Alexander Hodges v. New England Screw Companys.

There are some questions raised in the present suit which we find no difficulty in deciding.

We think the directors of the Screw Company are liable in equity, as trustees, for a fraudulent breach of trust. The jurisdiction of a Court of Equity over such a case was affirmed by Lord Hardwicke in the case of The Charitable Corporation v.Sutton and others, 2 Atkins, 404, in 1742, and has been exercised both in England and in this country ever since. In the case of the Attorney General v. Utica Insurance Company, 2 Johns. Ch. Rep. 359, Chancellor Kent recognizes the jurisdiction as well settled. In Robinson and others v. Smith and others, 3 Paige, 222, and in Cunningham v. Pell and others, 5 Paige, 607, the same doctrine is affirmed and acted on. So, also, by Vice Chancellor McCoun, in Verplanck v. Mercantile InsuranceCompany, 1 Edwards, 84. The cases on this point are so numerous, that we deem any farther reference unnecessary.

The primary party to sue for such fraudulent breach of trust, is the corporation; because the corporation is the party injured.Robinson and others v. Smith and others, 3 Paige, 222. But if the corporation refuse to sue, the stockholders may sue in their individual names. So, if the corporation be under the control of the guilty directors, the stockholders may sue. 3 Paige, 222; Angell Ames on Corp. 304, 305.

In the present case, the defendants, who are charged with the fraudulent breach of trust, are the directors of the corporation, and control its action. We think, therefore, that the present bill, so far as it seeks a remedy against directors, comes within the settled jurisdiction of the court, and that the plaintiff, under the circumstances, is the proper party to sue.

The main question in the case remains to be considered. Has the plaintiff proved the charges in his bill?

The bill sets forth in detail charges of gross fraud and breach of trust by the directors, and a violation of the charter by the Screw Company; and, if these charges are true, the defendants are justly answerable to this court for all the damages which the plaintiff has sustained.

In considering this part of the case, two questions arise.First. Did the directors commit the acts complained of, and, if they did, were these acts done with the fraudulent design charged? Let us examine the facts.

In 1845, the Screw Company were desirous of enlarging their business, and obtained an amendment of their charter, under which they erected a rolling mill, and carried on the business of rolling iron; and afterwards, finding this unprofitable, went into the business of making railroad iron, and carried on that business until it ceased to be profitable, which was in the latter part of the year 1847. The business was then suspended.

The rolling mill establishment was then without employment. It had cost $155,000, and was discredited in the market by the unprofitable business which had been carried on there. In erecting the rolling mill establishment, and in carrying on the business there, the Screw Company had incurred a heavy debt. Under these circumstances, the directors of the Screw Company formed the plan of purchasing the nail machine and patent for making wrought nails, and of forming a new company, who were to become the purchasers of the rolling mill and works, and patent and nail machine, and to carry on the business of making wrought nails. The Screw Company were to sell their nail machine and patent, and rolling mill, to the new company at cost, being $182,000, and to receive $82,000 in money, and the balance, being $100,000, in the stock of the new company. The whole capital of the new company was to be $300,000, to be divided into six hundred shares of five hundred dollars each, of which the Screw Company were to take two hundred shares, provided two hundred shares were taken by others, and the company organized in three months.

One great object of the directors, in making this arrangement, was to effect a sale of their rolling mill upon advantageous terms, and to realize from the sale, in order partially, at least, to relieve themselves from debt.

Another object was the anticipated profits of the new business.

The immediate effect of the arrangement was, that the Screw Company received $82,000 in cash, for their rolling mill and nail machine and patent, and still retained, as a stockholder in the Iron Company, one-third of the same property, the other subscribers to the Iron Company putting their money against the rolling mill of the Screw Company, at cost.

The plaintiff, although he objected to the purchase of the nail patent and machine, in the first instance, yet afterwards acquiesced in and approved of the measure. And the evidence shows, the directors had strong reasons to believe the purchase an advantageous one. Neither did the plaintiff object to the new company, and to the taking stock therein by the Screw Company, but he wished the stock, when taken by the Screw Company, to be divided among the stockholders, and he was not willing that the stock should be taken, except upon these terms.

This conduct of the plaintiff shows, he considered the plan of the directors a judicious one, and for the interest of the Screw Company, for, whether the stock were held by the Screw Company, as such, or by the stockholders of that company individually, the business and the profits of the Iron Company would be the same.

