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Wolfson v. Avery





APPEAL from the Circuit Court of Cook County; the Hon. HARRY M. FISHER, Judge, presiding.


Rehearing denied June 10, 1955.

Louis E. Wolfson filed a complaint in the circuit court of Cook County against Montgomery Ward & Company and its directors, seeking a declaratory judgment that section 35 of the Illinois Business Corporation Act, (Ill. Rev. Stat. 1953, chap. 32, par. 157.35,) which purports to authorize the classification of directors into not more than three classes and the election of only one class annually, is unconstitutional and void, and that the company's bylaw adopted pursuant thereto is therefore unlawful. After answer was filed, plaintiff moved for judgment on the pleadings. The court sustained the motion and entered judgment as prayed in the complaint. Defendants appeal directly to this court, on the ground that a construction of the constitution and the validity of a statute are involved. Pursuant to leave heretofore granted, several additional Illinois corporations having classified directors have intervened as amici curiae in support of the appeal.

From the allegations of the pleadings admitted by the answer and the motion for judgment, it appears that the board of directors of Montgomery Ward & Company consists of nine members divided into three classes of three directors each. At each annual meeting of the stockholders one class is elected for a term of three years. On August 18, 1954, appellee became the owner of 20,000 shares of common stock. About two months later he sent a letter to appellants asserting that the provision of the bylaws for the election of only one third of the directors each year was unlawful, and demanding the rescission and repeal of that portion of the bylaws relating to the classification of directors and their election for so-called "staggered" terms. Appellee further requested in the communication that the individual appellants forthwith announce to shareholders that at the annual meeting to be held on April 22, 1955, the full membership of the board of directors may be elected to office. After receipt of the letter appellants failed to rescind or repeal the allegedly illegal portion of the by-laws, although they had ample opportunity to do so, and appellee instituted the present action on November 1, 1954.

Section 35 of the Illinois Business Corporation Act, pursuant to which the company's bylaw was adopted, provides as follows: "When the board of directors shall consist of nine or more members, in lieu of electing the whole number of directors annually, the by-laws may provide that the directors be divided into either two or three classes, each class to be as nearly equal in number as possible, the term of office of directors of the first class to expire at the first annual meeting of shareholders after their election, that of the second class to expire at the second annual meeting after their election, and that of the third class, if any, to expire at the third annual meeting after their election. At each annual meeting after such classification the number of directors equal to the number of the class whose term expires at the time of such meeting shall be elected to hold office until the second succeeding annual meeting, if there be two classes, or until the third succeeding annual meeting, if there be three classes." The sole issue presented by the appeal is whether the classification of directors permitted by the statute, and their election for staggered terms, violate section 3 of article XI of the Illinois constitution, which guarantees to stockholders the right to cumulate their votes in the election of directors.

Under cumulative voting, a method designed to enable minority stockholders to gain representation on the board of directors, each shareholder is entitled to votes equal to the number of his shares multiplied by the number of directors to be elected. He may cast all his votes for a single candidate or distribute them among two or more as he sees fit. It is not disputed that in an election of only three members of a nine-member board, approximately 250 per cent as many votes are required to elect a single director as would be necessary if all nine members were to be elected at the same time. In an election of the full board of nine directors, the owners of 10 per cent of the stock voted, plus one share, could elect one out of the nine directors to be elected. On the other hand, if the board of directors is classified so that only three members are elected each year, it would require 25 per cent of the stock voted, plus one share, to gain a single seat on the board. Where all nine members are elected at once, a minority holding 49 per cent of the stock could elect four; and the majority holding 51 per cent of the shares, by cumulating their votes in the most advantageous manner possible, could elect no more than five out of the nine directors. If only three members of the board are elected each year, however, the holders of 49 per cent would be able to elect only one director at each election, and could never have more than three directors on the board at one time. Similarly, an owner of 25 per cent of the stock could elect two directors if all nine were chosen at once, whereas under the present bylaw such a shareholder would be unable to elect even one director. It is evident, therefore, that as the number of directors up for election decreases the number of share votes necessary to elect one director increases. (See Williams, Cumulative Voting for Directors, pp. 48-49, Harvard Business School, 1951; Ballantine, A Critical Survey of the Illinois Business Corporation Act, 1 Univ. Chicago L. Rev. 357, 385-386; The Corporate Directorship, National Industrial Conference Board Study No. 63 (1953) p. 12; Note, 66 Harv. L. Rev. 531, 532; Note, 56 Dickinson L. Rev. 330; 27 St. Johns L. Rev. 357, 358-359.) Classification of directors in fact impairs even majority representation by requiring the majority to wait for two or three years before it can secure representation proportional to its strength.

