Speiser v. Baker

ALLEN, Chancellor

[This case raises the issue] whether the circular ownership of stock among the companies involved in this litigation violates Section 160(c) of our general corporation law. Stated generally, Section 160(c) prohibits the voting of stock that belongs to the issuer and prohibits the voting of the issuer's stock when owned by another corporation if the issuer holds, directly or indirectly, a majority of the shares entitled to vote at an election of the directors of that second corporation. Plaintiff is Marvin Speiser, the owner of 50% of Health Med's common stock. Mr. Speiser is also president of Health Med and one of its two directors.

Named as defendants are the company itself and Leon Baker, who owns the remaining 50% of Health Med's common stock and is Health Med's other director. ... [Baker contends that Speiser is trying] to cement control of Health Med in derogation of his fiduciary duty to Health Med's other shareholders. For his part, to thwart an allegedly wrongful scheme Baker seeks a declaratory judgment that shares of another Delaware corporation -- Health Chem (hereafter "Chem") -- held by Health Med may not be voted by Health Med. The prohibition of Section 160(c) is asserted as the legal authority for this affirmative relief.

I.
The facts of the corporate relationships involved here are complex even when simplified to their essentials.
There is involved in this case a single operating business -- Chem, a publicly traded company (American Stock Exchange). On its stock ledger, Chem's stockholders fall into four classes: the public (40%), Mr. Speiser (10%), Mr. Ba ker (8%) and Health Med (42%). In fact, however, Health Med is itself wholly owned indirectly by Chem and Messrs. Speiser and Baker. Thus, the parties interested in this matter (as owners of Chem's equity) are Speiser, Baker and Chem's public shareholders.
How the circular ownership here involved came about is not critical for present purposes. What is relevant is that Chem (through a wholly owned subsidiary called Medallion Corp.) owns 95% of the equity of Health Med1 However, Chem's 95% equity ownership in Health Med is not represented by ownership of 95% of the current voting power of Health Med. This is because what Chem owns is an issue of Health Med convertible preferred stock which, while bearing an unqualified
right to be converted immediately into common stock of Health Med representing 95% of Health Med's voting power, in its present unconverted state, carries the right to only approximately 9% of Health Med's vote. In its unconverted state the preferred commands in toto the same dividend rights (i.e., 95% of all dividends declared and paid) as it would if converted to common stock. Speiser and Baker own the balance of Health Med's voting power. Each presently votes 50% of Health Med's only other issue of stock, its common stock. . . .

This circular structure was carefully constructed as a means to permit Messrs. Speiser and Baker to control Chem while together owning less than 35% of its equity. It has functioned in that way successfully for some years. Speiser has served as president of all three corporations. When Speiser and Baker's mutual plan required shareholder votes, Speiser apparently directed the vote of Health Med's holdings of Chem stock (its only substantial asset) in a way that together with the vote of Speiser and Baker's personal Chem holdings, assured that their view would prevail.

The conversion of Chem's (Medallion's) preferred stock in Health Med would result in the destruction of the Baker-Speiser control mechanism. Under Section 160(c) of the Delaware corporation law (quoted and discussed below), in that circumstance, Health Med would certainly be unable to vote its 42% stock interest in Chem. As a result, the other shareholders of Chem (i.e., the owners of the real equity interest in Chem) would have their voting power increased to the percentages shown on the above chart, that is, the voting power of the public stockholder of Chem would increase from 40% to 65.6%.

For reasons that are not important for the moment, Speiser and Baker have now fallen out. Control of Health Med and the vote of its Chem stock thus has now become critical to them. Mr. Speiser, by virtue of his office as President of Medallion and of Health Med, is apparently currently in a position to control Health Med and its vote. Baker asserts, not implausibly, that Speiser now seeks a Health Med stockholders meeting for the purpose of removing Baker as one of Health Med's two directors in order to remove his independent judgment from the scene.

None of Chem's public shareholders have heretofore complained that the failure to convert Chem's (Medallion's) preferred stock in Health Med to common constituted a wrong. Several shareholders have, however, now moved to intervene in this action and asked to be aligned with Mr. Baker. This application is resisted by Mr. Speiser -- who asserts some estoppel arguments personal to Mr. Baker as a ground for dismissing Bakers counterclaim. ...

