Equity Corp. v. Groves

60 N.E.2d 19, 294 N.Y. 8

• Court: New York Court of Appeals
• Decided: January 16, 1945
• Status: Published

Opinions

Lehman, Ch. J.

In the first seventeen paragraphs of the amended complaint, plaintiff sets forth a series of alleged acts by the defendant which “ constituted part of a plan and scheme on his part to defraud Chain and General and to make large, illegal and secret profits by the improper and illegal Use of the money of said corporation and at the expense of said corporation, all in violation of his fiduciary duty to said corporation and its stockholders and in oppression of said corporation.” These acts, it is said, were carried out by domination and control of a majority of the directors of “ Chain and General ” and of “ Interstate,” two corporations later merged in the plaintiff, which the defendant could exert through his ownership of the corporate stock. The successful culmination of these alleged wrongful acts ,was the sale to Chain and General, on November 4,1931, of stock of Interstate, “ resulting in a profit to defendant of $361,258.50 ” at the expense of Chain and General.

The defendant does not challenge the sufficiency of these allegations to constitute a cause of action for an accounting of the profits thus made by him, but since the profit to the defendant does not exceed the correlated loss suffered by the corporation and the plaintiff knows the amount of the profits even in advance of an accounting and has stated their amount in the complaint, the six-year Statute of Limitations must be applied to an action to recover such profits (Dunlop’s Sons, Inc., v. Spurr, 285 N. Y. 333) and would bar recovery in this action more than six years thereafter. The plaintiff does not contend otherwise, but in succeeding paragraphs contained in the amended complaint the plaintiff has alleged that thereafter the defendant “ used the funds representing the profits accruing to him by reason of said sale, or a large part thereof, to purchase a large block of the Common Stock of Yosemite Holding Corporation that the stock so purchased was thereafter exchanged for stock of the plaintiff, and that “ in or about May of 1933 the defendant caused his said stock of the plaintiff, or a large portion of it, to be sold, by reason of which defendant realized large profits.” It is to be noted that the complaint does not allege that the transaction in Yosemite Holding Corporation stock was wrongful or had any connection with the earlier transaction consummated in November, 1933, except that the profits resulting from the later transaction were made by the defendant upon the resale to a third party of stock bought by the defendant from a third party by the use of “ funds representing the profits ” accruing from the earlier wrongful transaction or a “ large part thereof.” If upon equitable principles the defendant must account to the plaintiff for profits he derived through the later transaction as well as the profits derived by him “ at the expense ” of Chain and General through sale of Interstate stock obtained with intent to sell to Chain and General, then resort to equity would be necessary to obtain adequate relief and the ten-year limitation provided by section 53 of the Civil Practice Act, would apply. Chapter 851 of the Laws of 1942 adding a new subdivision to section 48 of the Civil Practice Act, of course does not affect this action, previously commenced.

Directors of a corporation and in some cases stockholders who dominate and control a corporation, occupy a “ position of partial trust ” (4 Pomeroy’s Equity Jurisdiction [5th ed.], § 1090). Their relation to the corporation is fiduciary in character and they may be held accountable in equity for detriment to the corporation caused by their breach of the fiduciary obligation arising from that relationship and for profits resulting to them from such breach. Allegation and proof that the loss of the corporation, or the profit of the unfaithful fiduciary, resulted from his wrongful use of a fund subject to a trust, either express or constructive, which may be followed in spite of changes of form, is not an element of a cause of action for such an accounting. That cause of action exists even where the delinquent fiduciary has never received any corporate property or moneys which by the use of a legal fiction might be treated as a trust fund.

This court speaking through Cardozo, J., has -said: “ A constructive trust is the formula through which the conscience of equity finds expression.” (Beatty v. Guggenheim Exploration Co., 225 N. Y. 380, 386.) “ A constructive trust arises where a person holding title to property is subject to an equitable duty to convey it to another on the ground that he would be unjustly enriched if he were permitted to retain it. * * * An express trust arises because the parties intended to create it. A constructive trust is not based upon the intention of the parties but is imposed in order to prevent one of them from being unjustly enriched at the expense of another.” (3 Scott on Trusts, § 462.1.) It is analogous to a “ quasi contractual obligation ” and indeed the subject is treated by the American Law Institute “ in a separate restatement ” in connection with the subject of Quasi Contracts rather than in connection with the Restatement of the Law of Trusts. (See Scott, op cit., § 461, Restatement of the Law of Restitution, § 205, et seq.) Multifarious are the circumstances which may call for the imposition of a constructive trust. Some of the cases in which it has been imposed by the courts of this State are cited in the opinion of Judge Thacheb and it may readily be conceded, if the complaint had alleged, that the defendant did not pay back money which the defendant wrongfully constrained Interstate to loan to him, or that he sold to a third party the stock which it is alleged the defendant purchased with intent to resell to Chain and General at a profit, the power of a court of equity to impress a trust upon the money or stock and the proceeds of such money or stock might, in proper case, be invoked in order to obtain adequate relief. (Harrison v. Egan, 270 N. Y. 387.)

It is, however, undisputed that the moneys borrowed have been returned by the defendant to the corporate treasury and the stock purchased with intent to sell it to Chain and General has been transferred to that corporation at a profit. Where a trustee in breach of trust transfers a trust fund to a third party the wronged beneficiary may reach “ the product of the property in the hands of the trustee. This right to follow property into its product * * * is not limited to cases of express trusts. The principle is a broad one. It is applicable not only where the wrongdoer is an express trustee, not only where he is a fiduciary, but whenever a person wrongfully transfers property in which another has the beneficial interest, whether legal or equitable, and receives other property in exchange therefor.” (3 Scott, op. cit., § 507.)

