Warshaw v. Calhoun

• Decision Date: 03 June 1966
• Citation: 43 Del.Ch. 148,221 A.2d 487
• Parties: Esther R. WARSHAW, Plaintiff Below, Appellant, v. W. K. CALHOUN, Charles F. Curry, F. W. Duboc, Ray B. Duboc, Robert M. Duboc, W. L. Gench, John Latshaw, K. H. Mead, C. C. Otto, Western Casualty and Surety Company, a Kansas corporation, and the Western Insurance Securities Company, a Delaware corporation, Defendants Below, Appellees.
• Court: Supreme Court of Delaware

Page 487

221 A.2d 487

43 Del.Ch. 148

Esther R. WARSHAW, Plaintiff Below, Appellant, v. W. K. CALHOUN, Charles F. Curry, F. W. Duboc, Ray B. Duboc Robert M. Duboc, W. L. Gench, John Latshaw, K. H. Mead, C C. Otto, Western Casualty and Surety Company, a Kansas corporation, and the Western Insurance Securities Company, a Delaware corporation, Defendants Below, Appellees.

Supreme Court of Delaware.

June 3, 1966.

Appeal from the Court of Chancery in and for New Castle county.

Leroy A. Brill, of Bayard, Brill, Russell & Handelman, Wilmington, Laventhall & Zicklin and Javits Trubin Sillcocks Edelman & Purcell, New York City, for appellant.

Henry M. Canby and Richard J. Abrams, of Richards, Layton & Finger, Richard L. McMahon, of Berl Potter & Anderson, Wilmington, and Stinson, Mag, Thomson, McEvers & Fizzell, Kansas City, Mo., for appellees.

WOLCOTT, Chief Justice, CAREY, Justice, and STIFTEL, Judge, sitting.

WOLCOTT, Chief Justice.

This is an appeal by the plaintiff from a summary judgment entered by the Chancellor for the defendants. The plaintiff brought an action as a stockholder of The Western Insurance Securities Company ('Securities') naming as defendants Securities, The Western Casualty and Surety Company ('Casualty') and certain of the officers and directors of both companies. The record before us consists of pleadings, depositions, answers to interrogatories, and produced documents.

Casualty was initiated in 1910 and, in 1922, the Duboc-Gordon interests acquired control of it and incorporated it as a Kansas Corporation, retaining about 92% Ownership. It is a rapidly growing insurance company selling casualty insurance.

In 1925 the Duboc-Gordon group organized Securities for the purpose of controlling Casualty. Upon the organization of Securities, Duboc and Gordon exchanged their shares in Casualty amounting to about 92% Of the Casualty stock for shares in Securities. In addition, Securities acquired some additional shares of Casualty with the proceeds of the sale of its own stock. Since the organization of Securities the Duboc-Gordon group has continued to control it, in fact, owning about 55% Of Securities' outstanding stock. Securities has never owned any substantial asset other than its controlling ownership of Casualty. Securities has never had any appreciable income except dividends received upon its Casualty stock.

In the 1930's, Casualty dividends were reduced and Securities became delinquent on its Class A and preferred stock. These arrearages were discharged in May, 1959, and in December of that year dividend payments were resumed upon its common stock.

Securities is a holding company. It has kept its operating expenses to a minimum. No salaries are paid its officers and its operating expenses are taxes paid on dividends received and the cost of distributing dividends and information to stockholders.

Because of the stock ownership of the Duboc-Gordon group (55%), Securities is classified under the Internal Revenue Code for income tax purposes as a personal holding company. As a result of this classification, retained earnings by Securities are subjected to a tax which is at such a rate as to make the retention of any of its earnings by Securities prohibitive. Accordingly, since its classification as a personal holding company, Securities has made it a practice to pay out almost all of its earnings to its stockholders. With a minor exception, it has not increased its numerical holding of the stock of Casualty.

The stock of Securities has always sold at a discount from the value of the Casualty stock lying behind it. This discount has varied over the years between 25% And 50% Although currently the percentage of discount has declined.

Plaintiff purchased her stock in Securities in 1954, making subsequent purchases in 1956 and 1959. At the time she made her purchases she was aware that she was purchasing stock in a holding company controlled by the Duboc-Gordon group. She knew the Securities stock was selling at a substantial discount from the value of its underlying assets. She was aware that there were arrearages in dividends on the Class A and preferred stock which were being reduced annually, and she knew that no dividends were being paid on the common stock because of the arrearages.

