Continental Group, Inc. v. Justice, Civ. A. No. 81-455.

• Decision Date: 14 April 1982
• Docket Number: Civ. A. No. 81-455.
• Parties: The CONTINENTAL GROUP, INC., Plaintiff, v. Kermit JUSTICE, Thor S. Johnson, and Joseph Cashman, Defendants.
• Court: U.S. District Court — District of Delaware

536 F. Supp. 658

The CONTINENTAL GROUP, INC., Plaintiff, v. Kermit JUSTICE, Thor S. Johnson, and Joseph Cashman, Defendants.

Civ. A. No. 81-455.

United States District Court, D. Delaware.

April 14, 1982.

James F. Waehler of Tunnell & Raysor, Georgetown, Del., David F. Albright, Richard M. Kremen, and Gary G. Goldberger of Semmes, Bowen & Semmes, Baltimore, Md., for plaintiff.

Victor Battaglia and Wayne Marvel of Biggs & Battaglia, Wilmington, Del., for defendants Justice and Johnson.

Lawrence M. Sullivan, Wilmington, Del., for defendant Cashman.

MEMORANDUM OPINION

LATCHUM, Chief Judge.

This is a civil action brought by plaintiff, The Continental Group Inc. ("Continental"), seeking to recover $218,766.16 for goods sold and delivered by Continental to Winner Chemicals Inc. ("Winner") between December 4, 1978 and May 22, 1979. Continental alleges that the named defendants Kermit Justice, Joseph Cashman and Thor S. Johnson executed agreements whereby each guaranteed payment of all sums due to Continental by Winner together with interest. Continental further alleges that both Winner and the defendants have failed to pay Continental the amount due. Continental seeks, in this action, to recover from the named defendants, pursuant to the guaranty agreements, the amount due from Winner. (Docket Item "D.I." 1, ¶¶ 2, 3 & 4.)

All of the defendants deny liability. Justice and Johnson also advance three affirmative defenses and a counterclaim. (D.I. 6.) In the first affirmative defense, Justice and Johnson assert that Winner does not owe Continental for the goods sold and delivered to Winner because Continental failed to supply a suitable and non-defective product to Winner and that such failure amounts to a total or partial failure of consideration. (D.I. 6, ¶ 5.) In the second affirmative defense, Justice and Johnson contend that they are discharged from their obligations under the guaranty agreements because Continental supplied defective products to Winner, causing Winner to become insolvent. (D.I. 6, ¶ 6.) Justice and Johnson, in the third affirmative defense, assert that they are discharged from their obligations under the guaranty agreements because Continental wrongfully refused to undertake the defense of Winner in Ruffo v. Terryville Supermarkets, and wrongfully refused to provide products liability insurance coverage to Winner. Justice and Johnson allege that these wrongful refusals caused Winner to become insolvent. (D.I. 6, ¶ 7.) In their counterclaim, Justice and Johnson seek to recover $1,500,000 for the loss of their interest in Winner caused by Continental's defective products, wrongful refusal to defend, and to provide products liability insurance to Winner. (D.I. 6, ¶¶ 8 & 9.)

Continental has moved to dismiss the counterclaim of Justice and Johnson, pursuant to Rule 12(b)(6), F.R.Civ.P., for failure to state a claim upon which relief can be granted on the ground that Justice and Johnson do not have standing to assert their counterclaim. (D.I. 15.) Justice and Johnson, pursuant to Rule 37(a)(2), F.R. Civ.P., have also moved for an order requiring Continental to answer defendants' Interrogatories, Request for Production of Documents, and Request for Admissions. (D.I. 18.)

I. Justice and Johnson's Counterclaim

Justice and Johnson's counterclaim alleges that Continental breached its obligations to defendant guarantors by (1) providing defective products to Winner, (2) wrongfully refusing to defend Winner in any products liability action based on defects in Continental's products, and (3) wrongfully refusing to extend plaintiff's products liability insurance coverage to Winner. Continental argues that Justice and Johnson, as shareholders of Winner, lack standing to assert Winner's alleged claims against Continental. It contends that the claims asserted in the counterclaim belong to Winner, the corporation, and not to Justice and Johnson, its shareholders.

The Court agrees with Continental that Justice and Johnson, as shareholders, may not recover individually against Continental for acts allegedly causing injury to Winner. A shareholder has no personal or individual right of action against a third party for acts causing injury to a corporation. As one commentator has explained:

The corporation and it alone may sue ... to recover damages for injuries done to it .... So a stockholder has no capacity to sue or to maintain a counterclaim ... as an individual on a derivative claim, even though he is a sole or principal stockholder of the corporation.

