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Thomas P. Knapp v. Bankers Securities Corporation Appeal of Bankers Securities Corporation, 230 F.2d 717, 3rd Cir. (1956)
Thomas P. Knapp v. Bankers Securities Corporation Appeal of Bankers Securities Corporation, 230 F.2d 717, 3rd Cir. (1956)
2d 717
The present action was brought in the district court for the eastern district of
Pennsylvania by shareholders, New York residents, against the Bankers
Securities Corporation, a Pennsylvania corporation, and its directors, charging
that Albert M. Greenfield, one of the directors and the majority shareholder,
and the other directors were acting unreasonably in failing to eliminate
accumulated arrearages of dividends of approximately $3,000,000 on the
common stock in order that the preferred and common stockholders might
participate in the earnings of the corporation, that the distribution of earnings
was being arbitrarily withheld for the benefit of the majority shareholder, and
that for not making proper distribution of surplus earnings the corporation
might be subjected to the imposition of a surtax under the Internal Revenue
Code. Before filing an answer the defendant corporation moved for an order
requiring the shareholders to furnish security for costs pursuant to the
Pennsylvania statute. The district court held the statute inapplicable to this
action and denied the motion. D.C., 17 F.R.D. 245. This appeal by the
defendant corporation followed.2
3
The Pennsylvania statute, under which the defendant corporation seeks security
for costs, is applicable to diversity suits within its scope brought in the federal
district courts in Pennsylvania.3 It provides that a corporation shall be entitled
to security for reasonable expenses, including attorney's fees, which may be
incurred or assessed against it in connection with a suit brought by holders of
less than five per cent of the outstanding shares of any class of stock 'to enforce
a secondary right on the part of one or more shareholders against any officer, or
director * * * of a corporation, * * * because such corporation refuses to
enforce rights which may properly be asserted by it.' The shareholders in this
case hold less than five per cent of the corporation's stock and therefore if they
seek by the present suit to enforce a secondary right which might properly be
asserted by the corporation their suit would come within this statute.
power which the plaintiffs seek to invoke in this case. The question then is
whether in such an action the shareholder is seeking relief from a personal
wrong done to him and thus is enforcing a primary or personal right of his own
or is seeking to redress a wrong done to the corporation and thus is enforcing a
secondary right derived from the corporation.
6
'To permit each individual stockholder to sue for his supposed proportion of
corporate assets would be intolerable. Only by payment to the corporation itself
can creditors be fully protected. If every minority stockholder could sue in his
own name for his supposed proportionate share of a fund alleged to be illegally
withheld from the corporation, an innumerable number of suits might result * *
*, some of which might be won and others lost by the respective shareholders.
When plaintiff became a stockholder he knew, for he was bound to know, that
his rights as such, would have to be worked out through the corporation, and
not in his individual name. McAleer v. McMurray, 58 Pa. 126, 128; Craig v.
Gregg, 83 Pa. 19; White v. First National Bank of Pittsburgh, 252 Pa. 205, 97
A. 403. As said in the last cited authority ((252 Pa. at) pages 213-214, 97 A.
405): 'The difficulty with the plaintiff's case is that he has failed to show any
injury to himself apart from the injury to the corporation, in which he is a
stockholder."
the shareholder or the corporation, and who will be benefited if the action is
brought to a successful conclusion.
9
The right to dividends is an incident of the ownership of stock. 10 The fact that
the distribution of profits cannot ordinarily be enforced until after a dividend
has been declared does not detract from the shareholders' fundamental right to
share in the net profits of the corporation. This right is the basis of his suit to
compel the declaration of dividends. If the directors have wrongfully withheld
the declaration of dividends the shareholder is the injured party. He shows an
injury to himself which is quite apart from any which the corporation might be
thought to suffer.11 Even if the corporation might under some circumstances
have a right of action12 that fact would not affect the authority of its
shareholders to enforce by suit their personal and individual rights to the
declaration of a dividend.
