Rankin v. Frebank Co.

On December 4, 1967 plaintiffs James N. Rankin and William D. Myers filed a complaint against John G. McCoy (“McCoy”), Fred Bankey, Joseph Tillery, Frebank Company, a corporation (“Frebank”), Frebank Company Profit Sharing Plan, a trust, and Marion W. McCoy. In essence, the complaint prayed for an involuntary dissolution of Frebank and the recovery of “secret profits” said to have been wrongfully diverted by the controlling officers, directors and stockholders. The trial judge ordered the dissolution of Frebank, but denied recovery of most of the claims for secret profits. Plaintiffs have appealed from the judgment, claiming the trial judge awarded too little; defendants McCoy and Tillery also have appealed, claiming the trial judge awarded too much.

The Background

A. The Shares of the Company

Frebank Company was incorporated under the laws of California in July 1950. In conformity with a permit issued by the Corporation Commissioner, 100 shares were issued to Bankey, and 100 shares were issued to one E. S. Rockwell. After a series of transactions not relevant here, by late 1953 McCoy had become the rightful owner of Rockwell’s original shares.

The history surrounding the 100 shares issued to Bankey is more complex. Bankey had purchased the shares at least in part with funds provided by Rankin and Myers on the understanding that they would become shareholders. Thus in November 1950, Bankey had one-third of his shares issued in the name of Myers, and another one-third issued in the name of Rankin. However, when McCoy became the owner of Rockwell’s former shares, Bankey entered into a campaign to conceal from McCoy the existence of Rankin and Myers as shareholders. Instead, McCoy was to believe that there were but two equal shareholders in the corporation: McCoy and Bankey. Bankey told McCoy that he was a 50 percent shareholder, and at some time between November 14, 1952 and December 31, 1956 the stock book of Frebank was altered in a way calculated to conceal the status of Rankin and Myers. Plaintiffs contended that they played no part in the design to deceive McCoy and that McCoy was not in fact deceived. On the other hand, McCoy contended that Bankey and plaintiffs conspired to deceive him and that

In late 1960, Rankin and Myers (by this point disenchanted with Bankey) filed a lawsuit against Frebank and Bankey in an effort to be declared shareholders of Frebank. The court found that they were each entitled to one-third of Bankey’s shares. This judgment was upheld on appeal in Rankin v. Bankey (1961) 196 Cal.App.2d 554 [ 16 Cal.Rptr. 721 ],

Thus, by 1962, following completion of the litigation, Frebank’s shares were owned by McCoy (one-half interest), Bankey (one-sixth interest), Rankin (one-sixth interest), and Myers (one-sixth interest). Bankey sold his interest to Tillery in 1966, and McCoy transferred half of his shares to his wife in 1968 by reason of the provisions of an interlocutory decree of divorce.

B. The Bancoy Transaction

From its inception, Frebank was engaged in the business of the sale, engineering, research, development, and/or manufacturing of aircraft missile parts and components under contracts with various United States governmental agencies and defense contractors. However, in September 1954, McCoy and Bankey formed Bancoy Corporation for the purpose of carrying out the manufacturing aspects of the business then being conducted by Frebank. The stock of Bancoy was distributed 50-50 between McCoy and Bankey. From the perspective of McCoy, the purpose of forming Bancoy was to reduce the tax burden of Frebank. Aside from a tax advantage, he gained no financial advantage from the Bancoy transaction; but since Rankin and Myers owned no stock in Bancoy, the effect of shifting Frebank’s manufacturing business to Bancoy was to divert assets in favor of Bankey. Instead of having a one-sixth interest in the manufacturing proceeds (in Frebank), Bankey realized a one-half interest in the manufacturing proceeds (in Bancoy).

Bancoy manufactured Frebank’s products until early in 1956, and throughout this period plaintiffs did not know that they were without an interest in Bancoy. In 1958, Rankin and Myers learned that they were not stockholders of Bancoy, but they did not know that McCoy or Bankey had received any benefits from Bancoy. In 1962, plaintiffs’

Bancoy was finally dissolved in 1966. Over the years Bankey received $27,430.58 in salaries, $2,990 in dividends, and $20,134.99 in retained earnings, including a $14,750 note payable by Frebank, for a total of $50,555.57. McCoy received $6,750 in salaries, $2,990 in dividends, and $20,134.99 in retained earnings, including a $14,750 note payable by Frebank, for a total of $29,875.02.

C. The Tillery Note

The note payable by Frebank to McCoy was transferred to Tillery for $5,000 at a time when Tillery was an officer and director of Frebank. The note bears 4 percent interest, and Tillery has received interest payments of $2,950, but no payments on the principal.

