Opinion · District Court, D. Delaware

Downing v. Howard

68 F. Supp. 6

Type
Opinion
Court
District Court, D. Delaware
Jurisdiction
Delaware
Date
1946-10-18
Topic
bankruptcy

LEAHY, District Judge. The major question for decision is whether this action is simply a traditional stockholder’s derivative suit based upon a *10 breach of fiduciary duties by officers and directors acting under an unlawful conspiracy to waste assets with other defendants or whether this action is brought to enforce any duty or liability created under the Public Utility Holding Company Act of 1935. This is the first time the question has been put and everyone shares my inability to find a controlling authority on the first two alleged causes of action. 1. While the complaint charges the action is based on § 25 of the Act, the allegations of waste of corporate assets and the profits illegally obtained are the resultants of violations by officers and directors of their common law fiduciary duties in failing to exercise independent judgment for the good of the corporation and their participation in a fraudulent conspiracy with other defendants to profit at the expense of United. As to the first cause of action based on violation of the Act by holding of securities and the second cause of action based on voting for the merger of Mohawk and Niagara, if United had registered, these transactions would have been legal.

Citator

UpLaw has not yet analyzed Downing v. Howard. The absence of a flag is not a finding that it is good law.

Authority status
pending
Cited by
6 opinions
DOWNING v. HOWARD, (D.Del. 1946)
68 F. Supp. 6
DOWNING v. HOWARD et al.
Civil Action No. 457.
United States District Court, D. Delaware.
September 27, 1946.
As Amended October 18, 1946.
West Page 7
Stockholder's derivative action by Edward R. Downing, suing on his own behalf and on behalf of all other stockholders of the United Corporation (of Delaware), etc., against George H. Howard, George Whitney, Landon K. Thorne, and others to recover for alleged waste of assets of corporation. On defendants' motions to dismiss.

Motions granted.

A stockholder's derivative suit to recover from former and present directors and third parties, alleged to have acted in conspiracy, approximately $100,000,000 for waste of assets as a result of breach of fiduciary duty and for an accounting. Jurisdiction is said to be based on § 25 of the Public Utility Holding Company Act of 1935, 15 U.S.C.A. § 79y.

