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Lesnik v. Public Industrials Corp.

September 7, 1944


Appeal from the District Court of the United States for the Southern District of New York.

Author: Clark

Before L. HAND, SWAN, and CLARK, Circuit Judges.

This action began as a simple suit on a promissory note; but, in line with the economy of judicial effort encouraged by the new civil rules, the defendant was able, by filing counterclaims and a cross-complaint against additional parties brought into the case, to go to trial on the issue of whether it was defrauded by a conspiracy of directors of a company in which it held stock to refuse to declare dividends, thereby causing it financial ruin. Since the judge took this issue from the jury for lack of evidence to prove the allegations, this appeal raises the issue whether the original defendant did succeed in establishing a prima facie case. In addition, there are important preliminary problems of venue and jurisdiction over cited-in defendants raised by the claims of appellees herein that the new parties could not be legally compelled to appear and defend in this action.

According to the facts substantially not in dispute, defendant-appellant, Public Industrials Corporation, a Delaware corporation engaged solely in the holding of corporate securities, was reorganized as of January 15, 1938, under former § 77B of the Bankruptcy Act, 11 U.S.C.A. § 207. Its unsecured debts amounted to some $21,000; its secured debts, to some $46,000. In all, there were four secured creditors, holding as security 1,782 shares of the 7% cumulative preferred stock of Hightstown Rug Company, a Delaware corporation having its principal place of business in New Jersey. By the terms of the reorganization, Public Industrials' assets, which consisted of 2,398 further shares of the Hightstown preferred stock, were placed in escrow to insure ratable distribution to all creditors; payment of unsecured creditors was postponed until January 15, 1941; and secured creditors received in exchange for outstanding evidences of indebtedness nonnegotiable 5% notes payable January 15, 1939, but extendible for one-year periods by the written consent prior to the due date of the holders of two-thirds the principal amount thereof. Since Public Industrials was not a going concern, the success of the plan and eventual payment of all creditors thus depended upon receipt of dividends from the Hightstown stock and extension from year to year of the secured indebtedness.

C. Herbert Davison was president of Hightstown and owner of over 80 per cent of its common stock, in which all voting powers were vested. With his attorney, Guy George Gabrielson, he also owned the balance over Public Industrials' holding of the 10,872 outstanding shares of preferred stock. Hightstown's board of directors consisted of Davison, Gabrielson, Albert L. Wolfe, a legal associate of Gabrielson, and two minority directors appointed by Public Industrials through an agreement with Davison. Although the annual statements for the years 1940, 1941, and especially 1942 showed earnings and surpluses*fn1 well in excess of the $76,000 necessary to declare a dividends on the preferred stock, no such dividends were declared from 1939 through 1942. The board did not discuss the matter at the annual meetings of March 11, 1941, and June 30, 1942, due to the failure of the management to have prepared any annual statements for the preceding years; but at a meeting on July 29, 1942, in consideration of the favorable annual statement for 1941, one of the minority directors asked why a dividend should not be declared. Gabrielson answered that the management would by no means consider it. Then at a meeting on February 4, 1943, after the prosperous report for 1942, the same director seems to have moved to declare a dividend. What transpired thereafter was held inadmissible at the trial below as occurring after the date of the filing of the complaint in the present action.

Receiving no dividends from the Hightstown stock, the required percentage of secured creditors of Public Industrials voted each year for three years to postpone the due date of their notes. On January 14, 1942, however, when the secured creditors were about to extend the notes for another year, Gabrielson, through a dummy, one Andrew J. Noe, entered into a contract with Equitable Building Corporation, holder of a note for $15,883.52, or over onethird the principal amount of Public Industrials' secured indebtedness, by the terms of which Equitable agreed, in return for a check for $24,000, to refuse to extend the time for payment of its note, due the following day, and if the note was not then paid, to sell the collateral, 472 shares of Hightstown preferred. If Noe bid in the stock at the sale, Equitable was to pay the purchase price out of the $24,000; and if the sale did not realize the full amount due Equitable on the note, Equitable was to retain the difference from the $24,000. Any balance was to be returned to Noe. Equitable duly blocked the extension of the notes, demanded and failed to receive payment, and sold the stock at public auction to Noe for $2,100, approximately $4.45 per share. Then on February 2, 1942, Harry Lesnik, plaintiff below and another dummy of Gabrielson and Davison, purchased from the Bank of New York for $11,500 a $10,000 note of Public Industrials, upon which some $14,000 principal and interest was at that time due and which was secured by 500 shares of Hightstown preferred. On February 17, 1942, Lesnik wrote Public Industrials to advise that he would sell the collateral at public auction the following week; and on February 25, 1942, he bought in the stock at the sale for $500, or $1 per share. He thereupon turned over both the note and the stock to Gabrielson. On November 30, 1942, Gabrielson and Lesnik entered into a written agreement whereby the former would return the note to Lesnik for purposes of suit to collect the balance remaining due, but which reserved all rights to the note and any balance collected in Gabrielson. Accordingly, Lesnik brought suit on the note on January 4, 1943, in the Supreme Court of the State of New York. Alleging diversity of citizenship, Public Industrials at once transferred the cause to the court below.

