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ALSTER v. BRITISH TYPE INVESTORS

March 25, 1949

ALSTER
v.
BRITISH TYPE INVESTORS, Inc., et al.



The opinion of the court was delivered by: RIFKIND

This stockholder's derivative suit arises out of the same transaction which formed the subject of Upson v. Otis, 2 Cir., 1946, 155 F.2d 606; Marcus v. Otis, 2 Cir., 1948, 168 F.2d 649; Id., 2 Cir., S.D.N.Y., 169 F.2d 148. The action is by a stockholder of Automatic Products Corporation (Automatic), for the benefit of Automatic, against four members of a family of corporations: British Type Investors, Inc. (British), Allied International Investing Corporation (Allied), Scottish Type Investors, Inc. (Scottish), and Empire American Securities Corporation (Empire). *fn1" The corporate family included two additional members: the aforementioned Automatic, beneficiary of this action, and Majestic Radio and Television Corporation (Majestic). By stipulation, the evidence set forth in the record on appeal in Marcus v. Otis together with the exhibits are incorporated in this case. The fact inferences drawn from that record by the Court of Appeals are stipulated to be the facts of this action

Briefly summarized, the facts are: The directors of Automatic caused it to lend money to themselves and others of a group, including British, Allied, Scottish and Empire, formed for the purpose of acquiring Majestic stock. Therewith the borrowers bought from Dumont Radio and Television Corporation (Dumont) a large number of shares of Majestic. The sums borrowed have been repaid with interest. Plaintiff, a stockholder of Automatic, seeks to recover, on behalf of Automatic, the profits made by the corporate defendants from the sale of the Majestic shares they so obtained.

The familial relationship among the six corporations is established by these undisputed facts:

 British owned 56% of the voting stock of Allied, 65% of the voting stock of Empire, and 100% of the voting stock of Scottish. Allied owned more than 39% of the outstanding shares of Automatic, which constituted a controlling interest; Automatic owned more than 40% of the common stock of Majestic and Allied owned more than 18% of the common stock of Majestic; so that Automatic and Allied held a controlling interest in Majestic.

 Messrs. Franklin, Otis, and Hutchinson constituted three of the four directors of British, Allied and Scottish, three of the five directors of Empire, and three of the six directors of Automatic. Franklin and Otis held a controlling interest in British. *fn2" They were officers and composed the finance committees of British, Allied, Scottish and Empire, and were empowered to buy and sell securities on behalf of them

 At a meeting of the Board of Directors of Automatic, held in Chicago on April 20, 1943, at which Otis, Franklin and Hutchinson were present, among others, the decision was taken to buy, with Automatic's funds, Dumont's entire interest in Majestic. At this meeting the allocation of the stock to be purchased was made among the directors of Automatic, employees of Majestic, and the four corporate defendants in this action. Shortly thereafter, this decision was executed. In Marcus v. Otis, the Court of Appeals held that the action of the directors of Automatic, in lending Automatic's funds to themselves and to the wife of one of them constituted a conversion of the property of the corporation and a breach of their fiduciary duty and that each of the directors was primarily liable for the amount converted by him, with interest, and for the profits realized by him and secondarily responsible for the like liability of the others. Marcus v. Otis, by its pleadings, did not assert the liability of the corporations which are defendants in this action, nor did it attempt to impose liability upon the directors for the profits realized by these corporations.

 This case presents the question whether the corporations who benefited from the conversion of the funds of Automatic are likewise accountable for the profit realized by them from the resale of the Majestic shares allocated to them.

 Jurisdiction exists by virtue of diversity of citizenship; plaintiff is a citizen of Illinois and the defendant corporations are all citizens of Delaware; the the amount in controversy exceeds the statutory requirement.

 Plaintiff contends:

 1. The defendants were fiduciaries of Automatic and their use of its funds to finance their purchases of Majestic stock constituted a conversion of such funds, wherefore they are liable for the profits they realized from the sale of the stock, just as the directors of Automatic were held liable in Marcus v. Otis, supra;

 2. Whether fiduciaries or not, they are liable for having knowingly cooperated with Automatic's directors in the breach by the latter of their duty to Automatic;

 3. Whether fiduciaries or not, they were not bona fide purchasers; having passively accepted benefits arising from the Automatic directors' breach of duty, they are liable on the same theory on which an Automatic director's wife, to whom Automatic's funds were loaned in this transaction, was held liable.

