Thomas P. Knapp v. Bankers Securities Corporation Appeal of Bankers Securities Corporation, 230 F.2d 717, 3rd Cir. (1956)

230 F.
2d 717
Thomas P. KNAPP et al.

v.
BANKERS SECURITIES CORPORATION et al.
Appeal of Bankers Securities Corporation.
No. 11613.
United States Court of Appeals Third Circuit.

Argued Jan. 16, 1956.
Decided March 15, 1956.
Bernard G. Segal, Philadelphia, Pa., (Gilbert W. Oswald, Edward W.

Mullinix, Philadelphia, Pa., (Samuel D. Goodis, Folz, Bard, Kamsler,
Goodis & Greenfield, Philadelphia, Pa., Schnader, Harrison, Segal &
Lewis, Philadelphia, Pa., on the brief), for appellant.
Samuel H. Landy, Philadelphia, Pa. (Charles Lakatos, Martin J.
Vigderman, Freedman, Landy & Lorry, Philadelphia, Pa., on the brief),
for appellee.
Before MARIS, McLAUGHLIN and HASTIE, Circuit Judges.
MARIS, Circuit Judge.
The question which this appeal presents is whether a shareholders' action

against the corporation and its directors to compel the declaration of dividends
is a suit to enforce a secondary or derivative right on the part of the
shareholders within the meaning of the Pennsylvania security for costs statute.1
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.
The defendant corporation urges that a shareholder's suit to compel the

declaration of dividends does seek to enforce a secondary or derivative right
and it relies as authority for this proposition upon the decision of the Court of
Appeals of New York in Gordon v. Elliman, 1954, 306 N.Y. 456, 119 N.E.2d
331, a decision in which the court was closely divided, four judges holding that
a shareholders' action to compel the declaration of dividends is derivative so as
to require security under the New York statute and three judges dissenting. No
case has been called to our attention in which the Pennsylvania courts have
passed upon this precise question. Since as presented in the present case the
question is solely a matter of the scope and applicability of a Pennsylvania
statute, we must decide it in the light of such Pennsylvania authority as we find
helpful in the absence of direct authority on the point.4
It is an elementary principle of corporation law that the declaration of dividends

out of net profits rests in the discretion of the board of directors.5 However,
there are circumstances under which shareholders may compel the declaration
of dividends. If directors have acted fraudulently or arbitrarily in refusing to
declare a dividend when the corporation has a surplus which it can divide
among the shareholders without detriment to the business, a shareholder may
invoke the equitable powers of a court for relief. 6 It is just such equitable
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
It is established in Pennsylvania as elsewhere that a suit against directors for

misfeasance or misappropriation of corporate property is not one which can be
maintained by the shareholder in his individual capacity but that in such a suit
he acts fro the corporation in seeking damages or restitution of corporate
property and the suit is therefore derivative in nature. Kelly v. Thomas, 1912,
234 Pa. 419, 83 A. 307, 51 L.R.A.,N.S., 122. And it is also well established in
that state that a shareholders' derivative suit is to be regarded as quite distinct
from an action seeking relief for individual shareholders. Hornsby v.
Lohmeyer, 1950, 364 Pa. 271, 72 A.2d 294. In a secondary or derivative suit
the complaining shareholder brings before the court the corporation's cause of
action and it is the corporation which is the real party in interest. 7 It is the
rights of the corporation which are sought to be vindicated8 and restitution is
made directly to the corporation by the entry of a judgment in its favor.9 The
rationale of the rule is explained by the Supreme Court of Pennsylvania in
Beeber v. Wilson, 1926, 285 Pa. 312, 316, 131 A. 854, 855-856, as follows:
'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."
We think, however, that under the law of Pennsylvania a shareholders' suit to

compel the declaration of a dividend must be regarded as brought to vindicate a
primary and personal right of the shareholders and not to enforce a secondary
right derived from the corporation as the real party in interest. We are
compelled to reach this conclusion when we consider who is the injured party,
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 of the district Court will be affirmed.
Act of April 18, 1945, P.L. 253, 12 P.S.Pa. 1321-1323
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
Pennsylvania Business Corporation Law, Section 701, 15 P.S.Pa. 2852-701;

Hopkins v. Union Canvass Goods Co., 1932, 104 Pa.Super. 264, 158 A. 301;
Jones v. Motor Sales Co. of Johnstown, 1936, 322 Pa. 492, 185 A. 809, 811
Jones v. Costlow, 1944, 349 Pa. 136, 36 A.2d 460
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
In re Goetz's Estate, 236 Pa. 630, 635, 85 A. 65
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
Compare Lydia E. Pinkham Medicine Co. v. Gove, 1939, 303 Mass. 1, 20

N.E.2d 482, with Green v. Philadelphia Inquirer Co., 1938, 329 Pa. 169, 174,
196 A. 32, 34, in which the court said: 'Her remedy, in case she was dissatisfied
with the corporation's dividend policy * * * would have been the remedy of any
other stockholder, a suit against the company and its directors.'
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

Thomas P. Knapp v. Bankers Securities Corporation Appeal of Bankers Securities Corporation, 230 F.2d 717, 3rd Cir. (1956)

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Thomas P. Knapp v. Bankers Securities Corporation Appeal of Bankers Securities Corporation, 230 F.2d 717, 3rd Cir. (1956)

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230 F.

Thomas P. KNAPP et al.

United States Court of Appeals Third Circuit.

Bernard G. Segal, Philadelphia, Pa., (Gilbert W. Oswald, Edward W.

The question which this appeal presents is whether a shareholders' action

The defendant corporation urges that a shareholder's suit to compel the

It is an elementary principle of corporation law that the declaration of dividends

It is established in Pennsylvania as elsewhere that a suit against directors for

We think, however, that under the law of Pennsylvania a shareholders' suit to

The order of the district Court will be affirmed.

Act of April 18, 1945, P.L. 253, 12 P.S.Pa. 1321-1323

Pennsylvania Business Corporation Law, Section 701, 15 P.S.Pa. 2852-701;

Jones v. Costlow, 1944, 349 Pa. 136, 36 A.2d 460

In re Goetz's Estate, 236 Pa. 630, 635, 85 A. 65

Compare Lydia E. Pinkham Medicine Co. v. Gove, 1939, 303 Mass. 1, 20

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