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Kroese v. General Steel Castings Corp.

filed: January 31, 1950.

KROESE
v.
GENERAL STEEL CASTINGS CORPORATION ET AL.



Author: Goodrich

Before MARIS, GOODRICH and HASTIE, Circuit Judges.

GOODRICH, Circuit Judge.

Are a majority of a corporation's board of directors indispensable parties to an action by a shareholder to compel the declaration of dividends? That is the question before us in this case. The district judge, on motion, dismissed the complaint; he thought the directors were indispensable parties and that the court was powerless to grant relief in their absence. D.C.E.D.Pa.1949, 9 F.R.D. 273.

There has been no trial of facts; not even an answer by the defendants. All we have is the plaintiff's complaint, plus a motion to dismiss. On this state of the record we must assume, ad hoc, the truth of the allegations in the complaint. It is also to be observed, preliminarily, that the case is in federal court on grounds of diversity of citizenship only. We recognize rights and interests, therefore, as a Pennsylvania court would recognize them, including reference to the foreign law in the same fashion as a Pennsylvania court would make it.*fn1 Pennsylvania law was not briefed by either party in the argument, but we have made our own investigation. There is no Pennsylvania decision either directly in point or anywhere near it, but we will refer hereafter to such Pennsylvania authority as we find helpful in considering the general question.

On the basis of the plaintiff's statement, these facts may be assumed for the purpose of our consideration. The corporate defendant is a Delaware corporation whose principal office is in Ridley Township, Delaware County, Pennsylvania. It operates plants in Pennsylvania and Illinois for the manufacture of steel castings for locomotives and railway cars. The plaintiff is a resident of New York. The corporation has outstanding 456,576 no-par common shares, 92 per cent of which are held by four large users of the products manufactured by it.*fn2 Also authorized and outstanding are 100,000 shares of $6 cumulative preferred no-par stock. This issue is widely held and the plaintiff owns 120 shares. The certificate of incorporation provides that holders of the preferred stock are entitled to receive an annual dividend of $6 per share "Out of the net profits of the Corporation or out of its net assets in excess of capital, * * * when and as declared by the Board of Directors * * *." Back dividends on the preferred shares carry no voting rights unless, as is the case here, the corporation defaults on four quarterly dividend payments, in which event the preferred shareholders are entitled to elect one-third of the board of directors.

Dividend arrearages on the preferred shares amounted to $5,850.000 when the complaint was filed, or $57.75 per share. The corporation's net worth on December 31, 1947, was $28,000,105. It had a capital surplus of $4,133,449 and an earned surplus of $13,410,080. There were "net current assets" of $12,114,409, and a ratio of current assets to current liabilities of approximately 7 to 1. From 1940 through 1947 the corporation earned net profits totaling $18,278,617, and had accumulated out of earnings a reserve of $17,411,310 against plant facilities which had an original cost of $33,000,000.

The plaintiff further alleges that in refusing to declare preferred dividends the directors are "unreasonable and arbitrary" and acting primarily in the interest of the four major common shareholders they represent. He says that "in violation of their duties as fiduciaries to the holders of said preferred stock" the directors are expanding the corporation's production facilities in order to assure the four major common shareholders of an adequate supply of its products. The relief demanded is payment to the preferred shareholders of the arrearages.

The plaintiff has not served the majority of the board of directors of this corporation in the Eastern District of Pennsylvania. When he started his lawsuit he named no directors at all. The District Court on December 13, 1948, held that a majority of the directors were necessary parties and ordered them joined as defendants. But only three out of the twelve were served in Pennsylvania and the plaintiff says that there is no one state or federal district in which a majority of the board may be served.

We are faced squarely with the question, then, whether the action can proceed in the absence of personal jurisdiction over at least sufficient directors to make up the majority of the board. The defendants understandably support the result reached by the District Court in holding that the action could not go on without personal jurisdiction over the directors. If that holding results in the complaining shareholder being unable to bring his suit either in any federal court or, for that matter, in any state court the result may disappoint the plaintiff, but the defendants will bear up under it pretty well.

The defendants' argument is simple and easy to understand. Dividends are payable, they say, only when the directors vote them. To make the directors vote them there must be before the court the human beings, that is the directors, who are to be made subject to the decree. Like any other situation where the chancellor is asked to act against an individual because of alleged violation of a legal duty, there must be personal jurisdiction over the individual before he can be affected by the order.

It is hornbook law that there must be personal jurisdiction over an individual who is to be bound by a judgment at law or a decree in equity. The proposition is too elementary, too well settled to require us to display learning in citing authorities for its support.

But we do not think the case is as easily settled as the mechanical application of this well-settled rule about jurisdiction in personam would settle it. We think there are further considerations and these we proceed to state.

No one disputes the general proposition that the payment of dividends is, in general, a matter for the exercise of honest business judgment by the directors of a corporate enterprise. Courts are rightly reluctant to interfere with the management of a business concern by the individuals who have been selected by its owners to manage it.*fn3 But when it appears that the persons who are charged with managing according to their business judgment are not exercising that judgment, but are profiting some participants in the enterprise at the expense of others, then courts do interfere to protect the participants to whom this wrong is being done.*fn4 The plaintiff in this case makes charges in his complaint which, if true, would bring him under this rule.Let us say again, purely for emphasis, that we do not say the charges are true; we only take the plaintiff's allegations at this stage of the proceedings as though they were true.

It is to be observed that when a court steps in and orders the payment of a dividend, the corporate affairs have reached the point where the judgment of the directors is no longer controlling. The set of facts presented is such that the court substitutes its judgment, based on a rule of law, for the ordinary business judgment of those in charge of the business enterprise. The court says, in effect, to the directors, "You have abused your office. You have withheld earnings of this ...


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