D. Benefits Received from Frebank

From 1954 to 1966, Frebank paid to Bankey (who served as president of Frebank throughout this period) a total of $330,884, and to McCoy (who served as vice-president until 1966 and president thereafter) a total of $59,300. Moreover, Frebank furnished automobiles to McCoy and Bankey for their use, provided, insurance on the lives of McCoy and Bankey in the amount of $50,000, and established a profit-sharing plan benefiting Bankey in the amount of $5,597, and McCoy, in the amount of $2,549.

In July 1958, Rankin and Myers filed a petition for writ of mandate directed against Bankey, wherein they alleged that they had information and belief that compensation was being paid to Bankey and other officers of Frebank “in excessive amounts with the sole purpose of depleting the income of respondent company so that these petitioners will not receive their equitable share of dividends.” In that proceeding the court ordered that plaintiffs be permitted to inspect all of the records of Frebank. Although plaintiffs had access to all of the records of Frebank from August 1958 to the present, plaintiffs did not file the instant action until December 4, 1967.

E. Sun Machinery Transactions

From 1954 to 1967, defendant McCoy, under the name of Sun Machinery, sold or rented machinery to Frebank.

Plaintiffs claimed: (1) that defendants should be forced to account for the secret profits arising out of the Bancoy transaction (i.e., obligations paid by Frebank, cash payments to Bancoy, salaries paid by Bancoy to McCoy and Bankey, Bancoy dividends, Bancoy’s use of Frebank facilities, and Bancoy’s liquidation assets); (2) that defendants should be forced to pay over to Frebank assets wrongfully diverted to them by their concerted actions and self-dealing with respect to Frebank dividends, bonuses, life insurance, profit-sharing, automobiles, and salaries; and (3) that McCoy should be forced to pay over profits arising out of the Sun Machinery transactions.

The Judgment

Rulings of the trial court relevant to this appeal are numerous. The trial court ruled that:

(1) Bankey was obligated to pay to Frebank the money he had received from Bancoy ($50,557.57);

(2) McCoy was obligated to pay Frebank the net benefits received from Bancoy ($20,125.02; this figure takes into account the sale of the Frebank note from McCoy to Tillery);

(3) Tillery was entitled to enforce the obligation of the Frebank note in the face amount of $14,750 only to the extent of $5,000 plus interest thereon at 4 percent per annum;

(4) Tillery’s right to receive interest was limited to 4 percent on $5,000 (not 4 percent on $14,750, which was the face value of the note), and he was therefore obligated to pay Frebank $1,750;

(5) Plaintiffs’ claims for recovery from defendants McCoy and Bankey of benefits and monies received by them from Frebank arising from facts prior to December 4, 1964, were barred by the statute of limitations;

(6) McCoy and Tillery were to be denied indemnity under Corporations Code section 830 for their reasonable expenses, including attorney fees;

(7) McCoy and Tillery were to be charged with the responsibility of winding up and dissolving Frebank;

(8) McCoy was obligated to pay Frebank $3,000 for attorney fees;

(9) The court retained jurisdiction for supervising the dissolution of Frebank;

(10) Rankin and Myers were entitled to judgment against defendants McCoy and Bankey for their costs of suit, but were not entitled to judgment against any defendant for any other sum whatsoever.

Contentions on Appeal

McCoy and Tillery contend that the trial court erred (1) in ordering judgment for Frebank against McCoy; (2) in ordering that Tillery’s interest in the note was confined to $5,000; and (3) in denying the application of McCoy and Tillery for attorney fees.

Rankin and Myers contend that the trial court erred' fl} in denying their request for special findings; (2) in denying their right to a jury trial; (3) “in failing and refusing to apply to each and all of defendants’ transactions of self-dealing the essence of the legal test of fairness, to wit: arm’s length bargains”; (4) in refusing to hold McCoy, Bankey and Tillery liable jointly and severally for the Frebank money and assets wrongfully diverted to them; (5) in ordering McCoy and Tillery to wind up and dissolve Frebank; (6) in failing to consider the case of Rankin v. Bankey to be res judicata as to McCoy; (7) in denying that McCoy is liable to Frebank for benefits received by Bankey from Bancoy; (8) in holding that recovery against McCoy and Bankey is barred as to all transactions occurring prior to December 4, 1964; and (9) in refusing to award damages to plaintiffs individually.