Some of the individual defendants here are directors of both Securities and Casualty. In addition, Ray Duboc is the President of Securities and Chairman of the Board of Casualty. Securities' directors, who are also officers and directors of Casualty, receive salaries from Casualty.

In 1945 and 1950 a small increase in the capital of Casualty had been accomplished in order to meet reserve requirements by selling Casualty shares through a public undertaking through a local Kansas City brokerage house. But in 1953 it became apparent that Casualty must obtain substantial additional financing in order to meet the accepted standard of a proper ratio between premiums and capital, and to broaden the public ownership of its stock.

Upon the recommendation of the Kansas City brokerage house which was unable to accept the underwriting, Casualty approached Kidder, Peabody & Co. for this purpose. Negotiations were carried on between Ray Duboc on behalf of Casualty and a representative of Kidder, Peabody. Ultimately, the additional financing was obtained by effecting a stock split of Casualty stock with a set price of $23 per share for the new issue. This was offered to the public through Kidder, Peabody.

Securities, which at the time owned approximately 92% Of the Casualty stock, did not accept its rights to subscribe to the new Casualty stock for a number of reasons. It was without funds to take up the stock rights. At the time it was still in dividend arrears upon its Class A and preferred stock. If it had exercised its rights, there would have been insufficient stock available for public subscription which would have defeated the purpose of establishing a public market for Casualty stock. This same result would have followed had Securities offered the rights to subscribe to the new Casualty stock to its relatively small number of shareholders. If Securities accepted its rights to subscribe to Casualty stock, an additional burden would have been placed upon the underwriters of guarantying the price of the entire new issue of Casualty stock during the period allotted for the exercise of the rights. This would have resulted in increased cost of financing and might even have jeopardized the entire underwriting. Accordingly, in consideration of these reasons the underwriter insisted that an integral part of the underwriting be that Securities abandon its right to subscribe to the new Casualty stock. The directors of Securities agreed and transferred the rights of Securities to subscribe to Kidder, Peabody for a nominal consideration. The result of the abandonment of Securities' right to subscribe to the 1954 Casualty stock was to dilute the percentage ownership of Securities in Casualty.

In 1959 further financing of Casualty was required and the 1959 plan substantially followed the 1954 plan. Again, by reason of the fact that the retainment of earnings was prohibitive to Securities it found itself in no position to exercise its rights to subscribe to the new Casualty stock. Also, again Kidder, Peabody desired the neutralization of Securities' rights to subscribe as essential to the success of the underwriting. A price was established for the new Casualty stock which resulted in the placing of a purely minimal value on the rights, themselves, and no market in fact developed for such rights. The negotiations leading to the issue of 1959 were again carried on by Duboc and a representative of Kidder, Peabody. Again, the directors of Securities agreed to waive the Securities' rights to subscribe to the issue of 1959. Obviously, as a result of this transaction, the percentage ownership of Securities in Casualty was further diluted.

Finally, in 1962, another public offering of Casualty stock was made. It is this offering with which the plaintiff complains. The 1962 offering paralleled the offerings of 1954 and 1959 except that Securities waived a portion of its rights to subscribe to the new stock of Casualty in order to change the subscription ratio of stockholders other than Securities from 1 for 4 1/3 shares to 1 for 4 shares. This was done to avoid the issuance of a large number of fractional shares, the cost of which would have outweighed the value of Securities' rights thus waived.

The Securities directors then agreed to sell to Kidder, Peabody the remaining rights of Securities to subscribe to the new stock of Casualty at a figure which later turned out to be the maximum price developed for the sale of such rights. The reasons why the directors of Securities concluded that it could not exercise its rights and should not pass its rights on to its own stockholders were similar to those which had governed the prior public offerings of Casualty stock.

With respect to all of the public offerings of Casualty stock, Securities was not financially able to exercise its rights. In all of the public offerings the underwriter regarded it as necessary that the rights of Securities be neutralized in order to insure the success of the underwriting. As a result, all three of the public offerings were successful. Casualty stockholders increased from approximately 150 to over 1900. The results of the underwritings were more favorable to Casualty than would otherwise have been. Casualty stock became a desirable investment and is established in the over-the-counter market.

One result of the three public offerings of Casualty stock with the subsequent waiver or disposal by Securities of its rights to subscribe has been to reduce the percentage ownership of Securities in Casualty to slightly over 41%. This still represents control of Casualty.

In this action plaintiff seeks two remedies. She seeks an accounting...