10
It is suggested that the right here asserted must be regarded as one vested in the
corporation because the mechanics of relief have to be worked out by a decree
against the directors rather than against the corporation. Our answer to this
proposition was made by Judge Goodrich in Kroese v. General Steel Castings
Corporation, 3 Cir., 1950, 179 F.2d 760, 763-764, 15 A.L.R.2d 1117, when he
said:
11
'It is to be observed that when a court steps in and orders the payment of a
dividend, the corporate affairs have reached the point where the judgment of
the directors is no longer controlling. The set of facts presented is such that the
court substitutes its judgment, based on a rule of law, for the ordinary business
judgment of those in charge of the business enterprise. * * *
12
'In such a case, even though the individual directors are joined as parties, they
are not called upon to exercise any business discretion. The case has passed that
point. As said before, the court is declaring rights protected by a rule of law, not
calling upon the directors to exercise judgment. * * * The duty of a corporation
to pay dividends then and there has been imposed by the judgment of the court,
not by the ayes and nays of the members of the board. The situation becomes in
substance the same as that in which any corporate creditor sues the enterprise in
the corporate name to recover from it what it owes him; he does not need any
meeting of the corporation's board to make his judgment good. Nor does a
shareholder whose claim to dividends is based on his showing of fiduciary
mismanagement need a directors' meeting to make his rights good. The
judgment of a court is enough in either case.'
It is equally clear that the successful outcome of a suit such as the one before us
13
It is equally clear that the successful outcome of a suit such as the one before us
will benefit only the shareholders. The defendant corporation suggests that such
an action is for the benefit of the corporation in the sense that it is in the
interest of the corporation that it be well managed and have a good dividend
policy. We do not think that this highly theoretical benefit can outweigh the
obvious disadvantage to the corporation of losing the cash which if not
distributed to the shareholders would remain available for use in the conduct of
the corporate business. Certainly it cannot be a benefit to a corporation, as such,
to lose assets, even to its shareholders.
14
Since the suit before us cannot be regarded under Pennsylvania law as one to
enforce a secondary or derivative right on the part of the plaintiffs which might
properly have been asserted by the defendant corporation13 it is not within the
scope of the Pennsylvania statute which by its clear language is limited to such
suits. We do not think that the Pennsylvania courts would follow the reasoning
of the majority of the Court of Appeals of New York in Gordon v. Elliman to
the contrary. We, therefore, conclude that the district court did not err in
denying the defendant corporation's motion for security for costs under the
statute.
15
The order was appealable. Cohen v. Beneficial Indus. Loan Corp., 1949, 337
U.S. 541, 546-547, 69 S.Ct. 1221, 93 L.Ed. 1528
Cohen v. Beneficial Indus. Loan Corp., 1949, 337 U.S. 541, 555-557, 69 S.Ct.
1221, 93 L.Ed. 1528
Murdock v. Follansbee steel Corp., 3 Cir., 1954, 213 F.2d 570; Kroese v.
General Steel Castings Corporation, 3 Cir., 1950, 179 F.2d 760, 15 A.L.R.2d
1117, certiorari denied 339 U.S. 983, 70 S.Ct. 1026, 94 L.Ed. 1386
Koster v. Lumbermens Mutual Cas. Co., 1947, 330 U.S. 518, 522-523, 67 S.Ct.
828, 91 L.Ed. 1067
Cohen v. Beneficial Indus. Loan Corp., 1949, 337 U.S. 541, 548, 69 S.Ct.
1221, 93 L.Ed. 1528
Price v. Gurney, 1945, 324 U.S. 100, 105, 65 S.Ct. 513, 89 L.Ed. 776
10
11
White v. First National Bank of Pittsburgh, 1916, 252 Pa. 205, 213-214, 97 A.
403, 405. And see Stevens v. United States Steel Corporation, 1905, 68 N.J.
Eq. 373, 376, 59 A. 905, 906, in which the court in an action to compel the
declaration of dividends said: 'The corporation is not injured by the retention of
profits among its assets which might be distributed, and thus become the
private, separate property of the stockholders. On the contrary, the corporation
is enriched. The object of this suit is not to compel directors to do or refrain
from doing something for the benefit of the corporation, but to do something
for the benefit of the complaining stockholder which may be disadvantageous
to the corporation.'
12
13
In accord with our views are 3 Moore's Federal Practice, 2d ed., p. 3509;
Ballantine on Corporations, rev. ed. 1946, 234; Stevens on Corporations, 2d
ed. 1949, pp. 785-786; Reader, Suits against Corporations, Purdon's
Pennsylvania Statutes Annotated, Tit. 12, 1221-1820, pp. 1-3