It is alleged defendants violated § 5 of the Act, 15 U.S.C.A. § 79e, in that The United Corporation remained an unregistered holding company from December 1, 1935, to March 28, 1938, when it registered; defendants violated § 4(a)(6) of the Act, 15 U.S.C.A. § 79d(a)(6), by holding securities of subsidiaries, and in voting for the merger of Mohawk Hudson Power Corporation with Niagara Hudson Power Corporation and in acquiring certain shares of stock from the merger; and, in failing to submit a proper plan of compliance with the Securities and Exchange Commission, violated § 11(e) of the Act, 15 U.S.C.A. § 79k (e). In short, the charge is defendants are liable for waste of assets occurring during the period when United was violating the Act.First Cause of Action. This is contained in the first 42 paragraphs of the complaint. It is alleged United from its inception was controlled by defendants J.P. Morgan Co., Bonbright and Company and certain individuals associated with these firms, who prior to December 1, 1935, had profited from transactions with United and its subsidiaries. It is also alleged that they continued to profit after December 1, 1935, to March 28, 1938, when United registered under the Act. The allegation is that defendants "deliberately resolved to conduct the business of United in violations" of the provisions of the Act and "to cause United not to register with the Securities and Exchange Commission pursuant to the Act." Reliance is had on § 4(a)(6), which provides that it is unlawful to own or hold with power to vote any security of a subsidiary, unless a holding company is registered; and the allegations follow that between December, 1935, and March 28, 1938, United held in violation of § 4(a)(6) securities of subsidiaries with a market value of $194,000,000 but which on the date of registration had decreased in value to an extent in excess of $87,000,000. In the first cause, plaintiff seeks to recover this amount plus $1,000,000 representing salaries, expenses and taxes which arose out of retaining ownership of the mentioned securities. Paragraph 37 alleges United on December 1, 1935, should have reorganized or dissolved; and the rising market for the 13 month period after December 1935, in the event of sale of stocks of subsidiaries would have realized $194,000,000, whereas the value of such securities on the date of registration, March 28, 1938, was $107,000,000. The difference is the waste charged in violating § 4(a)(6). Paragraph 38 charges that these acts or omissions to act "were committed in furtherance of a fraudulent conspiracy by the defendants to waste and dissipate the assets of United and to profit at the expense of United by means of said acts and failures to act. In taking part in said conspiracy and the fraudulent acts and omissions pursuant thereto, the directors of United conducted themselves in wrongful violation of their fiduciary duties to United and the other defendants knowingly participated in and wrongfully induced such breach of fiduciary duty."Second Cause of Action. This also charges violation of § 4(a) (6) in that defendants caused United while unregistered to hold and vote shares of Niagara Hudson Power Corporation and of Mohawk Hudson Power Corporation in connection with a merger of those companies whereby United exchanged certain shares of Mohawk for shares of consolidated Niagara pursuant to the plan of merger. The acquisition of these shares it is alleged violated § 4(a)(3) and (4) of the Act. The damages claimed here, arising out of shrinkage ofWest Page 8market values and loss of dividends by reason of the exchange, is $3,866,550. The illegal acts under this cause of action it is alleged were committed "in furtherance of a fraudulent conspiracy among the defendants to waste and dissipate the assets of United and to profit at the expense of the defendant United." The individual defendants, as officers and directors, the charge is, acted in "breach of their fiduciary duties to defendant United, and were guilty of gross negligence in the discharge of said duties."Third Cause of Action. The charge here is that from January 1, 1936, to August 14, 1945, the individual defendants as officers and directors throughout that period violated the Act by failing to file a plan in compliance with § 11(e); and the value of the stocks retained throughout this period decreased in value by $87,000,000. Here, again, the charge is that the failure to act was committed "in furtherance of a fraudulent conspiracy among the defendants to waste and dissipate the assets of United and to profit at the expense of United by reason of said acts and failures to act" and that such conduct "constituted gross negligence and a fraudulent breach of their fiduciary duties as directors and officers of said United."Defendants. The individual and the partnership and corporate defendants are: George H. Howard, George Whitney, Landon K. Thorne, Hendon Chubb, Thomas H. Stacy, Wesley A. Sturges, John J. Burns, Edward H. Luckett, Roy K. Furguson, George L. Burr, Bruce D. Smith, O. Kelley Anderson, Frederic C. Dumaine, Jr., William M. Hickey, J. Francis Smith, Thomas W. Lamont, Junius S. Morgan, Russell C. Leffingwell, Francis D. Bartow, Arthur M. Anderson, Thomas S. Lamont, Harry P. Davison, Edward Hopkinson, Jr., Charles D. Dickey, Alfred L. Loomis, Commercial Enterprises Corporation; Thorne, Loomis Co., Inc.; J.P. Morgan Co., Inc.; Morgan, Stanley Co., Inc.; Harold Stanley, Henry S. Morgan, William Ewing, Perry Hall, Allen N. Jones, Edward H. York, Jr., John M. Young, Sumner B. Emerson and Alfred Shriner, individually and as copartners doing business under the firm name and style of Morgan, Stanley Co.; The United Corporation (of Delaware). In addition, the personal representatives of former officers and directors who have since died are joined and they are: Alfred H. Casparry and Harry P. Davison, as executors, and Bankers Trust Company, as trustee, under the last will and testament of Thomas Cochran, deceased; Eva R. Stotesbury, Charles D. Dickey and Morris R. Bockins, as executors under the last will and testament of Edward T. Stotesbury, deceased; Devereux Milburn, Francis Skiddy Von Stade and H. Hall Clovis, as executors, and Guaranty Trust Company of New York, as trustee, under the last will and testament of Charles Steele, deceased; Henry S. Morgan, Junius S. Morgan and J.P. Morgan Co., Inc., as executors under the last will and testament of J. Pierpont Morgan, deceased; Edna Rogers Carslisle and Randall J. LeBoeuf, executors under the last will and testament of Floyd L. Carlisle, deceased; H. Gates Lloyd, Jr., Richard W. Lloyd and Charles D. Dickey, executors under the last will and testament of Horatio G. Lloyd, deceased.

