McClure v. Borne Chemical Company

• Decision Date: 05 July 1961
• Docket Number: 13354.,No. 13353,13353
• Citation: 292 F.2d 824
• Parties: Charles A. McCLURE and Ruth H. McClure, suing on their own behalf and on behalf of all other stockholders of the Borne Chemical Company, Inc., similarly situated v. BORNE CHEMICAL COMPANY, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, the CEM Securities Corporation, Walter L. McManus, Marshall A. Jacobs, George E. Allen, Clyde E. Williams, Henry E. Brandli and H. Carl Northrup. Borne Chemical Company, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, Marshall A. Jacobs, Clyde E. Williams and H. Carl Northrup, Appellants. Charles A. McCLURE and Ruth H. McClure, suing on their own behalf and on behalf of all other stockholders of Borne Chemical Company, Inc., similarly situated v. BORNE CHEMICAL COMPANY, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, the CEM Securities Corporation, Walter L. McManus, Marshall A. Jacobs, George E. Allen, Clyde E. Williams, Henry E. Brandli and H. Carl Northrup. CEM Securities Corporation and Walter L. McManus, Appellants.
• Court: U.S. Court of Appeals — Third Circuit

292 F.2d 824 (1961)

Charles A. McCLURE and Ruth H. McClure, suing on their own behalf and on behalf of all other stockholders of the Borne Chemical Company, Inc., similarly situated v. BORNE CHEMICAL COMPANY, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, the CEM Securities Corporation, Walter L. McManus, Marshall A. Jacobs, George E. Allen, Clyde E. Williams, Henry E. Brandli and H. Carl Northrup.

Borne Chemical Company, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, Marshall A. Jacobs, Clyde E. Williams and H. Carl Northrup, Appellants. Charles A. McCLURE and Ruth H. McClure, suing on their own behalf and on behalf of all other stockholders of Borne Chemical Company, Inc., similarly situated v. BORNE CHEMICAL COMPANY, Inc., Thomas E. Betner, William L. Less, Thomas A. Marino, the CEM Securities Corporation, Walter L. McManus, Marshall A. Jacobs, George E. Allen, Clyde E. Williams, Henry E. Brandli and H. Carl Northrup.

CEM Securities Corporation and Walter L. McManus, Appellants.

Nos. 13353, 13354.

United States Court of Appeals Third Circuit.

Argued February 7, 1961.

Decided July 5, 1961.

Rehearing Denied September 19, 1961.

William T. Coleman, Jr., Philadelphia, Pa. (Harold E. Kohn, Bruce Kauffman, Dilworth, Paxson, Kalish, Kohn & Dilks, for Borne Chemical Co., Inc., and others; George V. Strong, Jr., Strong, Sullivan, Saylor, & Ferguson, Philadelphia, Pa., for CEM Securities Corp. and Walter L. McManus, on the brief), for appellants.

Arnold R. Ginsburg, Philadelphia, Pa., for appellees.

Before BIGGS, Chief Judge, and STALEY and HASTIE, Circuit Judges.

BIGGS, Chief Judge.

The question presented by these appeals is whether a shareholder who brings a derivative suit to enforce a corporate cause of action arising under Section 10(b), 15 U.S.C.A. § 78j(b), as implemented by Securities and Exchange Commission Rule 10b-5, and Section 29(b) of the Securities Exchange Act of 1934, 15 U.S.C.A. § 78cc, may be required to post security for costs, including reasonable attorney's fees.

The plaintiffs hold as joint tenants 100 shares¹ of stock of the defendant, Borne Chemical Company, Inc., a New Jersey corporation having its principal office in New Jersey. The defendants are the Borne Chemical Company, Inc., its officers and directors, and CEM Securities Corporation, a Delaware corporation. The action is alleged to have been brought by the plaintiffs "on behalf of themselves in their individual capacities as stockholders," as a "spurious class suit" on behalf of themselves and others similarly situated, and also "to enforce their derivative or secondary rights as stockholders" of Borne. It is alleged that the defendants violated Rule 10b-5 in connection with the sale by Borne to CEM of 10,000 shares of the company's authorized but unissued capital stock. The complaint alleges that the plaintiffs were fraudulently deprived of their pre-emptive rights with respect to the 10,000 shares and that the shares were sold at an improperly low price, and that the defendants engaged in certain manipulative practices affecting the market price of the shares. It is further asserted that the acts complained of were done in furtherance of a conspiracy between the officers and directors of Borne, the majority stockholders of Borne, CEM, and CEM's controlling stockholder. The complaint sets forth various activities alleged to be breaches of fiduciary duties by the defendants which in turn constituted violations of Rule 10b-5. The plaintiffs stipulated in the court below "that the causes of action * * * are all based upon violations of Rule X-10B-5"² by the defendants, with Section 29(b) of the Securities Exchange Act of 1934 providing a supporting basis for a cause of action by reason of the violations of Rule 10b-5. The plaintiffs claim "no other cause of action in this litigation against these defendants". Injunctive relief, an accounting and rescission of the sale of stock by Borne to CEM, and other extensive relief are prayed for.

