Opinion
No. 52/160.
10-06-1922
COSTELLO v. THOMAS CUSACK CO. et al.
Treacy & Milton, of Jersey City, H. C. Lutkin, of Chicago, and George F. Hurd, of New York City, for the motion. McDermott, Enright & Carpenter, of Jersey City, Robert H. McCarter, of Newark, and J. S. Hummer, of Chicago, Ill., opposed.
On Reargument Nov. 3, 1922.
On Reargument.
Suit by Clarence D. Costello against the Thomas Cusack Company and others. Decree granting preliminary injunction advised.
Decree affirmed 120 Atl. 15.
See, also, 124 Atl. 620.
Treacy & Milton, of Jersey City, H. C. Lutkin, of Chicago, and George F. Hurd, of New York City, for the motion.
McDermott, Enright & Carpenter, of Jersey City, Robert H. McCarter, of Newark, and J. S. Hummer, of Chicago, Ill., opposed.
GRIFFIN, V. C. The bill in this cause was filed for various purposes, including a prayer that it be decreed that certain amendments to the certificate of incorporation, submitted for adoption by the stockholders, be declared ultra vires, null, and void, and for an injunction. On the filing of the bill an order to show cause was granted, including a restraint against voting in favor of the passage of a resolution adopting the amendments and executing certificates for the amendments and filing of the same with the Secretary of State. The amendments attacked are as follows:
(1) No person shall be eligible to become or to remain a director of this corporation if he, or any member of his immediate family, shall be directly or indirectly interested, either as owner, partner, stockholder, officer, director, agent, employee, attorney, lender of money, beneficiary, trustee or otherwise, in any business which competes with, or is antagonistic to the business of this corporation.
(2) No attorney, agent, employee, partner, trustee or member of the immediate family of any such person who is rendered ineligible by paragraph 1 hereof, shall be eligible to become or remain a director of this corporation.
(3) Any director of this corporation disqualified to continue as such shall be subject to immediate removal from such office by a majority vote of the remaining directors of this corporation.
Under section 27 of the act concerning corporations (2 Comp. St 1910, p. 1612), power is given to include in an amendment anything which might be legally contained in the original certificate. No charge of irregularity in the proceedings to amend is made. This leaves to be determined the question whether the amendments proposed are ultra vires the corporation.
This question involves two propositions: (1) May a corporation, by its original certificate or an amendment thereof, disqualify certain stockholders from being directors; or, being directors, remove them? (2) Are the amendments so unreasonable that a court should declare them null and void?
As to the first question: Section 15 of the Corporation Act (2 Comp. St. 1910, p. 1607), in dealing with vacancies, assumes that the power of removal exists, and in Re Griffing Iron Co., 63 N. J. Law, 168, 41 Atl. 931, Mr. Justice Collins, speaking for the Supreme Court, said, "If the by-laws so warrant directors may even be removed during their term;" and this case was affirmed. 63 N. J. Law, 357, 46 Atl. 1097. It therefore seems plain that a director holds subject to be removed; and if the thing for which he may be removed exists prior to his election, by parity of reasoning he may be treated as ineligible.
The next questions to be considered are: Do the amendments contravene any property right of a stockholder? and Are they so unreasonable that their purpose condemns them? Neither the certificate of incorporation nor the by-laws were produced, nor was there any agreement produced touching the corporate rights of stockholders. There does appear in Mr. Cusack's affidavit that in paragraph 5 of the certificate of incorporation there is a provision for cumulative voting for directors to protect the minority stockholders. I must therefore assume that the rights of the stockholders are the same as those existing under the common certificate of incorporation, containing no special provisions, excepting that contained in said paragraph 5.
Counsel for the complainant cites Loewenthal v. Rubber Reclaiming Co., 52 N. J. Eq. 440, 28 Atl. 454, to support the theory that the Legislature is without power to authorize amendment of either the by-laws or the certificate of organization without the consent of all the stockholders—the theory being that the certificate and by-laws in force at the time of the acquisition of the stockconstituted a contract between the corporation and the stockholders, and between the stockholders inter sese. In that case the bill was filed to restrain a change in the certificate of organization and in the by-laws of the corporation which the individual defendants proposed to make by the vote of a mere majority of the stockholders under the sixth section of the supplement to the Corporation Act (P. L. 1893, p. 445). There four distinct corporations and one mercantile firm associated themselves together for business purposes under a written agreement prescribing that each corporation or partnership should be entitled to one membership and to one vote at all meetings. After the agreement was signed a certificate of incorporation was executed and filed. The stock was divided among the corporations and partnership in varying amounts. The by-laws adopted provided for six directors, and one was assigned to each corporation and partnership, excepting the Philadelphia Company, to which, on account of its greater holdings of stock, two directors were assigned. Article 6 of the by-laws provided that the same might be amended, added to, altered or repealed by the affirmative vote of the stockholders representing at least two-thirds of the whole capital stock. It therefore appeared that there were contractual relations between the parties, and the thing denounced was the attempt, without the consent of the complainants, to change the system whereby a mere majority might do that which in the by-laws could only be done by at least two-thirds. In the instant case none of these features, or ones calling for a similar conclusion, are presented. The amendments in question do not disturb the stockholders' rights under paragraph 5 of the certificate.
