Smith v. Brown-Borhek Co.

• Decision Date: 21 April 1964
• Docket Number: BROWN-BORHEK
• Citation: Smith v. Brown-Borhek Co., 414 Pa. 325, 200 A.2d 398 (Pa. 1964)
• Parties: Leland E. SMITH, Appellant, v.COMPANY, a Pennsylvania corporation, Robert L. Fox, A. B. Johnston, Mrs. Johnston Jost, Elmer L. Mack, Andrew S. Morgan, H. Gordon Payrow, Jr. and John L. Zapf.
• Court: Pennsylvania Supreme Court

Page 398

200 A.2d 398

414 Pa. 325

Leland E. SMITH, Appellant, v.BROWN-BORHEK COMPANY, a Pennsylvania corporation, Robert L Fox, A. B. Johnston, Mrs. Johnston Jost, Elmer L Mack, Andrew S. Morgan, H. Gordon Payrow, Jr. and John L. Zapf.

Supreme Court of Pennsylvania.

April 21, 1964.

Rehearing Denied May 29, 1964.

Harry A. Dower, Dower, Kanehann, Huston, McDonald & Cahn, Allentown, for appellant.

H. P. McFadden, Bethlehem, for appelleesRobert L. Fox, et al.

William B. Joachim, Jr., Bethlehem, for appelleesBrown-Borhek Co.

McFadden, Riskin & Williams, Bethlehem, for individualappellees.

Before BELL, C. J., and MUSMANNO, COHEN, EAGEN, O'BRIEN and ROBERTS, JJ.

BELL, Chief Justice.

Plaintiff owns 516 out of a total of 8,000 shares of stock (outstanding) in the Brown-Borhek Company.He brought this stockholder's derivative suit on October 23, 1962, to recover for the corporation $605,507.00, the amount of the loss allegedly resulting from negligent mismanagement by the individual defendants, who are, or were at the relevant times, officers and directors.The defendants filed an answer denying plaintiff's material allegations and set up new matter alleging ratification of the acts in issue.Plaintiff filed a reply to the new matter in which he admitted that the stockholders ratified defendants' challenged actions, but denied the legal effect of this ratification and the legality of many of the votes which were cast for ratification.The Court of Common Pleas granted defendants' motion for judgment on the pleadings and this appeal followed.

The transactions complained of are a series of sales on credit by Brown-Borhek Company to a large customer, Raydel Homes Corp., throughout 1960 and 1961, and an eventual compromise of the latter's indebtedness in 1962.In 1960 Brown-Borhek's sales to Raydel totaled $550,562, or 37% of all sales.On December 31, 1960, Brown-Borhek carried an account receivable from Raydel of $262,010, which amounted to 60% of Brown-Borhek's receivables and 29% of all its assets.In 1961, Brown-Borhek's sales to Raydel amounted to approximately $1,050,290, 50% of all sales.On December 31, 1961, Raydel's account receivable with Brown-Borhek was $653,994.00; ¹ this represented 80% of its receivables and 63% of all its assets.²

Raydel's indebtedness of $605,507 owing to Brown-Borhek as of November 30, 1961, was compromised on February 7, 1962, by an agreement under which Brown-Borhek received $363,300 worth of Raydel 5% noncumulative preferred stock with a par value of $10.00 a share and a promissory note for $242,207 with interest at 6% payable December 31, 1962.In defendants' new matter, they aver that this transaction was part of a composition by Raydel with its major creditors and that in addition Raydel made a cash payment to Brown-Borhek of $50,000.This cash payment was admitted by plaintiff in his reply.Brown-Borhek's President stated at the annual stockholders' meeting that Raydel is presently in bankruptcy, and that nothing of value has been realized as yet from the preferred stock or from the promissory note.

Plaintiff does not aver fraud nor personal profit by the defendants but alleges that the above transactions occurred when the individual defendants knew or should have known (a) that Raydel's liabilities greatly exceeded its assets and (b) that it was unable to met its current obligations, and (c) that defendants had no reasonable expectation that the indebtedness would be paid.Furthermore, plaintiff alleges that the Raydel stock and promissory note were worthless at the time of receipt.All of these allegations were specifically or substantially denied by defendants, who suffered far greater financial losses from this Raydel account than did the plaintiff.Both sides agree that the defendants set credit limits on sales to Raydel which they subsequently did not adhere to, and that Raydel's receivables were carried on the average for a longer period than those of other customers.³Finally, plaintiff alleges that during the last half of 1961 the President of Brown-Borhek spent his full time campaigning for the office of Mayor of Bethlehem and that its Vice President was similarly engaged in the management of the United Gas Improvement Company.Defendants aver that these outside activities did not prevent these officers from attending to their respective duties and particularly to this Raydel account and furthermore that the vice presidency had always been only a part time job.Defendants admitted that the directors failed to remove these officers, but denied that this failure was due to negligence on their part.

