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LACHMAN v. BELL

November 30, 1972

Gerald LACHMAN, Plaintiff,
v.
Harold K. BELL, Defendant


Gurfein, District Judge.


The opinion of the court was delivered by: GURFEIN

GURFEIN, District Judge.

This is a diversity case in which a motion has been made to dismiss the complaint under Fed. R. Civ. P. 12(b)(6). Affidavits have been submitted but they are not sufficiently comprehensive for the Court to treat the motion as one for summary judgment. I, therefore, exclude matters outside the pleading. Rule 12(b)(6). For purposes of the motion to dismiss, the allegations are taken to be true.

 The complaint alleges as follows:

 The defendant Bell was the principal officer and a director of Module Communities, Incorporated (MCI), a Delaware corporation, *fn1" with its principal place of business in New York. On March 14, 1969, the plaintiff entered into an agreement referred to as the "Founders Agreement" with MCI, Bell and others to purchase shares of common stock in MCI. The Founders Agreement provided that (1) each subscriber would pay $1,510 per share and that the shares would be split 1,000 to 1, making the actual purchase price $1.51 per share; (2) if any Founder received an offer to purchase his shares, MCI would have the option to repurchase them at the offer price or $1.51, whichever was lower; (3) upon the involuntary or voluntary liquidation, dissolution or winding up of the affairs of MCI, the owners of the shares in the corporation other than Founders shares would be entitled to receive $55.55 per share, before the Founders participated in any distribution. The defendant purchased 30,000 Founders shares for $45,300. The plaintiff purchased 600 Founders shares for $906.

 On June 25, 1969 the plaintiff entered into an agreement with MCI, Bell and others to purchase additional shares of MCI. This so-called "Investors Agreement" provided for the payment by investors of $55.55 per share. The defendant purchased 3,380 shares of Investors stock for $187,659 and the plaintiff purchased 1,800 Investors stock for $99,990. Accordingly, the total amount invested by the plaintiff for 2,400 shares of stock in MCI was $100,896, and the total amount invested by the defendant for 31,800 shares was $232,959.

 Some time later, MCI experienced severe financial difficulty and it appeared that the corporation would have to be liquidated or its affairs wound up. Thereafter, in the Summer of 1971, Starrett Housing Corporation (Starrett) expressed an interest in acquiring the business and assets of MCI. The plaintiff participated in the initial discussion when it was agreed that Starrett would acquire the business and assets of MCI pursuant to a formula which would recognize the right of owners of the MCI Investors shares to receive $55.55 for each of their shares of MCI stock before any payment to the owners of the Founders shares.

 Thereafter the defendant Bell excluded the plaintiff from the discussions with Starrett and rearranged the terms of the purchase so as to eliminate the preference to the Investors shares and to convert the transaction into one in which the defendant would realize a substantial profit while the other shareholders sustained a substantial loss. Pursuant to these discussions from which the plaintiff was excluded, Starrett, on January 14, 1972 offered to exchange stock of Starrett pro rata in exchange for all the stock of MCI. Each share of Founders stock (which cost $1.51 per share) and each share of Investors stock (which cost $55.55 per share) was to be exchanged for the same number of shares of Starrett.

 The plaintiff objected to the plan when it was presented to the board of directors. He demanded that the transaction be recast so that MCI would sell its assets to Starrett and then liquidate, in which event the Investors shares would be paid $55.55 per share before the Founders shares would participate in the distribution. As an alternative, the plaintiff proposed that since the Starrett offer was for the purchase of shares, MCI had the option to purchase the Founders shares at $1.51 per share under the Founders Agreement. He offered to advance the funds necessary for MCI to make the purchases. The defendant Bell opposed plaintiff's plan and favored the proposal he had arrived at with Starrett.

 It is further alleged that the defendant unlawfully participated in the discussions, deliberations and vote of the board of directors of MCI and that he threatened to prevent a transaction with Starrett unless the board defeated the plaintiff's proposal and adopted the merger proposed by Bell. It is further alleged that the board was coerced into ratifying the plan, and that Bell by virtue of this coercion dominated and controlled both the board and enough MCI shares to cause ratification of the merger agreement. It is also alleged that the defendant breached his fiduciary duty to the shareholders of MCI and acted for his own selfish interest by refusing to adopt either plan suggested by the plaintiff to effectuate the clear intent of the Founders Agreement. Damages in the amount of at least $101,706 are claimed.

 There is also a second claim for relief which, after realleging the first claim, alleges that the defendant breached the Founders Agreement with the plaintiff.

 I

 The first claim for relief is based upon a breach of fiduciary duty by the defendant as an officer and director of MCI, a Delaware corporation. Such a claim is governed in New York by the law of the State of incorporation which is Delaware. (Hausman v. Buckley, 299 F.2d 696 (2 Cir. 1962); Restatement 2d, Conflicts of Law § 309 (1969).)

 To find the governing Delaware case law we must analyze the nature of the complaint. This is not a suit on behalf of the corporation. Nor is it a suit against the corporation. It is also not a class suit. The plaintiff sues as an individual shareholder. The sole defendant is its chief officer and director who was a large shareholder of not one class of shares but of two classes of shares. While both the Investors shares and the Founders shares were equal in the right to vote and receive dividends while MCI was a going concern, there were substantial differences in the rights of each class upon termination of the business by liquidation or the like. In such event, the holders of the Investors shares who had paid much more for their shares, were entitled to be paid in full before the Founders shares received anything. The priority thus established by agreement was much like the priority generally afforded preferred stock over common stock in a liquidation. If a choice should arise then between liquidation and some other form of cessation of business as a separate entity, an owner of more shares of one class than the other would presumably find conflict between his own private interest and that of other shareholders. If he owned more Investors shares he would prefer, for his own interest, to liquidate and thus obtain the priority to which those shares are entitled. On the contrary, if he owned more Founders shares, bought at a much cheaper price, he would, for personal reasons, favor a transaction in which all shares, Investors and Founders, were treated alike. In this case it was obviously to Bell's private interest to favor the latter course and to avoid a liquidation. Nevertheless, there is the possibility that no matter how much he wanted to serve the interest of all the shareholders against his own selfish interest he was unable to do so. If the corporation found itself in dire economic straits where the form of transaction could be dictated by the buyer, a form of transaction might have to be accepted which in its effect would destroy the liquidating priority of the Investors shares. In that case his action may be privileged. See Warshaw v. Calhoun, 43 Del. Ch. 148, 221 A. 2d 487, 492-493 (Del. Ch. 1966); Abelow v. Midstates Oil Corp., 41 Del. Ch. 145, 189 A. 2d 675, 678 (1963); MacFarlane v. North American Cement Corp., 16 Del. Ch. 172, 157 A. 396, 399 (1928).

 This complaint quite clearly alleges that such was not the case. It states that the initial proposed transaction was to be a sale of assets and consequent liquidation. If that is taken as true, the subsequent activity of the defendant may well have directed to the furtherance of his own interest, which is mathematically demonstrable, rather than to the pursuit of some corporate objective. See Potter v. Sanitary Co. of America, 22 Del. Ch. 110, 194 A. 87, 91 (1931); MacFarlane v. North American Cement Corp., supra. It is true that at times an asset sale may not be in the best interest of the selling corporation, but such a determination should be made by directors with the sole benefit of the corporation and its shareholders in mind. Facts adduced at trial may, indeed, show that there never was such an inchoate asset deal or that Starrett unilaterally changed its mind. The complaint, however, does allege self-interest and breach of fiduciary duty in that the ...


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