1 W. Fletcher, Cyclopedia of the Law of Private Corporations § 36 at 149 (Wolf rev. 1974). Further, "when an injury to corporate stock falls equally upon all stockholders, then an individual stockholder may not recover for the injury to his stock alone, but must seek recovery derivatively on behalf of the corporation." 13 Fletcher § 5913. Each of the injuries alleged in Justice and Johnson's counterclaim are injuries inflicted upon Winner as a corporation. Justice and Johnson have alleged no facts showing that the issues raised by their counterclaim arises out of an injury separate from harms allegedly done to the corporation. Therefore, Justice and Johnson have no standing to assert these claims as shareholders. See generally Kauffman v. Dreyfus Fund, Inc., 434 F.2d 727, 732 (C.A. 3, 1970); McDaniel v. Painter, 418 F.2d 545 (C.A. 10, 1969); Bokat v. Getty Oil Co., 262 A.2d 246 (Del. 1970); 13 Fletcher, Corporations (1980 Revised Vol.) §§ 5911, 5913.

Justice and Johnson, however, argue that they assert their counterclaim as guarantors and, accordingly, are entitled to recover the independent claims of their principal, Winner. Generally, a guarantor, when sued by the principal's creditor pursuant to a guaranty agreement, cannot rely on an independent cause of action existing in favor of the principal against the creditor as a defense or a counterclaim. "It is for the principal to determine what use he will make thereof, and the guarantor has no control over him in this respect." Elliot v. Brady, 192 N.Y. 221, 85 N.E. 69, 71 (1908). This rule was designed to protect the underlying claims of the principal and to minimize litigation among the parties. See Restatement of Security § 133 and Comment on subsection (2) at 362-63 (1941).

Despite the general rule which prohibits the guarantor from asserting the principal's claims, courts have recognized three exceptions. A guarantor may assert the independent claim of the principal to set-off the creditor's claim against the guarantor where (1) the surety has taken an assignment of the claim or the principal has consented to the surety's use of the claim, (2) both principal and surety are joined as defendants, or (3) the principal is insolvent. See Restatement of Security § 133(2) at 360 (1941.) See also Arctic Contractors, Inc. v. State of Alaska, 573 P.2d 1385 (Alaska 1978). Justice and Johnson rely upon two of these exceptions. They assert (1) that Winner has consented to the defendants' use of their claim against Continental, and (2) that Winner is insolvent. Thus, Justice and Johnson argue that they may assert Winner's claim against Continental.

Justice and Johnson first contend that Winner has consented to the use of its claims against Continental. They rely on a letter dated November 2, 1981, in which William Poisez, president of Winner, notified the defendants that Winner did not object "to the utilization of any defense" by the defendants which Winner "may have against Continental." (D.I. 17, Exhibit A.) This letter does not grant consent to the defendants to assert Winner's claims against Continental because Poisez, as president, did not have the authority to assign or transfer those claims. This is so because Winner commenced voluntary bankruptcy proceedings on August 7, 1980, more than a year before Poisez' letter.¹ Section 541(e) of 11 U.S.C. specifically provides that the bankrupt estate will have the benefit of any defense available to the debtor and that a waiver of any "defenses by the debtor after the commencement of the case does not bind the estate." Thus, whatever claim Winner may have against Continental is an asset of the bankrupt estate and could not be transferred or assigned by Poisez' letter. The "consent exception," therefore, is not available to Justice and Johnson.

Secondly, Justice and Johnson contend that they may assert Winner's independent claims against Continental because Winner is insolvent. The Court agrees, for it is well established that when the principal is insolvent, the guarantor may set-off the principal's claims against the creditor. See In re Eastern Freight Ways, Inc., 577 F.2d 175, 180 (C.A. 2, 1978); Saxis Steamship Co. v. Multifacs International Traders, Inc., 375 F.2d 577, 583 n.8 (C.A. 2, 1967); In re Yale Express System, Inc., 362 F.2d 111, 114 (C.A. 2, 1966); Johnson v. Morley Construction Co., 98 F.2d 781, 789-90 (C.A. 2), cert. denied, 305 U.S. 651, 59 S.Ct. 244, 43 L.Ed. 421 (1938); Clark Car Co. v. Clark, 48 F.2d 169, 170 (C.A. 3, 1931); Arctic Contractors, Inc. v. State of Alaska, 573 P.2d 1385, 1386-87 (Alaska 1978). It would be inequitable to deprive the guarantor of what may be a perfectly good set-off between the principal and creditor when the guarantor would have no or little recourse against the principal. See Clark, 48 F.2d at 170. Judge L. Hand explained the rationale in the Morley case:

If the creditor then recovers from the surety, the surety has no recourse over against the principal, but must bear the loss except for such dividends as he may get in the insolvency proceedings. Yet having recovered from the surety and realized upon his claim, the creditor is without set-off when sued on the counterclaim by the principal's trustee or receiver, and the recovery goes to swell the estate. Had the creditor not sued the surety, he could, and of course would, have used the claim as a set-off against the counterclaim. Thus, the upshot of

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