Defendants, in addition to a denial of plaintiff's importantly relevant material averments, set up new matter, viz., ratification by the stockholders of Brown-Borhek at their annual meeting on April 10 1963.This ratification was made by and pursuant to the following resolution:

'WHEREAS, in accordance with the notice of this meeting the chairman has reviewed the handling of the Raydel account and the questions concerning it raised in a suit by Leland E. Smith, NOW THEREFORE

'BE IT RESOLVED that the actions of the officers and directors in connection with the Raydel account be and hereby are ratified and confirmed and made the actions of this Corporation.'

This resolution was carried by a vote of 6,693 to 405.Plaintiff's shares were not voted, but counsel for plaintiff was present at this stockholders' meeting.

The lower Court gave judgment for the defendants on the basis of this ratification.Plaintiff contends (1) that the aforesaid transactions could not be ratified under the law and (2) that even if ratification were permitted by law, (a) the transactions could not be ratified by less than all of the Brown-Borhek stockholders and (b) that the vote itself was legally defective because defendants voted their own shares and the proxies of other stockholders in favor of the resolution.We find no merit in any of these contentions.

The rule regarding judgment on the pleadings is well settled.

In Poole v. Great American Insurance Co., 407 Pa. 652, 182 A.2d 509, 510, the Court, quoting from Ross v. Metropolitan Life Insurance Co., 403 Pa. 135, pages 654-655, 169 A.2d 74, said: "A motion for judgment on the pleadings, like preliminary objections, is the equivalent of the old statutory demurrer and admits all facts which are well pleaded [but not the pleader's conclusions or averments of law.]Necho Coal Co. v. Denise Coal Co., 387 Pa. 567, 128 A.2d 771;Gardner v. Allegheny County, 382 Pa. 88, 114 A.2d 491.Such a motion should be granted and judgment should be entered only in a case which is clear and free from doubt [casessupra.]"Also Schrader v. Heath, 408 Pa. 79, 83, 182 A.2d 696;Universal Film Exchanges, Inc. v. Board of Finance and Revenue, 409 Pa. 180, 185 A.2d 542.

In Universal Film Exchanges, supra, the Court, quoting from Bogash v. Elkins, 405 Pa. 437, 439, 176 A.2d 677, accurately stated the applicable rule (409 Pa. page 188, 185 A.2d page 546): 'Preliminary objections admit all facts which are well pleaded, but not the pleader's conclusions or averments of law.Ross v. Metropolitan Life Insurance Co., 403 Pa. 135, 169 A.2d 74;Gardner v. Allegheny County, 382 Pa. 88, 114 A.2d 491;Narehood v. Pearson, 374 Pa. 299, 96 A.2d 895.'

We must therefore assume that defendants were aware of Raydel's precarious financial condition and took a business risk which turned out disastrously for all the stockholders of Brown-Borhek Company.

1.Could the Actions of Defendants be Ratified?

In Chambers v. Beaver-Advance Corp., 392 Pa. 481, page 486, 140 A.2d 808, page 811, the Court said:

'The general rule is well established that stockholders can ratify any action of the Board of Directors[or officers] which they themselves could have lawfully authorized.Russell v. Henry C. Patterson Co., 232 Pa. 113, 120, 81 A. 136, 36 L.R.A.,N.S., 199;Lowman v. Harvey R. Pierce Co., 276 Pa. 382, 120 A. 404, 406.This general rule is 'subject, however, to the limitation * * * 'the majority stockholder may not, as against the corporation and minority stockholder, dissipate or waste its funds, or fraudulently dispose of them in any way, either by ratifying the action of the board of directors in voting themselves illegal salaries or by any other [similar] act.'': Lowman v. Harvey R. Pierce Co., 276 Pa. 382, 386, 120 A. 404.'Accord: Reifsnyder v. Pittsburgh Outdoor Advertising Co., 396 Pa. 320, 152 A.2d 894.

We repeat; nowhere in his complaint does the plaintiff allege that there has been fraud, self-dealing, personal profit or intentional dissipation or waste of corporate funds.In the last analysis plaintiff bases his case on the alleged failure of the officers and directors to devote their full time to the management of the business and particularly to a prudent consideration of the Raydel account and failure to exercise 'that diligence, care and skill which ordinarily prudent men would exercise under similar circumstances in their personal business affairs'.This prudent man rule is the standard set forth in the Business Corporation Law of May 5, 1933, P.L. 364, Article 4, Section 408,15 P.S. § 2852-408.

Plaintiff in his oral argument before this Court repeatedly emphasized that the alleged mismanagement by defendants consisted of their negligent failure to exercise their duties, and not of affirmative negligence or the deliberate exercise of bad judgment or intentional wrongdoing.We believe that plaintiff portrays defendants' alleged failure to act as he would have had them do, as a failure to exercise wise business judgment in the light of the disastrous business transaction from which they suffered far greater losses than he.The meaning and application of the 'prudent man rule'(a) in the field of a testamentary or inter vivos trust, containing relatively few securities and (b) in the business or banking world are very different.For example,...