The last group of defendants have moved to dismiss the complaint as to them or to set aside service of process on the grounds of lack of jurisdiction of this court over foreign estates. All defendants have moved to dismiss under Rule 12(b) (1-5) of the Rules of Civil Procedure, 28 U.S.C.A. following section 723c.

Those sections of the Public Utility Holding Company Act of 1935,15 U.S.C.A. § 79et seq., which are called into play are found in the footnote.1
William H. Bennethum, of Wilmington, Del., and John F. Davidson and Ralph Bernstein, both of New York City (MarvelWest Page 9Morford, of Wilmington, Del., of counsel), for complainant.

Caleb S. Layton, of Wilmington, Del., and Ralph M. Carson, of New York City (Richards, Layton Finger, of Wilmington, Del., Thomas B.K. Ringe, of Philadelphia, Pa., and Allen T. Klots, Orison S. Marden, and Neal M. Welch, all of New York City, of counsel), for defendants George Whitney et al.

William S. Potter, of Wilmington, Del. (Southerland, Berl Potter, of Wilmington, Del., and Whitman, Ransom, Coulson Goetz, Simpson, Thacher Bartlett, Bigham, Englar, Jones Houston, Blair Ogden, Edwin Foster Blair, Robert I. Stevenson, and LeBoeuf Lamb, all of New York City, of counsel), for defendants George H. Howard et al.

William Prickett, of Wilmington, Del., and Horace R. Lamb, of New York City (LeBoeuf Lamb and Thomas P. Cook, all of New York City, of counsel), for defendants Edna Rogers Carlisle and Randall J. LeBoeuf, Jr., executors of Floyd L. Carlisle, deceased.

Caleb S. Layton, of Wilmington, Del., and Sidney W. Davidson, of New York City (Richards, Layton Finger, of Wilmington, Del., of counsel), for defendants Francis Skiddy Von Stade, executor, and Guaranty Trust Co. of New York, trustee, under will of Charles Steele, deceased.

John J. Morris, Jr., of Wilmington, Del., for defendant United Corporation.
LEAHY, District Judge.
The major question for decision is whether this action is simply a traditional stockholder's derivative suit based upon aWest Page 10breach of fiduciary duties by officers and directors acting under an unlawful conspiracy to waste assets with other defendants or whether this action is brought to enforce any duty or liability created under the Public Utility Holding Company Act of 1935. This is the first time the question has been put and everyone shares my inability to find a controlling authority on the first two alleged causes of action.

1. While the complaint charges the action is based on § 25 of the Act, the allegations of waste of corporate assets and the profits illegally obtained are the resultants of violations by officers and directors of their common law fiduciary duties in failing to exercise independent judgment for the good of the corporation and their participation in a fraudulent conspiracy with other defendants to profit at the expense of United. As to the first cause of action based on violation of the Act by holding of securities and the second cause of action based on voting for the merger of Mohawk and Niagara, if United had registered, these transactions would have been legal. Yet the loss to United would have been the same. Hence, the real cause of the loss was not failure to register, i.e., violation of the Act, but the loss resulted from the "fraudulent conspiracy among defendants to waste the assets of United and to profit at the expense of" United. At best, the alleged violations were violations by United. There is no provision in the Act imposing a duty or liability on officers or directors, as such, or upon outsiders acting in concert with officers and directors.

Clearly, then, the suit at bar is not a "suit in equity * * * brought to enforce any liability or duty created" by the Act. Absent other jurisdictional elements, a minority stockholder may not resort to the federal courts on simple allegations that directors and officers, with other co-conspirators, have violated federal statutes — such as anti-trust laws and the Interstate Commerce Act, 49 U.S.C.A. § 1 et seq. — in addition to committing breaches of fiduciary duty. Cf. Meyer v. Kansas City Southern R. Co., D.C.,11 F. Supp. 937, affirmed 2 Cir.,84 F.2d 411,414, certiorari denied299 U.S. 607,57 S.Ct. 233,81 L.Ed. 448. In the Meyer case, although not a direct action for violation of federal statutes, it was nevertheless said: "But so far as the [officers and directors] are liable for a breach of the fiduciary duties to minority stockholders imposed upon them by reason of their control of the St. Louis Southwestern, it is immaterial that their breaches of faith to the appellant also involved violations of federal statutes. The appellees' liability would be complete though their acts were not public offenses and a determination of federal law is thus not necessarily involved."

