JOHNSON v. MANSFIELD HARDWOOD LUMBER COMPANY

BENJAMIN C. DAWKINS, Jr., Chief Judge.

A program of corporate purchase of minority stock, as treasury shares, has reaped a whirlwind of bitterness, resulting in this three-pronged action.

Brought here under the Diversity Statute1 by eight plaintiffs, and addressed to our equitable powers, the suit is for a preliminary injunction, for rescission of certain stock sales made by plaintiffs to defendant in 1953, and for an accounting.

In their verified complaint, supported by various documents, plaintiffs pitch their claims on charges of deliberate fraud, or, alternatively, upon constructive fraud and unjust enrichment. They allege that, in 1953, defendant, Mansfield Hardwood Lumber Company (sometimes called "Mansfield"), through its President, A. S. Johnson, and its Vice-President, Brown McCullough, fraudulently conceived a scheme through which it induced them to sell their stock in the company to it, on the pretense that no dividends would be paid for the next fifteen to twenty years, that all profits would be reinvested in a reforestation program on its extensive land holdings, and that the corporate assets would not be liquidated and distributed to its shareholders in the foreseeable future.

At that time Mansfield's outstanding capital stock consisted of 4,836 shares, of which plaintiffs owned 1,516 shares, or approximately 33 per cent. It is alleged that the corporate management, together with others dominated by them, owned 2,751 shares, or approximately 56 per cent of the total, giving that group full control of its affairs.

Plaintiffs aver that all of them, except Mrs. Hattie Johnson and Mrs. Jeanette Johnson Jennette, sold their stock to the company for $350 per share, and the latter two, owning 547 and 668 shares, respectively, sold theirs for $400 per share. All plaintiffs contend that in doing so they accepted as true, and relied upon, the representations made to them by Mansfield's officers that no dividends would be paid for many years, and that no liquidation and distribution of the company's assets would be made. Since its stock was closely held, mostly by members of the same two families, was not traded on the open market and, accordingly, had no established market value, they also relied, they say, on the officers' statements as to the intrinsic value of the stock, for which they first were offered $300 per share.

Plaintiffs further say that, in arriving at their estimates of stock value, they placed strong reliance upon defendant's annual Balance Sheets, prepared and distributed to stockholders by the management. Copies of two of these statements are attached to the complaint. Under the heading of "Assets", as of June 30, 1952, one of the larger items was "Timber and Timber Lands", then valued at $969,234.03. The Balance Sheet of June 30, 1953, gave these assets a value of $987,674.84. Actually, but allegedly unknown to them at the time, the true value was almost $9,000,000.

Thus deceived, they turned in their stock for the prices mentioned, and were paid by the company with corporate funds, the last sales having been consummated by Mrs. Johnson and Mrs. Jennette on November 14, 1953.

Plaintiffs next aver that, notwithstanding such representations by Mansfield's officers, both as to stock values and the lack of prospects for liquidation, they began negotiations for sale of the corporate assets within a few months after the stock had been bought. On September 26, 1955, defendant's then officers, directors, and remaining stockholders voted to liquidate completely, selling all, or substantially all, of the assets. To that end, on May 25, 1956, it sold all of its timbered lands, comprising about 93,000 acres, to Robert Gair Company, Inc., for $8,823,000, $5,000,000 being paid in cash, and the balance represented by a mortgage note for $3,823,000, bearing 3 per cent per annum interest, payable in five years. All minerals underlying these lands were reserved to defendant, to be distributed pro rata to its remaining stockholders. A lumber mill owned by defendant, at Winnfield, Louisiana, was sold for $285,000, on September 29, 1955, and another mill at Zwolle, Louisiana, was sold on May 25, 1956, for $75,000. Another asset, the Reader Railroad in Arkansas, was sold for an unascertained amount. No one apparently knows the exact total worth of the minerals reserved for distribution.

Plaintiffs calculate that defendant's assets will realize, or be worth, approximately $10,000,000, from which each share of the remaining stock will receive about $3,000, as contrasted to the $350 and $400 per share they received. If they had not sold their shares, in reliance on defendant's representations, they now would be entitled to receive more than $2,000 per share. Thus, they say, defendant obtained stock worth approximately $3,300,000 for $609,200, or about 18 per cent of the true value.