The Defendants’ Appeal

A. The Judgment for Frebank against McCoy

(1) The Period Prior to McCoy’s Knowledge of the Existence of the Shareholders

McCoy in conjunction with Bankey set up Bancoy to perform Frebank’s manufacturing, an activity which Frebank itself was capable of performing. If McCoy had been aware of the existence of the minority shareholders, Rankin and Myers, there can be no doubt that such a scheme would have violated fiduciary obligations he held as an officer,

The trial judge explained his ruling as follows: “While there appear to have been valid business reasons at the time to form Bancoy, it is clear that its operation and business was made possible by Frebank and that Frebank was deprived of income it would have otherwise received and which would have increased the amount of funds available as profits to the shareholders of Frebank. [If] Had all stockholders of Frebank participated, there would have been no one to compláin on behalf of Frebank. Since they did not, the Court concludes that there must be returned to Frebank the benefits received by Bankey and McCoy from Bancoy—benefits which would otherwise have accrued to the benefit of Frebank. And this is so, even though McCoy was unaware that plaintiffs were stockholders.” Thus the trial judge assumed that although McCoy could not be charged with the violation of a duty to the minority shareholders (not even knowing of their existence), he could be charged with a violation of a duty to the corporation, and, unfortunately for him, there were some stockholders available to bring the action on its behalf.

We believe this position misconceives the duty owed by McCoy to the corporation. California Corporations Code section 820 provides that “Directors and officers shall exercise their powers in good faith, and with a view to the interests of the corporation. . . .” At the time McCoy entered into the transaction setting up Bancoy, and throughout the period in which Bancoy assumed the manufacturing functions of Frebank, McCoy had every reason to believe that his actions protected

(2) The Period After McCoy’s Knowledge of the Existence of the Other Shareholders

The trial court found that McCoy became aware of the existence of plaintiffs’ shareholder status by 1961. It is not clear whether McCoy had knowledge that Rankin and Myers were unaware of the Bancoy transaction. The trial court found that plaintiffs’ attorney had inquired, in writing, of Bankey as to how the stock of Bancoy was held, but received no reply. The record does not disclose any evidence suggesting that McCoy was aware of plaintiffs’ ignorance.

While McCoy received certain financial benefits from Bancoy after he knew of the existence of Rankin and Myers, it is clear that the benefits necessarily derive from profits made by Bancoy long before McCoy was aware that anyone but Bankey wás in the picture. Bancoy had become inactive sometime after “early 1956.” Consequently, it is difficult to see how McCoy’s 1961 discovery of their interest in Frebank could affect previously earned profits of Bancoy.

B. The Tillery Note

At one time California adhered to the strict and inflexible view that a director of a corporation could not, consistently with his fiduciary obligations, purchase outstanding obligations of the corporation (Davis v. Rock Creek L. F & M. Co. (1880) 55 Cal. 359 ), but while contemporary rules of law recognize that both trustees and directors of corporations assume fiduciary obligations, the nature and contours of those obligations are not coextensive. The 19th century equation of directors’ responsibilities with trustee responsibilities has long since been discarded. The prevailing rule was well stated in Todd v. Temple Hospital Assn., Inc. (1928) 96 Cal.App. 42 , 47 [ 273 P. 595 ], where the court observed that directors of corporations are not “trustees of the property of the corporation in such sense as to disable them from purchasing and enforcing corporation indebtedness, unless the circumstances of the transaction make it inequitable for them to do so.” (Accord, Stack v. Welder (1934) 137 Cal.App. 647 , 652 [ 31 P.2d 426 ]; Kleinsasser v. McNamara (1933) 129 Cal.App. 49 , 59 [ 18 P.2d 423 ]; Annot., 13 A.L.R.2d 1172 .)

C. McCoy’s and Tillery’s Attorneys’ Fees and Expenses

Defendants McCoy and Tillery applied for attorneys’ fees and expenses under Corporations Code section 830. These claims were denied at least in part because of the outcome of the case. In view of our reversal of the trial court’s judgment imposing liability on McCoy and Tillery, we vacate the judgment with respect to attorney fees and expenses, and remand the issue to the lower court for consideration on retrial.

