Jacobus v. Diamond Soda Water Manufacturing Co.

94 A.D. 366, 88 N.Y.S. 302

• Court: Appellate Division of the Supreme Court of the State of New York
• Decided: May 15, 1904
• Status: Published

Opinion

Laughlin, J.:

This is a statutory action brought by a director of the Diamond Soda Water Manufacturing Company pursuant to the authority conferred by sections 1781 and 1782 of the Code of Civil Procedure to prevent waste and injury to the property of the corporation, for the cancellation of a certain mortgage and bonds and for an accounting for mismanagement and for property wrongfully alienated. By the decision and interlocutory judgment the court has decreed the following relief: (1) The appointment of a receiver of the property of the Diamond Soda Water Manufacturing Company to take possession of its property, and manage its affairs until the interests of the parties may justify his discharge and the turning over of the property and management of the corporation to its officers; (2) that the receiver be authorized to discharge the indebtedness of the com-, pony and to institute legal proceedings to ascertain to what extent, if any, certain bonds of the company secured by the mortgage, referred to in the complaint, represent a valid indebtedness of. the company, and, if so advised, to institute proceedings to set aside said mortgage; (3) that the foreclosure of the mortgage and payment of interest thereon in the meantime be enjoined; (4) that the American Mineral Water Machine Company and its officers and agents be enjoined from managing, controlling, meddling or interfering with the business or customers of the Diamond Company or from occupying its offices or workshop; (5) that all agreements or contracts between the defendant companies relating to leases of machines or joint control of the business of the Diamond Company or the occupation of its offices or workshops by the American Company be canceled and annulled; (6) that all the defendants other than itself or the City Trust Company account to the Diamond Company for any and all of its moneys and property alienated, wasted, transferred or acquired by them or either of them and for the damages sustained by reason thereof, and that a referee be appointed to ascertain such damages; (7) that plaintiff. recover costs of all defendants other than the' Diamond Company and the City Trust Company, as trustee, together with an extra allowance, and (8) that the parties have leave to apply tó the court for such further order or judgment as may be necessary in the premises.

