Before SPARKS and MAJOR, Circuit Judges, and LINDLEY, District Judge.
This is an appeal from a decree entered January 26, 1945, dismissing for want of equity a suit to set aside as illegal, inequitable, and in breach of fiduciary relationship certain transactions (called "1942 plan") consummated September 9, 1942, between the Reconstruction Finance Corporation (called "RFC") and Maryland Casualty Company, a corporation (called "Maryland"), and its wholly owned subsidiaries, involving an increase of $12,500,000 in Maryland's indebtedness to RFC. The decree appealed from was predicated upon extensive findings of fact made by the lower court and its conclusions of law applicable thereto. The action was instituted as a class suit under Rule 23 of the Federal Rules of Civil Procedure, 28 U.S.C.A. following section 723c, by certain holders of the Common shares of Maryland on their own behalf and on behalf of all the holders of such shares as a class.
At the time the 1942 plan of refinancing was consummated, Maryland was indebted to the RFC because of loans theretofore advanced in the sum of $17,500,000, which indebtedness by the 1942 plan was increased $12,500,000, making a total indebtedness to RFC of $30,000,000. By reason of a certain provision contained in Maryland's charter, a legal consummation of the refinancing plan required its approval by two-thirds of the votes of each class of stockholders. For the purpose of readily obtaining the requisite approval of the Common stockholders, RFC shortly prior to the consummation of the 1942 plan caused 29,487 shares of Class A Preferred Stock held by it as security for loans theretofore advanced converted into 1,474,350 shares of and Claude A. Roth, all of Chicago, Ill. These shares of Common Stock thus acquired by RFC were voted in favor of consummation of the plan, and in the absence of counsel), for appellants.
Carl Meyer, Leo F. Tierney, and Donald M. Graham, all of Chicago, Ill. and
The contested issues arise from plaintiffs' contention that a conversion by RFC of Preferred Stock held by it into Common Stock was without authority and therefore illegal and void. Consequently, the 1942 plan was in violation of Maryland's charter both of Chicago, Ill., Harry N. Baetjer of two-thirds of the Common shares. In this connection, it is also asserted that RFC was without statutory power to hold Common Stock of an insurance company as security for a loan for capital purposes. A further contention is that the RFC occupied a fiduciary relation to the Common stockholders and could not bind them to a plan of financing which it is asserted was unfair to them. Further, it is contended that the 1942 plan was unnecessary and that it was unfair, inequitable and illegal in numerous other respects.
A large amount of testimony was heard and much was said in this court concerning the relationship existing between RFC and Maryland prior to the adoption of the 1942 plan. Inasmuch as plaintiffs' attack is directed solely at the 1942 plan, conceding the legality of all past transactions, it becomes unnecessary to enter into a detailed discussion of such transactions; in fact, they are material to the issues raised in this law suit only insofar as they throw light or bear upon what transpired in connection with the 1942 plan.
Maryland is an insurance corporation organized under the laws of the State of Maryland in 1898, and at the time relevant to this case had developed into one of the largest casualty and surety companies of the country. Its activities included the guaranty of mortgages on real estate. In the early 1930's it became seriously involved financially; in fact, it faced financial disaster. Included in its liabilities were $54,000,000 in real estate mortgages guaranteed by it. In common with many other insurance companies and financial institutions in general, it was no longer able to borrow money in the usual manner; it fact, its credit had been entirely exhausted. Like other concerns of its kind, it turned to the newly created RFC for financial assistance. An impressive showing was made to that agency of the need for such assistance and of the dire consequences not only to the insurance and casualty field but to the country in general which would otherwise ensue.
On October 17, 1933, the RFC agreed to make available to the Maryland capital funds $7,500,000, upon certain specified conditions, among which were that Maryland obtain subscriptions of at least $500,000 to stock subordinate to that issued to RFC as security for its loan, that twenty persons (officials of Maryland) guarantee the loan to the extent of $2,000,000, that some nineteen insurance companies jointly and severally guarantee the loan to the extent of $1,000,000. These requirements were made by RFC in order to comply with the law by which it was created. The proposal was approved by Maryland stockholders, and it was agreed between Maryland and RFC, for reasons not here material, that the loan should be made to Eastern Mortgage and Securities Company (called "Eastern"), a wholly owned subsidiary of Maryland. The loan thus obtained by Eastern was turned over to Maryland in exchange for 1,000,000 shares of newly created First Convertible Preferred Stock of Maryland, the certificates for which were issued in the name of and delivered to RFC to be held in pledge by it as security for the debt of the subsidiary. Eastern also delivered to RFC its note secured by the guarantees above referred to.
