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ZWEIFACH v. SCRANTON LACE CO.

October 18, 1957

Sol M. ZWEIFACH, Plaintiff,
v.
SCRANTON LACE COMPANY, First National Bank and Trust Company of Scranton, Harold J. Megargel, and J. D. Johnson, Defendants



The opinion of the court was delivered by: MURPHY

This is a diversity action, 28 U.S.C.A. § 1332(a)(1), wherein plaintiff, a citizen of New York, a shareholder and director *fn1" of The Scranton Lace Company, a Pennsylvania corporation having its principal office and place of business in this district, seeks to invalidate a contract between the corporation *fn2" and the Smith-Palmer Machine Corporation, of Illinois, whereby Scranton Lace assigned, transferred and delivered all of its remaining authorized *fn3" but previously unissued no par value common stock (82,197 shares) and 544 shares held as Treasury Stock to Smith-Palmer in exchange for all of the issued and outstanding Capital Stock of Southwest International Corporation, a Delaware corporation (142,093 shares 10 cents par value common stock of which Smith-Palmer was the sole owner *fn4" ).

Pursuant to a resolution duly approved and adopted at an annual meeting January 30, 1957, by nine of its ten derectors *fn5" the corporation, through its executive officers, shortly after the directors meeting, executed the contract, issued the stock certificate, transferred it on the books of the company, and next morning had it registered.

 Consolidated balance sheets were exchanged; *fn6" that of Southwest pro forma. Each represented they fairly reflected their financial position as of the date of closing. Each represented and warranted the respective shares and their authority to make the transfer. Each stipulated and agreed that the contract constituted a consummated transaction. However, to afford an opportunity to see that all representations and warranties were in accord with the facts, it was agreed that pending such examination the respective securities should be held by the General Counsel of Scranton Lace. If any question arose it should be submitted to arbitration and if the facts were not as represented and warranted recision would be the exclusive remedy. Meanwhile, each party was to have all the rights and incidents of ownership, including the right to vote thereon. See Act of 1933, supra, 15 P.S. § 2852-508.

 Pennsylvania law controls as to the rights and obligations of the parties. Miller v. Tulsa Petroleum Co., D.C.M.D.Pa.1953, 117 F.Supp. 359, at page 360; Solomon v. Neisner Bros., Inc., D.C.M.D.Pa.1950, 93 F.Supp. 310, at pages 312, 313, affirmed 3 Cir., 187 F.2d 735; Robert H. Fox Co. v. Keystone Driller Co., 3 Cir., 1956, 232 F.2d 831, at page 834; Smith v. Onyx Oil & Chemical Co., 3 Cir., 1955, 218 F.2d 104, at page 110; Krauss v. Greenbarg, 3 Cir., 1943, 137 F.2d 569, at page 570; York Metal & Alloys Co. v. Cyclops Steel Co., 1924, 280 Pa. 585, at page 588, 124 A. 752, at page 753.

 The problem involved, including plaintiff's objections to the transaction will be more clearly understood if the matter is placed in its proper setting.

 Organized for the purpose of 'Manufacturing lace curtains and other textile fabrics' *fn7" the company prospered for many years. Because of a general decline in the lace business the number of plants in the United States was reduced to four. Although maintaining its relative position in the industry, Scranton Lace operations for several years were unprofitable, unexpectedly so in December 1956. To stem the tide, management tried unsuccessfully to diversity, to develop new and additional products, to provide maximum use of facilities, increase employment, and earn profits for the stockholders.

 At his first directors' meeting plaintiff's request that North American Lace Company, one of the corporation's chief competitors, be permitted to inspect the plant, in the hope that they might lease all or part of it or consolidate their activities in Scranton, was refused, fearing it might be a harmful ruse to learn important trade secrets. In September, management after investigation advised the shareholders against submitting their shares in response to a request by Mica Corporation of Canada, Ltd., for tender of 25,000 shares at $ 27 per share. Only a few shares were tendered; none were purchased.

 Meanwhile, the market price for shares increased considerably because of plaintiff and his associates' activities and efforts to increase their proportionate ownership or control.

 Plaintiff's demand, December 11, that the secretary call a special meeting of shareholders to oust the Board of Directors was on December 16 refused, citing the Act of 1933 and the By-Laws. (As to Special Meetings, see 15 P.S. § 2852-501(c); By-Laws; Acts 1933, 1949, 1951, 15 P.S. § 2852-402(1), 405; Defendant corporation's By-Laws Art. II, §§ 2, 4, 6; Art. IV, § 1, and cf. Id. § 2.) See Ballard, Participation is Corporate Management Under the Pennsylvania Business Corporation Law, 25 Temple L. Quarterly 131 at 135.

 About that time management contacted David Milton and his associates of The Equity Corporation. An Executive Committee of three directors named by the Board of Directors (15 P.S. § 2852-402(6), explored possibilities.

 To ascertain what if any plans plaintiff and his associates had for the company and its future, Mr. Megargel arranged a meeting for January 4 in New York and named a Special Committee of two directors (15 P.S. § 2852-406; By-Laws Art, V, § 6) to aid the Executive Committee and to attend the New York meeting. All parties present were opposed to liquidation. Plaintiff complained that one of his associates was not named to fill a recent vacancy on the Board. No one present had any particular solution to offer for the pending problem.

 Upon returning to Scranton meetings were arranged and held between the Executive and Special committees and the Milton group, the last one about a week before the annual meeting. *fn8" Meanwhile the Executive Committee met almost daily examining a proposal submitted by the Milton group, investigating the assets, studying balance sheets and statements of profit and loss, published statements, Dun and Bradstreet reports, *fn9" consultations with brokers, checking security values and quotations, inquiring as to the status and reputation of David Milton and his associates and The Equity Corporation and interrelated companies.

 About January 24, the Executive Committee after careful, serious, extensive and intensive investigation, and the Special Committee decided that the proposal should be favorably reported to the Board of Directors at the annual meeting of January 30. Meanwhile all of the directors except plaintiff were advised generally as to the proposal. See and cf. Markovitz v. Markovitz, 1939, 336 Pa. 145, at page 150, 8 A.2d 46, at page 48, 124 A.L.R. 359; Hunsicker & MacIntosh v. Reading Laundries, Inc., 1936, 26 Pa. Dist. & Co. R. 215, at page 220; Ringler v. Atlas Portland Cement Co., 1930, 301 Pa. 176, at page 178, 151 A. 815; Halpern v. Grabosky, 1929, 296 Pa. 108, at page 112, 145 A. 834, at page 835.

 The Milton group was advised of the favorable reaction. Over a period of two or three days a proposed contract and resolution were prepared by Smith-Palmer's New York counsel. About 9:30 A.M. January 30, New York counsel brought the unilaterally executed proposed contract and resolution to the office of defendant's General Counsel (a director and member of the Special Committee). After several hours discussion the proposed contract and resolution were approved as to form and legal sufficiency. Mr. Megargel was so advised.

 Immediately before the annual meeting on January 30, plaintiff suggested a later meeting with Mr. Megargel to agree on a mutually satisfactory Board of Directors and assured him that none ...


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