With this latter point eliminated, it remains to be determined whether the amendments are so unreasonable as to be null and void.
In London City v. Vanacker, 3 Carth. 480; 90 Full Eng. Repr. p. 876, Chief Justice Holt said that "every by-law by which the benefit of the corporation is advanced is a good by-law for that reason, that being the true touchstone of all by-laws." The same may also be said of an amendment to the certificate of incorporation.
This amendment seeks, among other things, to render ineligible—or, if elected, to subject to removal—a director if he be also a director in a corporation whose business is in competition with or is antagonistic to the defendant corporation. There are two kinds of disqualification of a director: (1) Temporary; and (2) total or permanent disqualification.
1. A temporary disqualification arises, for instance, when two corporations attempt to contract with each other, and a director who is necessary to constitute a quorum in one is a director in the other, the contract thus consummated is voidable. Stewart v. Lehigh Valley R. R. Co., 38 N. J. Law, 505, at page 522; Metropolitan Tel. & Tel. Co. v. Domestic Tel. Co., 44 N. J. Eq. 568, at page 573, 14 Atl. 907. This being but a partial disqualification does not render the director objectionable in other transactions in which he may serve the corporation with that fidelity which is exacted of a trustee.
2. A total or permanent disqualification is one where the director is so employed in the service of a rival that he cannot serve both, but must betray one or the other. Cross v. W. Va., etc., Ry. Co., 37 W. Va. 342, 16 S. E. 587, 18 L. R. A. 582. This arises where a man is called upon in the performance of his trust to give his best endeavors for the promotion of both rival companies. Therefore, applying the rule mentioned by Chief Justice Holt, supra, an amendment to a certificate of incorporation, or by-law, which excludes such a person from the directorate, advances the benefit of the corporation, and is good. My conclusion, therefore, is that an amendment which renders ineligible—or, if elected, subjects to removal—a director if he be also a director in a corporation whose business is in competition with or is antagonistic to the defendant corporation is valid.
I also conclude that the amendment is valid if the director happens to be the owner, partner, officer, or trustee in a business which is a competitor of or antagonistic to the business of the defendant corporation.
By this first amendment a director is held ineligible if any member of his immediate family shall be directly or indirectly interested as owner, etc. To illustrate: Suppose a son of the director was a director in a rival corporation, and the two corporations desired to enter into an agreement; would the father be disqualified from sitting in his board, as the law now stands? Would the son be disqualified from sitting in his board? Would not each be entitled to vote on the agreement? How can it be said that the father and son have such interest in both corporations that neither can be trusted fairly to perform his duty as trustee? And, if the son and father could so sit, and there is no partial disqualification on account of their being members of rival corporations, it is unreasonable to wholly disqualify them from being directors by reason of such relationship.
This leads to the conclusion that this portion of the amendment is invalid.
As to the further provision of the first amendment disqualifying the director if he happen to be a stockholder, agent, employee, attorney, lender of money, or beneficiary of a rival concern, this part of the amendment I regard as invalid, for the reason that, having such a relation with the rival concern, he is not its trustee, and would not be precluded as a director from voting to makea contract with the rival concern. Nor can it be said that every person holding such relation to the rival concern must of necessity work against the interests of the corporation of which he is a director.
The second amendment goes one step beyond the first, in that it excludes from membership an "attorney, agent, employee, partner, trustee, or member of the immediate family of any such person who is rendered ineligible by paragraph 1." The "person rendered ineligible by paragraph 1" is the director; and this portion of the second amendment tends to disqualify a person who happens to be counsel to the director—not necessarily counsel of the rival concern. It also disqualifies a member of his immediate family from becoming a director, regardless of whether that member of the family happens to have any interest whatsoever in the rival concern. To illustrate: There might be five sons in the family of the director; one son might be a director in the competing corporation, and, under this paragraph, the four disinterested sons, being members of the immediate family of the director, would be ineligible. This, I take it, is an amendment which is unreasonable and beyond the power of the corporation to make.