Statutes conferring federal jurisdiction must be strictly construed, Indianapolis v. Chase National Bank,314 U.S. 63,76,77,62 S.Ct. 15,86 L.Ed. 47; Thomson v. Gaskill,315 U.S. 442,446,62 S.Ct. 673,86 L.Ed. 951; and my construction of the Act leads to this view: To fulfill the express purposes of this particular legislation, there are three specific sanctions spelled out in the Act: First, injunction, § 18(f), 15 U.S.C.A. § 79r(f), at the instance of the SEC; second, criminal punishment, § 29, 15 U.S.C.A. § 79z —3, at the instance of the Attorney General or any of his United States Attorneys; and third, § 26(b), 15 U.S.C.A. § 79z(b), which declares that contracts made in violation of the Act are void. Under § 4(a)(2) of the Act, it has been held that a private party, i.e., a stockholder, may maintain a stockholder's derivative action to recover on behalf of a corporation the consideration which has passed in connection with a contract which was specifically prohibited by § 26(b). Goldstein v. Groesbeck, 2 Cir.,142 F.2d 422,426, certiorari denied323 U.S. 737,65 S.Ct. 36,89 L.Ed. 590.

Plaintiff's main reliance is on the Groesbeck case, supra. There, a derivative stockholder's suit was instituted against Electric Bond Share Company, its directors and subsidiaries. Bond Share did not register under the Act, but challenged its constitutionality. Service company subsidiaries were organized to render contractual and financial services and they entered into contracts with operating utility subsidiaries. The suit was to recover fees paid by the operating subsidiaries. The court held that under the Act the contracts wereWest Page 11void and that recovery could be had under § 26. Now, my analysis of the Act fails to disclose any sanction against the holding of stock by an unregistered holding company comparable to the specific sanction given, for example, with respect to service contracts. In fact, the Act expressly prescribes the legal consequences of making forbidden contracts, i.e., such contracts are void. The holding of the Circuit Court in the Groesbeck case was based, therefore, not on the violation of § 4(a) but that § 26(b) "in express terms declares the contracts void." The case at bar involves no contracts void by virtue of the Act. The facility with which the Groesbeck case may be distinguished makes it of little help to our present problem. I conclude that plaintiff can not maintain a stockholder's derivative action in equity against United's officers and directors and other third party conspirators for causing United to violate § 4(a) of the Act. There is no provision in the Act giving a sanction against the acts complained of by permitting a private party to sue and to apply such sanctions. § 4(a) is penal in nature in order to force subject companies to register under § 5. For failure to register, a company may be subject to the penalty provided in § 29 — a penalty not to exceed $200,000. Electric Bond Share Co. v. Securities and Exchange Commission,303 U.S. 419,442,58 S.Ct. 678,82 L.Ed. 936, 115 A.L.R. 105, manifestly suggests that the sanctions of § 4(a) are penal in nature.2Moreover, § 4(a) would appear to be a regulatory statute; and a violation of its provisions would give no right of action to a private party. The Congressional Reports3show that § 4(a) establishes the mechanism by which holding companies are brought under the jurisdiction of the SEC so that the provisions of Title I may be effectively administered. A further analysis of the Act shows that when Congress intended to give private parties remedies under the Act, it so specified. § 17(b) prohibits officers and directors, under certain circumstances, from realizing profits, in other instances, from purchase and sale of securities of a subject company or any of its subsidiaries.4Again, § 16, dealing with private parties, creates liability for the making of false statements and applications.5No such specificity of remedy to a private party may be found with respect to § 4(a).6In the last analysis, it seems clear that the dutyWest Page 12of enforcing compliance with the Act is, with the exceptions noted, the exclusive function of the SEC.

The alleged violation of the Act under the third cause of action is without substance. There is no requirement under the Act or any rule of the SEC that a subject company must submit a particular plan. A § 11(e) holding company is given an option to submit a plan for divestment of control or of securities of subsidiaries. Section 11(e) is permissive, not mandatory, and it was so held in Commonwealth Southern Corp. v. Securities and Exchange Commission, 3 Cir.,134 F.2d 747,751.