The answer states, the result of the formation of the Iron Company and the sale of the rolling mill, has been to diminish the liabilities of the Screw Company to the amount of $15,000 below what they otherwise would have been.

Viewing the plan of the directors, therefore, as a mere business arrangement, and aside from the question of power under the charter, we think it was judicious, and for the interest of the Screw Company. Certainly, we cannot say they acted without ordinary care and discretion, and, least of all, that they had in view the fraudulent design of reducing the value of the plaintiff's stock in the Screw Company, in order to purchase it at their own price. And we are the more confirmed in this conclusion, when we recollect that the directors owned a large majority of the capital stock of the Screw Company, and could not reduce the plaintiff's stock, without, at the same time, and in the same proportion, reducing the value of their own.

The reason given by the directors for not dividing the stock in the Iron Company among the stockholders of the Screw Company, in conformity to the wishes of the plaintiff, is, that the Screw Company had incurred a heavy debt by the erection of a rolling mill and the business carried on there, and they thought the consideration received for the sale ought to be held for the payment of that debt.

We do not see anything unreasonable or improvident in this, — certainly nothing to sustain the charge of fraud imputed in the plaintiff's bill. It does not appear that the directors sought or secured to themselves any benefit or advantage which was not common to all the other stockholders in the Screw Company.^*

The bill charges the defendants with lending the endorsements of the Screw Company to the Iron Company. The answer gives the following account of this matter: That the Iron Company have not been able to complete and put in operation their machinery and works as soon as they expected; that in anticipation of having their works in operation at an earlier period, the Iron Company purchased a stock of coal and iron, proportioned to the full capacity of their works, and owing to the delay in getting them in operation, the notes given for the same became due, before the stock could be manufactured and put in market; that in order to meet the accruing liabilities, the Iron Company were obliged to borrow money from the banks, and, as the rules of the banks require an endorser, the Iron Company applied to the Screw Company, and to the other stockholders, to endorse their paper for the above purpose. This endorsement of the paper of the Iron Company by the Screw Company, was considered by the directors as for the interest of the Screw Company, that company owning so large an amount of the stock in the Iron Company, and being so largely interested in the success of its business.

The directors were individually liable upon the endorsements, as stockholders in the Screw Company, and to a much larger amount than the plaintiff. The other stockholders in the Iron Company took the same view of their interest in this particular, and endorsed the paper of the Iron Company to an amount corresponding to their interest in the stock.

If the stock taken by the Screw Company had been divided among the stockholders, we may fairly presume they would, individually, have endorsed the paper, which has now been endorsed by the Screw Company.

In relation to these endorsements, we may say as we have said of the notes of the Screw Company, that it is not a question of power, but of good faith and sound discretion on the part of the directors. We think the directors have acted in this matter in good faith, and with sound discretion.

Another question remains to be considered, and that is, are the directors personally liable for taking stock in the Iron Company, not upon the ground of any fraud in fact, on their part, but upon the ground that they violated the charter of the Screw Company in so doing? In the view we take of the facts upon this part of the case, it is not necessary for us definitely to decide, whether the act, under the circumstances, was a violation of the charter of the Screw Company; for, although the charter may have been violated, still, we do not think the directors ought to be personally responsible under the circumstances. We prefer to decide so important a question, upon a proceeding against the corporation, when that is the question directly put in issue. In considering the question of the personal responsibility of the directors, therefore, we shall assume that they violated the charter of the Screw Company. The question then will be, was such violation the result of mistake as to their powers, and if so, did they fall into this mistake from want of proper care, such care as a man of ordinary prudence practices in his own affairs. For, if the mistake be such as with proper care might have been avoided, they ought to be liable. If, on the other hand, the mistake be such as the directors might well make, notwithstanding the exercise of proper care, and if they acted in good faith and for the benefit of the Screw Company, they ought not to be liable.

It was contended by the counsel for the plaintiff, that the ground of innocent mistake could not avail the defendants, because they had not set it up in their answer. But the answer does allege that the directors, in all they have done in managing the affairs of the Screw Company, have acted in good faith and to the best of their ability, skill, and discretion, for the profit and benefit of that Company. This necessarily excludes the idea of a willful violation of charter, for it is impossible that these defendants could have truly and honestly sworn, they had acted in good faith towards the Screw Company in a matter in which they had knowingly and willfully violated their charter. It is worthy of observation, too, in this connection, that the bill no where charges that the directors knew the act complained of was a violation of their charter. It charges that the act was done with the design to defraud the plaintiff, and that it was a violation of the charter of the Screw Company; and to this charge the answer is responsive.

