Borak v. JI Case Company

• Decision Date: 29 May 1963
• Docket Number: No. 13947.,13947.
• Citation: 317 F.2d 838
• Parties: Carl H. BORAK, for and on behalf of himself and all of the other common stockholders of J. I. Case Company who are similarly situated to him, Plaintiff-Appellant, v. J. I. CASE COMPANY, a Wisconsin corporation et al., Defendants-Appellees.
• Court: U.S. Court of Appeals — Seventh Circuit

317 F.2d 838 (1963)

Carl H. BORAK, for and on behalf of himself and all of the other common stockholders of J. I. Case Company who are similarly situated to him, Plaintiff-Appellant, v. J. I. CASE COMPANY, a Wisconsin corporation et al., Defendants-Appellees.

No. 13947.

United States Court of Appeals Seventh Circuit.

May 29, 1963.

COPYRIGHT MATERIAL OMITTED

Alex Elson, Arnold I. Shure, Chicago, Ill., Bruno V. Bitker, Milwaukee, Wis., Elson & Lassers, Willard J. Lassers, Aaron S. Wolff, Chicago, Ill., for plaintiff-appellant.

H. Maxwell Manzer, Madison, Wis., Ray T. McCann, Walter S. Davis, Milwaukee, Wis., for appellees.

Peter A. Dammann, Gen. Counsel, David Ferber, Associate Gen. Counsel, Michael Joseph, Atty., Washington, D. C., S. E. C., for Securities and Exchange Commission, amicus curiae.

Before DUFFY and KILEY, Circuit Judges, and MERCER, District Judge.

FREDERICK O. MERCER, District Judge.

Plaintiff, Carl H. Borak, the holder of 2,000 common shares of J. I. Case Company, hereinafter referred to as Case, commenced this suit below on November 13, 1956, by filing his complaint in which he sought to have the then proposed plan of merger between Case and American Tractor Corporation, hereinafter ATC, declared illegal and void and to have Case and its officers and directors enjoined from taking any action to consummate the plan. Injunctive relief was denied. Subsequently plaintiff has filed three amended and supplemental complaints, the third of which was filed on January 12, 1962. It is that complaint which gives rise to this appeal. That complaint is in two counts, the first of which is based upon the laws of the state of Wisconsin and invokes the court's jurisdiction on the basis of diversity of citizenship. The second count purported to allege violations of Sections 10(b) and 14(a) of the Securities Exchange Act of 1934, 15 U.S.C.A. §§ 78j (b), 78n(a), and the jurisdiction of the court over that count is asserted to exist by reason of the provisions of Section 1331 and Section 1337 of the Judicial Code, 28 U.S.C.A. §§ 1331, 1337, and Section 27 of the Securities Exchange Act. 15 U.S.C.A. § 78aa.¹

After the third amended complaint was filed, the defendants² filed a motion for an order to compel plaintiff to provide security for expenses incurred and to be incurred by the defendants in defending the suit to comply with the provisions of Wis.Stat. § 180.405(4).³ After a hearing upon that motion the court filed an opinion holding that the only cause of action stated in count 1 of the complaint was derivative in nature and that the Wisconsin security for expense statute applied thereto, that count 2 does not state a cause of action under Section 10b of the Act,⁴ that the only relief which it had jurisdiction to grant under Section 14(a)⁵ of the Act was a declaratory judgment as to the validity or invalidity of the proxies involved in the suit, and that, insofar as count 2 prayed relief other than such a declaratory judgment, that count also stated a derivative cause of action under Wisconsin law, which was subject to the provisions of the Wisconsin security for expense statute. Accordingly, the court ordered plaintiff to furnish a bond in the amount of $75,000.00, conditioned for the payment of expenses to be incurred by the defendants in defending the suit. Upon plaintiff's refusal to provide security in accordance with that order, the court ordered that count 1 of the complaint be dismissed and that count 2 thereof likewise be dismissed, except to the extent that that count might be construed as a suit under Section 14(a) for a declaratory judgment as to the validity of the proxies solicited for the Case-ATC merger. This interlocutory appeal was then taken pursuant to the provisions of 28 U.S.C.A. § 1292(b) and the order of this court, entered October 24, 1962, granting to plaintiff leave to appeal.

Three issues are presented on this appeal. First, did the court below err in its conclusion that the cause of action stated in count 1 of the complaint was derivative in nature and therefore subject to the provisions of Wisconsin security for expense statute? Second, did the court below err in its holding that the Wisconsin statute applies to count 2 of the complaint insofar as that count sought retrospective relief? Third, did the court below err in holding that count 2 of the complaint did not state a cause of action under Section 10(b) of the Securities Exchange Act?

