Security Trust Co. v. Dabney

• Decision Date: 21 June 1963
• Citation: 372 S.W.2d 401
• Parties: SECURITY TRUST COMPANY, a Corporation, ex rel. Dages l. Boyle, Shareholder, Appellant, v. E. S. DABNEY et al., Appellees.
• Court: United States State Supreme Court — District of Kentucky

Page 401

372 S.W.2d 401

SECURITY TRUST COMPANY, a Corporation, ex rel. Dages l Boyle, Shareholder, Appellant, v. E. S. DABNEY et al., Appellees.

Court of Appeals of Kentucky.

June 21, 1963.

Rehearing Denied Dec. 13, 1963.

Frank S. Ginocchio, Lexington, for appellant.

Stoll, Keenon & Park, Harbison, Kessinger, Lisle & Bush, Lexington, for appellees.

PALMORE, Judge.

On January 10, 1961, pursuant to a resolution theretofore adopted by its board of directors, the shareholders of Security Trust Company, of Lexington, Kentucky, a state banking and trust company under KRS Chapter 287, approved an agreement of consolidation with First National Bank and Trust Company of Lexington. Seven days prior to this action one of Security's shareholders, D. I. Boyle, acting derivatively (KRS 271.605) for and in the name of Security, brought suit against its officers and directors and against First National, demanding that the agreement and proposed consolidation be adjudged unlawful and the defendant officers and directors of Security be required personally to indemnify plaintiff against a loss of $360.000 (later amended to $660.000) which, through the proposed exchange for shares in the re-organized First Security National Bank and Trust Company of Lexington, allegedly would result to some 12,000 shares of Security's own stock held by it in its various fiduciary capacities.

The trial court sustained defendants' motions to dismiss the complaint (as twice amended after the shareholders' meeting of January 10, 1961) and, plaintiff having declined to plead further, entered judgment accordingly. Plaintiff appeals.

As the terminology of KRS 271.605 implies, ¹ a stockholder's derivative suit must state a cause of action existing in favor of the corporate entity itself. 13 Fletcher, Cyclopedia of Corporations, § 559, p. 1274; Louisville Bridge Co. v. Dodd, 27 Ky.Law Rep. 454, 85 S.W. 683 (1905). The wrongful act for which a derivative suit will lie may be '(1) an ultra vires or illegal act of the corporate officers or of majority stockholders, (2) a fraudulent or unfair act of the corporate officers or majority stockholders, or (3) the wrongful act of a third person.' 13 Fletcher, Cyclopedia of Corporations, § 5951, p. 439. 'Stockholders' suits are especially important as a remedy for minority stockholders to call directors and controlling stockholders to account for mismanagement and fraudulent manipulation. In most cases there is a corporate right of action, but in some situations both an individual and a corporate right may arise.' Id., § 5941, p. 413.

'While an injury to the corporation resulting from wrongdoing, fraud or negligence of corporate officers operates, indirectly, as an injury to stockholders, the injury to stockholders is secondary and the injury to the corporation primary. A stockholder cannot, as an individual as distinguished from a representative of the corporation, sue directors or other corporate officers for mismanagement, negligence or the like, on a cause of action which belongs to the corporation. * * * He cannot sue to set aside a contract made in fraud upon corporate rights. * * * Improper manipulation of funds by the controlling stockholder creates a cause of action in favor of the corporation rather than in favor of a stockholder as an individual, as does a wrongful diversion of corporate assets.' Id., § 5924, pp. 395-396.

KRS 271.605 provides that a stockholder's complaint to enforce secondary rights shall 'set forth with particularity the effort of such shareholder or shareholders to secure from the directors and, if necessary, from the other shareholders the desired action, and the reasons for failure to obtain such action or the reasons for not making such effort to obtain such action.' This requirement appears to have been taken from Rule 23(b) of the Federal Rules of Civil Procedure, which in turn is an enlargement of old Equity Rule 27. Cf. 3 Moore's Federal Practice, R. 23, p. 3489 et seq.

With these fundamentals in mind, we shall first take up appellee's contentions that (1) a stockholder's derivative suit will not lie in this case, and (2) in any event the proceeding must fail because the complaining stockholder made no effort to secure the desired action within the corporation itself, through the other shareholders, before bringing suit.

According to the contract between the two banks, in round figures and subject to certain adjustments Security's 40,000 shares of stock outstanding had an estimated fair value of $4 million and First National's 100,000 shares $6 million, on which basis the 200,000 shares to be issued by the reorganized company in exchange therefor would be divided 80,000 to Security's and 120,000 to First National's stockholders. The assets contributed by the respective parties were to be passed on and be acceptable to a committee of six, three appointed by each board of directors. The plan was proposed pursuant to the procedures set forth in 12 U.S.C.A. § 215, requiring approval of the Comptroller of Currency, and to § 368 of the Internal Revenue Code as a tax-free reorganization. Until the next annual meeting, the new bank would be governed by a board of 15 named directors, six of whom were members of Security's board. Those of Security's directors not so named were to serve as 'advisory directors' until the next annual meeting.

After pleading the contract as an exhibit, the complaint launches a barrage of conglomerated charges, some of which, if true, would more appropriately serve as the basis for individual rather than corporate relief, some of which go strictly to the question of business judgment and, standing alone, would not provide a cause of action of any sort, and some of which actually do sound in the area of mismanagement, which is a proper subject of derivative relief. Shorn of conclusions and uncomplimentary adjectives, the factual content of the complaint and amended complaints may be categorized as follows:

A. The transaction is tainted with self-interest on the part of Security's directors, in that they are designated as members or advisory members of the new board of directors until the first annual meeting of shareholders.

B. It is a bad business deal for Security's stockholders and trust accounts. This is the net effect of charges that (1) Security's power and prestige will be dissipated through loss of identity into and absorption by the new and larger association, (2) Security's stockholders will be reduced from 100% to 40% ownership and, without good reason for such a move, will lose managerial control, (3) the new stock to be received in exchange will have less value than Security's old shares, a circumstance resulting wholly or in part from the fact that the 'fair value' of Security's stock is substantially in excess of the amount at which it is valued in the contract and the further fact that the fair value of First National's stock, as established by the contract, included an item of $400,000 for good will, whereas nothing is allowed to Security for good will, and (4) by virtue of the consolidation Security's stock, including that which is held in its trust accounts, will become subject to First National's liabilities.

By the first amended complaint it is alleged that the fair value of Security's stock held in its fiduciary capacity is $660,000 (instead of $360,000 as set forth in the complaint) more than the amount agreed upon in the contract, the larger value having been established by a bona fide offer to purchase such stock.

C. The initial board of the re-organized company will be constituted by contract rather than by election, depriving the shareholders of their statutory right of cumulative voting. Cf. Const. § 207.

D. The first amendment of the complaint alleges that at the stockholders' meeting on January 10, 1961, the vote was counted as 31,688 shares for and 7300 shares against the proposal. Of the 31,688 majority vote 9,347 were shares held by Security and 812 by First National in their respective trust accounts. (Elimination of the trustee stock would reduce the favorable vote to less than the required two-thirds.)

E. The second amended complaint sets forth a provision of 12 U.S.C.A. § 61 to the effect that no officer, clerk, teller or bookkeeper of a national bank shall act as proxy in voting its shares, and alleges that of the 31,688 votes in favor of the proposal 18,774 shares were voted by Security's officers as proxies.

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