The principal contention on the part of the appellants is that the evidence is insufficient to warrant the relief granted. Their claim more definitely stated is "that no illegal, fraudulent or wrongful acts on the part of the officers or directors of the Diamond Company have been shown; that at most the officers and directors have only been guilty of errors of judgment uninfluenced by any dishonest motive; that their acts are as consistent with innocence as with fraud, and, therefore, the plaintiff has failed to establish a cause of action. An analysis and discussion of all the evidence would unduly lengthen the opinion and is unnecessary. We deem it sufficient to state certain salient facts which we regard established by the evidence, although in many instances there was conflicting testimony. The court adopted a short form decision, but in support of the judgment all facts warranted by the evidence are deemed to have been found. The Diamond Company is a domestic stock corporation. It was incorporated on the 26th day of July, 1896, for the purpose of manufacturing and selling or leasing machines for carbonating water pursuant to letters patent granted to the defendant Malmstrom and one Loewenstein, which were assigned to the company, and pursuant to improvements thereon. The company, a few months after its incorporation, established offices and a factory at Nos. 572 to 578 First avenue in the borough of Manhattan, N. Y. Prior to the year 1901 it had manufactured and installed under leases in drug stores, saloons, restaurants, clubs and hotels about 200 machines which were in successful operation and upon which it was receiving gross rentals on an average of $4.50 per week for each machine. Its annual reports for the years 1898 to 1901, inclusive, show that its assets exceeded its liabilities by from $2,000 to $4,000. During the nine months preceding October, 1900, its net profits were $9,000, and it was making net profits of about $1,000 per ni'bnth. It owed certain of its directors for moneys advanced, aggregating several thousand dollars; and it owed a few thousand dollars in addition. It had for a long time been' short of funds to pay current obligations and was constantly pressed for the payment of bills that were past due, especially in the fall of 1900. It is doubtful if it would have been able to continue operations had not one or more of the defendants Riglander, Rothschild and Strauss, while members of its board of directors, advanced moneys, indorsed its paper or ■ guaranteed its credit from time to time. No judgment, however, was obtained against the company. Its business could have been profitably enlarged if it had had more money. It was not in the fall of 1900 in,serious danger of becoming insolvent provided the advances made by these three directors were permitted to remain; but otherwise it was. Prior to 1897 it had only manufactured 16 machines; but there is testimony to the effect that before the end of that year it had completed between 232 and 240. This may be somewhat inaccurate; but it is manifest that the company was without capital to construct machines in accordance with the demand, and that it did not turn out a great number of new machines after the year 1897. Its expenses were considerable. Its outlay for gas alone was from $400 to $500 per month, and it had quite a force of employees repairing and constructing machines, inspecting those in use, and daily replenishing their supply of water. The inventor, Malmstrom, was in its employ on a salary as superintendent. The contract between him and the company by which it purchased and he assigned the letters patent provided that he should assign to the company any further improvements made upon the patent. Certain improvements thereon were thereafter patented and assigned to the company. In the fall of 1900 Loewenstein, one of the directors, resigned, and the plaintiff was elected in his place. About this time Malmstrom manifested dissatisfaction on account of the fact that the directors had not procured more capital, and expressed an intention of severing his relations with the- company. He had invented and was constructing the model of another machine for similar úse. The principal difference between it and the Diamond Company machine, so far as shown by the evidence, was a new device by which water was pumped into the carbonating cylinder from the water main automatically by electricity, whenever the water became low, which dispensed with pumping by hand required with the Diamond Company machine. There is evidence indicating that the new machine, although also differing somewhat in size from the old, was merely an improvement upon the old, in which event the Diamond Company, under its agreement with Malmstrom, would have been entitled to have the invention assigned to it; but the particulars in which the two machines differed were not brought out either pointedly or clearly upon the trial, and the evidence would not warrant a finding to that effect. The attention of the defendant Mulholland was accidentally drawn to the new machine, and he opened negotiations with Malmstrom for an assignment of the application for letters pátent thereon. In the latter part of January or fore part of February, 1901, the officers and directors of the Diamond Company were informed that Mulholland contemplated buying up the treasury stock and all other stock he could; that he intended to buy out the company and organize a company to manufacture the new machine invented by Malmstrom, and that Malmstrom was to enter the employ of the new company on a salary and receive a large bonus and a royalty