As stated, plaintiffs claim that all this resulted, to their serious detriment, from a fraudulent scheme on the part of defendant's officers, Johnson and McCullough. In the alternative, in the event it is determined that no deliberate fraud was practiced, plaintiffs contend that in their sale and defendant's acquisition of the stock they and defendant neither understood the true value of the rights being sold and acquired, and because of this mutual error of fact the sales were invalid.

In the further alternative, plaintiffs contend that in acquiring their stock defendant used cash and credit which equitably belonged to them and that, accordingly, no consideration was paid for the stock, or such consideration as was paid was not serious, and the sales were invalid.

In the still further alternative, plaintiffs urge that the price paid by defendant was so utterly out of proportion to the true value of the stock as to render the consideration vile, and to permit those who stood in a fiduciary relationship to plaintiffs to enrich themselves unjustly at plaintiffs' expense, and, therefore, that the sales were invalid.

Plaintiffs pray for a decree rescinding the sales of their stock to defendant, recognizing them as its equitable owners, requiring defendant to account to them for their share of the liquidation proceeds, and to deliver to them their proper part of the mineral rights reserved for distribution. They further allege that defendant is about to distribute a large amount of cash on hand, and to be received, to the remaining shareholders, and proposes to transfer to them title to undivided interests in the minerals, which would make it possible for third persons to acquire indefeasible interests therein, all to plaintiffs' irreparable injury. Accordingly, they have asked for, and were granted, a temporary restraining order, renewed each ten days since the suit was filed on June 22, 1956, to hold matters in status quo until determination of the suit on its merits. They further pray for a preliminary injunction for the same purpose.

Defendant has filed a motion to dismiss, encompassing several points of defense, and a verified answer with supporting documents, which vigorously denies the alleged fraud and asserts additionally a number of affirmative defenses. While admitting generally that plaintiffs are former stockholders, who sold their stock to it for the amounts mentioned, partly at the behest of Johnson and McCullough, defendant contends that all statements made by them, in the negotiations leading up to the sales, were completely honest and factually correct. It further contends, with particular respect to the stock purchased from Mrs. Johnson and Mrs. Jennette, that they were thoroughly familiar with the company's affairs; that they initiated the negotiations and in effect importuned defendant to buy their stock, which constituted about 80 per cent of the total purchased, being all but 281 shares out of 1,516 which were bought; that defendant did not have sufficient cash or liquid assets on hand to pay the entire purchase price ($494,000); hence, it paid them $121,500 in cash, giving its notes for the balance, due serially each six months, secured by a mortgage on 11,845 acres of its property; that it paid the notes as they matured, and on May 25, 1956, it called the remainder of the unpaid notes, as was its privilege under the mortgage, paying the full balance of principal and interest, plus a 2 per cent charge for the privilege of calling the notes prior to their maturities. Defendant also alleges that, in addition to the payments already mentioned, it caused to be paid to Mrs. Johnson and Mrs. Jennette a sum equal to a 2 per cent dividend upon their stock, which payment was made some time subsequent to the consummation of the stock sale. Accordingly, defendant contends that by their actions they have ratified, confirmed and made valid their sale of stock to it, and now are estopped to bring this action to rescind it.

It further contends that it did not "immediately" begin to look for a sale of its timbered lands, after it had purchased plaintiffs' stock, but admits that in about the month of April, 1954, it began to negotiate with International Paper Company for that purpose. It further admits that on September 29, 1955, it agreed to sell those lands to the Gair Company, reserving all mineral rights, for $8,823,000.

While admitting that it was a closely held corporation, it denies that there was no market price for its stock; and it denies that plaintiffs had no accurate knowledge of the value of the company's assets, but, on the other hand, affirmatively alleges that they had representatives on the Board, as well as having participated in stockholders' meetings, and that they were entirely familiar with the company's assets.

It admits that the company followed the custom of circulating annual financial statements among its stockholders, but affirmatively alleges that these were accurate and correct according to the company's books. It denies that the statements made in the Balance Sheets of June 30, 1952 and 1953, were in any sense incorrect or that plaintiffs were required to evaluate their shares solely upon such statements. It affirmatively avers that the company's books, from which the statements were taken, were the usual and customary books in such a business, and that, in evaluating their shares, plaintiffs considered the nature and value of the assets rather than the book values alone.