III.

I turn now to Speiser's motion to dismiss the counterclaim seeking a declaratory judgment that Health Med may not vote its 42% stock interest in Chem. The prohibition contained in Section 160 of our corporation law is asserted as the principal basis for such relief. The pertinent language of the statute is as follows:

Shares of its own capital stock belonging to the corporation or to another corporation, if a majority of the shares entitled to vote in the election of directors of such other corporation is held directly or indirectly, by the
corporation, shall neither be entitled to vote nor counted for quorum purposes.

... The statutory language of Section 160(c) which Baker relies upon, when read literally does not, in my opinion, proscribe the voting of Health Med's stock in Chem. That is, I cannot conclude that Chem (or its Medallion subsidiary) presently "holds," even indirectly, a majority of the stock "entitled to vote" in Health Med's election of directors. The stock entitled to vote in such an election, and the extent of its voting power, is technically defined in Health Med's certificate of incorporation. In its unconverted state, Medallion's holding of preferred simply does not represent a majority of the voting power of Health Med. However, acceptance of Speiser's argument does not end the matter. The clause the parties argue over, even when read as Speiser reads it, does not purport to confer a right to vote stock not falling within its literal terms; it is simply a restriction. More importantly, other statutory
words may be read to extend Section 160(c) prohibition to the voting of Health Med's Chem holdings. Specifically, the principal prohibition of the statute is directed to shares of its own capital stock "belonging to the corporation." This phrase is not a technically precise term whose literal meaning is clear; it requires interpretation. I turn then to the analysis of these statutory words that leads me to conclude that they do reach the facts pleaded in the counterclaim.

A.
First a word on the function of courts when interpreting statutes. While it is our responsibility to accord to clear and definite statutory words their ordinary meaning, the process of interpretation cannot be -- and has never been -- entirely a dictionary-driven enterprise. Words themselves are imperfect and ambiguous symbols and the human imagination that shapes them into legal commands is inevitably unable to foresee all of the contexts in which the problem
addressed will later arise. Thus, in construing a statute:

There is no surer guide ... than its purpose when that is sufficiently disclosed; nor any surer mark of oversolicitude for the letter than to wince at carrying out that purpose because the words do not formally quite match with it.

... Over four hundred years ago, Lord Coke gave guidance to English judges engaged in the process of statutory interpretation that is sound today: The office of all Judges is always to make such construction as shall suppress the mischief and advance the remedy, and to suppress subtle inventions and evasions for continuance of the mischief ... and to add force and life to the cure and remedy according to the true intent of the makers of the Act. ... Heydon's Case, . . .

Following this sensible advice, we then begin our inquiry into what the legislature meant and intended by the words "belonging to," as used in Section 160(c), by a historical inquiry into the purposes meant to be served by Section 160(c) and statutes like it. This history is particularly instructive here because it demonstrates, I believe, that the very evil the statute sought to address is present here.

B.
Almost from the earliest stirrings of a distinctive body of law dealing with corporations, courts have been alert to the dangers posed by structures that permit directors of a corporation, by reason of their office, to control votes appurtenant to shares of the company's stock owned by the corporation itself or a nominee or agent of the corporation. ...

The rule that finds its first expression in these cases can be said to be of common law origin in the sense that it arose as a judicial gloss on the statutory right to vote shares. The reason for the rule is not mysterious. Such structures deprive the true owners of the corporate enterprise of a portion of their voice in choosing who shall serve as directors in charge of the management of the corporate venture. Chief Justice Taft, while still an Ohio trial court judge, stated the rationale succinctly in 1888:

"The power to vote is a power incident to ownership of stock, but to allow the directors acting for the corporation to vote the stock would not be distributing the power equally among the stockholders, as the dividends are distributed equally amongst them by payment into the treasury of the company, and it would be entrusting to persons in power the means of keeping themselves in power. . . ."

The earliest reported American decision on the point was even more succinct:
"It is not to be tolerated that a Company should procure stock in any shape which its officers may wield to the purposes of an election; thus securing themselves against the possibility of removal." Ex Parte Holmes,. . .

