Schmidt, Matter of

• Decision Date: 14 November 1983
• Citation: 468 N.Y.S.2d 663,97 A.D.2d 244
• Parties: In the Matter of Herbert J. SCHMIDT, Jr., Appellant (Magnetic Head Corporation, respondent). Herbert J. SCHMIDT, Jr., Appellant, v. MAGNETIC HEAD CORPORATION, et al., Respondents.
• Court: New York Supreme Court — Appellate Division

Page 663

468 N.Y.S.2d 663

97 A.D.2d 244

In the Matter of Herbert J. SCHMIDT, Jr., Appellant (Magnetic Head Corporation, respondent) Herbert J. SCHMIDT, Jr., Appellant, v. MAGNETIC HEAD CORPORATION, et al., Respondents.

Supreme Court, Appellate Division Second Department.

Nov. 14, 1983.

Berg & Duffy, Lake Success (James P. Duffy, III, Lake Success, Donald F. Leistman, Stewart Manor, and Walter J. Gumersell, Lake Success, of counsel), for appellant.

Farrell, Fritz, Caemmerer, Cleary, Barnosky & Armentano, P.C., Mineola (John P. Cleary, William V. Alesi, Mineola, and Eugene S.R. Pagano, Mineola, of counsel), for respondents.

Before LAZER, J.P., and MANGANO, GIBBONS and GULOTTA, JJ.

GIBBONS, Justice.

These appeals and the events leading up to the 1981 annual meeting of the Magnetic Head Corporation are closely associated with another case, Schmidt v. Magnetic Head Corp. 92 A.D.2d 151, 468 N.Y.S.2d 649 [decided herewith] ). For the sake of orderly exposition, a review of the facts and proceedings in that case, as well as those in this one, is necessary.

Appellant, Herbert J. Schmidt, Jr., and his wife Barbara were the principal stockholders in MCP Corporation, a Delaware corporation, up until April 30, 1978. On that date, respondent Magnetic Head Corporation, a publically traded New York corporation, acquired MCP by exchanging 47.5% of its issued shares for all of the MCP shares. By the terms of this acquisition appellant and his wife became the owners of 45.8% of the issued shares of Magnetic Head Corporation (hereinafter Magnetic Head), the largest stockholder interest. Appellant himself owns 32.3% of Magnetic Head.

Despite the large percentage of Magnetic Head shares owned by the Schmidts, they did not move into a controlling position. On April 30, 1978, the acquisition date, they entered into a shareholders agreement with Magnetic Head and the other former MCP Corporation shareholders, who, by dint of the acquisition, were now Magnetic Head shareholders. The shareholders agreement required each stockholder to sign an irrevocable proxy and designated James North, Charles Rockwell and Royce McKinley as proxy holders. North was the Schmidts' attorney. Rockwell was and is Magnetic Head's chief executive officer and chairman of its board of directors, while McKinley was and is president of Santa Anita Consolidated, Magnetic Head's largest pre-acquisition shareholder.

According to the shareholders agreement, it is to "remain in effect for five (5) years * * * or for the period during which Charles S. Rockwell shall be actively engaged in the management of the Company, whichever is longer, but in no event for a period in excess of ten (10) years". The proxy holders have, according to the agreement, "the exclusive right to vote all Shares subject to the provisions of this Shareholders Agreement * * * for whatever purposes and in any and all proceedings * * * wherein the vote or written consent of shareholders of the Company may be required or authorized by law". However, the agreement goes on to provide that "during any period in which Herbert J. Schmidt, Jr., and Barbara B. Schmidt * * * are the holders of 30% or more of the common shares of the Company the Proxy Holders shall vote the Shares for the election of Herbert J. Schmidt, Jr., Barbara B. Schmidt and James North for election as Directors and for determining the number of directors at not more than nine (9)". The proxy holders are also signatories to the shareholders agreement.

Three years after the acquisition, on April 30, 1981, North resigned both as a proxy holder and as a director. The shareholders agreement provides that, in the event of North's death, incapacity, or resignation as a proxy holder, appellant, Herbert J. Schmidt, Jr., could select a replacement. The agreement does not explicitly state what should happen if North resigned as a director. When North resigned both positions, a conflict arose between Schmidt and the majority group of the board of directors, headed by Rockwell, as to who had the authority to select North's replacement on the board. The board of directors, against the wishes of Schmidt, elected one Edward Gleason to fill the vacancy. The dispute as to this position on the board of directors led to the first action (see Schmidt v. Magnetic Head Corp., supra), in which, among other things, the Schmidts request specific performance, construction and reformation of the shareholders agreement, all seeking a direction that the Schmidts may designate North's successor as a director. Alternately, the Schmidts ask that the shareholders agreement be rescinded on the ground that a material element of the agreement was their power to designate a successor to North on the board of directors, and, without that element, there was no meeting of the minds. This court, in its opinion decided herewith, has held that the causes of action for reformation and rescission will survive a motion to dismiss (Schmidt v. Magnetic Head Corp., supra).