in addition. In February or March Mulholland looked over the plant and books of the company. On the seventh or eighth of February Malmstrom resigned as superintendent, but not as director, and announced that he had sold out and entered Mulholland’s employ. He had, in fact, so contracted, and the agreement was subsequently consummated. About this time, at a meeting of the directors, a proposition, said to have come from Mulholland, for the purchase of the capital stock of the Diamond Company was submitted and discussed. The capital stock consisted of 3,000 shares of the par value of $100 each. Two thousand nine hundred of these shares were issued for the patent rights purchased by the company. The other 100 shares were subscribed for by the incorporators, the defendants Riglander and Rothschild and one Mark J. Straus. These subscriptions, were not paid and there'was a formal agreement on the part of all parties in interest that they were not to be paid at all. There is evidence to the effect that they were subsequently released in consideration of services rendered by the subscribers. The patentees pursuant to an agreement in writing made on the 12th day of August, 1896, delivered 1,000 of their shares to a trustee to sell for the benefit of the company. There were some sales of this treasury stock for which the company received about $18,000 in cash and the discharge of obligations amounting to about $5,000 more. There were also some sales of stock owned by individuals. Mulholland’s proposition was that those shareholders who had paid in cash to the company should receive the amount which they had paid with interest thereon, but that otherwise the stock should be exchanged for a proportionate amount of stock in the new company. The plaintiff objected to this proposition and contended that the stock issued for the patent should be considered on the same basis as the stock issued for cash, but he did not object to a sale on an equitable basis. The spokesman for a majority of the directors declared, however, that they would accept this proposition and if the minority did not they “ would be wiped out and receive nothing.” At about this time another proposition was submitted as coming from one Lehman, but which some of the evidence indicates also came from Mulholland, to purchase 600 shares of treasury stock at $25 per share. This was- conditioned upon Lehman being employed as manager and guaranteed an annual salary of $5,000 for three years, and he was to loan the company, if absolutely necessary, $10,000. This proposition was finally withdrawn. Mulholland negotiated the purchase of the stock held by the majority of the directors — four of the seven — who were also officers of the company, and other stock, constituting altogether a large majority of the stock of the corporation, in the main upon the terms proposed except that he reimbursed with interest those from whom he purchased regardless of whether they purchased from the company or from others. These negotiations were conducted through the directors Riglander and Sloss, the president and manager respectively, but principally through the former. At the time Mulholland negotiated the purchase of the stock he' likewise arranged to pay the claims of the directors for moneys advanced to the company, or at least led them to believe that he would do this .later on. In December, 1900, or January, 1901, Rothschild.and Riglander asked the company fa/the moneys which they had advanc'ed and which they knew it could not pay. At a meeting of the directors on the 4th day of March, 1901, and after those who had advanced money to the company had agreed upon a sale of their stock to Mulholland, the question of giving them security for the indebtedness was considered at their instance, and a resolution was adopted authorizing the issue of bonds to the extent of $100,000, secured by a mortgage upon the company’s property, $52,000 of such bonds to go to the directors for the indebtedness to them and to pay the remaining indebtedness of the company, a statement of which was presented aggregating that amount. No action was taken with reference to the use of the remainder, of the bonds. The plaintiff protested and voted against the resolution on the ground that those who advanced this money did so on the agreement that it was not to be repaid until there, were sufficient funds in the treasury to warrant the same and he charged’ that it was a scheme to give Mulholland control of the company and to render the stock of those who did not go in with him worthless. Two-thirds of the stockholders consented to the giving of this mortgage in the form required by section 2 of the Stock Corporation Law (Laws of 1892, chap. 688); but to most, if not all those thus consenting the inducement had been previously held out that Mulholland would purchase their stock as he did. Rothschild and Strauss as officers of the company executed the mortgage to the City Trust Company which bore date March 1, 1901, to secure an issue of bonds aggregating $100,000 with six per cent interest due in one year, the interest payable quarterly; and it contained the usual chattel mortgage clause authorizing the mortgagee to take possession before default if the debt was deemed insecure. Bonds for the indebtedness of the company to the defendants Riglander, Rothschild and Strauss according to the statement presented at such meeting and in accordance with the amount of such indebtedness, as testified to by them and not controverted, aggregating $39,000, were accordingly issued and shortly thereafter assigned to Mulholland who paid the face value therefor.