As the country experienced a movement in the latter part of the 19th century towards comprehensive general laws of incorporation, the rule came to be expressed in those statutes. The first general incorporation law of this
State of which I am aware, the Act of 1883, contained such a prohibition. . . . The predecessor of our present general corporation law statute, first adopted in 1899, contained an expression of the rule typical for that period: Section 24. Shares of stock of the corporation belonging to the corporation shall not be voted upon directly or indirectly. . .

The nineteenth century cases on this subject dealt with a variety of schemes through which a corporation could
control the voting of its own stock: trusts (Ex Parte Holmes), agency (Monsseaux v. Urquhart; American Railway-Frog Co. v. Haven) and pledges (Brewster v. Hartley). The attempted use of a subsidiary for that purpose, however, was not
treated during that period because, until very late in the century, corporations generally had no power to own stock in other corporations. . . . But, with the amendment of the New Jersey corporation law in 1896 to permit holding company
structures ... and the 1899 emulation of that statute in Delaware ... the mischief addressed by Section 160(c) and its predecessors became feasible through the use of a separate corporation. The leading case dealing with this manifestation of the problem arose in Delaware in 1934. That case, Italo Petroleum Corp. v. Producers Oil Corp., . . . construed a version of the statutory prohibition not materially different from the section of the 1899 Act quoted above. Chancellor Wolcott there rejected the argument that stock belonging to a 99% owned subsidiary was not stock "belonging to the [parent] corporation" because it was owned legally by the subsidiary. Thus, he construed the statutory prohibition against voting (directly or indirectly) stock belonging to the corporation as a prohibition against voting stock belonging (directly or indirectly) to the corporation. In so holding, this court was motivated by the same concerns that underlay the pre-statute cases and the statutory codification itself:

"It seems to me to be carrying the doctrine of distinct corporate entity to an unreasonable extreme to say that, in a contest over control of a corporation those in charge of it should be allowed to have votes counted in their favor which are cast by a subsidiary stockholder wholly owned, controlled, dominated and therefore dictated to by themselves as the spokesmen of the parent." Italo Petroleum Corp. v. Producers Oil Corp., . . .

The statutory language construed in Italo remained substantially unchanged until 1967 when a version similar to the current version of Section 160(c) was enacted. . . .. One knowledgeable commentator has referred to the 1967 amendment as codifying the result of Italo Petroleum. . . . Actually, it did that and something more; it specified instances in which stock owned by a subsidiary would be conclusively presumed to be stock "belonging to" its parent. The critical question is, however, did the 1967 amendment intend to do the obverse? Did it intend to create a conclusive statutory presumption that, in no event would stock owned by another corporation that did not satisfy the new test (a majority of shares entitled to vote, etc.) be deemed to be stock "belonging to the corporation?"

There is no hint in the legislative words that such a result was intended and I think that (given the surprising fact that the underlying problem can -- as this case attests -- arise in situations in which the parent does not hold a majority of the stock entitled to vote at the election of the subsidiary's directors) the policy of the statute would require a clear expression of such an intention before it could be found. Moreover, there seems slight reason relating to the purpose of the statute for the legislature to have intended to create a safe harbor for entrenchment schemes implemented through the use of corporate subsidiaries while leaving all other agencies through which such plans could be executed governed by the general language "belonging to." Accordingly, attempting to read these words in a sensible way consistent with the underlying purpose of the enactment, I conclude that stock held by a corporate "subsidiary" may, in some circumstances, "belong to" the issuer and thus be prohibited from voting, even if the issuer does not hold a majority of shares entitled to vote at the election of directors of the subsidiary.

C.
Assuming the truth of the facts alleged in the counterclaim, I am of the view that this is such a case. Here the substantial ownership of Chem in Health Med is not simply large, it is -- at 95% -- practically complete. ...

The facts alleged exemplify the very problem Section 160(c) was intended to resolve. That is, here the capital of one corporation (Chem) has been invested in another corporation (Health Med) and that investment, in turn, is used solely to control votes of the first corporation. The principle (indeed the sole) effect of this arrangement is to muffle the voice of the public shareholders of Chem in the governance of Chem as contemplated by the certificate of incorporation of that corporation and our corporation law. In purpose and effect the scheme here put in place is not materially different from the schemes repeatedly struck down for more than one hundred fifty years by American courts. ...

For the foregoing reason, the motion to dismiss the counterclaim will be denied. ...