CONTINENTAL SECURITIES COMPANY and CLARENCE H. VENNER, Stockholders in the Interborough Rapid Transit Company, on Behalf of Themselves and All Other Stockholders Similarly Situated, and on Behalf of the Said Interborough Rapid Transit Company, Respondents,
AUGUST BELMONT and Others, Appellants, Impleaded with the INTERBOROUGH RAPID TRANSIT Company, Defendant.
APPEAL by the defendants, August Belmont and others, from an order of the Supreme Court, made at the Nassau Special Term, and entered in the office of the clerk of the county of Nassau on the 9th day of February, 1912, denying the said defendants' motion for judgment on the pleadings.
Joseph S. Auerbach [De Lancey Nicoll, Courtland V. Anable and Charles H. Tuttle with him on the brief], for the appellants.
J. Aspinwall Hodge [Stephen M. Yeaman with him on the brief], for the respondents.
The defendants appeal from an order of the Special Term in Nassau county that denied their motion for judgment against the plaintiffs on the pleadings. The plaintiffs are stockholders of a domestic corporation known as the Interborough Rapid Transit Company, and as such hold some 300 shares of stock out of a total issue of 350,000 shares with a capitalization of $35,000,000. As such stockholders they seek to maintain this action for the benefit of themselves and such other stockholders as may join with them to recover from the defendants a very large sum of money aggregating several millions of dollars. The law governing generally actions of this character has been declared and applied so repeatedly in recent years as to require no present citation of authorities. The cause of action is not in the plaintiffs themselves but is derivative, that is to say, such cause of action is derived from the right of the corporation itself and can be asserted only when the corporation itself neglects to assert it to the detriment of its stockholders. Therefore, the complaint should set forth such facts as disclose
a cause of action in the corporation itself and a refusal or neglect on the part of the corporation to bring an action thereon to the damage of its stockholders. Every such complaint must allege facts which show that the plaintiffs either demanded from the corporation the bringing of an action in its own name for the protection of its stockholders or the existence of such a state of facts which should dispense with such demand as futile. These circumstances arise generally when the corporation is under the control of the persons against whom the cause of action exists, or of those whose unlawful acts participated in the wrong from which the cause of action arose, or when there is danger that the cause of action may be lost through lapse of time, if a demand upon the corporation itself be resorted to. Without particularizing the matters set forth in the complaint in this action, it is clear that it sets up, assuming its allegations as true, a cause of action in favor of the corporation against the defendants for a fraudulent spoliation of the corporation by the defendants while acting as its officers. Likewise does the complaint set up that the plaintiffs as stockholders demanded from the directors that the corporation should bring an action against the defendants, and that such demand was ignored. The corporation itself, as was necessary, was made a party defendant in this action, and it has answered denying the substantial allegations of the complaint and demanding judgment for a dismissal thereof. The defendants contend, however, that the complaint is not sufficient to sustain the plaintiffs' derivative cause of action because it does not set up, either at all or in form of pleading sanctioned by the rules of pleading, that the plaintiffs, after the refusal of the directors of the corporation to comply with their demand, ever appealed to the general body of the stockholders, or it does not disclose facts which should dispense with such appeal as futile. The learned court at Special Term (See 75 Misc. 234), was of opinion that the complaint contained allegations which dispensed with the necessity of an appeal to the general body of the stockholders. In the disposition which we are about to make of this appeal we shall not discuss this point of the decision at Special Term, but shall consider the case entirely as if the complaint were silent as to this circumstance. It is important that such questions of law arising
in this action as can be now determined in advance of trial should be so determined in order that there be no possible waste of time and money hereafter in the conduct of the action.
It is true that it is stated in many standard text books and in the great legal encyclopedias that the general rule applicable to this character of actions requires that the plaintiff stockholder shall plead and prove that he had made a demand upon the managing body of the corporation, and upon its refusal or neglect to comply with such demand that he had appealed to the general body of the stockholders, or that he should allege the existence of such facts which should render either the demand or appeal futile and, therefore, unnecessary.
It is likewise true that in the very great number of reported decisions of this State there is to be found no case in which such rule has been declared and applied as a principle of decision in this character of actions. The chief authority in this country upon which such rule is attempted to be based is the opinion of the United States Supreme Court in Hawes v. Oakland (104 U.S. 450). It is true that it is there declared to be essential to the maintenance of these derivative actions by stockholders that the plaintiff 'must show, if he fails with the directors, that he has made an honest effort to obtain action by the stockholders as a body, in the matter of which he complains. And he must show a case, if this is not done, where it could not be done, or it was not reasonable to require it.' This opinion was formulated after a consideration of various English and American authorities which the court considered as supporting its conclusions. It is a cardinal rule in the interpretation of judicial opinions that, in order to measure the scope of the decision, recourse must be had to the precise controversy then before the court. In that case the action was not brought to recover on behalf of the corporation and its stockholders for any alleged fraudulent spoliation of the corporation's assets. As the court declared as to the complaint then at bar: 'There is no allegation of fraud or of acts ultra vires, or of destruction of property, or of irremediable injury of any kind.' That action was brought by a dissatisfied stockholder simply to prevent by injunction the continuance by the corporation of a course of business which was alleged to be against the true
interests of the stockholders. The English decisions upon which the court proceeded in its judgment ( Foss v. Harbottle, 2 Hare, 461; MacDougall v. Gardiner, 1 Ch. Div. 13, and other cases specified) were authorities in which it was declared that the courts would not interfere in the general management of corporations, and that where it was a question of business policy or in relation to acts which, though illegal in themselves, were yet subject to ratification by the body of the stockholders, the courts would not entertain an action by a dissatisfied stockholder who had failed to appeal to the general body of the stockholders. The limitations of the opinion in Hawes v. Oakland will appear from an examination of Brewer v. Boston Theatre (104 Mass. 378), which is referred to in the Hawes case as follows: 'In Brewer v. Boston Theatre (104 Mass. 378) the general doctrine and its limitations are very well stated.' In the Brewer case it is declared as follows: 'A majority of the corporators have no right to exercise the control over the corporate management, which legitimately belongs to them, for the purpose of appropriating the corporate property or its avails or income to themselves or to any of the shareholders, to the exclusion or prejudice of the others. And if they have obtained such unfair advantage by fraud or abuse of the trust confided to them as officers or agents of the corporation, it is not in the power of a majority to ratify or condone the fraud and breach of trust, so far as it affects the rights of the others without reasonable restitution. This proposition, if stated in reference to formal transactions, ...