Sanitary Farm Dairies v. Gammel

• Decision Date: 13 May 1952
• Docket Number: No. 14252.,14252.
• Citation: 195 F.2d 106
• Parties: SANITARY FARM DAIRIES, Inc. v. GAMMEL.
• Court: U.S. Court of Appeals — Eighth Circuit

195 F.2d 106 (1952)

SANITARY FARM DAIRIES, Inc. v. GAMMEL.

No. 14252.

United States Court of Appeals, Eighth Circuit.

March 6, 1952.

Rehearing Denied May 13, 1952.

COPYRIGHT MATERIAL OMITTED

Patrick J. Ryan, St. Paul, Minn., for appellant.

Mandt Torrison, St. Paul, Minn. (Gerhard Bundlie and Bundlie, Kelley, Finley & Maun, St. Paul, Minn., on the brief), for appellee.

Before GARDNER, Chief Judge, and THOMAS and JOHNSEN, Circuit Judges.

JOHNSEN, Circuit Judge.

This is a suit by a stockholder against the corporation for specific performance of a contract to repurchase his common stock. The appeal is by the corporation from the amount fixed by the trial court as the value or price of the stock under the contract. The rights of the parties are governed by Minnesota law.

The contract, made in 1929, gave plaintiff an option, without limitation as to time, to resell to defendant the stock involved, "at a sum of money per share equal to twelve times the net earnings per share of said common stock for the preceding twelve months." Plaintiff waited until January, 1945, to exercise his option. During the preceding twelve months, the corporation had had a 28-percent increase in its dairy business, as the result of some army-camp contracts.

There was an auxiliary provision in the contract that "In the event of inability of the parties to agree upon earnings * * * for said preceding twelve months an audit shall be made by an independent auditor, the cost of which shall be borne by the parties equally, and the earnings determined by such audit shall be controlling." Plaintiff, after the exercise of his option, was unwilling to accept the determination of earnings made by the firm of accountants employed by defendant, and the parties therefore selected Ernst and Ernst, an accounting firm operating on a national scope, to make an audit for purposes of their contract.

A supplemental agreement was executed between plaintiff and defendant, as first and second party respectively, providing "that the firm of Ernst and Ernst * * * shall be retained and hired for the purpose of making an audit of all the books and records of the second party, or such part thereof as may be requested by either party, for the purpose of ascertaining and determining the net earnings per share of the common stock of the second party for the twelve (12) months of the calendar year 1944, * * * and that, when such audit has been made, it shall be controlling upon the net earnings per share of the second party for the year 1944 and that thereupon the agreement of June 6, 1929 shall be carried out by the parties."

Plaintiff submitted to Ernst and Ernst, pursuant to the privilege accorded each party under the supplemental agreement, a list of a number of items or entries to which he particularly wanted consideration given. He also attempted to insist that Ernst and Ernst should treat the term "net earnings" in the repurchase agreement as meaning earnings before deduction of federal and state income taxes and not earnings after such deductions. There was a clause in the repurchase agreement that "In determining net earnings per share for any year it shall be considered that all of the earnings of the corporation for such year belong to the holders of the common stock except sufficient to take care of the current annual dividends on the preferred stock for such year." It was defendant's position that, under general accounting concept, as well as specifically on the language which the parties had used (the sufficiency of earnings "to take care of the current annual dividends on the preferred stock" not being capable of legal determination or natural significance without consideration of or provision for income taxes) the term "net earnings" in the situation necessarily meant earnings after deduction of taxes.

To escape having this question foreclosed to them as a matter of accountancy determination on the part of Ernst and Ernst, the parties orally agreed that it should be reserved and treated as a legal question for judicial resolution and that the way should be left open to them so to deal with it by having Ernst and Ernst make a determination of net earnings on the basis of both theories. This Ernst and Ernst did in the profit and loss statement contained in their audit report. Nothing else was reserved by the parties in relation to the auditing task or its result.