The problem here presented is whether in accordance with that principle equity will impose a trust not only on money wrongfully borrowed by the defendant and upon stock purchased ■ with intent: to resell to Chain and General, but upon profits derived thereafter by the defendant from a sale to a third party of stock purchased from a third party by the use of profits made upon the earlier sale to Chain and General.

There seems to be no difference of opinion in this court that the profits derived from the later transaction are not proceeds of the moneys borrowed wrongfully by this defendant. As Judge Thacher in his opinion points out that loan is important in this case, if at all, only as it shows the unconscionable means by which the defendant was enabled to make a profit by the purchase of stock with intent to resell to a corporation which he dominated and controlled. If the defendant bought the stock, as alleged, then the corporation to which he intended to resell the stock might insist that the title so acquired was held by the defendant for its benefit. “ He was under duty, on request of the corporation, to transfer the property to the corporation at cost.” The stock would be held by him under a constructive trust to carry out that duty and “ he could not rid himself of this trust ” by transfer of the stock to another. (N. Y. Trust Co. v. American Realty Co., 244 N. Y. 209, 219.) Nor could he rid himself of that duty by transfer at a profit to the corporation to which he was under a duty to transfer it at cost. For the profit thus wrongfully exacted he was bound to account, as any other fiduciary would be compelled to account for profits gained by breach of his obligation, though obviously after the transfer of the stock to the corporation for whose benefit the stock had been held in trust, the trust itself was otherwise at an end. The defendant does not challenge the right of the plaintiff to recover the profit obtained by a sale of the stock at more than cost, but no resort to equity is necessary for such recovery. The ten-year statute applies only if the corporation is entitled to recover not only the profits derived by the delinquent fiduciary from his breach of trust, but also the profits derived by the delinquent trustee from subsequent transactions in which the fiduciary used the ill-gained profits.

In every case which has been cited as authority to sustain such recovery the defendant has in breach of his trust — express or constructive — disposed of property belonging to another, or in which that other had a beneficial interest and consequently he could no longer convey that property to the beneficial owner. Only in such case has equity permitted the beneficiary to follow the trust property into other property for which it has been exchanged and if the property received in exchange thereafter increases in value the beneficiary in such case is entitled to the benefit. Here the beneficiary must concededly return profits which he made by breach of his fiduciary obligation. In no cited case has the beneficiary of a trust, express or constructive, been permitted to recover also the profits made by the fiduciary through use of such profits in other transactions and the principle upon which it has been held that a wronged beneficiary may reach the product of a trust fund does not justify such recovery. Accountability of the fiduciary has always been limited to the “ direct product which he receives from the property.” (See Restatement of the Law of Restitution, § 205.) (Italics are new.)

If the court should now decide that the defendant is accountable for the profits derived from the sale of securities purchased out of the profits the defendant derived from dealings with the corporation in which the defendant had breached his fiduciary obligation, then we must in effect discard the rule recently formulated in Dunlop’s Sons, Inc., v. Spurr (285 N. Y. 333, supra) and must hold that in every case the ten-year statute applies. True, in the cited case the complaint did not contain the allegations, which are contained in the complaint we are now considering, that the profits obtained by the defendant at the expense of the corporation in the transaction in which the defendant violated his fiduciary obligation were there after invested in other securities, and that additional profits were made by the subsequent sale of such securities. No valid distinction can, we think, be based on that difference. In each case the corporate plaintiff seeks and is entitled to recover from the defendant all the profits derived by the defendant in violation of his duty to the corporation and in each case the question presented is whether an accounting in equity is necessary in order that the plaintiff may recover all such profits. In each case, too, the complaint shows that the gains derived by the defendant from the transaction in which he violated his duty “ do not exceed the correlated losses suffered by the corporation.” (Dunlop’s Sons, Inc., v. Spurr, 285 N. Y. 333, 336.) An accounting in equity is necessary for complete relief in cases in which the amount of the gains which the corporation may recover may exceed the " correlated losses suffered by the corporation ” in an amount which can be determined only upon an accounting. If, as now contended, those gains may include not only the profits derived by the fiduciary in violation of his duty, but also the gains which the fiduciary may derive from subsequent sale of securities purchased “ by the use of the funds representing the profits ’ ’ accruing to him as the result of his earlier wrong, then it is difficult to conceive of a case where it can be said that the six-year statute would apply because no accounting in equity is necessary to enable the plaintiff to recover all the profits to which it may be entitled. The possibility always exists that the original profits may have been used to purchase securities which have increased in value or have been sold at a profit. Without an accounting the corporation might not be able to find out whether the original profits have been reinvested profitably. That might occur even after the action is brought, and if the plaintiff is entitled to the benefit of a profitable reinvestment, it seems to us that it cannot lose its rights by failure to plead that the defendant has or may have made such reinvestment. Thus, no valid distinction can be based upon the fact that in this case the profitable reinvestment has been pleaded. See, also, Hastings v. Byllesby & Co. (Haystone) (293 N. Y. 404) in which this court rejected the claim that the corporation was entitled to recover profits made upon a resale of securities purchased from the corporation, though in that case, as in the instant case, such profitable resale was pleaded.

The judgment should be affirmed, with costs.