Bailey v. Tubize Rayon Corporation

• Decision Date: 31 July 1944
• Docket Number: Civil Action No. 351.
• Citation: 56 F. Supp. 418
• Parties: BAILEY et al. v. TUBIZE RAYON CORPORATION.
• Court: U.S. District Court — District of Delaware

56 F. Supp. 418

BAILEY et al. v. TUBIZE RAYON CORPORATION.

Civil Action No. 351.

District Court, D. Delaware.

July 31, 1944.

James R. Morford (of Marvel & Morford), of Wilmington, Del., and Spencer Pinkham, of New York City, for plaintiffs.

C. F. Richards and C. S. Layton (of Richards, Layton & Finger), both of Wilmington, Del., and Cadwalader, Wickersham & Taft, of New York City, for defendant.

LEAHY, District Judge.

Holders of an aggregate of 1137 shares of Non-Cumulative Class A $1 seek to enjoin the defendant from enforcing as to them an amendment to defendant's certificate of incorporation, adopted under Sec. 26 of the Delaware Corporation Law, Rev. Code 1935, § 2058, as amended by 43 Del. Laws, c. 132, § 5, which changed its Class A and Common stock into a single class of new common stock. The present action was commenced after the amendment had become effective. No temporary injunction was sought. The matter is here on pleadings, testimony and oral argument.

Plaintiffs' action is predicated upon two primary contentions: (1) That the reclassification effected by the amendment was unfair to plaintiffs and (2) that the amendment was accomplished by a group of stockholders who owned a majority of the Class A and Common stock and who acted for their own benefit, in breach of their fiduciary obligations to the minority. Plaintiffs do not contend that defendant lacked the power to effect the amendment or that there was a failure to comply with the Delaware Statute. Before discussing the contentions, a reference must be had to the facts.

Prior to the amendment, defendant had outstanding $4,465,000 principal amount of Fifteen Year Sinking Fund Bonds, 24,395 shares of 7% Preferred Stock $100 par, 138,814 2/7 shares of Class A $1 par,¹ including 523 6/7 shares held in the treasury, and 300,050 shares of Common $1 par, including 636 2/4 shares held in the treasury. Capital structure and asset situation of defendant appears from its balance sheet as of September 30, 1943, which is set forth in the margin.²

The Class A stock entitled holders thereof to non-cumulative dividends, when and as declared by the board of directors of the defendant, at the rate of $7 per share per annum before any dividends could be paid on the Common stock. While Class A was also entitled to $100 per share on liquidation in priority to the Common stock, it and Common stock had a par value of $1 each and entitled the holders thereof to one vote per share at all stockholders' meetings. The reclassification amendment changed the shares of these two classes of stock into 705,282 shares of new Common stock, including 2,414 treasury shares, of which the Class A stockholders were given 78.7% and the Common stockholders 21.3% or, stating it in another way, the holder of one share of Class A stock received eight times as much new Common stock as the holder of one share of old Common stock—each share of Class A stock was changed into four shares of new Common stock and each share of old Common stock was changed into one-half share of new Common stock. Plaintiffs contend that the reclassification amendment was unfair because the old Common stock had merely a token value and the old Common stockholders were entitled to no substantial recognition in the reclassification. True, prior to the amendment the Class A stock had an asset value of $71.85 per share, and the old Common was under water to the extent of $12.96 per share. Subsequent to the amendment the new Common had an asset value of $14.14 per share. The question for determination is, therefore, whether on the basis of defendant's business, assets and earnings, the respective rights of the holders of the two classes of stock, and the market value of the two classes the amendment was fair.

Manifestly, on an asset basis the Common stock was under water. I shall not pause to discuss much of the statistical data offered at the trial; but I wish to state that it was of great help to me when I came to study the case, and counsel are to be commended for preparing for the court's benefit the lucid tables and diagrammatic charts symbolizing the corporate and financial factors called into action.

1. Fairness of the Plan. Defendant is engaged in the manufacture of rayon yarn and of knitted fabrics made therefrom. Since 1936 defendant has expended approximately $10,000,000 for plant expansion resulting in increased capacity of its plants of approximately 150%. There was much testimony that the manufacture of rayon is a growth industry. The management of defendant, according to the testimony, made an exhaustive study of the post-war prospects for the industry and developed plans for further increase of defendant's productive capacity. The reason given for the amendment is that the possible post-war expansion program could be more easily effectuated if defendant's capital structure were first simplified. This is clearly an adequate business reason for the amendment, irrespective of whether the post-war expectations of the directors are ever realized. The directors are endeavoring to prepare defendant to take advantage of any post-war expansion opportunities which may arise. But, the reasons for the amendment or the business necessity behind it are not matters for judicial determination. Allied Chemical & Dye Corp. v. Steel & Tube Co., 14 Del.Ch. 1, 120 A. 486; Cole v. National Cash Credit Association, 18 Del.Ch. 47, 156 A. 183; MacFarlane v. North American Cement Corp., 16 Del.Ch. 172, 157 A. 396; MacCrone v. American Capital Corp., D.C.Del., 51 F.Supp. 462, 463. Yet, in passing, it seems to me the amendment was planned with constructive intent.

