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Blau v. Rayette-Faberge Inc.

decided: February 8, 1968.


Lumbard, Chief Judge, and Moore and Feinberg, Circuit Judges.

Author: Feinberg

FEINBERG, Circuit Judge:

In Gilson v. Chock Full O'Nuts Corp., 331 F.2d 107 (2d Cir.1964) (in banc), this court noted an issue which it did not feel called upon to decide:

whether in a case where an attorney for a stockholder does nothing more than find a claim for the recovery of "short-swing" profits under § 16(b) of the Securities Exchange Act of 1934, 15 U.S.C. § 78p(b), which the corporation then successfully brings at the stockholder's request, the stockholder or the attorney has a right to be compensated by the corporation for the attorney's services * * *.

As was to be expected, the issue has now arisen. The stockholder is Isadore Blau, the attorney is Morris J. Levy, and the corporation is Rayette-Faberge, Inc. Blau and Levy, as plaintiffs, appeal from an order of the United States District Court for the Southern District of New York, Harold R. Tyler, Jr., J., which granted defendant corporation's motion for summary judgment. For the reasons given below, we reverse and remand.

According to the papers before Judge Tyler: Appellant Blau, in a derivative capacity on behalf of the corporation, employed Levy in June 1966 to investigate transactions by insiders of Rayette in its securities; the purpose was to discover whether the corporation was entitled to recover any short-swing profits under section 16(b).*fn1 Blau agreed to pay Levy a reasonable attorney's fee, contingent upon any benefit which the corporation might derive from his efforts and upon reimbursement of Blau by the corporation for the amount of Levy's fee. After an "exhaustive study," Levy discovered that Walter P. Niemec, an officer and director of the corporation, had purchased and sold shares of Rayette within six-month periods and that Rayette might be entitled under section 16(b) to recover the profits gained from these transactions. On one such series of transactions, which terminated in May 1964, the two-year statute of limitations had already run; on another series, spanning the period from November 1964 to April 1965, about 3/4 of the two-year limitation period had already gone by.

Levy, as attorney for Blau, advised the corporation in a letter dated July 28, 1966, of the existing cause of action under section 16(b), and the facts on which it was based. The letter requested the corporation to institute suit against Niemec to recover the short-swing profit, and stated that Blau would sue after sixty days on the corporation's behalf if by that time it had neither been paid nor commenced an action to recover the profits. On August 4, 1966, the corporation responded, through its assistant secretary, that the matter was under investigation. Levy received no further word; on Thursday, September 22, he prepared a complaint and wrote Blau that since the sixty days would expire the following Monday, they would have to meet for Blau to verify the complaint. On the next day, Levy received a letter and a telephone call from Rayette's New York counsel informing him that Niemec had agreed to pay the corporation his profits from the transactions referred to in Levy's July 28 letter and that no legal action would be necessary. Thereafter, Levy was informed that on September 26, 1966, Niemec paid the corporation $15,722.42 plus interest of $136.52.

Blau made demands on the corporation to pay Levy for his legal services, but these were refused. In November 1966, appellants brought this plenary action for recovery of legal fees. Both sides moved for summary judgment; Judge Tyler stated that he accepted Levy's averments but granted summary judgment for defendant on the ground that the rationale of our prior decision in Gilson v. Chock Full O'Nuts Corp., supra, required it. This appeal followed.

In Gilson, a stockholder of Chock Full O'Nuts had retained an attorney*fn2 on the same fee basis and for the same purpose as in this case. On April 10, 1962, the attorney informed that corporation that certain named directors had made "shortswing" profits and requested the corporation to bring suit by May 31, 1962, or the stockholder would bring suit before the running of the two-year statute of limitations on June 2, 1962. On April 16, 1962, the corporation replied that its preliminary investigation indicated no violation of section 16(b); it did not offer to communicate further with the attorney. Thereafter, the attorney drafted a complaint, but decided not to file it until May 31. Not until that date did the corporation file suit against the insiders and inform the attorney. After the section 16(b) action was settled for some $56,000, the stockholder and the attorney sued for a reasonable attorney's fee. The district court dismissed the complaint. On appeal, a panel of this court reversed, 326 F.2d 246 (2d Cir.1964) (Judges Swan, Clark and Marshall), apparently for the broad policy reasons that "reimbursement of attorney's fees was required by equitable considerations" and "in many cases * * * the possibility of recovering attorney's fees will provide the sole stimulus for the enforcement of § 16(b) * * *." Upon rehearing in banc,*fn3 the judgment of the panel was followed, but on a "somewhat narrower" basis, 331 F.2d at 109. The full bench noted analogous state court decisions and then stated:

