Urner v. Sollenberger

43 A. 810, 89 Md. 316, 1899 Md. LEXIS 53

• Court: Court of Appeals of Maryland
• Decided: June 20, 1899
• Status: Published

Opinion

McSherry, C. J.,

delivered the opinion of the Court.

This is a suit by the trustee of an insolvent foreign corporation to recover from a stockholder the unpaid balance due- on his subscription to the capital stock. The Roanoke Development Company of Virginia, after a brief career, made an assignment to the appellee for the benefit of its creditors. The company was one of the many ephemeral and speculative concerns, which, a few years ago, suddenly sprang into existence throughout portions of Virginia and Maryland, and perhaps elsewhere, and deluded the credulous and confiding by the promise of fabulous gains, and frequently misled the conservative and cautious to believe that obscure localities would, under their stimulating influence, speedily grow into permanent and important centres' of commercial and manufacturing activity. It soon went the way of all such ventures and hopelessly collapsed. Amongst the assets which the deed of trust conveyed were the appellant’s and other unpaid subscriptions. To the declaration filed in the cause, in addition to the general issue, there was a plea by way of equitable defence which raises the material question to be disposed of on this appeal. The deed of trust is peculiar in that it sets forth specifically the indebtedness due by the company, and for the payment of which this and other like collections from stockholders are being made. An outline of the prominent facts will disclose the precise nature of the controversy.

The Roanoke Development Company was organized in eighteen hundred and ninety. It issued a prospectus in which it was stated that the company proposed to purchase thirteen hundred acres of land adjacent to Roanoke; that the capital stock was one million one hundred thousand dollars, of which five hundred thousand dollars are “for the purchase of the property. ” There were eight directors of the company, five of whom were residents of Roanoke, and three resided in Philadelphia. Terry, Jamison, Simmons, Sands and Gale were the Roanoke directors. In September and December, 1888, February, 1889, and March and June, 1890, Terry acquired sundry parcels of land for the aggregate sum of $37,600. On October the eleventh, eighteen hundred and ninety, Terry, who was the father-in-law of Jamison, conveyed this same property to Jamison for the consideration of one hundred and seventy-five thousand dollars, part of which was alleged to be cash, and part the promissory notes of the purchaser. The deed was acknowledged on November the twenty-fifth, 1890. On the same October the eleventh, Jamison and wife conveyed this same property to the Development Company for a consideration of two hundred and seventy-five thousand dollars. The deed was acknowledged December the twenty-first, 1890. Thus, property which had cost Terry, a few months before, only $37,600, and which he had not fully paid for, was turned over to Jamison at a profit to Terry of $137,400; and on the same day was turned over to the company at a profit to Jamison of $100,000. The whole of this consideration of $275,000 (except $30,201.29, which was cash), was made up of the company’s promissory notes to Jamison for $87,306.05, and of Jamison’s notes to Terry for $i 39,201.29, which had been given by Jamison to Terry for this very same land, and the payment of which the company assumed, and also of something over $18,000 of Terry’s notes to the parties from whom he had purchased this same land, the payment of which was likewise assumed by the company. On October the eleventh, 1890, Jamison and Simmons conveyed to the company another parcel of land in consideration of $100,000. This land they acquired from Terry on March the first, 1890, for $23,500. On October the seventeenth, 1890, Routt and Dennison conveyed to the company another parcel of land for $125,000. The land belonged to Routt. Dennison had an option on it for $81,000. Less than a year before, Routt had purchased the same property for $13,600. Dennison’s share in this transaction amounted to $43,123,50. Routt received in cash $10,234.74. Thus, land which had cost these directors and promoters something over $70,000, was turned over to the company by them for $500,000, some of which consideration was paid in cash, but much the larger part either in notes of the company, or in notes given by some of these directors to other directors, and of which the company assumed the payment.