Let us look at the circumstances, under which the directors subscribed for this stock.

At the time of the transaction, no case, in which this question of authority was decided or considered, had occurred, either in England or this country. The law on the subject cannot be considered as known and settled.

There are large classes of corporations in Rhode Island and the other States, which may and do rightfully invest their capital in the stock of other corporations; such, for instance, as religious and charitable corporations, and corporations for literary and scientific purposes. So insurance companies may rightfully invest their capital in the stock of other corporations, such as banks and railroads, and the like. Nor have we any doubt that the Screw Company might have rightfully taken this stock in the Iron Company, in payment for their rolling-mill, if it had been taken with a view to sell again and not permanently to hold it.

Again, it is to be observed, the directors were not investing the dividends of the Screw Company in the stock of the Iron Company. They had on hand an unsaleable rolling-mill, and they owed a heavy debt for it, and one great object in taking the stock in the Iron Company, was to realize for the rolling-mill and in part pay thereby the debt.

The business, too, of the Iron Company was of a kindred nature with that carried on by the Screw Company; and, so far as the manufacture of rods was concerned, intimately connected with the business of the Screw Company.

It was like the case of a corporation for printing calicoes taking stock in the corporation which manufactured and supplied the print cloths. It deserves, also, to be remarked in this connection, that this question of power never seems to have been raised by the directors or the stockholders in either company, or by the plaintiff himself, until the present bill was filed. Under these circumstances, and giving proper weight to the answers of the defendants, we feel bound to say, that in subscribing for this stock they have acted in good faith, and with as much care and discretion as a man of ordinary prudence exercises about his own affairs, and that, if they have fallen into a mistake in regard to their powers, it was an innocent mistake, for which they ought not to be held answerable. We have in Rhode Island a large number of corporations, whose affairs are managed by directors, who are generally large stockholders, and act without compensation. If the innocent mistakes of these gentlemen, in cases where the law was unsettled or unknown, is to subject them for damages, great injustice would be done. The law requires of them care and discretion, such as a man of ordinary prudence exercises in his own affairs; and if they practice this, and nevertheless make a mistake, the law does not hold them answerable.

The plaintiff's counsel have referred to the amendment of the Screw Company's charter of October, 1845, as showing that the directors must have known they had no power to take stock in the Iron Company. There were two objects obtained by that amendment, which could not be obtained without it; one was the right to increase the capital stock to $300,000, and the other was the right to carry on the business of manufacturing and rolling iron, under the name of the New England Iron Company. The original charter was for manufacturing purposes, which we think clearly includes the power to manufacture and roll iron, but it must be done as the original charter stood, under the name of the Screw Company. The amendment in effect, authorized them to adopt a new name; but it did not confer any additional authority to manufacture and roll iron.

Neither do we feel ourselves justified in drawing any inference unfavorable to the defendants, from the fact, that the Screw Company do not appear among the petitioners for the charter of the Iron Company.

If the bill had stopped with the prayer for relief against the directors individually, there would have remained nothing more for us to consider in deciding the case. But it goes further, and prays for a dissolution of the union between the two companies, upon the ground that this union was a violation of the charter of the Screw Company. The bill does not pray for any specific mode of relief in this particular, but the counsel for the plaintiff contended, that the proper mode of relief was to order a sale of the stock of the Screw Company, by a master of this court, and we will consider the case, as if such specific relief had been prayed for.

The ground of the relief here prayed for is, that the corporation have violated their charter, and the decree is asked for against them upon the ground of such violation.

The counsel for the defendants contend that this court have no power to try any such question or to administer any such relief.

In considering this question, it is important to take an accurate view of the facts.

It is not a case where the majority of the stockholders have fraudulently violated the charter, for their personal advantage to the injury of the minority, nor is it a case of a willful violation of the charter. The majority acted in good faith, and under the belief that the charter authorized what has been done.

The question then is, whether, in such a case, this court has power, in a suit by a minority of the stockholders, to decree against the Screw Company a sale of their stock in the Iron Company, upon the ground that the Screw Company had exceeded their corporate powers in taking this stock? If so, under what head of equity jurisdiction does such a case fall?