Defendant further urges that the corporate liquidation now has been largely completed and that plaintiffs are without right to enjoin its further liquidation. If defendant is enjoined, it avers that a tax consequence, amounting to a $1,500,000 loss, will occur, due to defendant's inability to complete the plan of liquidation previously submitted to, and approved by, the United States Department of Internal Revenue, within one year from September 26, 1955. It further urges that should the injunction issue damages of approximately $150,000 per year will accrue because of nondistribution to the remaining stockholders of amounts realized from the liquidation.

Defendant next alleges that, if plaintiffs are entitled to any relief, which is denied, they have an adequate remedy at law. It avers that all plaintiffs had full knowledge as early as July of 1955, and prior thereto, of the company's proposed plan of liquidation; that defendant's position has changed substantially since it purchased plaintiffs' stock and since July of 1955; that plaintiffs, therefore, are barred by their own laches and are without equity in failing to exercise promptly their alleged equitable right to rescission and an accounting. Accordingly, defendant prays that plaintiffs' demands be rejected at their cost. They also argue that, on consideration of all the pleadings and attached documents, plaintiffs have not shown themselves to be entitled to equitable relief. Hence, their application for a preliminary injunction should be denied.

The motion to dismiss, which must be considered first, makes these points:

1. The complaint fails to state a claim upon which relief can be granted.

2. This is an action for rescission of a sale in which there is no allegation of tender by plaintiffs to defendant of the consideration received by plaintiffs from defendant pursuant to the sale.

3. If plaintiffs are entitled to any relief, which is denied, they have an adequate remedy at law.

4. The complaint affirmatively shows that defendant's position has so changed since the sale that it would be impossible for it to comply with an order granting the relief sought.

5. The complaint affirmatively shows that, if plaintiffs are otherwise entitled to relief, which is denied, they are barred by their own laches.

6. The complaint affirmatively shows that the alleged fraudulent scheme, and the alleged misrepresentations made pursuant thereto, were entered into by and were made on behalf of McCullough and Johnson, as stockholders, and other unnamed stockholders, and not on behalf of the corporation.

7. That there is a non-joinder of indispensable parties defendant, namely, the remaining twenty-four shareholders, whose interests will be directly affected by any decree rendered herein.

8. That there is a misjoinder of parties plaintiff, whose claims do not arise out of the same transaction, occurrence, or series of transactions or occurrences. These points will be considered seriatim.

1. Defendant's general motion to dismiss for failure to state a claim upon which relief can be granted naturally admits all well-pleaded facts in the complaint. If plaintiffs' allegations are true, they clearly would be entitled to the relief they seek. No citation of authority is required to demonstrate that this part of defendant's motion must be, and is, denied.

2. In support of its position that plaintiffs must have made, and must allege, a tender to defendant of the amounts paid by it for plaintiffs' stock, as a prerequisite to this action, defendant relies on a decision by a former member of this Court, now retired, Hollinquest v. Kansas City Southern Railway Co., 1950, 88 F.Supp. 905, 907, wherein one of present plaintiffs' counsel was the attorney for the defendant.

There, a personal injury damage suit, it was alleged that an agent of the defendant paid the injured person $100, and obtained a release, shortly after the accident, while she was in such physical and mental condition that she could not appreciate what she was doing, and when she had no opportunity to know or understand the extent of her injuries. Defendant pleaded lack of tender, and the Court ruled as follows:

We note that in the latest decision cited, Certified Roofing Co. v. Jeffrion, La. App., 1945, 22 So.2d 143, 146, that Court excused that plaintiff from making tender because it would have been refused by the defendant, stating:

For their part, plaintiffs here rely on a decision by the Louisiana Supreme Court, American Guaranty Company v. Sunset Realty & Planting Company, 208 La. 772, 23 So.2d 409, rendered on rehearing, loc. cit. 23 So.2d 430, on May 2, 1945, in an action to rescind certain deeds on grounds of fraud, where the Court ruled:

The decision just quoted from appears to be the last word on this subject by the highest Louisiana Court, notwithstanding earlier jurisprudence apparently to the contrary. As applied here, therefore, these plaintiffs are not required to tender back to defendant the amounts they received for their stock, especially since they pray for an accounting which, if granted, would entitle them to recover more than five times the price they were paid, less the amounts they received. Moreover, in keeping with the judicial philosophy enunciated in Certified Roofing, supra, we feel that plaintiffs should not be required to make a tender to defendant, because we know it would be refused—a vain and useless thing.

