Shell v. Hensley

• Decision Date: 14 July 1970
• Docket Number: No. 27447,27514.,27447
• Citation: 430 F.2d 819
• Parties: Claude E. SHELL, Petitioner-Appellant, v. Milford E. HENSLEY, Respondent-Appellee. Jack E. LOVE, et al., Petitioners-Appellants, v. Milford E. HENSLEY, et al., Respondents-Appellees.
• Court: U.S. Court of Appeals — Fifth Circuit

430 F.2d 819 (1970)

Claude E. SHELL, Petitioner-Appellant, v. Milford E. HENSLEY, Respondent-Appellee.

Jack E. LOVE, et al., Petitioners-Appellants, v. Milford E. HENSLEY, et al., Respondents-Appellees.

Nos. 27447, 27514.

United States Court of Appeals, Fifth Circuit.

July 14, 1970.

Alan W. Heldman, Birmingham, Ala., John P. Frank, Phoenix, Ariz., Truman Hobbs, Montgomery, Ala., for petitioners-appellants.

J. Vernon Patrick, Vernon Patrick, Bradley, Arant, Ross & White, Birmingham, Ala., for respondents-appellees.

Before AINSWORTH, DYER and SIMPSON, Circuit Judges.

AINSWORTH, Circuit Judge:

We must here determine, as in the Herpich cases¹ decided today, whether minority shareholders, this time of an Alabama corporation, have stated a claim for relief under various sections of the federal securities laws which entitles them to challenge in federal court, absent diversity, the way in which control of their corporation was sold to an Arizona-based complex of insurance companies. The District Court, deciding that this case should be accorded the normal process of factual development and a determination of the real merits of the case, overruled defendants' motions to dismiss the complaint. An important issue with which we deal is the extent to which proof of deception is necessary to show a violation of SEC Rule 10b-5, 17 C.F.R. § 240.10b-5.

These are appeals from interlocutory orders,² consolidated by a panel of this Court, which overruled defendants' motions to dismiss the amended complaint filed against them in the court below.³ Plaintiffs are shareholders of Alabama National Life Insurance Company, an Alabama corporation. They brought suit against Claude E. Shell (appellant in No. 27447), L. E. Cowling, National Securities, Inc. (NSI), Old National Insurance Company, Robert H. Wallace, and Jack E. Love. With the exception of Shell and Cowling, who is not a party to this appeal, defendants are members of the Arizona Group, the principal defendants in Herpich v. Wallace, 5 Cir., 1970, 430 F.2d 792 and appellants in No. 27514 herein. In the present case, the complaint, as amended, alleged violations of section 10(b) of the Exchange Act,⁴ Rule 10b-5,⁵ section 17(a) of the Securities Act of 1933,⁶ 15 U.S.C. § 77q(a), and applicable state law. Plaintiffs sought damages on behalf of Alabama National, themselves, and all Alabama National shareholders similarly situated. Federal jurisdiction was predicated upon section 27 of the Exchange Act, 15 U.S.C. § 78aa, and section 22 of the Securities Act, 15 U.S.C. § 77v.⁷ Defendants filed motions to dismiss for lack of jurisdiction and for failure to state a claim upon which relief can be granted. The District Judge overruled these motions. He did, however, grant defendants' motion to strike the class-action allegations from the amended complaint. The present status of the suit, consequently, is that of a derivative action brought on behalf of Alabama National under Fed.R.Civ.P. 23.1.

I.

From the complaint, as amended, affidavits, and documents,⁸ the facts, as alleged, appear as follows. Over a four-year period, Alabama National was defrauded in various ways by defendants, who acted in several combinations. Two periods of unlawful activity are presented: (1) 1965 until October 1967, during which time Shell and Cowling used the funds of Alabama or its subsidiary to finance transactions in securities between themselves, corporations they controlled, or both, for the purpose of enriching themselves at the expense of Alabama National; and (2) October 1967 and thereafter, during which time Shell formulated and carried out his agreement with the Arizona Group to sell control of Alabama National to the latter for a premium payable only to him.

A. 1965-October 1967.

It is alleged that in April 1965, Shell, then the president and a director of Alabama National, and Cowling, who was responsible for the incorporation and initial capitalization of Alabama National, caused the corporation to loan $432,000 to S & S Development Corporation, which Shell controlled. This loan, for which no security, or grossly inadequate security, was given, was made to finance the purchase by Shell or S & S from Cowling of 862,500 shares of stock in Capital Corporation of Texas. At all pertinent times until control of Alabama National was sold to the Arizona Group, both Shell and Cowling were "controlling persons," as that term is defined in the federal securities acts,⁹ of Alabama National. Cowling was also a controlling person of Capital Corporation, which in turn, was a controlling person of Alabama National. Capital Corporation held this control position at least partially as a result of its purchase of a substantial block of Alabama National stock from Cowling. Cowling had taken Capital Corporation's note in payment for these shares. In 1967, Bayou Land Corporation, a wholly owned subsidiary of Alabama National, was caused to loan Capital Corporation sums amounting to approximately $267,000 to enable the latter to pay Cowling interest that had accrued on this note. Like the loan from Alabama National to S & S, these advances were not secured by adequate collateral.