With respect to count 1 of the complaint, the only issue before us for decision is the question whether the court correctly held the provisions of the Wisconsin statute applicable to plaintiff's cause of action. As the court recognized in its opinion, that issue depends upon a determination whether the allegations of the complaint state a derivative cause of action brought on behalf of the corporation, or a primary cause of action to redress an injury to plaintiff as a Case stockholder. If the cause of action stated is derivative, then the statute was properly applied. If it is not derivative, but is a primary right in the plaintiff, the statute has no application.

Plaintiff's first amended and supplemental complaint asserted a derivative cause of action on behalf of the corporation. After the court ruled that the Wisconsin statute applied to the case and ordered plaintiff to furnish bond in the amount of $75,000.00, plaintiff amended his complaint in an attempt to allege the denial of his preemptive right to participate in the issuance of Case shares and an injury to himself, individually, as a shareholder of Case. He supported that allegation by the reallegation of essentially the same material facts which were alleged in the first amended complaint.⁶

In holding the Wisconsin statute applicable to count 1 of the third amended complaint, the court below said, in part:

"After reviewing the allegations of count 1, it is clear to us that the plaintiff still complains of fraud and self-dealing, failure of directors to perform their fiduciary duties, etc., as in the first amended and supplemental complaint, and seeks redress for the alleged wrong in behalf of the corporation. He does not allege any wrong to himself different from that suffered by other stockholders, nor limit the relief sought to damages sustained by reason of loss of pre-emptive rights. He is concerned in our opinion not with the fact that stock was issued to others without being first offered to Case stockholders but with the fact that stock was issued for an allegedly insufficient consideration. We therefore hold that § 180.405(4) was applicable, that count 1 set forth a derivative cause of action and that the plaintiff must furnish security for reasonable expenses."

The principle that directors of a corporation owe a fiduciary duty to the corporation and the stockholders thereof, to deal honestly in corporate affairs is hornbook law requiring no citation of authority. As it affects the rights of shareholders, that duty has a two-fold aspect. Except where the right has been abolished by statute, or, where permissible, by provision in a corporate charter, the shareholders of a corporation have a preemptive right to participate ratably in the issuance of new shares of the corporation if they desire so to do. E. g., Luther v. C. J. Luther Company, 118 Wis. 112, 94 N.W. 69; Spaulding v. North M. & T. S. Co., 106 Wis. 481, 494, 81 N.W. 1064; Hammer v. Werner, 239 App.Div. 38, 265 N.Y.S. 172. In addition to the preemptive right, the directors and officers of a corporation owe a fiduciary duty to not use their positions for their own personal advantage, or for the advantage of others, to the detriment of the interests of the stockholders of the corporation. E. g., Luther v. C. J. Luther Co., supra, 94 N.W. at 72; Hammer v. Werner, supra; Schwab v. Schwab-Wilson Mach. Corp., Ltd., 13 Cal. App.2d 1, 55 P.2d 1268. A breach of the duty owed to the shareholders of a corporation in that respect gives rise to a cause of action by the shareholders in their own right. Ibid. Count 1 of this complaint must be measured in the light of those established legal principles.

We are indebted to Judge Tehan for the following summary of the allegations of count 1 of the complaint which, with slight embellishment, is taken verbatim from his memorandum.

Count 1 of the complaint alleges that plaintiff, the owner of 2,000 shares of Case common stock acquired prior to the merger complained of, sues in a representative capacity on behalf of himself and all other common stockholders prior to the merger except those participating in or cognizant of the wrongdoing alleged. In addition to Case, he joins as defendants certain of its directors and former directors, some of whom are also officers and former officers, and the executor of the estate of a deceased director. Defendants who are now directors of Case are sued individually and as directors, the defendant Rojtman is sued individually and as representative of American Tractor Corporation shareholders receiving Case stock as the result of the merger between Case and American Tractor Corporation, and the defendant Beeber is also sued, individually and as representative of holders of certain purchase warrants. In Count 1, the plaintiff alleges substantially as follows: In October 1956, Case formally announced to its shareholders a proposed plan of merger between Case and American Tractor Corporation and proposed stock option amendments, which were purportedly approved by Case shareholders on November 15, 1956. The merger was purportedly consummated on January 10, 1957. Both the merger and stock option plan were effectuated by illegal and fraudulent acts and illegally deprived the plaintiff and other shareholders similarly situated of their preemptive right — rights which the plaintiff here seeks to enforce. Under the merger and plan, 648,852 shares of common stock and 1,197,704 shares of second preferred stock were set aside or issued without...