These transactions, by which the directors and promoters secured to themselves an enormous profit at the expense of the stockholders, whose interests they were bound to protect and were forbidden to betray, were gross and glaring acts of fraud which nothing can justify or excuse, and which no attempt has even been made to palliate. Subscriptions obtained to the capital stock of the company, when the subscribers were ignorant of these reprehensible deals, and when they were, in addition, assured that there was no promoters’ fund or advantage, were subscriptions obtained by fraudulent means and were revocable by the deceived subscribers, if rescinded by them whilst the company was a going concern, and within a reasonable time after the discovery of the fraud. Wenstrom, &c., Co. v. Purnell, 75 Md. 113. This proposition had been so often announced that it may be re garded as finally and definitively settled; and we do not understand that it is either questioned or denied. An effort to rescind the contract of subscription was made. The facts upon which its legal sufficiency depended were referred to the jury under appropriate instructions, and they have been found against the stockholders, and there is, therefore, no question of that kind to be considered on this appeal.

But fraudulent transactions like these may not only affect the liability of the subscriber to the company on his contract of subscription, but they are voidable as between the guilty director and promoter, on the one hand, and the company and its shareholders, on the other. Whilst the shareholder may have lost, by his laches or by his acquiescence, the right to rescind his contract of subscription on this ground, and may, in consequence, remain liable to pay his subscription when lawfully demanded; still such dealings between directors and the company of which they are directors, for their own personal gain and in violation of the trust which their positions impose, are voidable unless ratified by the.company. If they are fraudulent they are voidable because fraudulent (Brantly on Contracts, 158) ; and it comes to the question whether, when a stockholder is sued by the company or by a trustee, standing in the place of the company, to recover his unpaid subscription, and 'he has lost the right to rescind his contract of subscription, he may successfully resist the demand, if the voidable contracts between the company and its directors have not been disaffirmed, and if the purpose of the suit against him is to collect money from him, which is to be appropriated in part to the payment of the very obligations given by the company to the directors in execution of the voidable contract? Can he, when thus sued, disaffirm the voidable contract between the company and its directors, and thereby nullify the obligations so given by the company to its directors, and defeat, altogether, a recovery against himself, even though some of the claims, towards whose partial payment this unpaid subscription, when collected by suit, wrould be applied, are claims unaffected by and not growing out of the -fraudulent conduct of the directors ?

This presents an inquiry as to the effect of a voidable contract of the character of those under consideration. Is it inoperative unless ratified ? Or, is it operative unless dis-affirmed ? The doctrine on this subject is as well stated in Thomas v. Brownsville R. R., 109 U. S. 522, following Twin Lick Co. v. Marbury, 91 U. S. 587, as anywhere else: “ Such contracts are not absolutely void, but are voidable at the election of the parties affected by the fraud. It may often occur that, notwithstanding the vice of the transaction, namely, the directors or trustees, or a majority of them, being interested in opposition to the interest of those whom they represent, and in reality parties to both sides of the contract, that it may be one which those whose confidence is abused may prefer to ratify or submit to. It is, therefore, at the option of these latter to avoid it; and until some act of theirs indicates such a purpose, it is not a nullity. ” Whilst an utterly ineffectual attempt to ratify these sales was made by the board of directors on the nineteenth.of January, 1891, there is no pretence that either the corporation through its directors, or its stockholders, ever disaffirmed or repudiated them. This being so, and these contracts being voidable, by whom can they be avoided ? Obviously only by one of the parties to them. As the party who has been guilty of the fraud cannot rely on his own bad faith and misconduct to annul the obligation he has incurred under the voidable contract, it follows that the other, or defrauded party, alone can disaffirm. In this instance that party is the company. It comes then to the question, how can the company act ? Generally speaking, the right to disaffirm cannot be exercised by the stockholders separately, but it must be exerted collectively ; because there cannot be both an affirmance and a disaffirmance of one and the same transaction, and this might readily result if one stockholder had the power to disaffirm and 'another an equal power to affirm. ■ The power to disaffirm is contained in the power to affirm. If it pertains to one stockholder, acting for himself, it pertains to every other one as well. If one, acting for himself, should disaffirm and another should affirm, precisely opposite results would be attained, and both would be equally binding, not merely as respects the particular stockholder so disaffirming or affirming, but as respects the corporation ; because it is the thing —the contract — that is disaffirmed or affirmed, and not the mere personal relation of the stockholder to it. As a consequence, if the thing could be thus both affirmed and dis-affirmed, the anomalous situation would be presented of one and the same contract being alike inoperative and effective, at one and the same time, with reference to one and the same transaction. If one shareholder, owning a single share, cannot bind the corporation by a ratification of such a contract —and he cannot unless his act be the act of the company — it is difficult to see how the power to disaffirm, which is no greater or more extended than the power to ratify, can be availed of by the same stockholder to strike down, for his individual benefit, a contract which the majority of stockholders may have acquiesced in or may have precluded themselves from disturbing.