Shortly after this first loan was made, it became apparent to all concerned that the amount loaned by RFC was grossly insufficient. Therefore, on August 17, 1934, RFC agreed to advance for capital purposes an additional $10,000,000 on substantially the same basis as the first advance of $7,500,000. Another subsidiary of Maryland, Maryland Holding Company (called "Holding") was formed to effect this loan. Another series of First Convertible Preferred Stock was issued, designated as Series A, which like the previous stock was issued in the name of RFC. This loan, as the first loan, was properly approved by Maryland. It also is pertinent to note that each of the loans was approved by the Secretary of the Treasury and by the President of the United States, as required by law.
In 1937, for reasons which we think unnecessary to relate, the two Preferred Stock issues were reclassified into one issue consisting of 174,487 shares designated as Class A Preferred Stock, each share of which had a par value of $10.00, a principal asset preference and a principal redemption price of $100.00, bore a $3.50 cumulative annual dividend, and recited that the holder was entitled to 100 votes per share. Under the reclassification agreements, 75,000 shares of this stock were allocated as security for the Eastern loan, and the remaining 99,487 shares as security for the Holding Company loan. This stock also carried conversion rights and permitted such stock to be retired with the consent of two-thirds of the holders of the Preferred Stock. The 1937 reclassification of stock was approved by the necessary vote of each class of stock, including the Common.
At this point it may be noted that RFC, in connection with the loans made by it to Maryland, obtained and exercised a large measure of control over the management and affairs of the latter. This was achieved by reason of the voting rights acquired by RFC in connection with the stock held by it. A person designated by RFC became president and another designated by it became general counsel of Maryland. Other changes were made at the suggestion of RFC in the executive officers as well as the board of directors, although it appears that in the main such officers and directors were the same as those who served prior to the time of the loans made by RFC.
During the period from 1934 to 1942, Maryland unquestionably made remarkable progress in placing its financial structure in order; in fact, the progress thus made in itself constitutes a tribute to its management as well as to the wisdom of the officials of RFC in going to its rescue. Neither plaintiffs nor any other stockholder from 1934 to 1942 objected to or questioned the propriety of the protection which RFC exacted as a condition to the making of the loans.
Notwithstanding the progress made during this period, Maryland was continually in difficulty because of the inadequacy of its capital structure, which was a matter of serious concern both to Maryland and to RFC. As a result, numerous negotiations were carried on between Maryland and RFC relative to a further advance by the latter so as to put Maryland in a better competitive position and increase its earnings for the mutual benefit of Maryland and RFC. The latter ordered an investigation by one of its examiners, who in March, 1942 filed a voluminous written report reviewing the entire financial structure of Maryland, the progress it had made, and the deficiency in its capital structure, with a recommendation that a further loan of $12,500,000 be made.
As a result of this report, as well as many other factors unnecessary to relate, RFC tentatively agreed to make the additional loan. It was proposed by RFC that Maryland authorize and issue 299,487 shares of Preferred Stock to and in the name of RFC in exchange for a loan to Maryland of $12,500,000, and the surrender by RFC for cancellation and retirement the outstanding 174,487 shares of Class A preferred Stock then held by it as security for previous loans. The new stock issue proposed by RFC was to carry a lower dividend rate corresponding with the reduced interest rate on the RFC loans (old as well as new). The proposal also provided for the declaration and payment of all unpaid dividends accumulated upon the stock then held by it in an amount of more than $3,000,000. (No dividends had been paid on the stock held by RFC between 1937 and 1942.) A number of officials of Maryland who negotiated this 1942 transaction testified that they agreed to the RFC proposal because in their judgment it was fair. The proposal was approved by Maryland's executive committee and by its directors by a vote of 19 to 1 of those present. Of the 14 members not present, 13 wrote letters of approval. Thereupon, the plan was recommended to Maryland's stockholders and due notice sent to them of a meeting to take place on September 9, 1942, at which it was proposed to act upon the plan.
As negotiations between Maryland and RFC neared a conclusion in August, 1942, officers of the former pointed out to the latter the difficulty of securing the attendance of a sufficiently large number of holders of Common Stock to assure a two-thirds vote of all the outstanding Common Stock at a meeting of the stockholders to consider and act upon a proposed amendment to the charter essential to the making of the additional loan. Inquiry was thereupon made of RFC if it would be willing to effect a conversion of a part of the Class A Preferred Stock held by it into Common Stock so as to eliminate the possibility that the proposed amendment would fail due to non-attendance of Common stockholders. On August 20, 1942, RFC decided to effect a conversion of 29,487 shares of Class A Preferred Stock held by it. The ...