Berg v. Cincinnati, Newport & Covington Ry. Co.

• Citation: 56 F. Supp. 842
• Decision Date: 05 September 1944
• Docket Number: No. 146.,146.
• Parties: BERG et al. v. CINCINNATI, NEWPORT & COVINGTON RY. CO. et al.
• Court: U.S. District Court — Eastern District of Kentucky

56 F. Supp. 842

BERG et al. v. CINCINNATI, NEWPORT & COVINGTON RY. CO. et al.

No. 146.

District Court, E. D. Kentucky.

September 5, 1944.

COPYRIGHT MATERIAL OMITTED

Weinberger & Grad, of Cincinnati, Ohio, for plaintiff.

Floyd C. Williams, of Cincinnati, Ohio, and Stephens L. Blakely, of Covington, Ky., for defendants.

SWINFORD, District Judge.

This case is before me on the defendant's motion to dismiss the complaint.

The plaintiff is a resident of Ohio. The defendant, the Cincinnati, Newport and Covington Railway Company, is a Kentucky corporation. It will be referred to as Railway. The defendant, Columbia Gas and Electric Corporation, is a Delaware corporation. It will be referred to as Columbia.

It is alleged that the plaintiff is a stockholder in Columbia. That Railway owes Columbia $3,323,500, with interest from July 1, 1941. That Railway is insolvent. That notwithstanding its present insolvency, Railway now proposes to borrow $1,000,000 and pay a dividend of $30.08 per share or $300,800. That a mortgage on all assets of Railway is to be executed to secure the loan. That Columbia owns 9,678 34/47 shares of the outstanding 10,000 shares of Railway's capital stock. That Columbia also holds a demand note against Railway for $1,304,596.68. That by an understanding between the defendants there is to be a sale of Railway through Bayou Interests, Incorporated, to two other corporations, all of its capital stock and the demand note for $1,900,000 and that contracts have been signed by all interested parties pursuant to the agreement.

It is further alleged that Railway has paid a part of the interest on the demand note to Columbia. The amount of the payment is $78,275. That by reason of this interest payment and the dividend payment, the remaining assets of Railway are only $530,611. That the net result of these transactions is a loss to Columbia of its indebtedness against Railway of $3,325,500, to the damage of the plaintiff and other shareholders. That the alleged transactions are collusive and fraudulent.

It is further alleged that demand was made in writing, individually, upon every Director of Columbia to bring this action but that they failed and the corporation failed to bring it and that a reasonable time has elapsed between the date of the demand and the date of filing this suit.

The complaint contains a prayer for judgment for the full amount of the indebtedness owed Columbia by Railway; that Railway be enjoined from paying the proposed dividend or from borrowing the $1,000,000 and executing its note and mortgage to secure the loan. Prays that a receiver be appointed for Railway and for all equitable and legal relief.

The complaint is duly verified by the affidavit of the plaintiff.

The defendants' motion to dismiss is urged on several grounds.

It is first contended that the complaint does not allege jurisdictional grounds as required by Rule 23 (b), Rules of Civil Procedure, 28 U.S.C.A. following section 723c.

This rule requires that in secondary actions by shareholders of an association, incorporated or unincorporated, because the association refuses to enforce its rights, the complaint must be verified and aver that the plaintiff was a shareholder at the time of the transaction or that his share in the association devolved upon him thereafter by operation of law. That the complaint shall set forth with particularity the efforts of the plaintiff to secure from the managing directors or trustees, and, if necessary, from the shareholders, such action as he desires and the reason for his failure to obtain such action.

I think the complaint contains sufficient allegations to conform to these requirements.

The plaintiff states that he has been a shareholder during all of the negotiations set forth in his complaint. He alleges his written request upon the directors individually and collectively to institute suit in the name of Columbia against Railway. He does not state that he has made request upon the shareholders or others than the managing directors. Such an allegation is unnecessary. The shareholders are so numerous that it would be impractical to make such a request. The court will take cognizance of this fact and especially so when the directors have full control of such matters without the express authorization or permission of the shareholders. This is a matter which must of necessity address itself to the sound discretion of the court. Any other construction of this rule would be denying, in effect, the application of the rule by a shareholder. Delaware & H. Co. v. Albany & S. R. Co., 213 U.S. 435, 29 S.Ct. 540, 53 L.Ed. 862.