On the day that this mortgage was authorized the American Company was incorporated in Rhode Island for conducting a similar business to that conducted by the Diamond Company. The incorporators were Mulholland, the defendant Sloss, who was then a director and the manager of the Diamond Company, and the defendant Prindle and they became part of the board of directors. Mulholland was elected president and Sloss secretary. At meetings of the board of directors of the Diamond Company held on the twelfth and eighteenth days of March, respectively, four of its seven directors who Were the officers, having sold their stock to Mulholland, successively resigned, although their respective terms of office had not expired, and in their places the defendants Prindle, Kingsley, Barnes and Tuslca were elected. Sloss was elected president and became manager and Prindle was elected secretary and treasurer. At the same meeting of the board the defendant Sloss reported that the Diamond Company had more space in its shop than was needed for the economical management of the business and that the American Company desired to lease part of the shop and premises and to take possession at once and a resolution authorizing Sloss to .made a lease was adopted. Within a day or two thereafter the American Company established its place of business at the office and factory of the Diamond Company and assumed entire charge of its property and affairs. This was the situation oh the 30th day of April, 1901, when this action was commenced. On the first day of July thereafter, Sloss, who, as has been seen, was president of the Diamond Company and secretary of the American Company, reported to a meeting of the board of directors of the Diamond Company that he had effected an agreement with the American Company by which the latter was to have the right to maintain and operate all machines of the Diamond Company outstanding under leases and the right to build new machines under the Diamond Company’s patents, but at its own expense, and to receive the rents of the outstanding machines and those thereafter leased upon condition that it pay the Diamond Company a rental of twenty-five dollars per year for each large machine and. five dollars per year for each small machine, the expense of maintaining the machines- and manufacturing new ones to be borne by the American Company, but the Diamond Company was to pay “a little over” one-quarter of the office expenses, the precise amount apparently not having been definitely agreed upon. The board of directors of the Diamond Company thereupon adopted a resolution approving and ratifying this action of its president. Evidence was given on the part of the defendants tending to show that this arrangement between the defendant companies, although not ratified by the board of directors until the first of July, was in fact made at the outset when the American Company took charge. The contract apparently rested in paroi. It does not definitely appear how many small and how many large Diamond Company machines were in use at this time: or what would probably be the amount of rentals that it would receive from the American Company, but it is evident that that was left largely to the management of the latter company, and that the rentals would not. be sufficient to pay the principal upon the bonds when due, nor does it clearly appear that they would be sufficient to pay the interest. The American Company does not appear to have incurred any obligation to manufacture or lease Diamond Company machines. It merely obtained the right to do so. It seéms to have been left at liberty to supplant the Diamond Company machines with its own manufactured pursuant to Malmstrom’s new invention, the application for letters patent upon which he had assigned to the new company. The letters patent were granted but never issued. Shortly after the American Company took possession of the offices and factory of the Diamond Company, it took into its employ all the former employees of the old company, conspicuously posted its signs and replaced the blank forms and letterheads of the Diamond Company with its own and appropriated the old telephone number. The communications to the Diamond Company were answered, not in the name of that company, but by the American Company. The trade was given to understand in effect that the new company had superseded the old. Although it has manufactured and installed some new machines of the Diamond Company pattern it has in many instances replaced the Diamond Company machines with its own. It does not appear to have made any systematic effort to replace Diamond Company machines, but the prompt beginning and pendency of this action may account for its inactivity in that direction. Applications or inquiries concerning the cost or rentals of. the Diamond Company’s machines were answered by information calculated to lead to the purchase or leasing of the American Company’s machines in preference. This was the course of business from the formation of the American Company and its taking possession of the property of the Diamond Company. In these circumstances it is not difficult to forecast the future of the Diamond Company if it is to be left to the American Company. It is a reasonable inference from the evidence that it was Mulholland’s purpose from the outset to obtain the control of the Diamond Company and to appropriate its property and good will to the benefit and advantage of the American Company; that the officers and directors of the Diamond Company who sold and transferred their stock to Mulholland were aware of his purpose and that the mortgage and bonds were given and the latter transferred to Mulholland with the purpose on his part of so managing the affairs of the Diamond Company through a majority control of those interested in the American Company as to bring about a default in the payment of interest and enable him to acquire the property of the Diamond Company by a foreclosure of the mortgage. That this would be the probable result of the action taken must have been known to the former officers and directors of the Diamond Company, and the fair inference is that the security was demanded and given in furtherance of this scheme. "Within all the authorities, therefore, the execution of the mortgage and bonds and the assignment of the latter should be deemed in fraud of the rights of the minority stockholders of the Diamond Company, and should have been annulled. (Gamble v. Q. C. W. Co., 123 N. Y. 91; Skinner v. Smith, 134 id. 240; Farmers' Loan da Trust Co. v. N. Y. & N. R. Co., 150 id. 410; People v. Ballard, 134 id. 269 ; Sage v. Culver, 147 id. 241; Barr v. N. Y., L. E. & W. R. R. Co., 125 id. 263; Pondir v. N. Y., L. E. & W. R. R. Co., 72 Hun, 384.)

