Cohen v. Beneficial Industrial Loan Corporation Beneficial Industrial Loan Corporation v. Smith

• Citation: 69 S.Ct. 1221,93 L.Ed. 1528,337 U.S. 541
• Decision Date: 20 June 1949
• Docket Number: Nos. 442,512,s. 442
• Parties: COHEN et al. v. BENEFICIAL INDUSTRIAL LOAN CORPORATION. BENEFICIAL INDUSTRIAL LOAN CORPORATION v. SMITH et a
• Court: United States Supreme Court

337 U.S. 541

69 S.Ct. 1221

93 L.Ed. 1528

COHEN et al.

v BENEFICIAL INDUSTRIAL LOAN CORPORATION.

BENEFICIAL INDUSTRIAL LOAN CORPORATION

v. SMITH et a .

Nos. 442, 512.

Argued April 18, 1949.

Decided June 20, 1949.

Messrs. Philip B. Kurland, New York City, Charles Hershenstein, Jersey City, N.J., for Hannah Cohen, Ex'x and another.

[Argument of Counsel from page 542 intentionally omitted] Mr. John M. Harlan, New York City, for Beneficial Industrial Loan corporation.

Mr. Justice JACKSON delivered the opinion of the Court.

The ultimate question here is whether a federal court, having jurisdiction of a stockholder's derivative action only because the parties are of diverse citizenship, must apply a statute of the forum state which makes the plaintiff, if unsuccessful, liable for all expenses, including attorney's fees, of the defense and requires security for their payment as a condition of prosecuting the action.

Petitioners' decedent as plaintiff, brought in the United States District Court for New Jersey an action in the right of the Beneficial Industrial Loan Corporation, a Delaware corporation doing business in New Jersey. The defendants were the corporation and certain of its managers and directors. The complaint alleged generally that since 1929 the individual defendants engaged in a continuing and successful conspiracy to enrich themselves at the expense of the corporation. Specific charges of mismanagement and fraud extended over a period of eighteen years and the assets allegedly wasted or diverted thereby were said to exceed $100,000,000. The stockholder had demanded that the corporation institute proceedings for its recovery but, by their control of the corporation, the individual defendants prevented it from doing so. This stockholder, therefore, sought to assert the right of the corporation. One of 16,000 stockholders, he owned 100 of its more than two million shares, so that his holdings, together with 150 shares held by the intervenor, approximated 0.0125% of the outstanding stock and had a market value that had never exceeded $9,000.

The action was brought in 1943, and various proceedings had been taken therein when, in 1945, New Jersey enacted the statute which is here involved.¹ Its general effect is to make a plaintiff having so small an interest liable for all expenses and attorney's fees of the defense if he fails to make good his complaint and to entitle the corporation to indemnity before the case can be prosecuted. These conditions are made applicable to pending actions. The corporate defendant therefore moved to require security, pointed to its by-laws by which it might be required to indemnify the individual defendants, and averred that a bond of $125,000 would be appropriate.

The District Court was of the opinion that the state enactment is not applicable to such an action when pending in a federal court, 7 F.R.D. 352. The Court of Appeals were of a contrary opinion and reversed, 3 Cir., 170 F.2d 44, and we granted certiorari. 336 U.S. 917, 69 S.Ct. 639.

Appealability.

At the threshold we are met with the question whether the District Court's order refusing to apply the statute was an appealable one. Title 28 U.S.C. § 1291, 28 U.S.C.A. § 1291, provides, as did its predecessors, for appeal only 'from all final decisions of the district courts,' except when direct appeal to this Court is provided. Section 1292 allows appeals also from certain interlocutory orders, decrees and judgments, not material to this case except as they indicate the purpose to allow appeals from orders other than final judgments when they have a final and irreparable effect on the rights of the parties. It is obvious that, if Congress had allowed appeals only from those final judgments which terminate an action, this order would not be appealable.

The effect of the statute is to disallow appeal from any decision which is tentative, informal or incomplete. Appeal gives the upper court a power of review, not one of intervention. So long as the matter remains open, unfinished or inconclusive, there may be no intrusion by appeal. But the District Court's action upon this application was concluded and closed and its decision final in that sense before the appeal was taken.

