Gruber v. Chesapeake & Ohio Railway Co.

• Decision Date: 12 February 1958
• Docket Number: Civ. A. No. 30870.
• Citation: 158 F. Supp. 593
• Parties: Irving M. GRUBER and Leonora S. Gruber, Plaintiffs, v. The CHESAPEAKE & OHIO RAILWAY CO. et al., Defendants.
• Court: U.S. District Court — Northern District of Ohio

158 F. Supp. 593

Irving M. GRUBER and Leonora S. Gruber, Plaintiffs, v. The CHESAPEAKE & OHIO RAILWAY CO. et al., Defendants.

Civ. A. No. 30870.

United States District Court N. D. Ohio, E. D.

December 18, 1957.

Motion to Dismiss Appeal Granted February 12, 1958.

COPYRIGHT MATERIAL OMITTED

COPYRIGHT MATERIAL OMITTED

Jules Eshner (of Davies, Eshner, Johnson & Miller), Cleveland, Ohio, for plaintiffs.

Donald W. Hornbeck, J. H. Ritter and Richard Ogline (of Hornbeck, Ritter & Victory), Cleveland, Ohio, for Chesapeake & O. Ry. Co.

Robert J. Buckley and James A. Butler (of Bulkley, Butler & Rini), Cleveland, Ohio, for Robert J. Bowman, Robert J. Bulkley, Cyrus S. Eaton, Herbert Fitzpatrick and Walter J. Tuohy.

Carl M. Jacobs and Francis L. Dale (of Frost & Jacobs), Cincinnati, Ohio, for C. R. Hook, Jr.

CONNELL, District Judge.

Plaintiffs are joint shareholders of record of the Chesapeake and Ohio Railway Company, having purchased 5 shares of its common stock on April 3, 1947 and 10 shares of its common stock on October 10, 1948.

This is a shareholder's derivative suit brought on behalf of the Chesapeake and Ohio Railway Company, hereinafter called the C & O, against the directors and an officer of the corporation who are alleged to have committed waste of the corporate assets in the following transactions set forth in four separate causes of action:

1. A stock option plan adopted by the directors of the C & O on January 9, 1951, and ratified by a majority of the shareholders in April 1951.

2. A transaction with Mr. C. R. Hook, Jr., an officer of the C & O, relating to compensation received by him for a release of his option rights under such stock option plan.

3. Another transaction with Mr. C. R. Hook, Jr. with reference to the applicability of Section 16b, Securities and Exchange Act of 1934.

4. An amendment to an employment contract between the C & O and Mr. Walter J. Tuohy, a member of the board of directors.

The matter is presently before the court on cross-motion for summary judgment by the plaintiffs or in the alternative, to strike certain of defendant's defenses, and also on motion for summary judgment by the defendants.

As to plaintiff's first cause of action, there are no disputed issues of fact and primarily, the question to be decided is whether the C & O stock option incentive plan is invalid for lack of consideration running to the corporation.

On January 9, 1951, the board of directors of the C & O had a director's meeting to discuss the activity of prior years and the corporation's future. This meeting was attended by 14 out of the full membership of 15 members. Of the 14 members present, three were officers of the company; Mr. R. R. Young, Chairman, Mr. W. J. Tuohy, President and Mr. R. W. Purcell, Vice-President-Law.

At this meeting the past earnings, rate of return to shareholders, the market price of the company's shares on the stock market and other business incidental to operating the corporation was discussed.

A review of the average market price of the common stock, dividends and earnings of the C & O indicates there was cause for apprehension about the company's future, because in 1946, the average market price of shares was 58 1/8 in 1947, 48 1/8 ; in 1948, 38 3/16; in 1949, 30 5/8 ; and 30 1/8 in 1950.

The dividend to shareholders in 1946 was $3.50; in 1947, $3 plus 1/40 Nickel Plate; in 1948, $3; in 1949, $3; and $1.50 in 1950.

The average market price of the shares had dropped from 58 1/8 in 1946 to a low of 30 1/8 in 1950; the dividends to shareholders had dropped from $3.50 in 1946 to $1.50 in 1950; the earnings dropped from $3.62 per share in 1946 to $1.36 per share in 1949, but recovered to $4.25 per share in 1950.

Apparently the directors of the C & O decided to revitalize the corporation; it was their purpose to give more incentive and future certainty to their executives; they had to assure themselves the retention of their productive men in the expectation that more production in the form of earnings would consequently ensue. They therefore adopted by resolution a stock option incentive plan.

