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SCHUPACK v. COVELLI

September 30, 1980

Rae SCHUPACK, Individually and Rae Schupack on behalf of herself and all other stockholders of 2170 East Lake Road, Inc.,
v.
Albert COVELLI, Robert Orchard, 2170 East Lake Road, Inc., and McDonald's Corporation



The opinion of the court was delivered by: WEBER

OPINION AND ORDER

 In May of 1980 the Plaintiff filed in this Court a six count complaint against 2170 East Lake Road, Inc., McDonald's, Orchard and Covelli alleging that this stock redemption violated state and federal securities laws and Pennsylvania's common law of corporations. Although the Plaintiff's complaint proceeds under a number of distinct theories, basically what it alleges is that the stock redemption was improper because, at the time of redemption, the Plaintiff was not informed that McDonald's had franchised Orchard and Covelli individually to operate a McDonald's restaurant within the exclusive licensed territory of 2170 East Lake Road, Inc.

 Presently there is before this Court a motion by defendant McDonald's to strike and dismiss Count VI of this complaint. In this count the Plaintiff sues derivatively on behalf of 2170 East Lake Road, Inc. against McDonald's Corporation, charging that McDonald's violated its franchise agreement with 2170 by granting a separate franchise to Orchard and Covelli. In its motion to strike McDonald's argues that the Plaintiff lacks standing to bring a shareholders' derivative action because she is not presently a shareholder in 2170 East Lake Road, Inc. We disagree. Accordingly we deny McDonald's motion to strike Count VI of this complaint.

 The requirement that one have a present possessory interest in the stock of a corporation in order to sue derivatively on its behalf is a basic fundamental of corporation law. See e.g., 19 Am.Jur.2d, Corporations, § 559; 18 C.J.S. Corporations, § 566; Sum.Pa.Jur., Corporations, § 237 and cases cited therein. The rationale behind this standing requirement is quite simply the belief that only a party with an on-going proprietory interest in the corporation will adequately represent the corporation's interests in a derivative action. See e.g., Cohen v. Beneficial Industrial Loan Corp., 337 U.S. 541, 547-550, 69 S. Ct. 1221, 1226-1227, 93 L. Ed. 1528 (1949); Kauffman v. Dreyfus Fund, Inc., 434 F.2d 727, 735-736 (3d Cir. 1970), cert. denied, 401 U.S. 974, 91 S. Ct. 1190, 28 L. Ed. 2d 323 (1971). Moreover, this standing requirement is also implicit in the Federal Rules of Civil Procedure, which state that derivative actions may be "brought by one or more shareholders ...." Fed.Rules Civ.Proc., Rule 23.1.

 It is important to note, however, that one need not have legal title to stock in order to satisfy this standing requirement. Quite the contrary, it is clear that an equitable shareholder possesses a sufficient proprietory interest in the corporation to sue on its behalf. See e.g., In re The Pittsburgh and Lake Erie Railroad Company Securities and Antitrust Litigation, Appeal of Objactor Irving Trust Co., 543 F.2d 1058, 1067 (3d Cir. 1976), (Pledgee of stock has standing to sue derivatively); Scott v. Multi-Amp Corp., 386 F. Supp. 44 (D.C.N.J.1974).

 In this case the Plaintiff asserts that it is such an equitable shareholder of stock of 2170 East Lake Road, Inc. for two reasons.

 First the Plaintiff argues that the Defendants fraudulently failed to disclose McDonald's separate dealings with Orchard and Covelli at the time of the original stock redemption. Since this stock redemption agreement was fraudulently entered into, the Plaintiff contends that she is entitled to rescission of that agreement and the return of the stock. Therefore, under the Plaintiff's theory, this right to rescission gives her equitable ownership of the stock.

 
"Where the wrongful conduct which caused a stockholder to transfer or lose title to his stock is part of a course of conduct which also injured the corporation, so that evidence proving the wrong to the corporation will, either alone or with little additional evidence, establish the shareholder's right to recover his stock, he may maintain one suit to recover both the derivative and individual rights."

 In our view, this is a well reasoned approach to the question of shareholder standing to sue. As noted earlier, the basic policy underlying this standing requirement in derivative suits is the belief that the interests of the individual plaintiff should be consistent with those of the corporation he purports to represent. In a case such as this one, where standing is premised on a right to rescission, the fact that the corporate injury and shareholder's right to rescission arise out of the same transaction would insure the necessary commonality of interest between the individual plaintiff and the corporation. Therefore the policies behind limited standing in derivative suits would be satisfied by allowing such claims.

 In our case the wrong allegedly done to the corporation by McDonald's was the licensing of Orchard and Covelli to operate a McDonald's restaurant within the exclusive territory of 2170 East Lake Road, Inc. Similarly, it is argued that the stock redemption was fraudulent because the Plaintiff was not informed of the franchise granted by McDonald's to Orchard and Covelli. Clearly then in this case the elements necessary to prove the Plaintiff's right to rescission and the wrong done to the corporation are strikingly similar. Accordingly we hold that the Plaintiff's equitable interest in this stock is sufficient to give her standing to bring a derivative action on behalf of the corporation.

 The Plaintiff also argues that it is an equitable shareholder by virtue of the interest it retained in this stock under the escrow agreement entered into in May of 1977. As noted above, at the time of the stock redemption it was agreed that the shares would be held by the Second National Bank of Warren as an escrow agent, pending completion of payment by the corporation.

 According to the Plaintiff final payment has not, as of yet, been made by the corporation and the shares are still in the possession of the escrow agent. Therefore, the Plaintiff argues that it retains an equitable interest in those shares in the form of a right to possession in the event the corporation defaults in its payments. We agree but would go one step further. Generally "(under) the usual escrow agreement, the depositor loses control of the instrument or money placed in escrow, although he still retains legal title thereto until performance of the condition or the happening of the specific event upon which delivery is to be made to the depository." Paul v. Kennedy, 376 Pa. 312, 314, 102 A.2d 158, 159 (1954). See also, 28 Am.Jur.2d, Escrow, § 10. In this case the condition, payment by 2170 East Lake Road, Inc., was not performed. Therefore, the ...


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