Appellee's position is that since the degree of a minority's representation on the board varies directly with the number of directors to be elected, representation in proportion to its holdings is defeated if the entire board is not elected at one time; and that the purpose of the constitutional provision for cumulative voting in corporate elections is to give minority shareholders the right to proportional representation on corporate boards. The appellants, on the other hand, insist that the purpose of cumulative voting is not to guarantee proportional representation but simply to enable minorities to secure some representation or voice on corporate boards of directors. It is pointed out that a corporation may reduce the number of its directors to three without violating any constitutional or statutory restriction; that in such event the number of shares required to elect a single director would likewise be increased; that the constitution does not require any particular number of directors except that by use of the plural it contemplates at least two; that the percentage of shares which a minority group must have in order to secure any representation on the board of directors is therefore left to the discretion of the General Assembly; and that since the General Assembly may lawfully provide for corporations with three directors it may also provide for corporations with classified boards of directors with three in each class.

The determination of the issue presented in this case depends upon a proper construction of section 3 of article XI of the constitution, which reads as follows: "The general assembly shall provide, by law, that in all elections for directors or managers of incorporated companies, every stockholder shall have the right to vote, in person or by proxy, for the number of shares of stock owned by him, for as many persons as there are directors or managers to be elected, or to cumulate said shares, and give one candidate as many votes as the number of directors multiplied by the number of his shares of stock shall equal, or to distribute them on the same principle among as many candidates as he shall think fit; and such directors or managers shall not be elected in any other manner."

Although this State and many others have long had both mandatory cumulative voting and permissive classification of directors, no reported decision has been found in which the precise question presented here has been considered. In Wright v. Central California Water Co. 67 Cal. 532, 8 P. 70, a constitutional provision for cumulative voting was held to be violated where a majority of the shareholders approved a resolution to elect the company's seven directors in seven consecutive elections, electing one director at each election. The court observed: "We think the power thus conferred upon a corporate elector can only be exercised, according to the constitutional provision, by allowing him to cast his ballot singly, cumulatively or distributively, at one time, for the election of directors, for if but one director at a time be balloted for, a majority of the stockholders could, by combining, cumulate their voters each time upon a single candidate and elect him, and by thus shaping and controlling the manner of election it would be in the power of the majority of the stockholders to virtually cancel the votes of the minority and deprive them of their rights to representation on the board of directors." In People ex rel. Espey v. Deneen, 247 Ill. 289, this court recognized the soundness of the decision in the Wright case, saying "there can be no cumulative voting where there is but one officer to elect." The Deneen case involved the constitutional provisions of article IV, sections 7 and 8, as to cumulative voting in primary elections for representatives in the General Assembly. The court made this pertinent observation with respect to minority representation: "The constitution guarantees the right of minority representation, and the legislature has no power to pass any law the direct purpose or practical operation of which defeats, abridges or restricts that right." Some aspects of the Deneen case were overruled in People ex rel. Lindstrand v. Emmerson, 333 Ill. 606, but that decision reaffirmed the view that the cumulative voting provisions of the constitution must be construed so that their purpose is not defeated, and that the practical operation of a law must be considered in determining whether it defeats the right of minority representation.

