# Essex Universal Corporation v. Herbert J. Yates

> Court of Appeals for the Second Circuit · June 28, 1962 · 305 F.2d 572

URL: https://www.frixlaw.com/law-library/cases/9448683

## Case

- **Full name:** ESSEX UNIVERSAL CORPORATION, Appellant, v. Herbert J. YATES, Appellee
- **Court:** Court of Appeals for the Second Circuit
- **Decided:** June 28, 1962
- **Citations:** 305 F.2d 572; 13 A.L.R. 3d 346; 1962 U.S. App. LEXIS 4631
- **Precedential status:** Published
- **Opinion:** Concurrence by Friendly
- **Judges:** Lumbard, Clark, Friendly
- **Cited by:** 30 later opinions in the Frix Law Library

## Citator (automated)

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## Opinion text

FRIENDLY, Circuit Judge
(concurring) .
Chief Judge Lumbard’s thoughtful opinion illustrates a difficulty, inherent in our dual judicial system, which has led at least one state to authorize its courts to answer questions about its law that a Federal court may ask. 1 Here we are forced to decide a question of New York law, of enormous importance to all New York corporations and their stockholders, on which there is hardly enough New York authority for a really informed prediction what the New York Court of Appeals would decide on the facts here presented, see Cooper v. American Airlines, Inc., 149 F.2d 355, 359 , 162 A.L.R. 318 (2 Cir., 1945); Pomerantz v. Clark, 101 F.Supp. 341 (D.Mass.1951); Corbin, The Laws of the Several States, 50 Yale L.J. 762 , 775-776 (1941), yet too much for us to have the freedom used to good effect in Perlman v. Feldmann, 219 F.2d 173 (2 Cir.), cert. denied, 349 U.S. 952 , 75 S.Ct. 880 , 99 L.Ed. 1277 (1955).
*581 I have no doubt that many contracts, drawn by competent and responsible counsel, for the purchase of blocks of stock from interests thought to “control” a corporation although owning less than a majority, have contained provisions like paragraph 6 of the contract sub judice. However, developments over the past decades seem to me to show that such a clause violates basic principles of corporate democracy. To be sure, stockholders who have allowed a set of directors to be placed in office, whether by their vote or their failure to vote, must recognize that death, incapacity or other hazard may prevent a director from serving a full term, and that they will have no voice as to his immediate successor. But the stockholders are entitled to expect that, in that event, the remaining directors will fill the vacancy in the exercise of their fiduciary responsibility. A mass seriatim resignation directed by a selling stockholder, and the filling of vacancies by his henchmen at the dictation of a purchaser and without any consideration of the character of the latter’s nominees, are beyond what the stockholders contemplated or should have been expected to contemplate. This seems to me a wrong to the corporation and the other stockholders which the law ought not countenance, whether the selling stockholder has received a premium or not. Right in this Court we have seen many cases where sudden shifts of corporate control have caused serious injury; Pettit v. Doeskin Products, Inc., 270 F.2d 95 (2 Cir., 1959), cert. denied, 362 U.S. 910 , 80 S.Ct. 660 , 4 L.Ed.2d 618 (1960); United States v. Crosby, 294 F.2d 928 (2 Cir., 1961), cert. denied Mittelman v. United States, 368 U.S. 984 , 82 S.Ct. 599 , 7 L.Ed.2d 523 (1962); and Kirtley v. Abrams, 299 F.2d 341 (2 Cir., 1962), are a few recent examples. To hold the seller for delinquencies of the new directors only if he knew the purchaser was an intending looter is not a sufficient sanction. The difficulties of proof are formidable even if receipt of too high a premium creates a presumption of such knowledge, and, all too often, the doors are locked only after the horses have been stolen. Stronger medicines are needed — refusal to enforce a contract with such a clause, even though this confers an unwarranted benefit on a defaulter, and continuing responsibility of the former directors for negligence of the new ones until an election has been held. Such prophylactics are not contraindicated, as Judge Lumbard suggests, by the conceded desirability of preventing the dead hand of a former “controlling” group from continuing to dominate the board after a sale, or of protecting a would-be purchaser from finding himself without a majority of the board after he has spent his money. A special meeting of stockholders to replace a board may always be called, and there could be no objection to making the closing of a purchase contingent on the results of such an election. I perceive some of the difficulties of mechanics such a procedure presents, but I have enough confidence in the ingenuity of the corporate bar to believe these would be surmounted.
Hence, I am inclined to think that if I were sitting on the New York Court of Appeals, I would hold a provision like Paragraph 6 violative of public policy save when it was entirely plain that a new election would be a mere formality— i. e., when the seller owned more than 50% of the stock. I put it thus tentatively because, before making such a decision, I would want the help of briefs, including those of amici curiae, dealing with the serious problems of corporate policy and practice more fully than did those here, which were primarily devoted to argument as to what the New York law has been rather than what it ought to be. Moreover, in view of the perhaps unexpected character of such a holding, I doubt that I would give it retrospective effect. 2