Accordingly, this part of defendant's motion must be, and is, denied.

3. Do plaintiffs have an adequate remedy at law? We think not.

If plaintiffs were to be relegated to an action in damages, they would find themselves, should they prevail, with a judgment against an empty shell—a corporation which had transferred all of its assets to its remaining shareholders, in keeping with its plan of liquidation and distribution, on or before September 26, 1956. Then, but only then,2 could plaintiffs bring action against the individual stockholders who profited from the liquidation at plaintiffs' expense. As many as twenty-four separate suits, against each stockholder for his virile part, could or would be required. Each such defendant could, and undoubtedly would, insist upon being sued at his domicile. We are informed that some of them live outside Louisiana, as far away as New York City and Mineral Springs, Texas.

Moreover, if defendant transfers to the remaining stockholders pro rata the mineral interests it reserved in the sale of its timbered lands to Robert Gair Company, Inc., these stockholders in turn easily could put those interests partly or wholly beyond plaintiffs' reach by executing leases, and mineral or royalty sales to third persons. Likewise, by donations or otherwise, they could so divest themselves of any cash received from defendant, or confuse it with funds of third persons, so as to make it virtually impossible for plaintiffs to enforce any judgments they might obtain.

We are forced to conclude, therefore, that plaintiffs do not have an adequate legal remedy available to them in these circumstances.3 Hence, this part of defendant's motion must be, and is, denied.

4. Defendant's strange argument, that its position has so changed since it bought plaintiffs' stock that it could not comply with an order granting the relief sought, falls of its own weight. It refers, of course, to its having already distributed, before this suit was filed, to its present shareholders the cash it had received in selling its lands, its mills and its railroad. No authorities are cited, none could be, in support of this point.

Factually, the record indicates that defendant probably could respond in full. Irrespective of that, however, it is a sufficient answer, we think, to state that plaintiffs clearly are entitled to seek recovery, to the limit of defendant's ability to respond, from such cash and other assets as it may have on hand when, and if, plaintiffs prevail on the merits of their case.

For these reasons, this part of defendant's motion must be, and is, denied.

5. With respect to defendant's plea of laches, it is pertinent to view the practical aspects of the position in which plaintiffs allegedly found themselves. If they discovered, in July of 1955, that defendant had determined to liquidate and distribute, still—according to the essential thrust of their case—they did not know then the true values of defendant's properties, and how much the remaining shareholders would derive from them.

While they then may have been deeply disappointed to learn that—contrary to what they had been told in 1953—defendant indeed would be liquidated, yet they did not realize then that they had been bilked into taking less than one-fifth of the actual value of their stock.

Their complete disillusionment came on, or shortly after, May 25, 1956—less than one month before this suit was filed on June 22, 1956—when they learned that the liquidation actually was returning nearly $10,000,000. Surely, if such circumstances truly were theirs, they are not guilty of laches, or any unreasonable delay in crossing swords with defendant.

At this time, we cannot tell with certainty, on the present record, whether plaintiffs actually were so totally ignorant of developments or actual values, as they allege. Because of this, we have concluded that this part of the motion must be, and is, denied; but its counterpart in defendant's answer (together with all other defenses) is to be preserved for determination with the merits of the case after we have heard the evidence on both sides of the controversy.

6. In so far as defendant's motion attempts to exculpate the company from the alleged conduct of Johnson and McCullough, on the ground that they acted only for themselves and not for the corporation, we must look once again to the complaint, the allegations of which must be accepted as true for the purposes of this motion.

There it is expressly averred that these officers, in confecting and accomplishing their alleged scheme to defraud, were acting in their official capacities as President and Vice-President, respectively. Their knowledge and their action thereby became that of the corporation:

Moreover, the corporation ratified their action when it bought plaintiffs' stock for less than 18 per cent of its true value. It received the benefits. It cannot be heard to say now, if plaintiffs' charges are true, that Johnson and McCullough did not act for it.