Nor does the statute permit appeals, even from fully consummated decisions, where they are but steps towards final judgment in which they will merge. The purpose is to combine in one review all stages of the proceeding that effectively may be reviewed and corrected if and when final judgment results. But this order of the District Court did not make any step toward final disposition of the merits of the case and will not be merged in final judgment. When that time comes, it will be too late effectively to review the present order and the rights conferred by the statute, if it is applicable, will have been lost, probably irreparably. We conclude that the matters embraced in the decision appealed from are not of such an interlocutory nature as to affect, or to be affected by, decision of the merits of this case.

This decision appears to fall in that small class which finally determine claims of right separable from, and collateral to, rights asserted in the action, too important to be denied review and too independent of the cause itself to require that appellate consideration be deferred until the whole case is adjudicated. The Court has long given this provision of the statute this practical rather than a technical construction. Bank of Columbia v. Sweeney, 1 Pet. 567, 569, 7 L.Ed. 265; United States v. River Rouge Improvement Co., 269 U.S. 411, 414, 46 S.Ct. 144, 145, 70 L.Ed. 339; Cobbledick v. United States, 309 U.S. 323, 328, 60 S.Ct. 540, 542, 84 L.Ed. 783.

We hold this order appealable because it is a final disposition of a claimed right which is not an ingredient of the cause of action and does not require considerat on with it. But we do not mean that every order fixing security is subject to appeal. Here it is the right to security that presents a serious and unsettled question. If the right were admitted or clear and the order involved only an exercise of discretion as to the amount of security, a matter the statute makes subject to reconsideration from time to time, appealability would present a different question.

Since this order may be reviewed on appeal, the petition in No. 512, whereby the corporation asserts the right to compel security by mandamus, is dismissed.

Constitutionality.

Petitioners deny the validity of the statute under both Federal and New Jersey Constitutions. The latter question is ultimately for the state courts, and since they have made no contrary determination, we shall presume in the circumstances of this case that the statute conforms with the State constitution.

Federal Constitutional questions we must consider, because a federal court would not give effect, in either a diversity or nondiversity case, to a state statute that violates the Constitution of the United States.

The background of stockholder litigation with which this statute deals requires no more than general notice. As business enterprise increasingly sought the advantages of incorporation, management became vested with almost uncontrolled discretion in handling other people's money. The vast aggregate of funds committed to corporate control came to be drawn to a considerable extent from numerous and scattered holders of small interests. The director was not subject to an effective accountability. That created strong temptation for managers to profit personally at expense of their trust. The business code became all too tolerant of such practices. Corporate laws were lax and were not self-enforcing, and stockholders, in face of gravest abuses, were singularly impotent in obtaining redress of abuses of trust.

Equity came to the relief of the stockholder, who had no standing to bring civil action at law against faithless directors and managers. Equity, however, allowed him to step into the corporation's shoes and to seek in its right the restitution he could not demand in his own. It required him first to demand that the corporation vindicate its own rights but when, as was usual, those who perpetrated the wrongs also were able to obstruct any remedy, equity would hear and adjudge the corporation's cause through its stockholder with the corporation as a defendant, albeit a rather nominal one. This remedy born of stockholder helplessness was long the chief regulator of corporate management and has afforded no small incentive to avoid at least grosser forms of betrayal of stockholders' interests. It is argued, and not without reason, that without it there would be little practical check on such abuses.

Unfortunately, the remedy itself provided opportunity for abuse which was not neglected. Suits sometimes were brought not to redress real wrongs, but to realize upon their nuisance value. They were bought off by secret settlements in which any wrongs to the general body of share owners were compounded by the suing stockholder, who was mollified by payments from corporate assets. These litigations were aptly characterized in professional slang as 'strike suits.' And it was said that these suits were more commonly brought by small and irresponsible than by large stockholders, because the former put less to risk and a small interest was more often within the capacity and readiness of management to compromise than a large one.

We need not determine the measure of these abuses or the evils they produced on the one hand or prevented and redressed on the other. The Legislature of New Jersey, like that of other states,² considered them sufficient to warrant some remedial measures.

The very nature of the stockholder's derivative action makes it one in the regulation of which the legislature of a state has wide powers. Whatever theory one may hold as to the nature of the corporate entity, it remains a wholly artificial creation whose...