B. October 1967 and Thereafter.

It is further alleged that during October 1967, Shell, Love, and Wallace conspired and agreed that Shell would sell shares of capital stock in Alabama National and Capital Corporation which were registered either in Shell's name or in the names of corporations he owned to NSI for $1,600,000. This price exceeded the market value of the stock and its cost to Shell, and the excess over market value represented a premium payable only to Shell for transferring control of Alabama National. In furtherance and according to the terms of their scheme, Shell and the Arizona Group caused the following to be done: First, Alabama National was, and is being, required to pay part of the premium going to Shell for selling control of Alabama National. This result was, and is being, accomplished in part through the contrivance of a nine-year employment contract granted by the corporation to Shell. This contract calls for Shell to perform part-time work at a salary of $50,000 a year, which is more than he received when employed as the full-time president of the corporation. In addition, Shell and the Arizona Group caused Alabama National to purchase at excessive prices from NSI certain savings-and-loan stock, land, and a note secured by a mortgage; these transactions were effected so that NSI could use the money obtained from Alabama National to pay Shell for the sale of control. Secondly, Shell resigned his positions at Alabama National and used his best efforts to obtain the election of Wallace, Love, and Arizona Group designees as officers and directors of the corporation. Thirdly, Shell was not required to account to Alabama National for the payment received from NSI even though, as the conspirators knew, Shell had acquired the stock that NSI bought from him with funds he had borrowed from Alabama National while serving as an officer and director of the corporation. Fourthly, Alabama National was caused to assume certain obligations under a reinsurance agreement at no benefit to Alabama National, but to the benefit of the Arizona Group. Fifthly, defendants sent out misleading proxy materials, reports, and other mailings that served to deceive and lull Alabama National and its shareholders other than defendants. These statements included representations that the $50,000 to be paid Shell each year for nine years was for services rather than consideration for the sale of Shell's stock and omitted to disclose the true value of the savings-and-loan stock, land, and note bought by Alabama National from NSI or that Shell had a duty to account to Alabama National. Finally, defendants caused notices of the 1968 annual shareholders' meeting to be mailed so that they were not received by plaintiffs and their class of Alabama National shareholders until the day of the meeting, August 26, 1968.

Defendants characterize the complaint in this case as being in substance a claim of corporate waste or deprivation of corporate opportunity. They concede that this complaint may give rise to a state-law claim of fraud or breach of fiduciary duty, but contend that it may not be asserted in federal court absent diversity of citizenship between the parties. First, it is argued, a claim of violations of section 10(b) and Rule 10b-5 is not stated because "causal deceit" is not alleged. Secondly, and in any event, plaintiffs personally and on behalf of Alabama National lack standing to complain of purported violations of the section and the rule.

For reasons that follow, we conclude that the complaint was sufficient to withstand defendants' motions to dismiss for want of jurisdiction and failure to state a claim upon which relief can be granted. Accordingly, without making any suggestion how this case should be determined on the merits, e. g., Merlite Land, Sea & Sky, Inc. v. Palm Beach Investment Properties, Inc., 5 Cir., 1970, 426 F.2d 495; Exhibitors Poster Exchange, Inc. v. National Screen Serv. Corp., 5 Cir., 1970, 421 F.2d 1313, we affirm the judgment of the District Court in the appeals numbered 27447 and 27514.

II.

The threshold question we must determine is whether plaintiffs have standing to enforce the violations of section 10(b) and Rule 10b-5 which they allege in their complaint.¹⁰ See Herpich v. Wallace, 5 Cir., 1970, 430 F.2d 792. We conclude that plaintiffs, as shareholders of Alabama National, may sue the Arizona Group and Shell derivatively on behalf of Alabama National under the section and the rule.

The individual right of action implied under Rule 10b-5 may be invoked on behalf of a corporation in a shareholder's derivative suit. E.g., Herpich v. Wallace, 5 Cir., 1970, 430 F.2d 792; Rekant v. Desser, 5 Cir., 1970, 425 F.2d 872; City National Bank of Fort Smith v. Vanderboom, 8 Cir., 1970, 422 F.2d 221; Condon...