As I have concluded that the jurisdiction of this court, in the instant case, can not be based upon § 25 of the Act, it follows, under my view, that plaintiff is prosecuting the traditional minority stockholder's suit for waste and dissipation of assets through breach of common law fiduciary duties. Without jurisdiction based on § 25 of the Act, it can not be based on diversity. The amended complaint shows three defendants are citizens of the same state as plaintiff. This is not true diversity. See 1 Moore, Federal Practice, p. 481, for collection of cases.

Moreover, a number of defendants have moved to dismiss the complaint or to set aside the service of process as to them. These defendants are executors and trustees of the various estates of former officers and directors who have, since the time of the acts complained of, died. These defendants have been appointed by foreign courts and are administering their respective estates outside of the District of Delaware, i.e., New York, Pennsylvania, etc. The questions raised are (a) does this court have jurisdiction over the persons of foreign executors and trustees where the decedent has no assets in Delaware and died without the District of Delaware; (b) may this court determine the claim asserted against these defendants in their capacity as executors and trustees; and (c) does § 25 of the Act or any other federal statute confer jurisdiction over the moving defendants or the claim asserted against them as executors and trustees?

Here, again, it is unnecessary to deal with these questions in view of the conclusion already reached that this is not an action based upon § 25 of the Act. But, if it again be said that plaintiff is simply prosecuting the traditional minority stockholder's suit, the conclusion is there can be no jurisdiction over those particular defendants representing the foreign estates.

Absent funds, here, belonging to the foreign estates, personal representatives, appointed by foreign courts, may not be sued in this district in their representative capacities where the suit is an attempt to establish a claim against the estates of foreign decedents — here, the former non-resident alleged wrongdoers. Rule 17(b) of the Rules of Civil Procedure fixes the capacity to sue and be sued in the federal court. Under the rule, I look to the law of Delaware to determine whether the moving defendants may be sued here. Delaware has it settled that where an estate of a decedent is in process of administration by foreign executors and the estate has no assets in Delaware and a defendant, as personal representative, has not voluntarily submitted to suit, there is no jurisdiction over the person of such foreign representative or the claim alleged and asserted against such foreign estate. Bowles v. K.G. Dun-Bradstreet Corp., Del.Ch., 12 A.2d 392. Moreover, here the foreign estates are already being administered; and, the New York courts, for example, will not, on the basis of comity, recognize a judgment rendered by a foreign court against executors appointed in New York. Helme v. Buckelew,229 N.Y. 363,128 N.E. 216; McMaster v. Gould,240 N.Y. 379,148 N.E. 556, 40 A.L.R. 792; Burrowes v. Goodman, 2 Cir.,50 F.2d 92, 77 A.L.R. 249. Absence of comity by the courts of the decedent'sWest Page 13domicile questions the foreign court's constitutional power to adjudicate a claim against a non-resident decedent's estate. Riverside Dan River Cotton Mills v. Menefee,237 U.S. 189,196,35 S.Ct. 579,59 L.Ed. 910; Thorburn v. Gates, D.C., 225 F. 613, 616.

2. The question was also argued that, assuming arguendo the present complaint stated a good cause of action based upon § 25 of the Act, this court had no jurisdiction over the foreign representatives of the estates in question. Any discussion as to this second point would be simply dicta; and, as I have already decided no cause of action exists, the second point argued becomes moot. It is my opinion it should be left such.West Page 17
  1. Sec. 4: "(a) After December 1, 1935, unless a holding company is registered under section 5, it shall be unlawful for such holding company, directly or indirectly —

    "(1) to sell, transport, transmit, or distribute, or own or operate any utility assets for the transportation, transmission, or distribution of, natural or manufactured gas or electric energy in interstate commerce;

    "(2) by use of the mails or any means or instrumentality of interstate commerce, to negotiate, enter into, or take any step in the performance of, any service, sales, or construction contract undertaking to perform services or construction work for, or sell goods to, any public-utility company or holding company:

