Opinion
Decided October 11, 1926.
Corporations — Fiction of separate entity disregarded — Party in interest stockholder owning entire stock — Receivership and accounting of proceeds — Equitable set-off by defendant against stockholder — Receivership instituted to prevent defendant from collecting debt from stockholder.
1. In suit by receiver of corporation for accounting allegations that K was sole stockholder of corporation, that net proceeds of action would go to him, that he was indebted to defendant in excess of proceeds, had no other assets, and procured employment of receiver to defraud defendant and to prevent collection of defendant's debt, and was real party in interest in seeking accounting, and equitable set-off would avoid circuity of action, held to set forth valid defense.
2. Where corporation's stock is owned by one party, and party in interest is the stockholder, fiction of separate entity of corporation may be disregarded, where justice requires it.
ERROR: Court of Appeals for Cuyahoga county.
Messrs. Stearns, Chamberlain Royon, for plaintiff in error.
Mr. Howard F. Burns, and Messrs. Locher, Green Woods, for defendants in error.
Error proceedings are prosecuted to the judgment of the common pleas court in rendering judgment in favor of the defendant in error Howard F. Burns, receiver, plaintiff below. Various assignments of error are alleged, but we shall confine ourselves to one assignment of error, which, in our opinion, is controlling.
The plaintiff, appointed receiver of the Fairmount Pharmacy Company by order of the insolvency court, brought an action for an accounting against Wallace I. Knight, alleging that the assets of the corporation were all sold and all debts paid, and that the defendant held the proceeds and refused to pay the same to the stockholders; the petition concluding with the prayer that the defendant "be required to render a full accounting of all moneys received by him for and on behalf of the said the Fairmount Pharmacy Company."
Defendant Knight filed an answer, and made one Raymond H. Kelly party defendant. In his second defense Knight invoked the doctrine of equitable set-off for the amount he claimed Kelly owed him.
Upon trial of the case defendant Knight offered evidence in support of his second defense to the following effect:
(1) That Raymond H. Kelly owns all the capital stock of the Fairmount Pharmacy Company.
(2) That all the net proceeds of this action would go to Kelly, the sole stockholder, there being no other creditors.
(3) That Raymond H. Kelly is indebted to him, the defendant Knight, in a sum in excess of all the net proceeds of this action.
(5) That Raymond H. Kelly procured the employment of this receiver for the express purpose of defrauding this defendant, and for the express purpose of preventing the defendant from collecting his debt.
(6) That Raymond H. Kelly is undertaking, under the guise of receivership, to cheat and defraud this defendant by claiming that the corporation, not Kelly himself, is seeking this accounting.
(7) That Raymond H. Kelly is the real party in interest in this action, and that the defendant has no adequate remedy at law other than by equitable set-off in this action.
(8) That this remedy and equitable set-off would avoid circuity of action in the matter of enforcing the rights of this defendant.
The court sustained an objection to the introduction of this evidence.
The sole question we are now considering is whether, under the pleadings, as they appear from the second defense of defendant, the evidence offered was properly rejected.
The trial court apparently took the view that since the receiver is acting in behalf of the corporation the defendant would be limited in his cross-demands to an indebtedness owing to him by the corporation itself, and it therefore held that the indebtedness of Raymond H. Kelly to the defendant Knight could not be considered in this action by way of set-off or cross-demand.
The doctrine of equitable set-off is fully set forth in 24 Ruling Case Law, Sections 12 and 13, pp. 803 and 804, in the following language:
"Although the doctrine of set-off was not recognized at common law, it was so absolutely necessary to the administration of justice that a court of equity could not fail to supply it when the common law omitted it, and long prior to the statute of set-offs it had been a familiar and favorite principle of courts of chancery to adjust in one suit all conflicting demands between the parties, which were readily capable of such adjustment, where, from the relations and situation of the parties and from the nature of their mutual claims, equity and justice seemed to require a complete and speedy settlement. Consequently the jurisdiction of equity is not based upon any statute of set-off, and would exist as well without any such statutes as it now does, and would not be in any sense affected by the repeal of those statutes. * * * By the exercise of this equitable jurisdiction the courts are enabled to do justice between the parties in cases not strictly within the provisions of the statute. * * *
"Courts of equity interfere, in cases of set-off, on grounds analogous to those upon which their whole preventive jurisdiction is based, that is, to prevent irremediable injustice, and the criterion by which the allowance of set-off is to be determined is whether it is equitable."
If the contention of the plaintiff receiver, which the trial court adopted, is correct, it would be for the reason that the formal petition upon which the case was tried makes no mention of Raymond H. Kelly, and therefore, for the purposes of this case, Raymond H. Kelly is not a party to the suit.
In the case of Auglaize Boxboard Co. v. Hinton, 100 Ohio St. 505, 126 N.E. 881, the following language applicable to our discussion is found at page 518 (126 N.E. 885):
"There is a consistent determination by courts to look through corporate forms, and this disposition is shown with increasing firmness as the interests of justice require."
Also, in Smith v. Felton, 43 N.Y. 419, the court said:
"Equity will look through the form of the transaction, and adjust the equities of the parties with a view to its substance rather than its form, so long as no superior equities of third persons will be affected by such adjustment."
We must assume, in our consideration of this case, that the evidence offered and rejected was true. It would therefore appear that no third person is involved in this action, there being no creditors; that Kelly owns all the stock, is entitled to the proceeds, and is insolvent; that no other person than Kelly has any interest in the outcome of this action; that he is the real party in interest; that he is desirous to collect from the defendant Knight under the guise of an action by a receiver, without paying what he owes him. The question therefore arises whether the mere fiction of a corporation should stand in the way and make it impossible for a court of equity to make a just and equitable determination of the case.
In every case where the stock of a corporation is owned entirely by one party, and the party in interest is the stockholder, the fiction of the separate entity of the corporation may be disregarded where the ends of justice require it. Cincinnati Volksblatt Co. v. Hoffmeister, 62 Ohio St. 189, 56 N.E. 1033, 48 L.R.A., 732, 78 Am. St. Rep., 707; State ex rel. v. Standard Oil Co., 49 Ohio St. 137, 30 N.E. 279, 15 L.R.A., 145, 34 Am. St. Rep., 541; First National Bank of Chicago v. Trebein Co., 59 Ohio St. 316, 52 N.E. 834.
The ancient maxim, "Equity regards the substance rather than the form," seems to us applicable to this case. In order to sustain the position of the trial court, it would be necessary to regard the form rather than the substance.
We hold, therefore, that the allegations of the second defense, if substantiated by evidence, present a valid defense to this action instituted by the receiver, and that the evidence offered in substantiation of the same was improperly rejected.
The judgment of the common pleas court is therefore reversed, and the cause remanded.
Judgment reversed and cause remanded.
SULLIVAN and VICKERY, JJ., concur.