As to the third amendment, I think it is void, because it provides for the immediate removal of the director, which means summary, and without a hearing; for the word "immediate" negatives the idea of a hearing, giving the person charged time to prepare. In Re Griffing Iron Co., supra, the court said:
"The statute recognizes a power of removal (section 15), and such power is * * * inherent. If there be a fixed term of office removal must be for cause." Page 175 (41 Atl. 934).
In proceedings to remove a director the board acts judicially, and is without power to remove him for cause without giving him a hearing with reasonable opportunity to prepare. Thompson on Corp. § 820.
In Stanley v. Freeholders of Passaic, 00 N. J. Law, 392, 38 Atl. 181, it was said that a party whose rights are to be directly affected by official action is entitled to have an opportunity afforded him of being heard in relation thereto before action is taken, whenever such action is judicial in its character.
The third amendment is therefore void.
It was represented by counsel, and it appears from examination of the case, that amendments in substantially the same form were approved in People v. Ittner, 165 Ill. App. 360, and were accordingly adopted by the defendant corporation in preparing these amendments. In the case of Laughlin v. Geer, 121 Ill. App. 534, decided some six years earlier, the court's decision was almost diametrically opposite to that expressed in the Ittner Case. In the latter case the court did not cite Laughlin v. Geer; and therefore there is presented the situation of the courts of two separate districts, of equal standing, entertaining different views.
In Cross v. W. Va., etc., Ry. Co., supra, cited by complainant, a by-law was held valid which declared that no person who was attorney against the corporation in a suit should be eligible as a director. It will be perceived that the"attorney" mentioned in that case was one who was then actively engaged as attorney against the corporation. Here the provision is that no one who is attorney for any one in a business which competes with or is antagonistic to the business of the corporation is eligible, although he might never have a suit against the corporation.
Having reached the conclusion that parts of the amendments are both valid and invalid, the question arises: Must all the amendments be declared invalid if regularly adopted and filed? This question must be answered in the negative; the invalid may be excised, and the residue stand. Amesbury v. Bowditch Mut. Fire Ins. Co., 6 Gray, 596.
As this case is novel, and not free from doubt, if the general rule were followed an injunction would not be allowed in advance of final hearing McMillan v. Keuhnle, 78 N. J. Eq. 251. 78 Atl. 185; Citizens' Coach Co. v. Camden Horse R. R. Co., 29 N. J. Eq. 299. This case, however, is an exception to the general rule, in that it calls for a construction of the proposed amendments without extraneous evidence, and a determination as to their validity; nothing could be offered on final hearing that is not now before the court. In such a situation a preliminary injunction may issue. United Cigar Stores v. United Confectioners, 92 N. J. Eq. 56, 111 Atl. 603, affirmed 92 N. J. Eq. 449, 113 Atl. 226, 17 A. L. R. 779.
A decree will be advised in accordance with the foregoing views.
On Reargument.
After the memorandum of October 6th instant had been forwarded to counsel, a re-argument was asked on two points, viz.: (1) Whether, under article 7 of section 8 of the Corporation Act (2 Comp. St. 1910, p. 1604), the power to file an amended certificate in the form therein set forth is in conflict with the Corporation Act. (2) On the question of reasonableness, and the power of the court to determine what was reasonable or unreasonable.
1. The seventh article of section 8 is as follows:
"VII. The certificate of incorporation may also contain any provision which the incorporators may choose to insert, for the regulation of the business and for the conduct of the affairs of the corporation, and any provision creating, defining, limiting and regulating the powers of the corporation, the directors and thestockholders, or any class or classes of stockholders; provided, such provision be not inconsistent with this act."
This section was construed in the case of Audenreid v. East Coast Milling Co., 68 N. J. Eq. 450, 59 Atl. 577. In that case it appeared that the certificate of incorporation provided that any resolution in writing, signed by all the members of the board of directors, should constitute the action of the board as fully as if the same was passed in open meeting; and it was sought to sustain this grant of power under the seventh article of section 8, above set forth. Vice Chancellor Bergen, at page 467 (59 Atl. 584), said:
"If the power to legislate as these incorporators have legislated exists, it must be found in the expression, 'any provision creating, defining, limiting and regulating the powers' of directors."
