354 U.S. 91 (1957), 316, Smith v. Sperling

Docket Nº:No. 316
Citation:354 U.S. 91, 77 S.Ct. 1112, 1 L.Ed.2d 1205
Party Name:Smith v. Sperling
Case Date:June 10, 1957
Court:United States Supreme Court
 
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354 U.S. 91 (1957)

77 S.Ct. 1112, 1 L.Ed.2d 1205

Smith

v.

Sperling

No. 316

United States Supreme Court

June 10, 1957

Argued March 27-28, 1957

CERTIORARI TO THE UNITED STATES COURT OF APPEALS

FOR THE NINTH CIRCUIT

Syllabus

This is a stockholder's derivative suit brought in a Federal District Court in California on grounds of diversity of citizenship by a citizen of New York against two Delaware corporations and the directors of one of them, who are citizens of California. The complaint alleged fraudulent wastage of the assets of Warner Bros., the plaintiff's corporation, for the benefit of a son-in-law of one of its directors and the son-in-law's corporation. It alleged that a demand on the directors of Warner Bros. to institute the suit was not made because it would have been futile, since all or a majority of them had approved the contracts involved. The District Court found that (1) the contracts were made in good faith and without fraud, (2) the stockholders, officers or directors were not "antagonistic to the financial interests" of Warner Bros., (3) none of the directors "wrongfully participated" in the acts complained of, and (4) if a demand had been made on Warner Bros. to institute suit, the management would not have been disqualified "from faithfully doing their duty," but that "such a demand would have been futile." On these grounds, the District Court realigned Warner Bros. as a party plaintiff and dismissed the bill for want of diversity jurisdiction.

Held: it erred in doing so, and the judgment is reversed and the cause remanded. Pp. 92-98.

(a) In considering the issue of federal diversity jurisdiction, the District Court should have considered only the face of the pleadings and the nature of the controversy, without attempting to adjudicate the merits of the charges of wrongdoing. Pp. 94-98.

(b) Federal law governs the question of federal jurisdiction; but local law will govern the decision on the merits. Pp. 95-96.

(c) There is "antagonism" between a corporation and its stockholder whenever the management is aligned against the stockholder and defends a course of action which the stockholder attacks, even though the management acts in good faith. Pp. 95, 96-98.

(d) Absent collusion, there is diversity jurisdiction when the real collision of issues is between citizens of different States. P. 97.

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(e) On the record in this case, it is evident that there is such a collision here. Pp. 97-98.

(f) Diversity jurisdiction having once vested, it was not lost merely because the original plaintiff died while the suit was pending and the special administrator substituted for him was a citizen of California. P. 93, n. 1.

(g) The bill meets the requirements of Rule 23(b) of the Rules of Civil Procedure that the stockholder show with particularity what efforts he made to get those who control the corporation to take action, "and the reasons for his failure to obtain such action or the reasons for not making such effort." P. 94, n. 2.

237 F.2d 317 reversed and remanded.

DOUGLAS, J., lead opinion

MR. JUSTICE DOUGLAS delivered the opinion of the Court.

This suit was filed in the Federal District Court in California by reason of diversity of citizenship. It is a stockholder's derivative suit. The first cause of action, the only one involved here, is based on alleged fraudulent wastage of assets of Warner Bros. Pictures, Inc. (which we will call Warner Bros.) for the benefit of one Sperling, a son-in-law of a director of Warner Bros., and United States Pictures, Inc. (which we will call United), the son-in-law's corporation. Extended allegations are made concerning various agreements between Warner Bros. and United which, it is charged, are unfair to Warner Bros. Demand on the directors of Warner Bros. to institute this action was not made, because, it is averred, such a demand would be futile since, inter alia, all or a majority of the

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board of directors approved the contracts. The plaintiff is a citizen of New York;1 the defendant directors are citizens of California; and Warner Bros. [77 S.Ct. 1114] and United are Delaware corporations.

The complaint joined Warner Bros. as a defendant. It was urged before the District Court, and it is claimed here, that, since the cause of action sought to be enforced is one that belongs to the corporation, and since the corporation is not "antagonistic" to the stockholder within the meaning of that term as used in Doctor v. Harrington, 196 U.S. 579, 588, Warner Bros. should be realigned as plaintiff. In that event, there would be no diversity of citizenship, since Delaware corporations would be on both sides of the lawsuit. Strawbridge v. Curtiss, 3 Cranch 267.