The appellants further contend that the complaint should be dismissed for loches in bringing the action. The basis of this claim is that plaintiff knew the facts herein stated at or shortly after the time the various acts occurred. These matters all occurred in a comparatively brief period of time. Prior to the authorization of the mortgage and bonds and to the incorporation of the American Company on the fourth day of March, nothing tangible had taken place to warrant the commencement of the action. Only a month elapsed thereafter before the action was brought. In the circumstances, it cannot be claimed that the plaintiff was not justified in waiting a reasonable time for further developments, and until something occurred directly between the companies to the prejudice of the Diamond Company. The court, therefore, would not be warranted in dismissing the complaint on the ground of loches.

The appellants also claim that the complaint should have been dismissed for want of equity. This is based upon the fact that the plaintiff and the other minority stockholders who retained their stock were offered an opportunity at the time to sell their stock upon the same basis as the majority stockholders, namely, to receive for stock for which cash had been paid to the company the amount of such cash, and for other stock a proportionate amount of stock in the new company, which offer was renewed upon the trial, together with the further offer to reimburse them the amount of any advances or disbursements made for the company, with interest. We fail to see merit in this contention as applied to the facts of the case at bar. The stockholders of the Diamond Company individually, acting in good faith for their own interests, were at liberty to sell their stock and to resign as officers and directors, but, being officers “and directors, they were not at liberty by concerted action to obtain security upon all the property of the company for advances made for the purpose of transferring the same, pursuant to a prior agreement, whereby they were to be paid the face value of their claims and accrued interest in cash and make a favorable disposition of their stock to the principal stockholder in a rival corporation, with knowledge of his purpose and intent to use the same for the purpose of obtaining control and acquiring the property of the Diamond Company, and thus rendering the stock of the minority holders worthless.'

Prior to the commencement of the action the defendants Rothschild, Riglander and Strauss ceased to be directors of the Diamond Company and for this reason they contended that the action given to a director by virtue of the provisions of sections 1781 and 1782 of the Code of Civil Procedure is not maintainable against directors out of office. The object of the statute was to authorize an action to prevent waste and injury to the corporate property and to recover property of the corporation wrongfully and unlawfully disposed of and damages of and an accounting by the wrongdoer. They were necessary parties because part of the relief demanded was the cancellation of the mortgage and bonds given for their benefit. But aside from this the efficiency of the statute would be seriously impaired were it held that the action could only be maintained against directors while in office.

It will be observed, however, that the court has not adjudged the invalidity of the mortgage or bonds or directed their cancellation. The court has merely decided in that regard that the security was fraudulently given with a view to enabling Mulholland to obtain the control and property of the corporation. The parties in interest all being before the court, in these circumstances it would seem that the court would have been justified in canceling the mortgage and bonds, because even though there be some actual indebtedness as a basis for their issue if the directors to whom it was contemplated that the bonds should be issued, were not entitled thereto or the issue was made for this fraudulent purpose, the mortgage and bonds could have been canceled without impairing the claim upon the actual indebtedness and an appropriate provision in the judgment would prevent its becoming a bar to the enforcement of any rights of the claimants or their assignee for moneys advanced to the company. However, as has been observed, so far as bonds have been issued secured by this mortgage, it appears that they were issued for a valid indebtedness. There is no evidence that the defendant Strauss agreed to allow his advances to stand until the company should be able .to pay the same without embarrassment. The only satisfactory evidence of any agreement on the part of the other parties to whom bonds were issued for advances made to allow their advances to await the financial convenience of the company is á letter, addressed by them to the company on the 21st day of December, 1896, in and by which they agreed to make no demand on the company for past advances made by them “ until such time as your company earns all or part of the amount advanced by us by the rentals of carbonators or the sale of carbonated water; or until your company sells treasury stock; provided, however, that Mr. Malmstrom and Mr. Loewenstein continue their services to your company as at present and faithfully discharge their duties,” In the fall of 1900'Loewenstein resigned as a director and Malmstrom resigned. Ms position as superintendent prior to the giving of this mortgage. It thus appears that the relations .of these parties to the company had changed and the defendants Riglander, Rothschild and Strauss, who made the agreement, were not prohibited by the terms thereof from then demanding their advances, or security therefor if demanded in good faith. But ás has been seen they demanded and obtained the security in bad faith. They intended to use the bonds to effect a sale of their stock and to realize on their claims at once, well knowing that the only object of the purchaser was to compass the ruination of the company, the management of whose affairs was in their hands as trustees, and at a time when they knew the company, if pressed for payment then, or when the indebtedness by the terms of the mortgage became due, would be unable to meet the obligation and would very likely be subjected to a foreclosure and sale of all its property. It is, however, difficult to see what they may be required to account for at the present time, so far as the mere giving of the mortgage and bonds is concerned. The inference is fairly justified that they were aware of Mulholland’s purpose to acquire the control and management of the affairs of the Diamond Company and to conduct its affairs in the interest of himself and the other stockholders of the American Company, and that the execution of the mortgage and bonds upon the property of the Diamond Company to secure the same were desired by him-in furtherance of that purpose. In view, therefore, of their trust relations with the company, the court would have been justified in canceling the bonds and mortgage, as all the parties in interest are before the court. In these circumstances Riglander, Rothschild and Strauss are liable for the damages sustained by the Diamond Company in consequence of their acts in turning its affairs over to the new rival company, at least so far as the interests of the non-consenting stockholders are concerned. (Farmers' Loan & Trust Co. v. N. Y. & N. R. Co., supra; Skinner v. Smith, supra, and other cases, supra.)

