Spirt v. Bechtel

• Decision Date: 13 March 1956
• Docket Number: Docket 23832.,No. 197,197
• Citation: 232 F.2d 241
• Parties: S. Burton SPIRT, Plaintiff-Appellant, v. S. D. BECHTEL et al., Defendants, and C. F. Bradley, John M. Franklin, V. J. Freeze, C. D. Gibbons, Herman Goldman, John W. Hanes, R. M. Hicks, Cletus Keating, G. F. Ravenel, Mary Dempsey Harris and United States Trust Company of New York, as executors of the estate of Basil Harris, deceased, Helen Whitney Gibson and Manufacturers Trust Company, as executors of the estate of Harvey G. Gibson, deceased, Louis Walker, Elisha Walker, Jr., and Robert E. Walker, as executors of the estate of Elisha Walker, deceased, and United States Lines Company, Defendants-Appellees.
• Court: U.S. Court of Appeals — Second Circuit

232 F.2d 241 (1956)

S. Burton SPIRT, Plaintiff-Appellant, v. S. D. BECHTEL et al., Defendants, and C. F. Bradley, John M. Franklin, V. J. Freeze, C. D. Gibbons, Herman Goldman, John W. Hanes, R. M. Hicks, Cletus Keating, G. F. Ravenel Mary Dempsey Harris and United States Trust Company of New York, as executors of the estate of Basil Harris, deceased Helen Whitney Gibson and Manufacturers Trust Company, as executors of the estate of Harvey G. Gibson, deceased Louis Walker, Elisha Walker, Jr., and Robert E. Walker, as executors of the estate of Elisha Walker, deceased, and United States Lines Company, Defendants-Appellees.

No. 197, Docket 23832.

United States Court of Appeals Second Circuit.

Argued December 7, 1955.

Decided March 13, 1956.

Louis H. O. Fischman, New York City (William E. Haudek, of Pomerantz, Levy & Haudek, New York City, of counsel), for appellant.

Cravath, Swaine & Moore, New York City (Ralph L. McAfee, Edward Q. Carr, Jr., New York City, and Peter W. Anson, New York City, of counsel), for appellees.

Before SWAN, FRANK and LUMBARD, Circuit Judges.

SWAN, Circuit Judge.

This is a stockholder's derivative action brought on behalf of the United States Lines Company against directors and officers of said corporation who are alleged to have received unlawful compensation and to have profited through breach of fiduciary duties. The complaint was filed October 24, 1949. Federal jurisdiction is based on diversity of citizenship. The defendants, other than the corporation, are nine directors who served for various periods between January 1, 1943 and December 31, 1949, and the estates of three deceased directors. Trial to the court without a jury was had on documentary evidence and pretrial depositions. The issues were limited to the existence of liability, the amount of recovery, if any, being left for a future accounting. Judge Palmieri gave judgment for the defendants. The plaintiff has appealed.

The trial court's opinion is reported in D.C., 129 F.Supp. 872. The facts therein set out need not be here repeated. When desirable for the discussion additional facts will be mentioned. The complaint alleges three causes of action, which will be considered seriatim. The first seeks recovery of "option profits," by which is meant the difference between the price of $5.81 per share paid to the corporation by the optionee upon exercising his option and the market value of the shares thereby acquired. It is the plaintiff's theory that, if the optionee's fixed salary for the year when the option was exercised, plus his option profits, exceeded $25,000, the excess is recoverable by the corporation as "compensation" received by the optionee in violation of the statutory limit imposed by sections 805(c) and (f) of the Merchant Marine Act, 46 U.S.C.A. § 1223 (c) and (f), set out in the margin.¹

During the years in which the options were exercised the corporation was a "contractor" within the meaning of section 805(c) and received subsidies under the Merchant Marine Act. The parties are in dispute as to whether the statutory provisions create in the subsidized ship operator the right to recover the excess above $25,000 per annum received by any director, officer or employee, the defendants contending that § 805(c) was intended only to safeguard the public interest in the expenditure of governmental subsidies granted to maritime carriers, and was not designed to create private rights and obligations.² The trial judge did not pass on this contention, since he found no violation of § 805(c). Nor need we pass on it, since we agree with his determination that the "option profits" were not "compensation" for personal services within the meaning of the section.^*

