unless the agreement is not integrated or is only partially integrated (see Fogelson v Rackfay Constr. Co., 300 NY 334 , supra; Richardson, Evidence [Prince, 10th ed], § 614). In the case at bar, the agreement appears to be integrated. However, as already argued, in the present posture of this case it cannot be said that the agreement does not, impliedly or through a broad reading of paragraph 3, give the Schmidts the authority to replace North with someone of their choosing. Thus, we cannot say, on this motion to dismiss, that there is, in fact, an omission which cannot be filled by implication. Furthermore, I submit that the provision in paragraph 3, relating to the three directors, may be ambiguous, allowing for extrinsic evidence.

It is not the case that ambiguities in an agreement always reveal themselves on a reading confined to the agreement itself. Some ambiguities are latent, requiring extrinsic evidence not only to explain their meaning, but also to reveal their very existence (Todem Homes v Freidus, 84 Misc 2d 1023, 1029 , mod on other grounds 55 AD2d 640 ; Ambiguity in Contract — Extrinsic Evidence, Ann., 40 ALR3d 1384, § 4; see Richardson, Evidence [Prince, 10th ed], § 629). On a motion for summary judgment, where ambiguity is alleged, it is incumbent on the party claiming ambiguity to set forth his proof so that the court can determine if a trial is necessary to pass on the credibility of the extrinsic evidence (Sutton v East Riv. Sav. Bank, 55 NY2d 550 , supra; Mallad Constr. Corp. v County Fed. Sav. & Loan Assn., 32 NY2d 285 , supra). However, this case is not presently before us in the context of a motion for summary judgment. Defendants moved to dismiss the com *172 plaint pursuant to CPLR 3211. The sufficiency of the pleadings is at issue, not whether plaintiffs in fact have extrinsic proof which would suggest that the shareholders’ agreement is ambiguous. If the court had converted the motion to one for summary judgment, providing adequate notice to the parties (CPLR 3211, subd [c]), then the plaintiffs would have been compelled to set forth what they intended to show at trial (Rovello v Orofino Realty Co., 40 NY2d 633, 635 , supra). Without such a conversion, plaintiffs may have been lulled into believing an extensive evidentiary showing was unnecessary. Since plaintiffs have not yet had an opportunity to present any extrinsic evidence they may have, it should not be presumed that there is no ambiguity in the relevant provisions found in the agreement (cf. Rich v Lefkovits, 56 NY2d 276, 281-282 ; Rovello v Orofino Realty Co., supra, p 636).

My conclusion is that the interpretation of the shareholders’ agreement proffered by the plaintiffs is a rational one, which cannot be precluded as a matter of law on a motion to dismiss. Accordingly, I vote to reinstate plaintiffs’ first, second and fifth causes of action.