Treadway Companies, Inc. v. Care Corp.

ON PETITION FOR REHEARING

KEARSE, Circuit Judge:

Counterclaim plaintiffs-appellees Care Corporation, Dr. Robert W. Browne, and Philip deJourno (hereinafter collectively referred to as “Care”) have sought a rehearing of that portion of our decision of August 12, 1980, pp. 357-386, which reversed the judgment of the district court and allowed Fair Lanes to vote the 230,000 shares of Treadway Companies Inc. common stock which it purchased in order to preserve the possibility of a merger between Fair Lanes and Treadway. Since Care has not called to our attention any “points of law or fact which ... the court has overlooked or misapprehended,” (Fed.R. App.P. 40(a)), the petition is denied.

Care’s principal contention here is that the law with respect to stock transactions to affect control of the corporation regards sales and purchases differently, and that a sale is “malum prohibitum.” First, we note that Care’s claim that “universally articulated state law absolutely proscrib[es] the sale of stock” to affect control of a corporation (Petition at 1, emphasis in original) is simply not supported by the cases. Sales of stock to affect control have been upheld, for example, in McPhail v. L. S. Starrett Co., 257 F.2d 388, 394-96 (1st Cir. 1958); and Northwest Indus., Inc. v. B. F. Goodrich Co., 301 F.Supp. 706, 712 (N.D.Ill. 1969). That these cases were decided in federal courts does not alter the facts that they applied state law and that they have subsequently been cited with approval by state courts. See, e. g., Kors v. Carey, 39 Del.Ch. 47 , 158 A.2d 136 (1960); Condec Corp. v. Lunkenheimer, 43 Del.Ch. 353 , 230 A.2d 769 (1967).

Further, Care’s attempted distinction between sale cases and purchase cases is an artificial construct that obscures rather than illuminates the law. The operative question in the cases is not whether the issuing corporation bought or sold, but whether the transaction was designed to perpetuate the incumbent management’s control. The general principle, cited in McPhail v. L. S. Starrett Co., supra, is as follows:

“Directors cannot take advantage of their official position to manipulate the issue and purchase of shares of the stock of the corporation in order to secure for themselves the control of the corporation and then to place the ownership of the stock in such a position as will perpetuate that control. Such action constitutes a breach of their fiduciary obligations to the corporation and a wilful disregard of the rights of the other stockholders.”

( 257 F.2d at 394 , emphasis added; quoting Anderson v. Albert & J. M. Anderson Mfg. Co., 325 Mass. 343, 346-47 , 90 N.E.2d 541, 544 (1950). State courts, like the federal courts in McPhail and Northwest Industries, supra, have acted on this principle. Thus where a sale has been made to effect, but not maintain, control, it has been upheld. See, e. g., Yasik v. Wachtel, 25 Del.Ch. 247 , 17 A.2d 309 (1941) (shares sold *387 transferred voting control, but court found “no agreement or arrangement” by which management would participate in the owning or voting of the shares; complaint therefore dismissed); Cummings v. United Artists Theatre Circuit, Inc., 237 Md. 1 , 204 A.2d 795, 805 (1964) (“There is no merit to the suggestion that Skouras had the board enter into this agreement to perpetuate his control. The control, it is true, would be transferred to the Naifys who were on friendly terms with Skouras, but there is no evidence of an agreement, express or implied, under which Skouras would retain actual control”; injunction denied.) Where a sale has been made in order to retain control, it has been set aside. E. g., Elliott v. Baker, 194 Mass. 518 , 80 N.E. 450 (1907) (sale to third person found to have been made with the “secret understanding” that stock would be voted to keep management in control; sale set aside); Kullgren v. Navy Gas & Supply Co., 110 Colo. 454 , 135 P.2d 1007, 1011 (1943) (issuance of stock “to avoid enforced separation from what was no mean employment”; sale and voting of stock restrained). 1 And where a purchase has been made in order to retain control it has been held improper. See, e. g., Bennett v. Propp, 41 Del.Ch. 14 , 187 A.2d 405 , 408 (1962) (“the purchases were made to preserve management control”; officer who caused the purchases held liable); Petty v. Pentech Papers, 347 A.2d 140, 143 (Del.Ch. 1975) (“use of corporate funds to purchase corporate shares primarily to maintain management in control is improper”; purchase enjoined).

By focusing on whether or not the transaction will perpetuate management’s control, the cases take a normal first step in business judgment analysis, since the issue of self-perpetuation is but an aspect of the fundamental threshold question, “Is the director or officer interested in the transaction?” In the present case, the evidence of record required that this question be answered in the negative. As discussed in greater detail in our August 12 opinion, at 383-384, the purpose of Treadway’s sale of stock to Fair Lanes was to facilitate a merger between Treadway and Fair Lanes; Fair Lanes had made the sale a precondition to negotiations. Neither initially nor in the present petition has our attention been directed to any evidence suggesting that the merger talks were disingenuous or that the Treadway directors did not seriously seek a merger with Fair Lanes. 2 Nor is there any question as to the *388 fact that upon the planned merger, all Treadway directors-other than Lieblichwere to lose their positions. The fact that the sale of stock would allow some of those directors, despite the proxy contest at the annual meeting to hold office until the merger with Fair Lanes could be completed, must be evaluated in light of the planned termination of their incumbency upon consummation of the merger. In the circumstances it could not properly be found that the purpose of the sale was to perpetuate management’s control.

The petition for rehearing is denied.

. Care’s heavy reliance on the result in Condec Corp. v. Lunkenheimer, supra, is misplaced since important factual aspects of Condec are readily distinguishable. Condec involved Lunkenheimer Company’s attempt to sell its assets to U.S. Industries Corporation (“U.S.I.”) in order to fend off a takeover by Condec Corporation. The agreement for the sale of assets was immediately preceded by an agreement for an exchange of 75,000 shares of Lunkenheimer stock for a like number of shares of a U.S.I. subsidiary; the exchange was conditioned on the consummation of the sale of assets. The exchange agreement was successfully challenged by Condec on the basis of facts not established in the present case. The most important of these was the court’s finding that the Lunkenheimer management would apparently retain their positions if the U.S.I. transactions were consummated, but would lose those positions if Condec took over. 230 A.2d at 773-74 . Further, the court found that the exchange brought no cash into Lunkenheimer’s treasury and was not in furtherance of any proper corporate purpose. Id. at 777 .

. Care’s contention that there were dispositive findings of the district court that were “not overturned by this Court” is belied by our original opinion. For example, with respect to whether the purpose and effect of the sale to Fair Lanes were to perpetuate management’s control, we pointed out the error in the district court’s focusing solely on the imminent proxy contest at the annual meeting, in disregard of the ultimate goal of a merger with Fair Lanes (at 381-384). Further, as to whether the Treadway directors other than Lieblich acted in bad faith, or had an interest in the transaction, or acted for an improper purpose, we held that “the evidence does not permit a finding that Care carried [its] burden.” (At 383; id. at 382-384.) And our observation that the Treadway board instructed its investment bankers to study Care and received a report that a combination with Care would not be in Treadway’s best interests (at 365), together with our conclusion that there was no evidence of any bad faith on the part of any director other than Lieblich, obviously rejected, as to *388 the directors other than Lieblich, the district court’s conclusion that “no good faith effort was ever made” by the Treadwav board to investigate Care.