For these reasons, this part of the motion must be, and is, denied.

7. The present stockholders are not indispensable parties defendant. In law, if they had been joined, a plea of prematurity by them would be good.

Defendant is a Delaware corporation. As such, it, its stockholders, and persons claiming against it are subject to the corporation laws of that State. Christian v. Texas Gas & Power Corp., D.C.N.D. Tex.1952, 14 F.R.D. 80, 81. A footnote in that opinion quotes the Corporation Law of Delaware, Section 51, 8 Del.C. § 325, as follows:

Naturally, the present shareholders' rights will be affected by the final outcome of this suit, either advantageously or adversely. But the same would be true in a suit brought, say, against American Telephone and Telegraph Company. No one would contend seriously that all of its multiple thousands of shareholders would be indispensable parties defendant in any suit brought by an outsider —plaintiffs are very much on the outside now—against that company. In the Christian case, supra, Judge Dooley passed upon a similar contention with this language:

As will be noted from the quotation, in that case the corporation had been dissolved, and its assets turned over to its shareholders, about six months before the suit was brought. Here defendant has not been dissolved. It is still a going concern, although now in the last stages of liquidation. Its shareholders are liable to plaintiffs, if at all, only secondarily. They not only are not indispensable parties; they would be improper parties if they had been joined.

This part of the motion, therefore, must be, and is, denied.

8. As stated, the last point of defendant's motion is that there is a misjoinder of parties plaintiff.

We think the complete answer to that argument is found in Rule 20(a), Fed. Rules Civ.Proc. 28 U.S.C.A.:

Analysis of plaintiffs' claims shows clearly that they seek recovery from the same defendant, whose officers allegedly acted in the same manner as to all plaintiffs, at roughly the same time, and with substantially the same results. All plaintiffs seek the same relief on the same grounds, i. e., 1) actual fraud, or 2) constructive fraud and unjust enrichment. All claims present common questions of fact and law. Their right to relief, if they establish it, arises out of the same series of transactions.

A multiplicity of suits, all aimed at the same goal and utilizing the same protective measures, would result if they could not join together in one assault upon their adversary.

We not only think plaintiffs properly have joined in their action here; it would have been improper for them to have proceeded separately.4

For these reasons, and those given above, this part of defendant's motion, and the entire motion, are denied.

This brings us at last to consideration of the whole case, as presented by the pleadings and supporting papers, with particular regard to whether a preliminary injunction properly should issue. That matter has been submitted on those documents, no testimony having been taken.

In passing, we must note for the record that, because of the many problems confronting us, as shown by the very length of this opinion, with time being of such importance, we have been forced to proceed to our preliminary determinations herein under much pressure. Frankly, we have not read all of the many authorities cited in the voluminous briefs, but we have studied carefully what we consider to be the controlling cases and texts, in an effort to grasp thoroughly the essentials involved. That we do not mention some of the authorities cited in the briefs does not mean we have not considered them. We simply do not have the time to discuss and distinguish them from those we do cite as apposite, according to our best judgment.

It also should be clearly understood that, in ruling upon the case in its present posture, we are not expressing a final opinion on the merits. Necessarily, we must rule definitively upon the points now before us, but we emphasize that our findings at this stage of the matter are subject to revision, if facts not now before us require a change in our views as here expressed.

In our approach to this complicated matter, we have tried to maintain in proper balance, above the welter of facts, figures and prior decisions heaped upon us, the equities involved on both sides of the case. Inevitably, notwithstanding this plethora of legal and factual complexities, we find ourselves returning ultimately to the single, simple, inescapable fact: Plaintiffs received from defendant less than one-fifth of the actual value of their stock.

Serious charges of deliberate fraud are made. Those charges are vehemently denied. Their resolution must await decision until all of the evidence is heard. Plaintiffs bear the heavy burden of proving actual fraud, not just by a preponderance of the evidence, but beyond a reasonable doubt.5 Nonetheless, defendant admits in its answer that it began negotiations for sale of its timberlands —its most valuable asset—in April, 1954, only five months after it purchased the last of plaintiffs' stock. That could have occurred in all good faith, but at this point in the case it must be regarded as a circumstance rather strongly against defendant's position.6 It is to actions, not just words, that we must look.

