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Higgins v. Shenango Pottery Co.

decided: May 10, 1960.

ALICE S. HIGGINS, PLAINTIFF, ON BEHALF OF HERSELF AND OTHER STOCKHOLDERS OF SHENANGO POTTERY COMPANY, SIMILARLY SITUATED, AND HILDA BARKBY, ADMINISTRATRIX OF THE ESTATE OF HARRY BARKBY, DECEASED, INTERVENOR,
v.
SHENANGO POTTERY COMPANY, NOW SHENANGO CHINA, INC., A CORPORATION; JAMES M. SMITH, JR., GEORGE B. ZAHNISER, CHARLES W. READ, DANIEL H. TRELOAR, JR., ZENO J. PFAU, JOHN B. MCCARTY AND ALVAH M. SHUMAKER, INDIVIDUALLY AND JAMES M. SMITH, JR., GEORGE B. ZAHNISER, CHARLES W. READ, DANIEL H. TRELOAR, JR., ZENO J. PFAU, JOHN B. MCCARTY AND ALVAH M. SHUMAKER, TRADING AS CASTLE ENGINEERING COMPANY, A PARTNERSHIP, LYNNE ANDERSON WARREN AND PEOPLES FIRST NATIONAL BANK AND TRUST CO., EXECUTORS OF ESTATE OF JAMES M. SMITH, JR., DECEASED, DEFENDANTS. ALICE S. HIGGINS, ETC. AND HILDA BARKBY, ETC., APPELLANTS IN NO. 13,026 AND NO. 13,027 SHENANGO POTTERY COMPANY, NOW SHENANGO CHINA, INC., A CORPORATION, APPELLANT IN NO. 13,060. LYNNE ANDERSON WARREN AND PEOPLES FIRST NATIONAL BANK AND TRUST CO., EXECUTORS OF ESTATE OF JAMES M. SMITH, JR., DECEASED, APPELLANTS IN NO. 13,061 GEORGE B. ZAHNISER, APPELLANT IN



Author: Mclaughlin

Before McLAUGHLIN, KALODNER and HASTIE, Circuit Judges.

McLAUGHLIN, Circuit Judge.

The facts in this case are set forth at length in Higgins, et al. v. Shenango, Pottery Co., et al., 3 Cir., 1958, 256 F.2d 504, but for clarity a resume is appropriate.

This is a derivative action brought by a stockholder of Shenango Pottery Co., a Pennsylvania corporation, (Shenango) engaged in the manufacture of chinaware. Several of the defendants were officers and directors of Shenango: James M. Smith, Jr., now deceased, son of the founder and Chairman of the Board, James M. Smith, Sr., was a director and president; George B. Zahniser, a nephew of Smith, Sr., was a director and vice-president; Charles W. Read, since dismissed as a defendant by stipulation, was a director and vice-president. The remaining individual defendants were in no way connected with Shenango: Daniel H. Treloar, Jr. was in the life insurance business; Zeno J. Pfau was an automobile dealer; Alvah M. Shumaker was an attorney; and John B. McCarty was a bar manager. The principal plaintiff, Alice S. Higgins, daughter of Smith, Sr. and sister of Smith, Jr., is a minority stockholder of Shenango.

On January 31, 1944 the Pittsburgh Ordnance District of the War Department offered Shenango the opportunity to participate in a non-magnetic land mine program. The principal parts of the mine, the bell and base, were to be ceramic, larger and heavier than ordinary dinnerware and involved an operation foreign to the manufacture of dinnerware, that of threading the parts to fit with other pieces. On February 5, 1944 Smith, Jr., Zahniser and James K. Love, the latter another director of Shenango but not a party here, traveled to the Onondago Pottery Company in Syracuse, New York to investigate the land mine program already in operation at that firm. Based on this investigation they recommended to the remaining three directors, Smith, Sr., Jonathan Higgins, husband of the principal plaintiff and Charles W. Read, that Shenango refrain from entering the land mine program.*fn1 The considerations prompting this recommendation ostensibly were a complicated assembly operation, rigid government tests and a requirement of additional space and labor. As a result the Board decided it was not feasible for Shenango to bid for a mine contract.