The corporation are not the trustees of the stockholders, so far as the corporate property is concerned. A corporation may become a trustee, as an individual may, and, as such, would be subject to the ordinary jurisdiction of the court, in relation to the trust property. But the relation of corporation and stockholders does not imply a trust in the corporation.

It is true, the English Court of Chancery have exercised a control over charitable corporations in respect to breaches of trust, but the jurisdiction has been cautiously limited to corporations of that character. Such was the Attorney General v. Foundling Hospital, 4 Bro. 165; 2 Vesey, Jr. 42. Such corporations are clearly trustees in respect to the charitable fund, for those who are entitled to the benefit of the charity.

But, in respect to a mere trading corporation, like the Screw Company, we do not find any precedent, either in England or this country, for considering the corporate body as the trustees of the stockholders, and, as such, subject to the general jurisdiction of a Court of Chancery, at the suit of a stockholder.

Let us examine the cases.

In the case of the Attorney General v. Utica InsuranceCompany, 2 Johns. Ch. R. 371, Chancellor Kent reviewed, with careful research, the jurisdiction of a Court of Chancery over corporations up to that period. He came to the conclusion, that in the State of New York, all corporations were amenable to the Supreme Court, and to that Court only, according to the course of the common law, for non-user or mis-user of their franchises; and that the jurisdiction of a Court of Chancery over corporations was limited to the directors and officers of the corporation, in their character of trustees, for a breach of trust.

In the case of Verplanck v. Mercantile Insurance Company, 1 Edwards, 84, the bill was by a stockholder against the company, charging, among other things, that the company had violated their charter, and praying for an injunction to restrain the further operations of the company, and for the appointment of a receiver of all its property and effects, with a view, after payment of debts, to a distribution among stockholders generally, in fact to dissolve the corporation and wind up its affairs.

The Vice Chancellor, while he affirmed the jurisdiction of the court over the directors, denied in the strongest terms the jurisdiction over the corporation. He held, if the parties stood in the relation of partners to each other, or as cestui quetrust and trustees, he should have no doubt as to the authority and duty of the court. But that the corporation were not the trustees of the stockholders, nor did the parties stand in the relative situation of partners, and that a Court of Chancery had no power to interfere with the chartered rights and franchises of a corporation at common law.

The same view is taken of the power of a Court of Chancery, at common law, over corporations, by Chancellor Sanford, in the case of the Attorney General v. Bank of Niagara, 1 Hopkins, 354, and in the case of the Attorney General v. Bank ofChenango, 1 Hopkins, 598.

The case of Verplanck v. Mercantile Insurance Company, to which we have referred, (1 Edwards, 84,) came before Chancellor Walworth, on appeal from an interlocutory order, before Vice Chancellor McCoun's decision was made, (2 Paige, 438.) Chancellor Walworth takes the same view of the common law jurisdiction of a Court of Chancery over corporations for breach of charter, as was taken in the cases which we have cited, and refers his authority to act in that case to the statute which confers it. (Revised Statutes of New York, 463.) These cases show a clear understanding of the profession and the courts of New York, that at common law no such jurisdiction existed in a Court of Chancery. And this authority is entitled to the more weight, because, from an early period in her history, a large chancery jurisdiction has existed in that State, and has been most ably administered.

The only English case we have been able to consult, which is an authority for this jurisdiction, is the recent case ofSolomons v. Laing, decided at the Rolls. It is reported in the London Jurist for April, 1850.

The bill in that case charged, that the directors in the South Coast Company were guilty of a willful violation of the charter of that company, in taking stock in the Portsmouth Company, in their names, as trustees of the South Coast Company, and paying therefor with the funds of the South Coast Company.

The bill, among other things, prayed that the directors of the South Coast Company might be decreed to have purchased the stock in the Portsmouth Company on their own account, and not as trustees of the South Coast Company; and that the directors of the South Coast Company might be decreed to repay to that company the sums which had been taken from their funds to pay for the stock; and that the Portsmouth Company might also be decreed to repay the same.

The defendants demurred to the bill. The opinion of the Master of the Rolls is to the effect, that the directors were guilty of a willful violation of the charter of the South Coast Company, and a breach of trust, and ought to be held to have purchased the stock in the Portsmouth Company on their own account, and ought to be decreed to repay to the South Coast Company the amount which they had taken from the funds of that company to pay for the stock.