Like most such plans its basic purposes were twofold; to induce its competent executives to remain with the company; and to provide them with an incentive for more efficient management resulting in higher earnings.

This is a day and age in which, despite all the efforts of our educational system, there is a shortage of competent executives. Leadership cannot be gleaned from books. Some men are endowed with leadership though their formal education may appear to be inadequate. Other men reach such positions by hard work, experience, and natural aptitudes. Education per se does not bestow the quality of leadership on executives. Great corporations now go into competition with each other to secure the services of coming executives. The largest corporations vie with each other to entice away promising young leaders of smaller industries, to join theirs. Many young executives are overcome by the temptation to go with larger companies, at larger salaries with the increased variety of benefits offered.

It becomes a problem in industry to hold its own leadership: to keep its coming executives from seizing the tempting offers held out to them by its own competition.

The process of holding onto top and coming executives and leadership has become such a matter of self-defense that most unique plans have been invented to prevent such losses. Many such plans have become the subject of litigation. Most go into automatic operation without any objection. Competition has become keenest in a contest for men.

The C & O adopted its plan in the year 1951 which came under attack by the plaintiffs in 1954.

It adopted its plan because some type of similar plan is the modern and quite universal business practice of the country today; it has become a business custom that corporation executives are given a proprietary interest in the company for which they work, through the granting of common stock at its present market price. The executive's "benefit" materializes when the stock which he has received rises in price on the market through increased efficiency in management and operation of the company. The company is compensated by increased profits, ultimately distributed to the shareholders through dividends, and elicited to a great extent by that continuity of service on the part of its executives which would otherwise be frustrated.

An incidental benefit received by such executives is the capital gain treatment of the profits from the sale of such securities under Section 130A of the Internal Revenue Code, as added in 1950, 26 U.S.C.A. § 130A provided that the plan complies with certain prerequisites.

Competition in industry today is not at all limited to marketing the finished product but most essentially includes an unceasing effort to acquire men of outstanding ability to direct and manage the industry itself. Of greater significance however is the anxiety of industry to hold such men once they are acquired. Many companies have calmed their anxiety by granting key employees partial ownership through a stock option plan.

The acquisition or retention of key personnel and the signing of an employment contract are the two most common forms of benefits received by a corporation sufficient to constitute consideration for the issuance of stock under such a plan. Within the plan itself, there must be included conditions or circumstances which are calculated to insure that the corporation will receive the contemplated consideration. See Rosenthal v. Burry Biscuit Corp., 30 Del.Ch. 299, 60 A.2d 106; Sandler v. Schenley Industries, Inc., 32 Del.Ch. 46, 79 A.2d 606.

The purposes of the stock option incentive plan of the C & O herein as set forth in Exhibit 1 are: "to secure to The Chesapeake and Ohio Railway Company * * * the advantages of the incentive inherent in stock ownership on the part of key officers responsible for the continued success of the company and to create in such key officers a proprietary interest in, and a greater concern for the welfare of the Company".

The options were granted "For the services and duties to be rendered and performed by the officers * * * at the purchase price herein specified and subject to all of the terms and conditions set forth herein".

The phrase "to be rendered and performed" is in the future tense and it connotes the idea of officers being later rewarded for what they meanwhile do.

The conditions set forth within the plan begin with par. 4 which provides that the options must be exercised before 5:00 p. m. December 31, 1957; that an optionee may on or after May 1, 1951 exercise his option as to not more than 20% of the shares made available to him, and subject to provisions of par. 5 hereof, an optionee may exercise his option as to the remaining shares made available to him as follows: 20% on or after the option date in 1952; 20% on or after the option date in 1953; 20% on or after the option date in 1954; and the remaining 20% on or after the option date in 1955.

Paragraph 5(a) provides "If in any of the calendar years 1951, 1952, 1953, or 1954, the net income of the Company, computed in accordance with the formula hereafter in this paragraph 5 set forth, shall fall below an amount equal to $3.50 per share of the Company's common stock outstanding at the end of each such year, respectively, this option shall be revoked as to the number of additional shares otherwise becoming available for purchase by each participant in the succeeding year in accordance with the schedule set forth in par. 4 hereof."

Thus the criterion of business success became a condition precedent to exercising part of the option and the condition precedent was that the company must earn at least $3.50 per year, or approximately 10% of the cost of the stock. Thus, if the company and its plan did not accomplish what it envisaged, neither would the executives!

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