After analyzing this paragraph, he said:
"The method of exercising the power created must conform to settled legal principles, unless it be otherwise distinctly authorized by the legislative act. No such express authority is conferred by this act and it ought not to be inferred from ambiguous expressions" —and he held the amendment invalid.
At the time our Corporation Act was passed there resided in the stockholders the power to remove directors for cause, and after a hearing, but not arbitrarily, which power the stockholders might delegate to the directors. This being an important feature of the law at the time of the adoption of our Corporation Act, to hold that the ambiguous language in the seventh paragraph gave power to the stockholders to amend the certificate to arbitrarily create a disqualification and authorize the removal of a director would be doing violence to the legislative intent.
2. The next question to be considered is: Are the amendments arbitrary? And this question must be determined by their reasonableness. This has been dealt with in the first memorandum. On the reargument, in view of the memorandum of the court, counsel called the attention of the court to the effect of the words "directly * * * interested in any business which competes," etc., as tending to show the propriety of the disqualification, and pointed out that an employee or agent may be so connected with a rival concern that it becomes his duty to use his best endeavors to take to his own employer the business and trade of the corporation of which he is a director, as appears to be so in this case. The difficulty, as I see it, with this argument, is that the test of his ineligibility is that he is directly interested in the business of the competitor, without specifying that the character of the interest is such as to bring his services to his employer and his duties as director in conflict. In the other cases, where the exclusion was held valid, the very nature of the office held in the rival company condemned the director occupying the dual relation.
The difference is clearly presented in this case. One might be an employee of a rival concern, directly interested in its prosperity, whose duties are not such as to take from him the power to properly serve the corporation of which he is a director. On the other hand, a situation may arise where a director, being an agent or employee of a rival concern, might do it infinitely more damage than if he were a director of the rival concern. The director of the rival concern might not possess the peculiar knowledge of the trade which would enable him to obtain information and use it against the corporation of which he is a director. That situation seems, in a measure, to appear in this case. Mr. Cusack, in his affidavit, charges that Mr. Costello is a man experienced in the trade; that for a long time he was in the service of the Cusack Company; that he left its employ and became manager of the O. J. Gude Company; that the Cusack Company had been trading with the O. J. Gude Company and other concerns allied with the Gude Company, and that, for the protection of the Cusack Company, it was deemed wise to give up trading with Gude and such other companies. And Mr. Costello, in his affidavit, says as follows:
"I state that the reason which has made it necessary for me to give some attention to establishing paint plants of the O. J. Gude Company in competition with the Cusack Company has been for the reason that the Thomas Cusack Company refused to accept or carry out orders for paint display for the O. J. Gude Company," —and he, as manager in charge of this particular line of competition, if he serves the Gude Company properly, must use his best endeavors to take the trade of the Cusack Company of which he is a director.
There is a further feature: He charges in the bill that the corporation is insolvent and mismanaged, whereas the bill itself leads to the strong inference that Mr. Costello does not believe it to be insolvent; and a reading of the bill in connection with the affidavits of the defendant makes it appear quite plain that it is far from being insolvent. And it further appears that the attorney of Mr. Costello went to two banks in Chicago about the 1st of February, 1921, and stated to the rep resentative of one of the banks that he represented certain minority stockholders of the company; that he had valuable and confidential information regarding the Thomas Cusack Company; that the earnings of the company were grossly exaggerated; its financial condition was not as it was represented; and, in substance, stated that the business was badly managed, and in an unsatisfactory condition, and if the companywas indebted to the bank in any sum he would advise the bank to collect it as soon as possible while there was yet opportunity. And an officer of the other bank swore substantially to the same effect, stating that this attorney said he represented Costello, a minority stockholder; that the company was going broke, and that if the company owed the bank any money, he would advise the bank to "get the money while the getting was good." These affidavits of the two bankers are not denied by the said attorney, and he is the only person who could deny the same from all of which it plainly appears that the complainant, Costello, to say the least, was using his best endeavors to greatly injure the corporation of which he was a director. In such a case, I apprehend there would be as much reason to remove him as there would be to remove a director of a rival concern. But, as before stated, the amendment to remove is too broad, in that it tends to disqualify every employee having a direct or indirect interest in the rival concern, regardless of the nature of his employment.
Since the filing of the bill an order was made admitting one H. H. Buchholtz, Jr., a stockholder, as a party complainant.
I regret that I had not more time to investigate this interesting question, but, in view of the fact that an appeal will be taken, I deemed it wise to promptly decide the case so that it may be heard at the next term of our court of last resort.
I will advise an order in accordance with the foregoing views.