*582 As a judge of this Court, my task is the more modest one of predicting how the judges of the New York Court of Appeals would rule, and I must make this prediction on the basis of legal materials rather than of personal acquaintance or hunch. Also, for obvious reasons, the prospective technique is unavailable when a Federal court is deciding an issue of state law. Although Barnes v. Brown, 80 N.Y. 527 (1880), dealt with the sale of a majority interest, I am unable to find any real indication that the doctrine there announced has been thus limited. True, there are New York cases saying that the sale of corporate offices is forbidden; but the New York decisions do not tell us what this means and I can find nothing, save perhaps one unexplained sentence in the opinion of a trial court in Ballantine v. Ferretti, 28 N.Y.S.2d 668 , 682 (Sup.Ct.N.Y.Co.1941), to indicate that New York would not apply Barnes v. Brown to a case where a stockholder with much less than a majority conditioned a sale on his causing the resignation of a majority of the directors and the election of the purchaser’s nominees.
Chief Judge Lumbard’s proposal goes part of the way toward meeting the policy problem I have suggested. Doubtless proceeding from what, as it seems to me, is the only justification in principle for permitting even a majority stockholder to condition a sale on delivery of control of the board — namely that in such a case a vote of the stockholders would be a useless formality, he sets the allowable bounds at the line where there is “a practical certainty” that the buyer would be able to elect his nominees and, in this case, puts the burden of disproving that on the person claiming illegality.
Attractive as the proposal is in some respects, I find difficulties with it. One is that I discern no sufficient intimation of the distinction in the New York cases, or even in the writers, who either would go further in voiding such a clause, see Berle, “Control” in Corporate Law, 58 Colum.L.Rev. 1212, 1224 (1958); Leech, Transactions in Corporate Control, 104 U.Pa.L.Rev. 725, 809 (1956) [proposing legislation], or-believe the courts have not yet gone that far, see Baker & Cary, Corporations: Cases and Materials (3d ed. unabr. 1959) 590. To strike down such a condition only in cases falling short of the suggested line accomplishes little to prevent what I consider the evil; in most instances a seller will not enter into a contract conditioned on his “delivering” a majority of the directors unless he has good reason to think he can do that. When an issue does arise, the “practical certainty” test is difficult to apply. The existence of such certainty will depend not merely on the proportion of the stock held by the seller but on many other factors — whether the other stock is widely or closely held, how much of it is in “street names,” what success the corporation has experienced, how far its dividend policies have satisfied its stockholders, the identity of the purchasers, the presence or absence of cumulative voting, and many others. Often, unless the seller has nearly 50% of the stock, whether he has “working control” can be determined only by an election; groups who thought they had such control have experienced unpleasant surprises in recent years. Judge Lumbard correctly recognizes that, from a policy standpoint, the pertinent question must be the buyer’s prospects of election, not the seller’s —yet this inevitably requires the court to canvass the likely reaction of stockholders to a group of whom they know nothing and seems rather hard to reconcile with a position that it is “right” to insert such a condition if a seller has a larger proportion of the stock and “wrong” if he has a smaller. At the very least the problems and uncertainties arising from the proposed line of demarcation are great enough, and its advantages small enough, that in my view a Federal court would do better simply to overrule the defense here, thereby accomplishing what is obviously the “just” result in this particular case, and leave the development of doctrine in this area to the State, which has primary concern for it.
*583 I would reverse the grant of summary judgment and remand for consideration of defenses other than a claim that the inclusion of paragraph 6 ex mero motu renders the contract void.
. See Vestal, The Certified Question of Law, 36 Iowa L.Rev. 629, 643 (1951), referring to Fla.StatAnn. (Cum.Supp. 1950) §§ 25.031 and 25.032.
. See Mr. Justice Black dissenting in Mosser v. Darrow, 341 U.S. 267, 276 , 71 S.Ct. 680 , 95 L.Ed. 927 (1951); Levy, Realist Jurisprudence and Prospective Overruling, 109 U.Pa.L.Rev. 1 (1960).

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Source: Frix Law Library, https://www.frixlaw.com/law-library/cases/9448683. Public record. Not legal advice.