Before L. HAND, AUGUSTUS N. HAND, and CHASE, Circuit Judges .
The appeal is by the plaintiff from a judgment dismissing the complaint on the merits in a derivative suit brought in 1945 by a stockholder against officers and directors of the Thatcher Manufacturing Company, a corporation organized under the laws of New York. Jurisdiction is based on diversity, the plaintiff being a resident of Illinois and the individual defendants all being residents of New York. Although the action originally was broader in scope, the present appeal raises only issues concerning the liability of the individual defendants for fraud and waste in granting options to purchase common stock in the corporation to five persons under circumstances about to be stated.
The corporation, which will now for convenience be called Thatcher, was, during the period involved in the suit, and for some years previously had been, a large manufacturer of glass containers with factories in New York and Illinois. In December 1943, when the events principally relied on by the plaintiff began to take place, Thatcher's authorized stock consisted of 150,000 shares of no par preference stock convertible into no par common stock share for share and of 300,000 shares of no par common. There were then 132,000 shares of the preference stock and 146,836 shares of the common stock issued and outstanding. The appellant's holdings were 75 of the last named shares. Held in the treasury as a reserve against the possible conversion of the outstanding preference shares were 132,000 of the common together with 18,000 additional common shares held against the possible future conversion of an equal number of treasury-held preference shares should the latter ever be issued.
While Thatcher manufactured and sold containers extensively, its large volume of business had not been very lucrative for some years and its common stock, which was listed on the New York Stock Exchange, had fluctuated from a high of 48 7/8 to a low of 33 7/8 in 1936; from a high of 9 1/4 to a low of 5 in 1942; and in 1943 it went from a low of 6 1/4 to a high of 14. From 1935 to 1940 dividends had been paid upon it but none thereafter. A large part of its business was in milk bottles which were made to special order for purchasers and fibre containers were a competitive threat.
That there was cause for apprehension on the part of managament of Thatcher concerning the future of the corporation when a special meeting of the directors was called for December 15, 1943, is fairly evident. There were eight directors of which four were elected by the preference shareholders and four by the common shareholders*fn1 Of these, three elected by the preference shareholders, viz., Landon, Swan and Mandeville, and three elected by the common shareholders, viz., Turner, Ackerman and Dugan, were present. They had all been directors for several years, some had been for many years, and it may be taken for granted that they were well informed regarding the affairs of the corporation.
At this meeting appellee Pollock appeared and presented a program whose adoption and the steps taken to carry it out led up to this litigation. Pollock was well known to the directors. He had formerly been a vice-president of a corporation which had on December 31, 1942, become a wholly owned subsidiary of Thatcher. He had been engaged in business similar to that of Thatcher for about twenty-eight years and had been Thatcher's New York Sales Manager since January 1, 1942, under a five-year contract at a salary of $25,000 a year plus commissions and had received under his contract $52,000 in 1942. In 1943 he received $75,740 under it.
At the above mentioned meeting Pollock told the directors in substance that he believed in the future of the corporation and that he and his associates, who do not otherwise have anything to do with this suit, had bought some 35,000 common shares of which he held 7,668 shares and which he called the working control. He produced the sales slips to confirm his statement and told the directors that regardless of what was done at the meeting he and his group intended to increase their stockholdings. He explained what his ideas were as to changes in management and business practices necessary to solve the corporation's problems. These in brief were to put him in charge of its affairs as president with authority to make changes in so-called key personnel as he then outlined, including provision for giving incentives through a stock option plan to certain key men who were to be retained or hired from outside. This was agreed to by the directors. The then president, Ackerman, resigned. Pollock was elected president and Ackerman chairman of the board of directors. One of the directors suggested that Pollock's existing contract be cancelled and it was voted to request the resignation of all officers, other than Ackerman and Pollock, to be accepted at the pleasure of the board.
Thereafter Pollock as president proceeded along the plan he had outlined to the directors and at the next regular monthly meeting of the board on December 22, 1943, the following occurred when the same above mentioned directors and Pollock were present. Ackerman resigned as chairman of the board and left the meeting. Pollock offered to cancel his contract as sales manager and to accept a salary of $50,000 a year for five years as president plus options to purchase 5,000 shares of common stock at $10 a share on or before February 1, 1944; 5,000 shares at $15 and 5,000 shares at $20 on or before January 1, 1949. This offer was accepted. He then explained what changes he proposed to make in so-called key personnel and what stock options he desired to have granted to such men as he wished to retain or hire from outside. These options were voted, Pollack and Dugan abstaining from voting, but of them we are now concerned with only those to Rodewald, a new man and to Dusterdieck, Powers and Dugan, all retained men and the latter a director. Rodewald was to be Vice-President and Assistant to the President, Dusterdieck Vice-President in charge of sales, Powers Secretary and Treasurer, and Dugan Vice-President in charge of manufacturing. Of these Dusterdieck and Powers were voted options on 500 common shares at $10; 500 at $15; and 500 at $20 while Rodewald and Dugan were voted 1500 at $10; 2000 at $15; and 1500 at $20; all to be exercised on or before the dates in the options to Pollock, and all optionees were to be allowed to borrow from the corporation on the security of the stock up to eighty per cent of the amounts needed to exercise their options, such borrowings to be repaid in eight equal annual installments bearing 6% interest.
The market price of the common shares on December 22, 1943 was 13 3/4 and its average over that year was about $10. Its fair value as of that date was determined by the directors on the basis of its average market price for the year and the option price set at that value.
At this meeting it was decided to grant stock purchase options to other executives and employees, some to be thereafter determined and this proposed program became generally known to the employees.
When the above action was taken, the fact that there was not available in the treasury sufficient stock to permit the exercise of all the options was overlooked. Pollock had mistakenly included in his statement as to options to key executives made at the meeting of December 15, that "There are 39,260 shares available which would leave 8,260 shares to be used as an incentive for other men or new men as taken on" and this was apparently accepted as so. But by the time the regular monthly meeting of the directors was held on January 19, 1944, it had been realized that more common stock was needed to carry out the program and at that meeting it was voted to postpone carrying out the incentive option plan to permit the stockholders of the corporation to vote on a proposal to reclassify the 18,000 shares of unissued preference stock into common stock. This would provide 18,000 additional shares of common and by releasing the 18,000 common shares then held in reserve would make available in all 36,000 additional common shares.
The annual meeting of the stockholders was held, after due call, at Elmira, N.Y., on March 2, 1944. The reclassification was voted and the certificate of reclassification required by the law of New York was filed on March 6, 1944. The notice of this meeting was sent to stockholders together with a proxy statement and a letter from the president. The stockholders were thereby informed, inter alia, that:
The Company in 1941 contracted with Mr. Pollock for his services for a term of five years, under which his compensation is partly determined by a percentage on general line sales. On election as President Mr. Pollock has offered to terminate that contract for a new five year service contract at a fixed salary of $50,000.00 each year thereof and the granting to him of an option to purchase 5,000 shares of Common Stock at $10.00 per share on or before April 1, 1944, 5,000 shares of Common Stock at $15.00 per share and 5,000 shares of Common Stock at $20.00 per share to be exercised on or before January 1, ...