 A true comprehension of the issues requires an appreciation of the salient conclusion of fact that Franklin and Otis controlled a network of corporations and exercised that control over each of them to accomplish a scheme whereby the funds of Automatic were employed, for the benefit of the defendant corporations, to buy securities for the avowed purpose of making a speculative profit upon their resale. Where such a network of corporate entities with interlocking directorates and cross investments is presented, it is often difficult to determine who really controls, who provides the impetus for multiple corporate action, and whose purposes are being served by such actions. *fn3" Here the facts compel the conclusion that from Otis, Franklin and Hutchinson came the impetus for participation by all the defendants herein. That their private purposes, rather Automatic's, were furthered by such participation is a finding which, by the stipulation, I receive from Marcus v. Otis

 It cannot be disputed, as a matter of law, that those in control of a corporation are duty bound to refrain from injuring non-controlling interests or profiting at their expense. See Consolidated Rock Products Co. v. DuBois, 1941, 312 U.S. 510, 522, 61 S. Ct. 675, 85 L. Ed. 982. This duty is fiduciary, see Southern Pacific Co. v. Bogert, 1919, 250 U.S. 483, 488, 39 S. Ct. 533, 63 L. Ed. 1099, analogous to that of a director towards his corporation. See Farmers' Loan & Trust Co. v. New York & N.R. Co., 1896, 150 N.Y. 410, 430, 431, 44 N.E. 1043, 34 L.R.A. 76, 55 Am.St.Rep. 689.

 The director owes a fiduciary duty to all ownership interests, and it is for the protection of all that he is denied the right to profit from personal use of corporate funds. The controlling interests owe a duty to the non-controlling interests not to profit at their expense. Nor may they profit by use of corporate funds in which the non-controlling have, by definition, an interest, unless the controllers permit the non-controllers to profit proportionately. This is normally accomplished by permitting the corporation itself to earn the profits arising from the use of its funds. Nothing in Blaustein v. Pan American Petroleum & Transport Co., 1944, 293 N.Y. 281, 56 N.E.2d 705, casts doubt upon this rule, for there no use (or misuse) of corporate property or funds was involved. In Everett v. Phillips, 1942, 288 N.Y. 227, 43 N.E.2d 18, the common directors of two companies were said not to have breached their duty toward either company because it was not demonstrated that they did not act for the best interests of both in lending the money of one to the other. There the borrowing corporation was not sued for abusing its control over the lender.

 The plaintiff's first contention is, in effect, that the fiduciary obligations of directors and controlling interests are identical, and that the prophylactic rule which denies to directors the right to profit from their personal use of corporate assets, even in the absence of corporate injury, is equally applicable to controlling stockholders. Thus boldly stated, plaintiff's proposed rule is broader than the circumstances of his case require. Here Automatic had minority interests. These minority interests were not permitted to participate in the scheme proportionately or otherwise. Instead, their proportionate share of the borrowed corporate funds was used for the benefit of the majority interests and their confederates. By forcing them to disgorge to Automatic, their profits, realized from the exploitation of the common property of all Automatic's stockholders, in effect, are returned to all the stockholders in proportion to their interests. *fn4"

 Plaintiff's second contention, that the defendants are liable as knowing participants in a fiduciary's breach of trust, provides another and perhaps traditionally more acceptable ground of recovery. One who participates with a director in a breach of the latter's duty toward the corporation is like a director, liable for his profits. Irving Trust Co. v. Deutsch, 2 Cir., 1934, 73 F.2d 121; Cahall v. Lofland, 1921, 12 DelCh. 299, 114 A. 224. Franklin and Otis were authorized to buy and sell securities for all four corporate defendants, and their involvement of these defendants as purchasers was ratified by the several boards of directors. No abstruse exposition of elementary doctrines of agency is required to find that the defendants knowingly participated with Automatic's directors in their breach of duty to Automatic.

 The defendants urge that the 'business judgment' rule protects them from liability in the same fashion that the Court of Appeals, in Marcus v. Otis, held it protected the directors with respect to the participation of several employees of Majestic in the syndicate. The analogy is inappropriate. To extend credit to employees of a subsidiary and thus afford them the opportunity to acquire a stock interest in their employer may encourage their best efforts on its behalf. But the corporate defendants herein did not render any services to Majestic or Automatic, the proper performance of which it might be reasonable to ...


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