    "(3) to distribute or make any public offering for sale or exchange of any security of such holding company, any subsidiary company or affiliate of such holding company, any public-utility company, or any holding company, by use of the mails or any means or instrumentality of interstate commerce, or to sell any such security having reason to believe that such security, by use of the mails or any means or instrumentality of interstate commerce, will be distributed or made the subject of a public offering;

    "(4) by use of the mails or any means or instrumentality of interstate commerce, to acquire or negotiate for the acquisition of any security or utility assets of any subsidiary company or affiliate of such holding company, any public-utility company, or any holding company;

    "(5) to engage in any business in interstate commerce; or

    "(6) to own, control, or hold with power to vote, any security of any subsidiary company thereof that does any of the acts enumerated in paragraphs (1) to (5), inclusive, of this subsection.

    "(b) Every holding company which has outstanding any security any of which, by use of the mails or any means or instrumentality of interstate commerce, has been distributed or made the subject of a public offering subsequent to January 1, 1925, and any of which security is owned or held on October 1, 1935 (or, if such company is not a holding company on that date, on the date such company becomes a holding company) by persons not resident in the State in which such holding company is organized, shall register under section 5 on or before December 1, 1935 or the thirtieth day after such company becomes a holding company, whichever date is later."

    Sec. 25: "The District Courts of the United States, the Supreme Court of the District of Columbia, and the United States courts of any Territory or other place subject to the jurisdiction of the United States shall have jurisdiction of violations of this title or the rules, regulations, or orders thereunder, and, concurrently with State and Territorial courts, of all suits in equity and actions at law brought to enforce any liability or duty created by, or to enjoin any violation of, this title or the rules, regulations, or orders thereunder. Any criminal proceeding may be brought in the district wherein any act or transaction constituting the violation occurred. Any suit or action to enforce any liability or duty created by, or to enjoin any violation of, this title or rules, regulations, or orders thereunder, may be brought in any such district or in the district wherein the defendant is an inhabitant or transacts business, and process in such cases may be served in any district of which the defendant is an inhabitant or transacts business or wherever the defendant may be found. * * *" ↩
  2. See, too, North American Co. v. Securities Exchange Commission,66 S.Ct. 785,793, n. 8, which states that holding companies "are forced to register by reason of the provisions of § 4(a)." ↩
  3. S. 621, 74th Cong., 1st Sess., p. 25; H.R. 1318, 74th Cong., 1st Sess., p. 11. ↩
  4. Section 17(b), 15 U.S.C.A. § 79q(b):

    "Suit to recover such profit may be instituted at law or in equity in any court of competent jurisdiction by the company entitled thereto or by the owner of any security of such company in the name and in the behalf of such company if such company shall fail or refuse to bring such suit within sixty days after request or shall fail diligently to prosecute the same thereafter; but no such suit shall be brought more than two years after the date such profit was realized." ↩
  5. Section 16, 15 U.S.C.A. § 79p:

    "(a) Any person who shall make or cause to be made any statement in any application, report, registration statement, or document filed pursuant to any provision of this chapter, or any rule, regulation, or order thereunder, which statement was at the time and in the light of the circumstances under which it was made false or misleading with respect to any material fact shall be liable in the same manner, to the same extent, and subject to the same limitations as provided in section 78r of this title with respect to an application, report, or document filed pursuant to sections 78a to 78jj of this title.

    "(b) The rights and remedies provided by this chapter, except as provided in section 79q of this title, shall be in addition to any and all other rights and remedies that may exist under sections 77a to 77mm of this title or sections 78a to 78jj of this title, or otherwise at law or in equity; but no person permitted to maintain a suit for damages under the provisions of this chapter shall recover, through satisfaction of judgment in one or more actions, a total amount in excess of his actual damages on account of the act complained of. Aug. 26, 1935, c. 687, Title I, § 16,49 Stat. 829." ↩
  6. I find the principle just discussed recently applied in this Circuit. See Steckler v. Pennroad Corp., D.C.,44 F. Supp. 800, affirmed 3 Cir.,136 F.2d 197, certiorari denied320 U.S. 757,64 S.Ct. 64,88 L.Ed. 451, involving a stockholder's suit against directors for accounting, where directors caused corporation to purchase stock of railroads in violation of New York and Massachusetts statutes. ↩