Public Industrials in its answer to the complaint set forth, among other things, three counterclaims. The first two were substantially similar and maintained that Lesnik, Davison, Gabrielson, and Wolfe had conspired, by refusing to declare dividends on the Hightstown stock when there were ample funds so to do, to wreck the plan of reorganization and to depreciate the value of the stock so that they could acquire Public Industrials' shares at a very low price. The third, after repeating the general allegations of conspiracy against Davison, Gabrielson, and Wolfe, went on to charge that they falsely informed Lesnik that he had power to sell the collateral received from the Bank of New York and that the resultant "fictitious and forced public sale" had destroyed the market value of Hightstown preferred, to Public Industrials' loss. As a result of these conspiracies, Public Industrials claimed damages of $400,000.

Thereafter Public Industrials moved to bring in Davison, Gabrielson, and Wolfe as defendants to the counterclaims, under Federal Civil Rule 13(h), 28 U.S.C.A. following section 723c; and this motion was first denied by the district court and a motion for reargument was also denied. Subsequently, upon renewal of this before another judge and with most extensive affidavits (which had not been presented before), it was finally granted in a written opinion dated April 30, 1943, 51 F.Supp. 989; and Gabrielson and Wolfe were thereupon duly served. Davison, however, was not then served. After they were served, Gabrielson and Wolfe sought an order vacating the service upon them, on the ground that it was in violation of the venue requirements of § 51 of the Judicial Code, 28 U.S.C.A. § 112, since they both were residents of New Jersey and Public Industrials was a Delaware corporation. This motion was denied by another district judge in a written opinion dated May 29, 1943, 51 F.Supp. 994. Then Gabrielson, Wolfe, and Lesnik moved for summary judgment on the counterclaims under Rule 56(b), asserting that the court had no jurisdiction, since decision of the counterclaims would involve delving into the internal affairs of a foreign corporation. This motion the same judge denied in a written opinion dated September 28, 1943. Trial was thereafter held before still another district judge and a jury, October 7 to 14, 1943, at the conclusion of which the court directed a verdict for plaintiff in the original action and dismissed the counterclaims of Public Industrials. Nearly three months after this judgment was entered, Public Industrials succeeded in effecting service upon Davison, whose motion to quash the service was granted by the original district judge on January 14, 1944. This appeal is taken from this order and from the judgment entered by the trial judge.

As was inevitable, the failure of Hightstown to pay dividends on its preferred stock and the refusal of Public Industrials' secured creditors to extend the due date of their notes beyond January 15, 1942, caused a complete breakdown of the plan of reorganization for Public Industrials. The latter, therefore, filed a voluntary petition in bankruptcy in the Wilmington, Delaware, court on November 15, 1943, and received a stay against the enforcement of the judgment below. Thereafter Public Industrials seemingly secured a purchaser for its Hightstown stock at a price which would enable the payment of all creditors,*fn2 and requested of the Delaware court a dismissal of its petition in bankruptcy. Counsel for Lesnik vigorously opposed such action. So Public Industrials, through an advance from the intended purchaser of the Hightstown stock, tendered to him on April 15, 1944, the amount of the judgment below in Lesnik's favor. He refused to accept this tender, however, and the money was deposited with the Delaware court at Lesnik's disposal. Lesnik then petitioned us to dismiss the appeal from the judgment below on the original note, on the ground that the tender made the appeal moot. On May 5, 1944, we denied that the appeal was moot, but affirmed the judgment below on the note, stating that the tender showed the appeal to be without merit. The present appeal is thus only from the dismissal of Public Industrials' counterclaims and from the order quashing service against Davison.

To narrow the scope of our considerations yet further, we agree at the outset that the court below was justified in dismissing the third counterclaim. Its ambiguous phraseology appears to present the theory that Davison, Gabrielson, and Wolfe conspired with Lesnik to bring about an illegal sale of the collateral received upon purchase of Public Industrials' note from the Bank of New York. The record, however, is barren of proof that such sale was in fact illegal. Rather, it is clear that the sale or assignment of a secured indebtedness carries with it the assignor's rights in the security, which here included full powers of sale. Schram v. Sage, D.C.E.D. Mich., 46 F.Supp. 381, 383; Restatement, Security, 1941, § 29. Nor is there any merit to appellees' contention that the court below erred in failing to grant summary judgment in their favor. While the courts of one state unquestionably should not interfere in the internal management of a foreign corporation, Rogers v. Guaranty Trust Co. of New York, 288 U.S. 123, 53 S. Ct. 295, 77 L. Ed. 652, 89 A.L.R. 720; Cohen v. American Window Glass Co., 2 Cir., 126 F.2d 111, resolution of the present counterclaims would in no wise involve such an eventuality. Clearly this was not an action to force declaration of a dividend, as was the Cohen case, or performance by a corporation of its obligation to provide a sinking fund to redeem preferred stock, as in Nothiger v. Corroon & Reynolds Corp., 266 App.Div. 299, 42 N.Y.S.2d 103, affirmed 293 N.Y. 682, 56 N.E.2d 296, cited by appellees.