The defendants did not file an answer but moved to require plaintiffs to post security for expenses including reasonable attorneys' fees. In their motion the defendants asserted a right to security for expenses and counsel fees under the Pennsylvania Act of April 18, 1945, P.L. 253, No. 114, § 2, 12 Pa.Stat. § 1322, under Section 11(e) of the Securities Act of 1933, as amended, 15 U.S.C.A. § 77k(e), "as well as under equitable principles and rules." The court below denied the motion on condition that the plaintiffs file a statement limiting their claims to causes of action arising under Rule 10b-5 and Section 29(b). The plaintiffs did file such a statement which was accepted by the court below and the defendants have appealed.

The defendants make three arguments in support of their contention that a plaintiff who brings an action arising under Sections 10(b) and 29(b) of the Securities Exchange Act of 1934, 15 U.S. C.A. §§ 78j, 77cc, may be required to post security for expenses including reasonable attorneys' fees. These three arguments seek to overcome the fact that no provision of Section 10(b), Rule 10b-5 or Section 29(b) explicitly authorizes a court to require such security. First, it is contended that state law determines whether a plaintiff may be required to post security and that since both Pennsylvania, the State in which the court below sits and New Jersey, the State of incorporation and principal place of business of Borne Chemical Company, have security-for-expenses statutes, the defendants are entitled to the posting of security. Second, it is argued that under "general federal equity law" plaintiffs such as those at bar who bring derivative suits may be required to post security for expenses and that, therefore, even if state law be inapplicable the defendants are entitled to security. Third, the defendants assert that a security for expenses provision should be implied from Section 10(b) of the Securities Exchange Act of 1934 by analogy to other provisions of the Securities Acts which couple security for expenses provisions with provisions granting private rights of action. These arguments frame the three basic questions which must be considered. Preliminary to dealing with these questions, however, it is necessary to discuss the origin and nature of security for expenses statutes so that some of the fundamental considerations leading to our decision may be made plain.

Historically, the derivative suit has been the principal defense of the minority shareholder against abuses by the majority. In this era of the widening gulf between corporate control and corporate ownership, such suits have often served the further purpose of protecting the stockholders of a corporation against management which is sometimes unrepresentative and on occasion insufficiently concerned with the minorities' interests. Often where the wrongdoing is on the part of corporate officers and directors management has refused to act and where the wrongdoers control the corporation there is but small chance that the corporation itself will bring suit or vigorously prosecute the litigation. Equity, therefore, provided shareholders with the device of a derivative suit by means of which they could assert the interest of their corporation against management and third parties when those in control of the corporation were acting in breach of their trust.

There were, of course, obvious dangers of abuse inherent in a device that allowed an individual member of an association, whose interest might be very small, to bring a suit on behalf of the entire association. Consequently, equity itself imposed many limitations on the use of the derivative suit designed to prevent its use as a means to usurp the power of management, of the majority, or to turn the suit to private advantage. For example, equity imposed the requirements of exhaustion of intracorporate remedies,³ of contemporaneous ownership,⁴ and also defined an area of managerial discretion by developing the so-called "business judgment rule."⁵ Despite these safeguards and others, however, there were many who felt that the abuses of the derivative suit as it had developed outweighed its utility as a tool by which corporate democracy and fiduciary duties could be enforced. Certain stockholders, it was observed, would sue the management in behalf of the corporation with no thought of gaining a corporate recovery but solely in the hope that management would "buy them off" by entering into a secret settlement with them. Some suitors gained financial advantages only by virtue of their nuisance value without having ever had a bona fide claim on behalf of the corporation. Moreover, it was vehemently suspected that many derivative suits were brought in the interest of attorneys seeking fees to be paid from the corporate treasury rather than by their clients who were often shareholders having so small an interest in the corporation as to render their ostensible concern for its welfare almost incredible.

In 1944 the Legislature of the State of New York enacted Section 61-b of the New York General Corporation Law, McKinney's Consol.Laws, c. 23, the first state security for expenses provision.⁶ The law was based on a report made by Franklin S. Wood for a committee of the New York State Chamber of Commerce which contained an analysis of approximately 1300 derivative suits brought in the New York courts between 1932 and 1942 and which concluded that the equitable device was being abused. See Wood, Survey and Report Regarding Stockholders Derivative Suits (1944). Similar statutes were adopted in Maryland,⁷ New Jersey⁸ and Pennsylvania⁹ in 1945. Subsequently, California¹⁰ and Wisconsin¹¹ adopted security for expenses statutes that vary substantially from the New York model. The majority of state legislatures have not enacted such legislation.

Generally a security for expense statute provides that shareholders with relatively small holdings may be...