The Plaintiffs’ Appeal

Many of plaintiffs’ arguments may be treated summarily. Their claims at trial required a thorough-going investigation of virtually all the

Plaintiffs also urge that we should be influenced by federal cases on the subject. The leading case is Ross v. Bernhard (1970) 396 U.S. 531 [ 24 L.Ed.2d 729 , 90 S.Ct. 733 ], which held that “the Seventh Amendment preserves to the parties in a stockholder’s suit the same right to a jury trial that historically belonged to the corporation and to those against whom the corporation pressed its legal claims.” (Id., at p. 542 [24 L.Ed.2d at p. 738].) Ross is one of a long line of cases in which the United States Supreme Court has reread the historical underpinnings of the Seventh Amendment in an effort to compose a new logic for that section of the Constitution. (See Curtis v. Loether (1974) 415 U.S. 189 [ 39 L.Ed.2d 260 , 94 S.Ct. 1005 ]; Dairy Queen v. Wood (1962) 369 U.S. 469 [ 8 L.Ed.2d 44 , 82 S.Ct. 894 ]; Beacon Theatres v. West over (1959) 359 U.S. 500 [ 3 L.Ed.2d 988 , 79 S.Ct. 948 ].) Thus if this action were tried in a federal court, it is clear that plaintiffs would be entitled under the

The trial judge accepted defendant McCoy’s contention that defendant Bankey and plaintiffs entered into a conspiracy to conceal from McCoy the fact that plaintiffs were shareholders of the company. Plaintiffs argue that McCoy was estopped to raise the contention because it had already been litigated in Rankin v. Bankey, supra, 196 Cal.App.2d 554 . This position is without merit. In Rankin v. Bankey, plaintiffs sought and obtained a declaratory judgment against Frebank and Bankey to the effect that plaintiffs were entitled to be recognized as shareholders. Bankey contended at the trial that plaintiffs had loaned money to him and that it was never agreed that Bankey would invest money for plaintiffs. (Id., at p. 557.) Bankey at no time during the trial even remotely suggested that plaintiffs and he had conspired to conceal plaintiffs’ shareholder status from McCoy. Such a position would have been entirely inconsistent with his defense.

On appeal, Bankey tried a new tack. He argued that assuming there was an agreement for Bankey to invest on behalf of the plaintiffs, the agreement was made in violation of the Corporations Code and constituted a conspiracy to deceive the Corporations Commissioner. Even on appeal Bankey never remotely intimated that plaintiffs had sought to deceive McCoy, let alone that such a conspiracy should somehow inure to his benefit. The Court of Appeal noted that there was no finding in the record to support the contention that plaintiffs had conspired to deceive the commissioner, or anyone else. (Id., at p. 562.) Plaintiffs now contend that since the Court of Appeal found no evidence of a conspiracy to deceive anyone, McCoy, who was not even a party to the action, should now be precluded, indeed estopped, from demonstrating the existence of this conspiracy, a conspiracy to which Rankin freely confessed on cross-examination during the trial of this case.

“It is now settled in this state that the following three questions are determinative of the applicability of the doctrine of collateral estoppel: ‘Was the issue decided in the prior adjudication identical with the one presented in the action in question? Was there a final judgment on the merits? Was the party against whom the plea is asserted a party or in privity with a party to the prior adjudication?’ ” (Vanguard Recording Society, Inc. v. Fantasy Records, Inc., 24 Cal.App.3d 410 , 417 [ 100 Cal.Rptr. 826 ], quoting Bernhard v. Bank of America, 19 Cal.2d 807 , 813 [ 122 P.2d 892 ].)

A better but ultimately unsatisfactory argument is plaintiffs’ contention that the trial court’s finding in Rankin that Bankey fraudulently caused the records of Frebank to be altered on December 31, 1956 (to reflect him to be the owner of one-half of the shares of the corporation) should have been deemed to be binding upon McCoy in the instant case. Plaintiffs seize on the date of alteration as significant because McCoy, in 1953, became a 50 percent shareholder, a director, and vice-president of the corporation. They argue that his belief that Bankey was a 50 percent shareholder could not be described as reasonable because he was charged with knowledge of the records of the corporation (Pacific Vinegar etc. Works v. Smith, 152 Cal. 507 [ 93 P. 85 ]). However, again, the issue litigated was not identical. The date of alteration of the records in Rankin was of no legal consequence; instead, the crucial issue was the cause or motive for the alteration of the records. Thus the factual finding as to the date of alteration of the records was not the product of a contest between adversaries with a vital interest in its outcome. The issue, therefore, was not identical.

Even if the issue were identical, it is not altogether clear that McCoy, who was not a party to the proceeding, should be bound merely because of his status at Frebank. A finding that a person is in privity with a party to a prior adjudication cannot be based on so mechanical a test. There must be a true identity of interest between the earlier party litigant and the party to be estopped. To bind a person to a factual finding of an earlier case to which he was not a party or a successor in interest of a party or a controller of the litigation, although occasionally permitted (People ex rel. State of Cal. v. Drinkhouse, 4 Cal.App.3d 931 , 937 [ 84 Cal.Rptr. 773 ]), inevitably raises constitutional questions of grave import. Such questions would seem to be of particular consequence in this context. McCoy had no financial interest in the shareholder status of plaintiffs. As far as he was concerned, it was a dispute between plaintiffs and Bankey. To rule that McCoy could not raise an issue because a sub-issue had been decided in another case in which he had no more

C. The Award of Individual Damages

Plaintiffs insist that the trial court should have awarded damages to them individually instead of to the corporation. Since (as discussed ante) Bankey is the only person liable under our resolution of the case, we confine our discussion to Bankey’s liability for the Bancoy transaction.