The audit of defendant's accounting firm had shown net earnings of $97,707.68 for the period involved — that determination having been made with income taxes deducted. Ernst and Ernst's determination arrived at earnings of $180,602.90 without deduction of income taxes and $104,349.12 with such deductions made. This result was the product in part of their refusing to recognize as expense various items which defendant's accountants had so classified, and also of their making other adjustments on independent appraisal and judgment, which gave rise to some deductions not included in expense by defendant's accountants.

Plaintiff still was not satisfied and refused to accept Ernst and Ernst's determination as "controlling" and to proceed on the basis of it to a resolution of the legal question reserved. Instead, he instituted this plenary suit and asked the court to make a determination of the earnings of the corporation and the value of his stock, as an open accounting matter. He engaged some accountants of his own for purposes of the suit, and they thereafter supplied him with a report to the effect that his stock was entitled to be valued or priced on the basis of earnings of $220,739.23.

This figure in substantial measure, as the evidence showed, was the product of viewing corporate items and entries abstractly and without regard contextually to the corporation's regular mode of operating its business and to its established accounting policies. The setting of practice and system was treated by plaintiff's accountants as of slight, if any, moment, in the task of their immediate employment,¹ despite the part which that factor had played structurally and fiscally throughout the life of the corporation and during all of the time, from 1929 to 1944, that plaintiff had chosen to retain his stock, that he had been occupying the role of a director of the corporation, and that as a stockholder he had had the advantage of such benefits as currently accrued to the corporation from payment and acceptance of its income taxes on this basis. A few examples will suffice, we think, to indicate the nature of the disparity between the determination of earnings made by plaintiff's accountants and that arrived at by Ernst and Ernst.

Thus, plaintiff's accountants abstractly classified as capital outlay a considerable number of items, many of which were of relatively small amount individually but aggregately quite substantial, solely because they regarded all of these items on their face as possessing a useful and contributive life in the business of more than a year. Ernst and Ernst, in more realistic, over-all perspective, had accepted the corporation's treatment as expense of most of these items. Some they so recognized on the basis of consistent corporate practice and resulting structural relationship, in conjunction with the tax authorities' previous allowance of the items as proper 1944 deductions. Other items similarly branded as capital outlay by plaintiff's accountants on mere invoice or entry inspection had been granted recognition by Ernst and Ernst as repair or replacement expenditures, after seeking information and receiving explanation from the officers of the corporation as to their nature and purpose (repeated by the officers on the witness stand) and with a viewing of the purported facts given them as properly justifying the corporation's treatment of the items.

Again, plaintiff's accountants rejected allowance of any of the cash withdrawals made by officers of the corporation through the course of the year for alleged travel and entertainment purposes, because no supporting vouchers or itemized statements had been filed covering the use of these funds.² Ernst and Ernst on the other hand had given recognition to the withdrawals as expense, in relation to the practical considerations that the corporation throughout its history, and during plaintiff's 15-year tenure as director, had never required its officers to make any such formal or detailed accounting of their travel and entertainment expenditures; that the officers stated — with repetition made on the witness stand — that the money had been used only for purposes of the business; that the records showed the amounts to be in line with those of previous years; and that the withdrawals had been allowed as business expenditures on the examination of records made by the income-tax authorities.

Other items disallowed by plaintiff's accountants and given recognition by Ernst and Ernst involved simply the question of whether they in fact had been purchases for the corporation or for the officers and their families personally. Plaintiff's accountants branded them as personal purchases on the invoices alone, from their general nature. Explanation made by the officers and repeated by them at the trial was warrantive of the corporation's payment of the items as business purchases.³ The question as to these items therefore was at most a matter of reaching a proper judgment and conclusion in the auditing task on the evidentiary elements which were involved.

One additional item may perhaps even more specifically serve to demonstrate the basis of difference in the results arrived at by Ernst and Ernst and plaintiff's accountants. This involved the question of the value at which the corporation reasonably should have carried on its books for 1944 an inventory of milk bottles, whose use it had discontinued. Defendant, during 1944, for reasons prompted by war conditions, had changed from the use of round milk bottles to square ones, as other large...