The opinion of the court was delivered by: GANEY
The issues now before us arise out of two separate civil actions which, although based upon different grounds, have as their common purpose the single objective of obtaining an injunction preventing the consummation of a 'Purchase Agreement' entered into between The Midvale Company and the Midvale-Heppenstall Company on December 2, 1955.
Under the agreement Midvale agreed to sell, subject to the approval of a majority vote of the Midvale stockholders, all of its physical and operating assets to Midvale-Heppenstall for approximately $ 6,100,000 in cash. Settlement is to be made on or before December 30, 1955, the last business day of the year, so that Midvale may take advantage of an operating loss carry-back for federal income tax purposes for the years 1953 and 1954. If the agreement it consummated on or before that date, Midvale claims that it will sustain an operating loss of approximately $ 6,800,000, which, when allowed by the Commissioner of Internal Revenue, will eliminate any liability of the corporation for federal income taxes for the year (estimated at $ 325,000) and give rise to a carry-back claim for refund of federal income taxes for the years 1953 and 1954, amounting to almost $ 1,800,000. This will leave an operating loss carry-over of approximately $ 2,700,000, available to offset taxable income of Midvale realized in the years 1956 to 1960, inclusive, unless sooner exhausted. The carry-back will not produce as large a saving if it is taken from a year following 1955. For in the year 1953, the profit of Midvale before taxes based on income was $ 3,127,781 as compared with $ 824,901 for 1954 and $ 608,400
in 1955. It is for this reason that Midvale is desirous of consummating the sale in this calendar year.
One of the actions, Samuel Gomberg et al. v. The Midvale Company et al., was brought by four of the dissenting minority stockholders of The Midvale Company on behalf of themselves and on behalf of all other stockholders similarly situated against The Midvale Company ('Midvale'), a Delaware corporation; Baldwin Securities Corporation ('Baldwin'), a Pennsylvania corporation; and the twelve directors of Midvale. The court's jurisdiction over the subject matter of this action depends on diversity of citizenship of the parties. The basis of the action is that 'the proposed purchase price is so grossly inadequate as to shock the conscience of the Court and constitute a constructive fraud on the minority shareholders.'
There are presently authorized and outstanding 600,000 shares of capital stock of Midvale. The four plaintiffs collectively own but 10,000 shares or 1.66 percent of them. Baldwin owns 371,750 shares or 61.9 percent of the total; by virtue of this ownership, it is able to control, through the election of directors, the operation of Midvale. Baldwin is an investment corporation managed by a board of eleven directors, nine of whom are also directors of Midvale. Although their stockholdings in Baldwin are considerably less than an actual majority, the directors own sufficient stock in that corporation to give them practical working control over it. Under date of December 7, 1955, Midvale notified its stockholders that a special meeting would be held on December 21, 1955, for the purpose of considering and taking action upon the approval or disapproval of the proposed sale. At the meeting of the shareholders, 431,896 votes were cast in approval of the sale. Of these, 371,750 were voted by Baldwin and 1,400 of those were of the directors, leaving 58,746 cast by the assenting minority. The dissenting votes numbered 58,373.
Midvale owns a fully equipped steel plant occupying approximately seventy-three acres of land at Wissahickon and Roberts Avenues, Philadelphia, Pennsylvania. Over twenty-two percent of the building area is occupied by installations of the several Armed Forces of the United States Government containing facilities which must be so maintained until 1966 in connection with other nongovernment facilities so as to permit them to be placed in complete operation for full production within 120 days. Among its facilities are four open hearth furnaces, machine shops, tempering plants, hammering shop, tire mill, power house, research laboratories and storehouses. It has railroad sidings connecting with two of the large railroad companies. It is one of the principal producers of armor plate, and heavy steel forgings of all kinds weighing from 10,000 to 400,000 pounds. Most of its products are manufactured in accordance with the specifications of individual customers, and require a very high degree of technical skill to meet those specifications. A substantial portion of its productions is designed principally for use in heavy ordnance material for the Armed Forces, such as armor-plate, gun tubes and shells.
During the period from January 1, 1947 to November 11, 1955, Midvale has spent $ 6,987,000 on capital improvements. Of that amount, $ 3,561,000 was spent subsequent to January 1, 1951. These improvements were necessary to keep the plant going and did not add substantially to its value. In addition, it has during such period spent substantial amounts for repairs and maintenance.
Midvale has been in existence since 1923. With the exception of four years it has shown an annual profit. The loss years were 1932, 1947, 1948, and 1949. Although its annual sales since 1950 have been between twenty-two and thirty million dollars, its net profit has not been high. In 1953, it was $ 1,357,781, in 1954 it amounted to $ 724,901 and for the first ten months of 1955 the total was $ 236,869. Its dividend rates for those same years were $ 1.35, $ 1.00 and $ .75.
According to the balance sheet which constituted a part of the proxy statement sent to all the stockholders, Midvale had, as of October 31, 1955, current assets of $ 13,464,773 and current liabilities of $ 3,054,131. The inventory of raw material, supplies, work in process and semi-finished products had a book value of $ 4,273,335; the land was valued at $ 456,834, and the plant and equipment had a net book value after reserve for depreciation, of $ 7,718,273. Over three-fourths of the inventory consisted of work in process, most of which was allocable to existing firm contracts, and that in pricing work in process no profit element was included. For local tax purposes, the land and plant are assessed at a valuation of $ 2,561,000.