It will be seen, that the relief sought was against the directors, and that relief was to be had by decreeing that the stock which stood in their names as trustees, should be theirs in their own right, and that they should repay to the South Coast Company the amount which they had taken from the funds of that company to pay for the stock.

All this falls within the settled jurisdiction of the court.

It is true the Master of the Rolls holds the Portsmouth Company also liable to refund, upon the ground that they knowingly participated in the breach of charter and trust of the South Coast Company, in receiving the money for the stock. But in this respect the decree is against the Portsmouth Company, as against any other party, whether corporation or individual, who has participated in a fraudulent breach of trust.

It does not appear that any other relief was prayed for against the South Coast Company, except to make them with the other defendants pay the costs.

The South Coast Company demurred to the original bill, but they do not appear by demurrer, or otherwise, to the amended bill.

It is proper, also, to bear in mind that the South Coast Company was a Railway Company, having extensive powers under an Act of Parliament; and the Master of Rolls, in his opinion, as reported, attaches importance to this circumstance. The bill also charged a willful breach of charter and trust, which were confessed by the demurrer.

The Screw Company are a trading corporation, having no power under their charter to interfere with the rights of others, any more than a partnership would have; their charter giving them a more convenient organization for the transaction of business, than they could have as a co-partnership, and nothing more.

In the present case, too, all that has been done has been done in good faith for the benefit of the Screw Company, and under the belief that it was lawful.

The counsel for the plaintiff referred to the clause in the charter of the Screw Company, which made the stockholders individually liable for the debts of the company, and endeavored to support the jurisdiction upon a supposed analogy between such a charter and a case of co-partnership.

But a copartnership is a contract, and this is the ground of the jurisdiction. A charter is not a contract, except as between the State and the corporation. The powers and rights and duties of the corporation and of the stockholders, are defined by charter; and the individual liability of the stockholders is the result of statute and not contract. The same view is taken of this subject in the case of Verplanck v. Mercantile InsuranceCompany, already referred to.

If this analogy were to hold, so far as to confer jurisdiction, then this court would be bound to entertain suits generally between the stockholders and the corporation, in respect to the corporate business and property, and the management thereof, and the corporate franchises and a breach thereof — a jurisdiction wholly unknown both in England and in this country.

We do not say, that, where a member of a corporation is illegally excluded by the corporation from his share of the profits, and the amount cannot be ascertained, except by an account, which can only be had in equity, that a Court of Equity will not take jurisdiction, the remedy at law being incomplete. This was the case in Adley v. Whitstable Company, 17 Vesey, 315.

The counsel for the plaintiff have referred to the observations of Lord Cottenham, as announcing the principles which guide intelligent, upright courts in discharge of the new duties to which, from time to time, they are called, by the onward movements of civilized society. Taylor v. Salmon, 4 Mylne Craig, 134. But these observations should be taken with reference to the case then under consideration.

The point in this case was a matter of practice. The plaintiffs in the bill were the directors in a mining company, of which the members were so numerous that they could not be made parties. The question was, whether, under such circumstances, the directors might not maintain the suit. The point was ruled in favor of the plaintiffs upon existing rules of practice. The court was exercising a known and settled jurisdiction, and the question was one of mere form.

In the present case, we are called upon to assume a jurisdiction heretofore unknown to the law.

We readily agree, the law is progressive and expensive, adapting itself to the new relations and interests which are constantly springing up in the progress of society. But this progress must be by analogy to what is already settled, especially with reference to jurisdiction, which is not to be extended to new cases, unless they bear some analogy to what is already established.

Thus, when Lord Hardwicke first entertained a bill by a corporation against directors, he referred the authority of the court to the well known head of equity jurisdiction over trustees, considering the directors in the light of trustees, and in that capacity answerable to the court for a breach of trust.

Besides, corporations, like the Screw Company and Iron Company, are not of recent origin. They have existed to a limited extent in England for centuries, and to a great extent in this country for more than half a century. And yet, no jurisdiction, like this, has ever been exercised in this country, and none in England, unless the recent case decided at the Rolls may be considered an authority in favor of the jurisdiction.

This power over corporations, not being vested in this court by law, we think it far better and safer that the General Assembly should confer it, if it be thought for the public good, rather than that we should assume it.

^* Various charges of fraud set forth in the bill were here considered by the Court, and found to be unsustained by proof; but as they involved the discussion of no questions of law, they have been omitted in the report.