Of course we do not mean to question, by anything we have said, the doctrine followed in Davis v. Shaw, 78 Md. 316. A minority stockholder may undoubtedly invoke the aid of a Court of Equity by a bill of complaint when the corporate transaction assailed is ultra vires, illegal or fraudulent ; and upon satisfactory proof the Chancellor may strike down the contract and restrain its execution. The relief granted in such a case would be affirmative relief. The plea by way of equitable defence, in the case at bar, seeks to substitute an election by a single stockholder to disaffirm, for a decree of a Court of Equity annuling a voidable contract. But we are dealing with the power to disaffirm and not with the right to appeal to a Court of Equity to procure the annulment of a fraudulent contract by a decree. One is the act of a party; the other is the act of a Court of Justice. The two things are essentially different.

Bearing in mind that the transactions denounced are only voidable, and therefore do not need ratification to make them valid, it is obvious they are binding until properly avoided. It must be a corporate act that avoids them, if they are avoided by a disaffirmance, and not by a decree; and that corporate act must be done either by the directors or the stockholders. All corporate action must be taken by at least a majority of those who are authorized to act for the corporation — whether they be directors or stockholders— and as a disaffirmance — not a judicial annulment — of these contracts could only have been effected by corporate action, it could only have been accomplished by the action of a majority of the directors or stockholders. “The rule is that the majority governs, and every stockholder contracts that such shall be the rule.” 1 Mor. Cor., sec. 474; Hart v. Ogdensburg & L. R. R. Co., 89 Hun. 316. This is the pivotal point of the case.

Now, whilst the deed of trust includes, amongst the claims to be paid some of the notes given by the company in consideration of these sales by the directors to it, there are also enumerated other debts,,which are not tainted in the same way. Some of these notes are apparently in the hands of the original payees ; some have gone into the possession of other holders, and part of the indebtedness, for the payment of which the deed provides was, according to the evidence in the record, incurred for money borrowed by the company from other parties. The rights of these alleged innocent holders are not before us, and were not and could not have been before the trial Court. As to them it is obvious, if the stock subscription has not been rescinded, the liability of the stockholders is unimpaired by any fraudulent dealings between the directors and the company, for the unpaid subscriptions are a trust fund for the payment of debts. Rider v. Morrison, 54 Md. 429. And, as to the original payees, their right to participate in the fund depends, not upon the nature of their contract, that is, not upon whether it was a contract that might have been, but was not, dis-affirmed, but upon whether there is a contract that is still subsisting, because it has not been disaffirmed by the only party who could disaffirm it, or has not been annuled by judicial decree.

Though one of the objects designed to be accomplished by the deed of trust was the ratable distribution of the assets amongst all the creditors, including the holders of the notes given in execution of these voidable transactions ; it cannot be said that the deed “ by its terms may operate as an instrument in aid of the fraud,” (Farrell v. Farnan, 67 Md. 81), because, confessedly, there are claims which are free from any suspicion of fraud and which the deed directs to be paid; and, because, even those growing out of these sales are dependent on contracts which were merely voidable and have not, so far as the record discloses, been avoided, and are, therefore, still obligatory. In a word, the whole question comes back to the proposition that a voidable contract of this character is not a void contract, but is “binding until avoided.” Clark on Corp., 513.