Where a majority of the stockholders and directors of a Delaware corporation, acting in good faith, speak for the corporation by taking action under appropriate statutory and charter provisions, a presumption of fairness arises in favor of such action. Under the Delaware decisional and statutory law an amendment will not be condemned unless it is so unfair as to amount to constructive fraud. Allied Chemical & Dye Corp. v. Steel & Tube Co., 14 Del.Ch. 1, 120 A. 486; Cole v. National Cash Credit Association, 18 Del.Ch. 47, 156 A. 183; MacFarlane v. North American Cement Corp., 16 Del.Ch. 172, 157 A. 396; Porges v. Vadsco Sales Corp., Del.Ch., 32 A.2d 148. Clearly, the plan sub judice would not be condemned under the Delaware decisional law. I prefer, however, in this case to leave the limits of the "gross unfairness" or "constructive fraud" tests as fixed by the Delaware decisions and look at the facts of the case before me to see if the amendment is fair in the light of the practical adjustments inherent in this particular transaction. Cf. MacCrone v. American Capital Corp., D.C. Del., 51 F.Supp. 462, 466; Barrett v. Denver Tramway Corp., D.C.Del., 53 F.Supp. 198.³ Unless the act of the majority of the directors and stockholders is so palpably unfair as to afford no basis for a difference of opinion among reasonable men, the court should not substitute its judgment for that of the stockholders and directors. I think the amendment meets any independent test of fairness.

It is plaintiffs' theory that the right to $100 in liquidation is deemed to have matured as a result of the amendment. This theory has been rejected in this court and in this circuit. Goldman v. Postal Telegraph, Inc., D.C.Del., 52 F. Supp. 763; Hottenstein et al. v. York Ice Machinery Corporation, D.C.Del., 45 F. Supp. 436, affirmed, 3 Cir., 136 F.2d 944. Cf. In re United Light & Power Co., D.C. Del., 51 F.Supp. 217, affirmed In re Securities and Exchange Commission, 3 Cir., 142 F.2d 411. The rule in this circuit is clear that the preferential right of the Class A stockholdes to receive $100 in liquidation gives them no present interest in any portion of the defendant's assets. That right would arise only upon the liquidation of the defendant and, since defendant is engaged in a profitable going business, it is impossible to foresee ultimate liquidation values of the company.

Consideration of the factors usual in testing a plan will show that the amendment was fair to the Class A stockholders.

(a) The amendment was fair in the treatment of the interests of the Class A stockholders in the assets of the defendant. The defendant's balance sheet as of September 30, 1943, shows that it had a total surplus of $9,503,130. The only right which the Class A stock had to such surplus was the right at some indefinite future time to receive $100 per share on liquidation. But this right is contingent upon liquidation. Plaintiffs ignore the fact that a great portion of the assets which they now claim could have been declared as dividends to the old Common. Clearly, the Class A stockholders, prior to the amendment, could not claim any portion of the defendant's surplus by reason of the fact that all of the earnings available for dividends on the Class A stock up to $7.00 per share had not been declared and paid to them as dividends. Under the rule of Wabash R. Co. et al. v. Barclay et al., 280 U.S. 197, 50 S.Ct. 106, 74 L.Ed. 368, 67 A.L.R. 762, where earnings available in any year for dividends on the Class A stock are not paid but are plowed back into the business "the right for that year was gone" and the Class A stockholders would not be entitled thereafter to assert a claim in respect to such unpaid dividends. Prior to actual liquidation, the right of the Class A stockholders to the $9,503,130 of defendant's surplus is no better than the claim which the old Common stockholders had therein.

Another test shows the Class A stockholders were fairly treated from the standpoint of their interest in defendant's assets. The defendant's assets may properly be measured by capitalizing earnings. There was offered in evidence a calculation of the probable post-war income of the defendant. The average annual income for the years 1939-1941, for example, after providing for preferred stock dividends and all...