The rationale of the remaining counterclaims is that Davison, Gabrielson, and Wolfe fraudulently withheld dividends on the Hightstown preferred stock so as to acquire Public Industrials' holdings in the stock at ruinous prices, and that Lesnik joined in this conspiracy by purchasing the note held by the Bank of New York and forcing sale of the collateral at $1 per share. Under such circumstances, Lesnik was properly included as a member of the conspiracy, for persons joining and participating in a conspiracy at any time before the accomplishment of its ultimate objectives are equally liable with the originators. Nyquist v. United States, 6 Cir., 2 F.2d 504, certiorari denied 267 U.S. 606, 45 S. Ct. 508, 69 L. Ed. 810; United States v. Wilson, D.C.N.D.W. Va., 23 F.2d 112; Calcutt v. Gerig, 6 Cir., 271 F. 220; Rosco Trading Co. v. Goldenberg, Sup., 182 N.Y.S. 711; Meredith v. Art Metal Const. Co., 97 Misc. 69, 161 N.Y.S. 1, affirmed without opinion 176 App.Div. 949, 162 N.Y.S. 1131; cf. Original Ballet Russe v. Ballet Theatre, 2 Cir., 133 F.2d 187. Hence Lesnik himself cannot and does not object to the pleading of the counterclaims. But even as to the cited-in defendants, liable as coconspirators jointly and severally with Lesnik, Lewis v. Ingram, 10 Cir., 57 F.2d 463, certiorari denied 287 U.S. 614, 53 S. Ct. 16, 77 L. Ed. 533; Ellerd v. Griffith, 5 Cir., 22 F.2d 793, the trial of the issue of conspiracy once and for all here is obviously desirable and proper unless jurisdiction over them cannot be obtained or their joinder deprives the court of jurisdiction. Federal Rule 13(h); cf. Rule 13 (a). And as there was complete diversity of citizenship between Public Industrials and all the other parties, the codefendants are confined to their claims of improper venue and must concede the court's substantive jurisdiction over the counterclaims.

Since the adoption of the federal rules, it has been recognized that important provisions as to the addition of parties under Rules 13 (counterclaims), 14 (third-party practice), and 24 (intervention) may have limited effect if requirements of federal jurisdiction and venue are necessarily to be applied to all such parties just as though they were being originally sued by the plaintiffs in the actions. These rules are a part of that fundamental tenet of modern procedure that joinder of parties and of claims must be greatly liberalized to provide at least for the effective settlement at one time of all disputes of which parts are already before the court. They should, therefore, receive such favorable construction as is possible, consistent with due recognition of the settled principle that procedural rules cannot be used to extend federal jurisdiction or venue. Rule 82.

But jurisdiction is not extended by mere devices making possible more complete adjudication of issues in a single case, when based upon jurisdictional principles of long standing, even though the effectiveness of the new devices makes their use more frequent. Cf. Freeman v. Bee Machine Co., 319 U.S. 448, 454, 63 S. Ct. 1146, 87 L. Ed. 1509. Obviously a mere broadening of the content of a single federal action must not be confused with the extension of federal power; otherwise, such recognized steps as the union of law and equity or the free joinder of counterclaims would be dragged into the ambit of jurisdictional prohibitions, while actually they compress and desirably reduce the bulk and amount of federal litigation. Consequently the adding of parties under the rules has been viewed in the light of the ancient and well-established principle that a federal court has "ancillary" jurisdiction to complete adjudication of interrelated matters where its jurisdiction has once been competently invoked. See cases collected, 1 Moore's Federal Practice 462-470; Dobie and Ladd, Cases on Federal Jurisdiction and Procedure, 1940, 336-346.

Now, however well settled may be the general principle of federal ancillary jurisdiction, nevertheless it is sufficiently uncertain as to its exact limits, or, as it has been put, "amorphous," 53 Harv.L.Rev. 449, 458, 40 Col.L.Rev. 148, 153, to afford justification for a considerable amount of desirable procedural reform. Hence the district courts and the commentators generally have supported joinder under all three of these rules (especially Rule 14 where most of the cases seem to arise) of at least issues closely related to the subject of the original suit, without new grounds of substantive jurisdiction.*fn3 Discussion as to venue, however, appears to have been much more limited, with the cases - outside of the present one and the closely similar case of United States, for Use and Benefit of Jones Contracting Co. v. Skilken, D.C.N.D. Ohio, 53 F.Supp. 14 - confined to impleader under Rule 14, and rather divided as to whether the concept of "ancillary" jurisdiction can be used to make unnecessary venue qualifications beyond those required for the original action.*fn4 Hardly any of these cases have reached the appellate courts; perhaps the only appellate decisions which appear instructive are Williams v. Keyes, 5 Cir., 125 F.2d 208, certiorari denied 316 U.S. 699, 62 S. Ct. 1297, 86 L. Ed. 1768, holding the district court not ousted of jurisdiction when the defendants, after removing the action from a state court, impleaded other defendants residing in plaintiff's district; and United States, to Use and for Benefit of Foster Wheeler Corp. v. American Surety Co. of New York, 2 Cir., 142 F.2d 726, 728, affirming rulings ...

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