Kavanaugh v. Wetmore

CHASE, J. The rules adopted in this state relating to corporate ■management and the right of stockholders to sustain an action in their names, but in behalf of the corporation of which they are stockholders, have been frequently stated by the courts. In Flynn v. Brooklyn City R. R. Co., 158 N. Y. 493, 53 N. E. 520, the court say: • “As a general rule, courts have nothing to do with the internal management of business corporations. Whatever may lawfully be done by the directors or stockholders, acting through majorities 'prescribed by law, must of necessity be submitted to by the minority, for corporations can be conducted upon no •other basis. All questions within the scope of the corporate powers which relate to the policy of administration, to the expediency of proposed measures, • or to the consideration of contracts, provided it is not so grossly inadequate as to be evidence of fraud, are beyond the province of the courts. The minority directors or stockholders cannot come into court upon allegations of a want of judgment or lack of efficiency on the part of the majority and change the course of administration. Corporate elections furnish the only remedy for internal dissensions, as the majority must rule so long as it keeps within the •powers conferred by the charter. To these general rules, however, there are some exceptions, and the most important is that founded on fraud. While •courts cannot compel directors or. stockholders, proceeding by the vote of a .majority, to act wisely, they can compel them to. act honestly, or undo their work if they act otherwise. Where a majority of the directors or stockholders, ■or both, acting in bad faith, carry into effect a scheme which, even if lawful upon its face, is intended to circumvent the minority stockholders and defraud them out of their legal rights, the courts interfere and remedy the wrong. Action on the part of directors or stockholders pursuant to a fraudulent scheme ■designed to injure the other stockholders will sustain an action by the corporation, or, if it refuses to act, by a stockholder in its stead for the benefit ■of all the injured stockholders.” It was said in Robinson v. Smith, 3 Paige, 222, 24 Am. Dec. 212, and repeated in Brinckerhoff v. Bostwick, 88 N. Y. 52, that: “The directors of a corporation who willfully abuse their trust or misapply the funds of the company, by which a loss is sustained, are personally liable •as trustees to make good that' loss, and they are also liable if they suffer the corporate funds to be lost or wasted by gross negligence and inattention to the ■duties of their trust.” It is further said in Flynn v. Brooklyn City R. R. Co., supra: “The right of action, however, belongs to the corporation, and should be brought by it as plaintiff; but whén it will not bring.the suit itself, an aggrieved stockholder, after due demand and a refusal or unreasonable neglect to proceed, may bring it in his own -name' upon making the corporation a [545] party defendant. Greaves v. Gouge, 69 N. Y. 154. Such an action Is not for the benefit of the plaintiff alone, but is representative in character, and for the benefit of himself and all other stockholders similarly situated.” This court, in Hanna v. People’s National Bank, 76 App. Div. 224, 78 N. Y. Supp. 516, said: “In case of loss to a corporation through the culpable misconduct of its directors, a cause of action exists in favor of the corporation, and, in case of refusal of such corporation to bring the action, or in case the wrongdoers are in control of the corporate management, such action may be prosecuted by a stockholder. But the cause of action does not belong to the prosecuting stockholder. It still belongs to the corporation, and the judgment in such case is, in effect, a judgment in favor of the corporation. The cause of action is' a corporate asset. It is a substitute for the corporate loss through the director’s misconduct, and in law makes good such loss to the corporation. "When such cause of action is reduced to money, it must necessarily go back to the treasury of the corporation, to be disposed of like any other corporate asset.” See, also, Craig v. James, 71 App. Div. 238, 75 N. Y. Supp. 813. The claim against the individual defendants is a corporate asset, and the right of action is primarily in the corporation. The plaintiff’s right to maintain this action is derivative and wholly based on the failure of the corporation to do its duty in prosecuting an action to recover corporate assets. The breach of duty must be shown by an intentional determination by the corporation not to bring the action. Such determination can be shown by an express refusal on the part of the corporation to commence the action. It may frequently occur that a corporation will neither refuse to commence the action nor proceed to act. A determination not to commence the action can be reached without giving expression to such determination, and the failure to give expression to its determination should not affect the right of stockholders to proceed in behalf of the corporation. The breach of duty is not necessarily dependent upon any expression of purpose by the corporation. Where a corporation so unreasonably neglects and fails to bring an action that such neglect and failure amounts to a refusal to act, the breach of duty which must be shown before an action is commenced by a stockholder will be established as if an express refusal to act had been shown. A matter of sufficient importance to demand an action in the name of the corporation or by a stockholder or stockholders in its behalf to recover corporate assets lost, or in danger of being lost, by the fraud or neglect of its officers and agents, would require consideration followed by appropriate official or corporate action, and the preparation of papers, before an action could be commenced. What would be an unreasonable delay by the corporation after a demand that an action be commenced would vary in nearly every case. It might be a very short or a comparatively long time, according to the circumstances and the importance of the matter under consideration, and the amount of work necessary to be done before proceeding with the action. The determination of a corporation as to whether it will or will not bring an action to recover corporate assets is quite different from the determination of a person as to whether he will or will not pay an indebtedness when the same is due and payable and demand is made therefor. The refusal now under consideration is a definite, deliberate act and exercise of judg [546] tnent. If the defendants in this case should admit the allegations of the complaint so far as the same relate to the question of a demand and the neglect of the corporation to act thereafter, no issue would remain relating thereto upon which to offer testimony, and a finding in the language of the complaint would not be sufficient to sustain a judgment in favor of the plaintiff. The complaint should allege a demand and express refusal to bring the action, or facts which excuse the plaintiff from making such a demand, or such other facts as will warrant the conclusion that the corporation’s failure and neglect to bring the action after demand is so unreasonable as to amount to a refusal to act. All of the authorities in this state, so far as they have been called to our attention, sustain this conclusion. Leslie v. Lorillard, 31 Hun, 305; Greaves v. Gouge, 69 N. Y. 154; Brinckerhoff v. Bostwick, 88 N. Y. 52; Flynn v. Brooklyn City R. R. Co., 9 App. Div. 269, 41 N. Y. Supp. 566; s. c., supra; Fitchett v. Murphy, 46 App. Div. 181, 61 N. A. Supp. 182; Craig v. James, supra; Loewenstein v. Diamond Soda Water M. Co., 94 App. Div. 383, 88 N. Y. Supp. 313. • The interlocutory judgment should be affirmed, with costs, with leave to the plaintiff to serve an amended complaint on payment of the costs in this court and in the court below. All concur.