The defendants Kingsley, Barnes and Tuska, three of the new directors of the Diamond Company, were charged with actual fraud, and they were, therefore, justified in defending the action. They were not called as witnesses, nor was Mulholland. The inference is doubtless justified that they became directors at the instance of Mulholland; but it does not appear that they knew of any fraudulent purpose on his part, nor is it shown that they were aware that any of the officers, directors or stockholders of the Diamond Company had any objection to the arrangement subsequently made between the two companies. Kingsley has only five shares of stock. His only connection with the American Company is that he is an attorney in the office of its attorneys. Tuska, who represented one of the directors' in closing his transfer to Mulholland and Barnes, is an employee of the American Company. For aught that appears, they may -have supposed that there was a common understanding, assented to by all parties in interest, to make the contract and establish the relations that were subsequently made and established between the companies. If so, no stockholder could complain. (Skinner v. Smith, supra; People v. Ballard, supra.) The plaintiff remained a member of the board of directors, and it does not appear that he protested or voted against the subsequent proceedings or 'the taking possession of the offices and factory of the Diamond Company by the American Company, or in any manner complained to these three defendants. They are, however, proper parties to the action, and although, so far as appears, they may have acted innocently, the minority stockholders, neither having assented to the arrangement, nor having done anything to estop them from demanding" an accounting for mismanagement, are entitled to such an accounting even against the directors who may have acted in good faith, for the reason that it is manifest that it was not a mere temporary arrangement, such as it was intimated in Denike v. New York & Rosendale Lime & Cement Co. (80 N. Y. 606) might be legal; but one by which the entire property, including the good will of the Diamond Company was turned over to the management of a rival company without any restrictions or limitatians for the protection of the stockholders. The arrangement was clearly ultra vires (People v. Ballard, supra) and a constructive fraud upon the stockholders of the Diamond Company. The Diamond Company virtually suspended the functions for which it was incorporated, and of this any of the stockholders who were riot parties to the arrangements, or the State, might complain and demand a restoration. (People v. Ballard, supra.) The directors, therefore, may be required to account: but, for the reasons stated, cost's should not be imposed against the three directors last named. Although there is no demand for the removal of the directors or the election of others in their stead, the court in these circumstances acquired jurisdiction to appoint a receiver (Code Civ. Proc. § 1810, subd. 1; Halpin v. Mutual Brewing Co., 91 Hun, 226, 227); and if it shall become necessary, the directors may hereafter be removed and others elected or appointed in their places. (Code Civ. Proc. § 1781, subd. 4.)

The exceptions taken upon the trial, and the other points raised by the appellants have been examined, but we think they do not present reversible error, or merit special discussion.

It follows, therefore, that the interlocutory judgment should be modified by eliminating the provision awarding costs against the-defendants Kingsley, Barnes and Tuska; and as thus modified, it should be affirmed, with costs against the appellants other than Kingsley, Barnes and Tuska.

Van Brunt, P. J., O’Brien and Hatch, JJ., concurred.; Ingraham, J., concurred in result.

Judgment modified as directed in opinion, and as modified affirmed, with costs against the appellants other than Kingsley, Barnes and Tuska.