The District Court held a hearing on the issue -- a hearing that lasted 15 days. It found:

(1) that the contracts in controversy were made in good faith and without fraud; that they were considered by the

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directors to be in the best interests of Warner Bros. and that, in approving them, they exercised their best business judgment;

(2) that Warner Bros. was not under the domination or control of the Warners on the board, and that the stockholders, officers, or directors were not "antagonistic to the financial interests" of Warner Bros.;

(3) that neither all nor a majority nor any of the directors and officers of Warner Bros. "wrongfully participated" in the acts complained of; that the board was not dominated or controlled by the Warners and Sperling or by any one or more of them;

(4) that, if demand had been made on Warner Bros. to institute suit, the management would not have been disqualified "from faithfully doing their duty" as officers and directors, but that "such a demand would have been futile."2

For these reasons, the District Court realigned Warner Bros. as a party plaintiff and dismissed the bill. 117 F.Supp. 781. The Court of Appeals affirmed. 237 F.2d 317. The case is here on a writ of certiorari. 352 U.S. 865.

This is a corporate cause of action brought by a stockholder. Whether it is a proper case for assertion by a stockholder of that cause of action is not the question here. Such was the problem involved in Hawes v. Oakland, 104 U.S. 450, upon which so much reliance is placed in supporting the court below. Here, we assume that this corporate cause of action may be enforced by the stockholder.

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We are concerned only with a question of federal diversity jurisdiction.

The gist of the findings of the District Court is that, since there was no fraud on the part of the directors in making the contracts, but only an exercise of independent business judgment, the management was not antagonistic to the financial interests of the corporation. That is an issue that goes to the merits, not to the question of jurisdiction. There will, of course, be antagonism between the stockholder and the management where the dominant officers and directors are guilty of fraud or misdeeds. But wrongdoing in that sense is [77 S.Ct. 1115] not the sole measure of antagonism. There is antagonism whenever the management is aligned against the stockholder and defends a course of conduct which he attacks. The charge normally is cast in terms of fraud, breach of trust, or illegality. See Doctor v. Harrington, supra; Venner v. Great Northern R. Co., 209 U.S. 24; Koster v. (American) Lumbermens Mutual Casualty Co., 330 U.S. 518, 522-523. The answer, of course, always denies the charge of wrongdoing. To stop and try the charge of wrongdoing is to delve into the merits. That does not seem to us to be the proper course. It is a time-consuming, wasteful exertion of energy on a preliminary issue in the case. The instant case is a good illustration, for it has been over eight years in the courts on this question of jurisdiction.

Since our decision in Erie R. Co. v. Tompkins, 304 U.S. 64, the law which governs the merits in these derivative actions is local law. Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541, 555-556. The result, then, of the approach followed by the court below is to have more than a preliminary trial on matters going to the merits of the controversy. Obviously, federal law would govern the preliminary trial on the issues of wrongdoing, for that matter goes to the question of federal jurisdiction. Yet, should the District Court decide those issues in favor of

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the stockholder, a second trial on the merits will require that the same issues be tried out according to the set of rules supplied by local law.

It seems to us that the proper course is not to try out the issues presented by the charges of wrongdoing, but to determine the issue of antagonism on the face of the pleadings and by the nature of the controversy. The bill and answer normally determine whether the management is antagonistic to the stockholder, as Central R. Co. v. Mills, 113 U.S. 249, and Doctor v. Harrington, supra, indicate.3 The management may refuse or fail to act for any number of reasons. Fraud may be one; the reluctance to take action against a close business associate may be another; honest belief in the wisdom of the course of action which the management has approved may be still another; and so on. As the Court said in Delaware & Hudson Co. v. Albany & S. R. Co., 213 U.S. 435, 451,

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where the management was deemed to be antagonistic to the stockholder, "The attitude of the directors need not be sinister. It may be sincere." Whenever the management refuses to take action [77 S.Ct. 1116] to undo a business transaction or whenever, as in this case, it so solidly approves it that any demand to rescind would be futile, antagonism is evident. The cause of action, to be sure, is that of the corporation. But the...

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