Plaintiffs contend that they had a personal right of action against Bankey independent of the corporation. The cases do not support this position. As the court explained in Shenberg v. DeGarmo, 61 Cal.App.2d 326 , 330 [ 143 P.2d 74 ]: “It is a general rule that a corporation which suffers damages through wrongdoing by its officers and directors must itself bring the action to recover the losses thereby occasioned, or if the corporation fails to bring an action, suit may be filed by a stockholder acting derivatively on behalf of the corporation. An individual may not maintain an action in his own right against the directors for destruction of or diminution in the value of the stock. . . . This rule is justifiable, for the rights of creditors of the corporation, which are superior to those of the shareholders, would not be protected if individual shareholders were permitted to sue in their own right.” None of the cases cited by plaintiffs contradict this general rule. Instead, they speak to an exception to that rule (which is not applicable here) “where it appears that the injury resulted from the violation of some special duty owed to the stockholder by the wrongdoer and having its origin in circumstances independent of the plaintiff’s status as a stockholder.” (Shaw v. Empire Savings & Loan Assn., 186 Cal.App.2d 401 , 407 [ 9 Cal.Rptr. 204 ]; italics original.)

In Jones v. H. F. Ahmanson & Co., 1 Cal.3d 93 , 107 [ 81 Cal.Rptr. 592 , 460 P.2d 464 ], the Supreme Court made clear that the individual wrong suffered by the shareholder under the exception described in Shaw “need not be unique to that plaintiff. The same injury may affect a substantial number of shareholders. If the injury is not incidental to an injury to the corporation, an individual cause of action exists.” (Fn. omitted.) Here, however, the wrong suffered by plaintiffs is, at least, incidental to a loss suffered by the corporation, and thus no private right of action accrues.

This case illustrates that shareholders’ derivative suits cannot all be pressed into a single mold. The paradigm derivative suit seeks to recover for the benefit of the corporation and its whole body of shareholders when injury is caused to the corporation that may not otherwise be redressed because of the failure of the corporation to act. (Jones v. H. F. Ahmanson & Co., supra, at p. 106.) The individual suit is said to lie only when there is no injury to the corporation. (Id., at p. 107.) In Ahmanson, the plaintiff avoided this problem by the dubious stipulation that the corporation had not been injured. (Id., at p. 107.) This procedure, although insuring an equitable damage award, runs thé risk of damaging the interests of creditors, and compels the parties to stipulate to fiction. A rule which permits a court to equitably distribute damages in a derivative action safeguards the interests of creditors while simultaneously protecting the interests of shareholders. We adopt it as the most effective method of accommodating the relevant interests involved in this case.

Disposition

Accordingly, the judgment is modified as follows:

That portion of the judgment which orders, adjudges and decrees that Frebank recover from Bankey the sum of $50,557.57 is modified to provide that the salary that Bankey received from Bancoy be distributed among all the shareholders of the corporation, but that the retained

That portion of the judgment entitling Frebank to recover from defendant John G. McCoy the sum of $23,125.02 is reversed;

That portion of the judgment entitling defendant Frebank to recover from Joseph Tillery the sum of $750 is reversed;

That portion of the judgment ordering Frebank to pay Tillery the sum of $5,000 in full payment and discharge of a note of Frebank in the principal amount of $14,750 is modified to provide that Frebank must pay the full amount of $14,750, together with any interest presently owing;

That portion of the judgment denying the applications of defendants McCoy and Tillery for indemnity against Frebank, that portion of the judgment ordering McCoy to repay $3,000 to Frebank for attorney fees paid in connection with this action, and that portion of the judgment denying attorney fees, are vacated and remanded for further proceedings in light of this opinion.

That portion of the judgment that plaintiffs Rankin and Myers shall recover costs of suit from defendant McCoy is vacated and remanded for further proceedings in light of this opinion.

The other portions of the judgment are affirmed.

Kaus, P. J., and Ashby, J., concurred.

A petition for a rehearing was denied May 8, 1975, and the petition of the plaintiffs and appellants for a hearing by the Supreme Court was denied June 11, 1975.