The purpose of the stock option plan, approved by the stockholders in May 1943, was to permit the Board of Directors to allot, "with due regard for meritorious service," stock options to key officers and employees as an inducement to those in the employ of the corporation to continue therein and to those absent in war activities to return to the company when their war activities ceased, and to encourage all optionees to strive more diligently for the company's success. On November 30, 1943, the Board of Directors, acting through an authorized committee, granted stock options to eight officers and 39 other employees.³ The option price of $5.81 was based on the average market price during the preceding 30 consecutive trading days; it was slightly above the market price of November 30, 1943.⁴ The options were to run for five years and were exercisable after June 15, 1944 in ten per cent. instalments if the optionee had remained in the company's employ for the preceding six months. Optionees on leave of absence of war service could not exercise their options until after returning to the company's employ. For reasons unnecessary to detail none of the options was exercised before November 26, 1945. On that date, which was shortly after the company had received from the General Counsel of the United States Maritime Commission a letter expressing his opinion that the difference between the option price and the market price at the time of exercising the option would not be regarded as compensation for services within the meaning of section 805(c), the optionees were notified that they were at liberty to exercise their options. Options for 1,100 shares were exercised in 1945, for 44,832 shares in 1946, for 24,066 shares in 1947 and for 18,484 shares in 1948 — a total of 88,482 shares.⁵ It was stipulated that if the option profits are treated as compensation, at least 14 of the optionees, seven of whom have appeared as defendants, received annual compensation in excess of $25,000 for one or more of the years 1946 to 1948.

Judge Palmieri followed the opinion expressed by the General Counsel for the Maritime Commission. We agree with the plaintiff that the General Counsel's opinion was not an administrative ruling by the Maritime Commission itself and need be followed by the courts only in so far as its reasoning is persuasive.⁶ The plaintiff makes a powerful argument against the correctness of the trial court's decision, but it does not convince us. It is true that before exercising his option to take up any part of the optioned shares, the optionee must have worked for the company for a specified period of time; that continuation in the employ of a corporation has been held to be the consideration which validates a stock option,⁷ and that for tax purposes exercise of a stock option may give the optionee compensation in the amount of the difference between the option price and the market price of the shares acquired by exercise of the option.⁸ But no authority has been cited which construes "compensation" as used in section 805(c) of the Merchant Marine Act to include such so-called "option profits." The meaning of "compensation" as there used is to be determined by the purpose of the statute. That purpose was to develop a strong merchant marine and to compel subsidized corporations to operate on a sound basis and not waste their assets by paying exorbitant salaries. One of the customary ways for a corporate employer to retain a competent personnel was to offer valuable officers and employees "incentive" stock options to induce them to continue to serve and to give them a financial interest in the corporation's success by investment in its stock. We cannot believe that the Congress meant to prohibit this customary method of developing efficient management by limiting the annual "compensation" receivable by such officers and employees. The plaintiff says that the legislative history of section 805(c) shows that one purpose of the statute was to prevent undercapitalization of subsidized operators, and argues that, except for the stock options, the corporation could itself have sold the shares at their market price when the options were exercised. But plainly the statute did not forbid all incentive stock options. Even on the plaintiff's theory the exercise of such an option was unassailable unless it resulted in the optionee receiving in excess of $25,000 per year. We do not believe that the Congress intended by section 805 (c) to discriminate between stock options all of which were unassailable when granted but some of which, if the corporation prospered, through development of an efficient organization, were certain to become assailable under the $25,000 limitation of "compensation," if that were to be applied. In our opinion dismissal of the first alleged cause of action was correct.

The second cause of action asserts liability of the defendants to account for tax losses sustained by the corporation and tax advantages gained by the optionees by reason of the corporation's relinquishment of any claim to tax deductions attributable to the stock options. The theory is that each optionee was subject to income tax on the amount of his "option profits" in the year when he exercised his option, and the corporation was entitled to deduct a corresponding amount from its gross income in figuring its own income tax for that year; and that in order to relieve the optionees from their income tax liability, the defendants, "in breach of their fiduciary duties," caused the corporation to exercise and file with the Commissioner of Internal Revenue, its consent not to claim any deductions attributable to the stock options in its own tax returns.

On April 12, 1946 the Commissioner of Internal Revenue promulgated a ruling known as I.T. 3795 (1946 — 1 C.B. 15). It dealt with employees' stock options granted before February 26, 1945 (the date of the decision of Commissioner of Internal Revenue v. Smith, 324 U.S. 177, 65 S.Ct. 591, 89 L.Ed. 830), recognized that under tax decisions before the Smith case there might be reasonable doubt as to the compensatory nature of stock options, and provided an expeditous method of obtaining a ruling as to the tax consequences of the...