Magnetic Head held its annual meeting on October 6, 1981. Prior thereto, the board of directors, under the control of the Rockwell majority, solicited the proxies of stockholders in favor of: (1) a slate of eight directors, including the board's nomination to replace North; (2) an amendment to the articles of incorporation to double the number of authorized common stock from 6,000,000 to 12,000,000 at $0.10 par value; and (3) an amendment to authorize 4,000,000 shares of preferred stock at $1 par value. Issuance of the new stock would be at the board's discretion. Current shareholders would not be entitled to any pre-emptive rights. The board would determine the voting rights, if any, of each class of preferred stock issued.

Appellant, contending that the shareholders agreement was no longer in force, solicited proxies in favor of his and his wife's nominees to the board and in opposition to the new stock authorizations. The inspectors at the annual meeting, appointed by Rockwell, considered the irrevocable proxies binding. As a result, the measures proposed by the Rockwell group were easily passed.

On October 27, 1981, Mr. Schmidt brought the instant action, purportedly pursuant to section 611 of the Business Corporation Law, to annul the tabulation of the votes at the shareholders meeting insofar as the inspectors were not disinterested, breached their duties, and were negligent and unfair. By order to show cause, dated October 23, 1981, Mr. Schmidt initiated the instant proceeding purportedly pursuant to section 619 of the Business Corporation Law, to set aside the election of the board of directors and to vacate the passage of the amendments to the articles of incorporation authorizing the issuance of the new shares. Schmidt also requested consolidation of those matters pending in the Supreme Court.

Motions were made by Magnetic Head and the other named defendants in the section 611 action to dismiss that action and the proceeding brought pursuant to section 619, for failure to state a cause of action. By order, dated January 29, 1982, Special Term dismissed the action on the ground that "[t]he sole and exclusive remedy * * * to test the procedures, fairness and conduct of such elections is pursuant to Section 619 of the Bus.Corp.Law". Special Term refused to deem the action a proceeding brought under section 619, since such a proceeding was "presently pending before this Court". In a decision, also dated January 29, 1982, followed by a judgment entered March 16, 1982, the same court dismissed the section 619 proceeding. These appeals followed.

Special Term properly dismissed the action to annul the tabulation of the vote at the October 6 annual meeting. Section 611 of the Business Corporation Law governs the conduct of inspectors at a corporation election and reads as follows:

"The inspectors shall determine the number of shares outstanding and the voting power of each, the shares represented at the meeting, the existence of a quorum, the validity and effect of proxies, and shall receive votes, ballots or consents, hear and determine all challenges and questions arising in connection with the right to vote, count and tabulate all votes, ballots or consents, determine the result, and do such acts as are proper to conduct the election or vote with fairness to all shareholders. On request of the person presiding at the meeting or any shareholder entitled to vote thereat, the inspectors shall make a report in writing of any challenge, question or matter determined by them and execute a certificate of any fact found by them. Any report or certificate made by them shall be prima facie evidence of the facts stated and of the vote as certified by them."

While this section clearly prescribes the duties of an inspector at a shareholders meeting, it does not, in and of itself, provide the mechanism for challenging the results of such a meeting. Specifically, the exclusive method for testing the validity of an election of an officer or director is either through an action in the nature of quo warranto brought by the Attorney-General, or through a proceeding instituted under section 619 of the Business Corporation Law (see Christ v. Lake Erie Distrs., 51 Misc.2d 811, 815-816, 273 N.Y.S.2d 878, mod. on other grounds 28 A.D.2d 817, 282 N.Y.S.2d 728; 3 White, New York Corporations [13th ed.], par. 619.01).

Section 619, titled "Powers of supreme court respecting elections", reads as follows:

"Upon the petition of any shareholder aggrieved by an election, and upon notice to the persons declared elected thereat, the corporation and such other persons as the court may direct, the supreme court at a special term held within the judicial district where the office of the corporation is located shall forthwith hear the proofs and allegations of the parties, and confirm the election, order a new election, or take such other action as justice may require."

The nature and extent of an inspector's...