Apart from the assets to be included in the proposed sale, Midvale has approximately $ 6,500,000 of net liquid assets consisting of cash, accounts receivable and short term Government securities. When this amount is added to the proposed purchase price and the claimed tax refund which will result from the sale, Midvale will have, after the sale is consummated, in excess of $ 14,000,000 in cash as its sole asset. It is not contemplated by the board of directors that this fund will be distributed among the stockholders. On the contrary, Midvale's name will be changed to General Industrial Enterprises, Inc., and its corporate existence will be continued with a different business purpose. As stated in the proxy statement: 'It is the present intention to employ substantial but varying proportions of its assets * * * for investment and reinvestment in situations which, in the judgment of its Board of Directors, present promising opportunities for ultimate financial profit to the shareholders of Midvale, and, to the extent deemed desirable by its Board of Directors, to participate in the management and control of any or all enterprises in which it has a financial interest.'
Midvale cannot assign unfinished work under defense contracts or the obligation to maintain certain facilities in proper working order without the consent of the particular Governmental agency involved. In this action, the approval of Midvale-Heppenstall as an assignee of Midvale has been obtained. The obtaining of this approval is one of the major factors which must be considered in seeking a purchaser. Even though one may offer a substantially higher price for Midvale's assets, if he is not approved by the appropriate agency, his offer cannot be accepted by Midvale.
While its facilities have a capacity to do an annual volume of business amounting to 48 million dollars, all Government work at Midvale of any consequence will cease on March 31, 1956, and there is no present likelihood that it will resume. Yet Midvale or its successor must maintain the Government facilities until 1966. In the opinion of the president of Midvale the change in the character of armor-plate used by the Armed Forces means that there will be less need for Midvale's heavy facilities in the future. In addition, the change from steam locomotives to Diesel engines by the railroads has largely taken away the locomotive steel tire business from Midvale. It has made efforts to counteract these adverse conditions but without success. Tentative propositions were discussed with a number of responsible persons over a period of two years. But because of the special nature of the Midvale business and the necessity both of maintaining the Government and Midvale facilities, and of having the Government approve any purchaser, the task of finding one was most difficult. Finally The Heppenstall Company made an offer which was fairly acceptable to Midvale. Negotiations began on August 31, 1955 and culminated in the Purchase Agreement of December 2, 1955. The directors of Midvale were of the opinion that the price offered was fair and that no better one could be obtained from an acceptable source. Neither Baldwin nor the directors
of Midvale have any interest in The Heppenstall Company, Midvale-Heppenstall or the corporations which have agreed to purchase preferred shares in Midvale-Heppenstall.
We now come to the question of the reasonableness of the purchase price. Although section 11.06 of the Purchase Agreement provides that the parties thereto agree with the agreement shall be construed and enforced in accordance with the laws of Pennsylvania, plaintiff should not be bound by that choice. In the actions before us a statute of Delaware, the state in which Midvale was incorporated, grants the right to the board of directors, upon the approval of a majority of stockholders, to sell the entire assets of the corporations. 8 Del.C. § 271. We think the Courts of Pennsylvania would refer to Delaware law to determine whether or not the purchase price is adequate. See Restatement, Conflict of Laws, § 197; § 199, Comment a. We must refer to that law also. Kroese v. General Steel Castings Corp., 3 Cir., 1949, 179 F.2d 760, 15 A.L.R.2d 1117. In the absence of statutory provisions to that effect, equity imposes a standard which the terms, conditions and expedience of a sale must meet. Majority stockholders and directors cannot appropriate to themselves the assets of a corporation, and this may not be done indirectly by their personally sharing in the profits of the sale of the corporate assets. Moreover they owe a duty to the minority stockholders to see that the assets are sold for a fair and adequate price. Allied Chemical & Dye Corp. v. Steel & Tube Co., 1923, 14 Del.Ch. 1, 120 A. 486; Allaun v. Consolidated Oil Co., 1929, 16 Del.Ch. 318, 147 A. 257; Baron v. Pressed Metals of America, Del.Ch.1955, 117 A.2d 357.
In the actions before us there has been no showing that the majority or the directors are gaining a personal advantage from the sale. The burden is, therefore, on the plaintiffs to show that the disparity between the value of the property to be sold and the money to be received is so unreasonable as to indicate that the sellers are recklessly indifferent to the interest of the whole body of stockholders. Baron v. Pressed Metals of America, supra, 117 A.2d 357, 361. Our initial inquiry is what is the value of the assets to be sold. The assets are the physical and operating assets of Midvale. They are not to be sold item by item, but as a going concern. In such a situation the book value, cost, replacement cost, insurance valuations, assessed valuation and appraisals of specific items are entitled to little consideration. The guiding standard is the value of the assets in connection with a sale, or the market value. Allaun v. Consolidated Oil Co., supra, 147 A. 257; Baron v. Pressed Metals of America, supra, 117 A.2d 357, 361-362.
Pursuant to section 2.20(1)(ii) of the Purchase Agreement Midvale-Heppenstall is guaranteed at least $ 4,000,000 worth of inventory priced at cost or market whichever is lower. Since Midvale is currently operating at a profit, it may fairly be assumed that the work in process was allocable to profitable contracts. Plaintiffs claim that Midvale-Heppenstall will in fact realize in excess of $ 4,000,000 on the inventory. They therefore subtract that amount from the purchase price of $ 6,100,000, and allocate the balance of $ 2,100,000 to Midvale's land, plant and equipment. The book value for these items is $ 8,276,432; the land being valued at $ 456,834, while the plant and equipment is $ 7,819,598. Subtracting $ 2,100,000 from $ ...