The leading authority for a proceeding such as this is Dodge v. Woolsey, 18 How. 331, 15 L.Ed. 401. This case, decided by the Supreme Court in 1855, laid down the rule, never seriously questioned and entirely sound in principle, that a stockholder in a corporation has a remedy in chancery to ask for such a remedy as the facts in the case might require to prevent the directors from making a misapplication of their capital or profits which might lessen the value of his shares if the acts intended to be done amounted to what is called in law a breach of trust or duty.

The now old but more recent case of Hawes v. Oakland, 104 U.S. 450, 460, 26 L.Ed. 827, enumerates the grounds on which such an equitable remedy may be sought. The pertinent part of the opinion from that case is quoted:

"We understand that doctrine to be that to enable a stockholder in a corporation to sustain in a court of equity in his own name, a suit founded on a right of action existing in the corporation itself, and in which the corporation itself is the appropriate plaintiff, there must exist as the foundation of the suit —

"Some action or threatened action of the managing board of directors or trustees of the corporation which is beyond the authority conferred on them by their charter or other source of organization;

"Or such a fraudulent transaction completed or contemplated by the acting managers, in connection with some other party, or among themselves, or with other shareholders as will result in serious injury to the corporation, or to the interests of the other shareholders."

In applying Rule 23 (b) to a situation of this character the United States District Court for the Southern District of New York in the case of Cohen v. Industrial Finance Corporation, 44 F.Supp. 491, 494 (decided January 15, 1942), pointed out that the rule was the modern successor to Equity Rule 27, 28 U.S.C.A. § 723 Appendix, and in that connection said: "This rule owes its origin to equitable considerations and should be construed accordingly. Each case should be considered upon its peculiar facts and any arbitrary construction of the rule, which would result in the emasculation of the equitable considerations that led to its enactment, should be avoided."

I think the bill contains allegations sufficient to conform to any reasonable judicial construction of Rule 23 (b).

It is next contended by the defendants that the bill does not state a cause of action because the plaintiff is but a simple contract creditor. In this defendants ignore the fact that the plaintiff proceeds, not as a creditor but as a shareholder in Columbia and as such has a right to protect his assets where the managing directors refuse to do so. This right is either statutory under the statute law of Kentucky or may be asserted as a right to be granted by a Federal Court under its general equitable powers.

The state statutory authority is found in the following quotation, Civil Code of Kentucky, section 298: "On the motion of any party to an action who shows that he has, or probably has, a right to, a lien upon, or an interest in, any property or fund, the right to which is involved in the action, and that the property or fund is in danger of being lost, removed or materially injured, the court, or the judge thereof during vacation, may appoint a receiver to take charge of the property or fund during the pendency of the action, and may order and coerce the delivery of it to him."

Section 271.370 of the Kentucky Revised Statutes, 1942, reads in part as follows: "At the suit of a creditor or stockholder of any corporation authorized to do business in this state, the circuit court or circuit judge in vacation shall have jurisdiction to appoint a receiver to collect, protect, and preserve its assets and to continue the business of the corporation, where it is shown in the suit that the directors or officers are guilty of such fraud, mismanagement, or dissipation of the corporation's assets as to jeopardize the interest of the creditors or stockholders. Any officer or agent of the corporation may be made a party to such suit. But no creditor or stockholder shall be a receiver."

The cases from the Court of Appeals of Kentucky construing and applying these sections are numerous. A reading of them discloses that they add nothing to an understanding of the clear and unequivocal language of the statutes. Each case necessarily rests on its own peculiar facts and the application of the provisions is addressed to the sound judicial construction of the court sitting in chancery. It must be borne in mind that by the defendants' motion they admit the truth of the allegations contained in the bill. There is an allegation of fraud and collusion, of mismanagement and waste of the properties of Columbia. These coupled with the affirmation that Columbia is conspiring to permit a $1,000,000 secured indebtedness from Railway to a new creditor, when its present assets are little more than half that amount, to the exclusion of the present valid indebtedness of more than three million dollars which it now owes Columbia, is surely sufficient to bring the case within the statutes quoted. To my mind it is just such a case as plaintiff has stated that prompted the legislation.

I have carefully examined all the cases cited by the defendants in support of...