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Managers Securities Co. v. Mallery

March 26, 1935


Appeal from the District Court of the United States for the District of Delaware; John P. Nields, Judge.

Author: Davis

Before WOOLLEY, DAVIS, and THOMPSON, Circuit Judges.

DAVIS, Circuit Judge.

This is an appeal from a decree of the District Court holding that the losses resulting from the sales of the common stock of the General Motors Corporation, hereinafter called General Motors, were chargeable against the Class A surplus account of the appellant company.

In order to stimulate and maintain the zeal and co-operation of the responsible executives of General Motors and to promote its general welfare by enabling them to acquire a substantial interest in its common stock, the Managers Securities Company, hereinafter called defendant, was organized on November 26, 1923. The company was composed of about 70 of the responsible managing executives of General Motors. The charter authorized the issuance of $28,800,000 in 7 per cent. cumulative preferred stock divided into 288,000 shares of the par value of $100 a share; $4,000,000 in class A stock divided into 40,000 shares of the par value of $100; and $1,000,000 in class B stock, divided into 40,000 shares of the par value of $25 a share. These three classes of stock were issued. Defendant then sold all its class A and class B stock to General Motors for $5,000,000. It then purchased from the General Motors Securities Company 30 per cent. of its issued capital stock for which it gave in payment its 288,000 shares of preferred stock plus $4,950,000 in cash. The General Motors Securities Company owned 7,500,000 shares of the stock of General Motors. This gave the defendant the equivalent of 2,250,000 shares of General Motors stock, for which it paid in stock and cash $33,750,000.

On November 27, 1923, the day following its organization, the defendant and General Motors entered into the following contract which was commonly called the "5 after 7 contract": "General Motors hereby agrees on or before April 1st in each year, commencing with April 1st, 1924, and ending April 1st, 1931, to pay to the Managers Company 5 per cent. of the net earnings of General Motors for the preceding calendar year after deducting from said net earnings 7 per cent. on the capital employed during said year."

There were other transactions between the appellant and General Motors, but the knowledge of them is not necessary to the disposition of this case.

At the time of the organization of the defendant, plaintiff purchased from General Motors 200 shares of class A and 200 shares of class B stock of the defendant. When these executives purchased their stock, they were required to sign an option providing that if they should leave the employ of General Motors or its subsidiary, through no fault of their own, they would sell their class A stock to General Motors at a price equivalent to its par value plus its proportion of the class A surplus "as shown on the books of the company as of April 30th" in the year in which the repurchase was made. In 1929 the plaintiff left the employ of General Motors, which exercised its option and repurchased his class A stock, and thereafter he had only the 200 shares of class B stock.

From the first the defendant was very successful and made a great deal of money.This continued until the "depression" in the fall of 1929.By the summer of 1926, all the preferred stock had been retired, and 30,000 shares of the class A stock had been retired by 1928, from the income received from the "5 after 7 contract," leaving only 10,000 of class A stock and 40,000 shares of the class B stock outstanding. The charter of the defendant was then amended by reducing its authorized capital to $2,000,000 consisting of the stock as above stated.

The indebtedness of the defendant company having been paid and the stock outstanding as above indicated, it was decided that it would be to the advantage of the stockholders to invest the income of the company in the stock of General Motors rather than pay it directly to the stockholders as and when earned. Consequently the defendant borrowed $25,000,000 from J. P. Morgan & Co., gave its note for that amount, and on March 8, 1928, purchased 168,300 shares of General Motors stock for $25,144,075. Later in that year General Motors increased its capital and gave 2 1/2 shares of new common stock for each share of the old, so that the 168,000 shares was increased to 420,750.

Considerable loss was sustained as a result of the purchase of this stock, and the plaintiff contends that it was purchased solely for the account of the class A stockholders, and that the loss incurred must be borne by them on the dissolution of the defendant.

The determination of this question depends primarily upon the laws of Delaware and the provisions of the charter of the defendant.

Section 3 of the Delaware Corporation Law, chapter 65 of the Revised Code of 1915, § 1917, as amended by 34 Del. Laws, c. 112, § 1, provides that every corporation: "Shall possess and exercise all the powers and privileges contained in this Chapter, and the powers expressly given in its charter or in its certificate under which it was incorporated, so far as the same are necessary or convenient to the attainment of the objects set forth in such charter or certificate of incorporation; and shall be governed by the provisions and be subject to the restrictions and liabilities in this Chapter contained, so far as the same are appropriate to and not inconsistent with such charter or Act under which such corporation was formed." Rev. Code Del. (1915) § 1917, as amended by 34 Del. Laws, c. 112, § 1.

Paragraph 3 of section 5 of the Delaware Corporation Law requires that the certificate of incorporation set forth, "the nature of the business, or objects or purposes proposed to be transacted, promoted or ...

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