There are policy considerations against requiring a corporation to pay a stockholder for volunteering to do what the corporation ought to do and might well have done without any impulse from him, considerations that would be especially strong in a case where the stockholder's request was made shortly after the information became available from reports under § 16(a) and at a time when the corporation still had many months in which to sue. We find it unnecessary in this case to weigh such considerations against the contrary ones that have been urged in support of Dottenheim [v. Emerson Elec. Mfg. Co., 7 F.R.D. 195 (E.D.N.Y.1947)]. See 2 Loss, Securities Regulation 1054 (2d ed.1961). For the record shows that the services appropriately rendered by Gilson's attorney were considerably more than simple preparation of the statutory request to the corporation to sue.

The court then emphasized the corporation's "negative attitude" toward the attorney's letter "and the prospective running" of the statute of limitations in the very near future; this justified preparation of a complaint by the attorney. Therefore, "It would run counter to effective enforcement of the statute wholly to deny compensation in such a case." Id. at 110.

We can understand why the district judge in this case construed the in banc opinion to mean that drafting a complaint may in special circumstances be compensable, but services short of that could never be compensable because they were not "appropriately rendered." However, that question was explicitly left open in Gilson, and further consideration of the underlying issues leads us to a contrary result. In this case, the stockholder would not be paid "for volunteering to do what the corporation ought to do and might well have done without any impulse from him." Taking Levy's averments as true -- as the district judge did -- it is quite clear that the corporation would most probably have done nothing at all about Niemec's trading activities had Levy not investigated on Blau's behalf. Given this set of facts, we find it necessary to examine the competing policy considerations which the Gilson in banc court alluded to, but did not weigh.

In the leading case of Smolowe v. Delendo Corp., 136 F.2d 231, 148 A.L.R. 300 (2d Cir.), cert. denied, 320 U.S. 751, 64 S. Ct. 56, 88 L. Ed. 446 (1943), this court not only allowed an attorney's fee in a 16(b) action, but also cautioned that such allowances should "not be too niggardly," because "in many cases such as this the possibility of recovering attorney's fees will provide the sole stimulus for the enforcement of § 16(b) * * *." See Cook and Feldman, Insider Trading Under the Securities Exchange Act, 66 Harv.L.Rev. 385, 421 (1953). In Smolowe, the stockholder had to sue to recover the "short-swing" profits for the corporation. But the same insistent policy applies even if suit is not brought, as in Dottenheim v. Emerson Elec. Mfg. Co., 7 F.R.D. 195 (E.D.N.Y.1947). In that case, as in this one, investigation by a stockholder's attorney led to a letter to a corporation; no litigation was necessary, and the corporation recovered substantial short-swing profits from its president.*fn4 When the stockholder sued for reimbursement of legal expenses, the corporation moved to dismiss. The district court denied the motion; after referring to the Smolowe holding that reimbursement of a stockholder is proper when he has had to bring suit, the court stated (id. at 197):

The distinction is urged, by the defendant, that the complaint here does not allege that an action was commenced. It would appear that the purpose of the statute would be as effectively thwarted if such distinction were to be approved as if reimbursement were to be denied entirely. If the objective is the recovery by the corporation of unlawful profits, would it be reasonable to say that a stockholder shall be entitled to all his expenses if he needs to bring suit, but that he shall be denied reimbursement where the same benefit to the corporation has resulted without the necessity of legal proceedings and at less expense? This would be penalizing efficiency and expediency. A stockholder acting in good faith would be induced to accompany his request to the corporation with only scanty information in the hope that the corporation might thereby neglect to bring suit, so as to enable the stockholder to ...

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