The first offers to buy, for $300 per share, admittedly were made by defendant's officers, and it was they who ultimately concluded the transactions by presenting them to their Board for approval, readily granted. These officers stood in a fiduciary, or quasi-fiduciary, capacity in their relation to plaintiffs. It was their duty to advise plaintiffs fully, frankly and faithfully as to the true value of their stock.7

We find it hard to believe now, although our mind is open and we reserve final judgment, that plaintiffs knew much about the value of the stock, for otherwise they surely would not have sold it for such a small fraction of its real worth. While the value may have changed substantially since 1953,8 defendant's officers then must have known, approximately at least, the true worth of the corporate assets, and consequently, the true value of its shares, either as a going concern or in liquidation. In any event, deliberate fraud aside, there is enough shown dehors that question, we think, to justify us in preserving the status quo until trial on the merits has been had.

We refer to plaintiffs' alternative grounds for relief. Can it conscientiously be said that the consideration they got was serious, as required by Louisiana law, or that the transactions did not constitute an unjust enrichment to defendant? We shall answer those questions after first referring to the applicable Louisiana authorities, and others which are pertinent.

Article 2464 of the LSA-Civil Code of Louisiana reads:

In Murray v. Barnhart, 1906, 117 La. 1023, 42 So. 489, 491, the Court said:

Later, in 1928, the same Court, in Blanchard v. Haber, 166 La. 1014, 118 So. 117, 119, said:

To the same effect are Hirsch v. Rosenberg, La.App., 14 So.2d 331; Shreveport Laundries v. Teagle, La.App., 139 So. 563; Spanier v. DeVoe, 52 La.Ann. 581, 27 So. 174, and D'Orgenoy v. Droz, 13 La. 382. See also Cali v. National Linen Service Corp., 5 Cir., 38 F.2d 35.

Pomeroy's Equity Jurisprudence, Vol. 3, Section 927, pp. 634-638, states:

Applying these authorities to the admitted facts of this case, it is our opinion that the price paid by defendant for plaintiffs' stock was so trifling, so inordinately out of proportion to its true value, that no fair-minded person could say it was "serious". Its inadequacy "shocks the conscience".

Article 1965 of the LSA-Civil Code of Louisiana, provides:

Restatement of the Law, on the subject of "Restitution", page 12, states:

Herrmann v. Gleason, 6 Cir., 126 F.2d 936, 940, held:

On the basis of those authorities, it is also our opinion that defendant was unjustly enriched through its purchase of plaintiffs' stock, and ought to make restitution.

It may be that plaintiffs, and especially Mrs. Johnson, Mrs. Jennette, and Max Brown, by their knowledge of the facts and their subsequent actions, have knowingly ratified defendant's conduct so as to be estopped from prevailing in their claims. Nevertheless, we think they are entitled to their day in court to prove, if they can, their right to recover. Such serious matters ought not to be decided merely on the face of the papers.

The problem which has caused us our greatest concern, in determining whether a preliminary injunction should issue, is the large potential tax consequence with respect to defendant's liquidation. Naturally, that is a result which all parties, and the Court, wish to avoid.

We are informed by all counsel, however, that a conference was held at Washington, D. C., on August 2, 1956, between plaintiffs' and defendant's counsel, on the one hand, and an official of the United States Department of Internal Revenue, on the other, wherein the latter informally stated that the tax loss probably could be avoided if defendant's remaining assets are transferred to a Court-designated trustee, as stake-holder, with power to invest in short-term Government securities. We think application for a formal ruling to that effect by all means should be made at once, and when received, the transfer should be made.

We thus conclude that plaintiffs are entitled to a trial. To protect their rights pending final determination, they likewise are entitled to have all assets remaining in defendant's hands, or subject to equitable control and distribution by this Court (including payments received and to be received, upon the balance of the purchase price for the timberlands, from the Gair Company), preserved for their benefit, should they succeed on the merits.

For these reasons, therefore, the preliminary injunction will be granted. Its terms, and the amount of bond to be furnished by plaintiffs, will be fixed after due hearing, to be arranged shortly. The case will be set for trial on its merits at the earliest possible date.