Several days subsequent to the decision, Smith, Jr., Treloar and Pfau investigated the possibility of undertaking the manufacture of mines and, as a result, begain formation of a corporation, Castle Engineering Company (Castle). Castle submitted a bid which was not acceptable to Pittsburgh Ordnance because Castle was not as yet a corporate entity. It was then decided, allegedly at the instigation of Pittsburgh Ordnance, that Shenango's name be inserted in place of Castle and upon award of the contract to Shenango, to have it sublet to Castle. Smith, Jr. immediately telephoned Shenango from Pittsburgh and had the proposal put before the other five members of the Board who were present at Shenango. The Board approved. On this point, the district court found, as a conclusion of law, that the business judgment of the five board members was influenced by the knowledge that Smith, Jr. and two other directors and officers of Shenango, Zahniser and Read who had previously joined with Smith, Jr., Treloar and Pfau, were interested in Castle. The contract was awarded to Shenango which in turn sublet it to Castle, with the exception of the part calling for the manufacture of the ceramic base and bell. These parts Shenango was to supply at two dollars for every pair accepted and paid for by the government. At this stage it would be well to outline the full import of that arrangement.

The government inspection of the land mines consisted of a waterproof test and a drop test. Five mines were submerged in water for twenty-four hours, at the end of which time they were disassembled. If any trace of water was found, ten more were put through the same test and if water was found in any one of the ten the entire lot was rejected. After that five mines were dropped from a prescribed height on to concrete. If there was a failure of any of the parts of more than one mine, ten others were tested. If three or more of the fifteen showed failure the entire lot was rejected. Castle contracted to have the inspection on the basis of a lot consisting of ten thousand mines. Thus if either test was failed the entire ten thousand mines would have been rejected and Shenango would not receive payment for any of the ten thousand pairs of bases and bells, which were the most expensive part of the mine. It should be further noted that although the contract was sublet, Shenango remained liable thereon.

Castle was reorganized into a limited partnership; Smith, Jr., and Treloar becoming the general partners and Zahniser, Pfau and Read, later joined by Shumaker and McCarty, being the limited partners. It had a stated paid-in capital of $50,000 of which only $32,200 was actually paid in by the end of the fiscal year, July 31, 1944. The question of the validity of the limited partnership was raised. However, it is irrelevant since in our previous opinion we stated that the liability of the limited partners for return of improperly received profits is not limited by the amount of their partnership contribution. 256 F.2d at page 510.

Castle drew heavily on the financial resources of Shenango, and in many of its negotiations used the name, reputation and credit rating of Shenango. The trial court found that even the bid submitted by Castle contained information descriptive of Shenango but the court felt the constant use of Shenango's name was merely carelessness; a conclusion not borne out by the record.

Castle subsequently was awarded two other contracts, one of which was terminated with a monetary allowance before any land mines were supplied under it, both of which contracts the court held were corporate opportunities diverted from Shenango. The total net profit to Castle was $326,603.71 in a little over nine months.*fn2 Eventually this was reduced, as excessive profit, to $181,603.71 on renegotiation by the War Contracts Price Adjustment Board. Shenango made a profit of $248,587.58 on the manufacture of the base and bell. This was not renegotiated. Defendants argue that Shenango's profit is proof that they had the common good in mind and that there was no improper diversion of corporate opportunities; that the land mine project was in reality a joint venture between Shenango and Castle. This argument can be dismissed forthwith. Leaving behind a portion of the spoils is hardly justification. It leaves unanswered much the same question as arose in Tenth National Bank of Philadelphia v. Smith Construction Co., 1913, 242 Pa. 269, 287, 89 A. 76, 82. There officers of the Smith Company formed a partnership, the Maryland Company, to furnish services and supplies to the Smith Company at a profit. The court stated:

"* * * the 10 per cent. paid to the Maryland concern might have been saved to the Smith Company, - in substance it was nothing more or less than a commission for services that could have been performed directly by the officers of that company. Again, if the Maryland Company could furnish coal and horses to the Smith Company at a profit, it has not been made plain why the men who constituted that concern did not perform this service directly as officers of the latter corporation, and thus save to it the amount of such profits. Cases may be cited where the officers of a corporation have been permitted to make and retain profits for themselves through the formation of outside agencies controlled by them, which profits they could have saved to their constitutent company had their thought been only for its welfare; but in such instances the law has ceased to look at the mere form of the device employed - it now pierces through the surface and seizes upon the evils which lie within."

On January 5, 1950, after several futile demands that the Board of Directors act to recover profits diverted from Shenango to Castle, plaintiff instituted this stockholder's derivative action. At the close of plaintiff's evidence the district court dismissed the suit against defendants Pfau, McCarty and Shumaker under Rule 41(b), Fed.R.Civ.P. 28 U.S.C. The plaintiff appealed and this court, in an amended opinion filed June 24, 1958, reversed and remanded the cause. 256 F.2d 504. However, prior to our decision, the district judge on May 23, 1956 pursuant to a lengthy adjudication which included 111 findings of fact and 17 conclusions of law found defendant Treloar not liable on the merits and gave judgment against the Estate of Smith, Jr. and Zahniser, jointly and severally, in the sum of $316,603.71 with interest at 6% which totaled $538,396.99. Then on October 3, 1956, the district judge granted a new trial on the issue of damages only. The matter came on for trial in March of 1959. Because of this court's remand, evidence was taken on the issue of liability of the defendants, Pfau, McCarty and Shumaker. And since final judgment had not been entered in favor of Treloar, the question of his liability was reopened.

On July 29, 1959 the district court entered an amended order for judgment again exonerating Treloar, Pfau, McCarty and Shumaker, and holding Zahniser and the Smith, Jr. Estate liable. As to damages the court determined these to be Castle's profit after renegotiation with the War Contracts Price Adjustment Board, namely, $181,603.71. It fixed the rate of interest at 3%, rather than 6%, from the date the profits were realized. Including interest, the damages amounted to $262,456.58.

Plaintiff appeals from that part of the judgment dismissing the defendants Castle, Phau, Treloar, McCarty and Shumaker and reducing the amount of damages. Defendant Shenango appeals from the judgment dismissing the above named defendants. Defendants Zahniser and the Estate of Smith, Jr. appeal from the judgment entered against them. As set out in the opinion of the district judge, this litigation is in such posture that should we disagree with the judgment below or any part thereof, we may direct whatever judgment as is required by the evidence and the law.

The questions in the various appeals can be divided under three major headings: The liability of Zahniser and the Estate of Smith, Jr.; the liability of the other defendants; and the amount of damages.

Liability of Zahniser and Smith, Jr.

The trial judge considered the inspection and recommendations made by Smith, Jr., Zahniser and Love, and the resulting action of the entire Board determining it would not be feasible for Shenango to enter the mine program as having been made in good faith and as a business judgment. However, the subsequent events; Smith, Jr. forming a company to pick up the opportunity rejected by Shenango on his recommendation and vote; Zahniser joining him and later Read; the Directors of Shenango, upon Castle's bid being rejected, reversing their previous decision and with knowledge that Smith, Jr., one of their number and son of the Chairman of the Board, was prime mover of Castle, authorizing Smith, Jr. to bid in the name of Shenango for the benefit of Castle; these events, the court found, demonstrated that Smith, Jr. and Zahniser, knowing that either Shenango or Castle had a prospect of making a profit were then in a ...


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