With these observations, we come to the rulings on the prayers. The plaintiff’s secoyid and third prayers and the defendant’s first (all of which were granted) submitted to the jury the question, whether after the discovery by the defendant of the fraud, by the practice of which he had been induced to subscribe to the company’s capital stock, he rescinded his subscription in a reasonable time. These instructions are free from error. The defendant’s second prayer proceeds upon the theory that if the fraudulent and voidable sales made by the directors to the company ‘ ‘ were never submitted to the stockholders of said company for ratification,” and if the trustee named in the deed of trust had knowledge of these transactions and accepted the deed, “ for the purpose of enforcing the same against the stockholders, * * * the deed of trust is void.” But the vice of the prayer lies both in the premise and in the con elusion. It is ei'roneously assumed in the former, that a. failure to submit these voidable sales to the stockholders, for ratification, of itself, operated to avoid the sales, whilst, precisely the converse, that a voidable contract is valid until disaffirmed, is the rule ; and in the conclusion it is asserted that the deed of trust is void because these voidable contracts were not ratified and because the trustee accepted the deed with a knowledge of the circumstances attending the consummation of those sales. The conclusion, that the deed of trust is void, is again faulty, because it disregards the principle thus stated in the appellant’s brief, “that the mere presence of fraudulent claims, along with honest ones, in a deed of trust need not invalidate the deed.” The voidable contracts of sale, and the deed of trust are distinct and different acts, and their validity must be determined according to their respective merits. The making of the previous fraudulent contracts did not deprive the corporation of the right to make a deed of trust of all its property for the equal benefit of all its creditors. Horwitz, Garnishee, v. Ellinger, 31 Md. 492. The defendant’s third prayer was wrong, because it assumed as a legal postulate, that no valid sale of land could be made to the company by its directors, unless the purchase was either authorized or ratified by all the stockholders. The contention that the contract could not be ratified except by unaminous consent of all the stockhold^ ers cannot be maintained. That principle does not apply to acts which might have been authorized by a majority in the first instance. San Diego, &c., R. R. Co. v. Pacific Beach Co., 112 Cal. 53 ; S. C., 33, L. R. A. 788. Such a sale would be voidable, and as we have seen, a voidable sale is valid until disaffirmed — it is not invalid until ratified. The same fault is the basis of the fotirth prayer, for this prayer asserts that the purchases by the company from its directors were not purchases of land within the terms of the prospectus, because there is no legal evidence that such purchases were authorized or ratified by the corporation. This, as we have pointed out, is precisely the converse of the true doctrine.

(Decided June 20th, 1899).

This is not a case where stockholders are seeking redress against delinquent directors as in Booth v. Robinson, 55 Md. 419 ; nor can the plea by way of equitable defence confer upon a Court of Law the jurisdiction of a Court of Equity. Taylor & Bradford v. State, use of Miller, 73 Md. 222. In such a plea, under Sec. 83, Art. 75 of the Code, the facts pleaded must show a case where a Court of Equity would restrain the execution of the judgment; and accordingly it has been held that the defendant in an ejectment proceeding could not plead that the deed under which the plaintiff claimed, had been executed in fraud of the rights of the creditors under whom defendant claimed, because the remedy of the defendant was to have the conveyance set aside in equity. Williams v. Peters, 72 Md. 584.

The verdict and judgment in the Baltimore City Court wmre rendered in favor of the plaintiff, the trustee, and against the defendant stockholder for the amount of the unpaid balance due on his subscription to the capital stock. We find no errors in the rulings of the trial Court. We cannot conclude this opinion without condemning in the strongest terms the culpable and atrocious fraud practised upon the appellant to induce him to become a stockholder; and but for the fact that the jury have declared he failed to repudiate the subscription in a reasonable time after discovering the deceit, he would be released from all liability. As the case now stands, however, we are obliged to affirm the judgment.

Judgment affirmed tuith costs.