Appellants contend the language of section 3 of article XI does not forbid classification of directors and their election for staggered terms, but plainly contemplates a power in the General Assembly to continue the practice which was well known at the time the constitution of 1870 was adopted. In support of the contention it is argued that since the section gives stockholders the right to vote for as many persons as there are directors "to be elected," it contemplates the possibility that less than the whole number may be elected at any particular annual meeting; and that the construction adopted by the circuit court renders meaningless the words "to be elected." Appellee takes the position that the words in question are neutral, and were used merely to describe the persons involved in future elections, to make it clear, for example, that if a corporate board is increased or decreased in size the new number is to be chosen rather than the original number. We may say at once that the failure of the convention to expressly forbid classification is not determinative. This court has not heretofore taken so literal an approach to the constitutional provision. Neither the filling of vacancies by directors, nor the issuance of nonvoting stock is expressly forbidden, yet statutes authorizing both practices have been held invalid. (People ex rel. Weber v. Cohn, 339 Ill. 121; People ex rel. Watseka Telephone Co. v. Emmerson, 302 Ill. 300.) Nor do we think the words "to be elected" can be given the meaning or significance ascribed to them by appellants. The same phrase appears in sections 7 and 8 of article IV of the constitution, dealing with minority representation in the General Assembly. Thus, after stating that three representatives shall be elected in each senatorial district every two years, these provisions declare that "each qualified voter may cast as many votes for one candidate as there are representatives to be elected, or may distribute the same, or equal parts thereof, among the candidates, as he shall see fit." (Emphasis supplied.) Since three representatives must always be elected, the phrase in question was obviously not used in reference to the number of representatives to be elected, and we would not be warranted in attributing a different meaning or intent to the words as used in section 3 of article XI, unless the context so requires. A careful examination of the entire section fails to disclose any indication that the words "to be elected," appearing in the first clause, were intended to imply that less than the entire board could be elected at one time. On the contrary, the second clause of the section, which deals expressly with cumulative voting, indicates rather that all directors must be elected at each regular election. It confers on each stockholder the right "to cumulate said shares, and give one candidate as many votes as the number of directors multiplied by the number of his shares of stock shall equal, or to distribute them on the same principle among as many candidates as he shall think fit." (Emphasis supplied.) Appellants argue in effect that the words "candidate" and "candidates" in the second part of the section refer to the office or offices of "directors or managers to be elected," mentioned in the first part of the section, and that the phrase "number of directors" must therefore mean only the number which is to be elected at the particular annual meeting. The argument is not convincing. In our opinion these words should be given their ordinary meaning, namely the whole number of directors of the corporation. In People ex rel. Watseka Telephone Co. v. Emmerson, 302 Ill. 300, we had occasion to construe the present section of the constitution in deciding whether a corporation could provide for preferred stock without any right in the owner to vote for directors. It was contended that the phrase "every stockholder," as used in section 3, should be construed to mean "every stockholder entitled to vote." It was held, however, that under this provision of the constitution all stockholders must have the right to vote for directors. We observed that "If the convention intended that only those stockholders who were given the right to vote by the charter or articles of incorporation adopted by the company were included it would have been perfectly easy to word this section so as to convey this meaning, but instead of so wording it the convention used the language, `every stockholder shall have the right to vote, in person or by proxy, * * * for as many persons as there are directors or managers to be elected,' and followed this with a provision as to cumulating said shares." In the case at bar it should likewise follow that since the convention failed to qualify the words "number of directors," it must have intended their natural meaning as all the directors of the corporation.

Appellants and the amici curiae rely upon the rule that any subject of government which is not within some constitutional inhibition may be acted upon by the General Assembly, and that constitutional provisions should be liberally construed in order that the legislative enactment may be sustained. It is true that section 3 says nothing about the number of directors which a corporation must have, except that the use of the plural in connection with cumulative voting implies there must be more than one; that it does not in terms require the whole number of directors to be elected at each regular or annual meeting; and that the classification of directors and their election for staggered terms is not expressly forbidden. It is well settled, however, that prohibitions may be found not only in the language used but also by the necessary implications of such language. The guaranty of minority representation prohibits any law which in effect defeats or nullifies it, even though such law does not in express terms attempt to nullify the right. It is not disputed that staggered elections enlarge the percentage of votes necessary to obtain representation on the board, and may result in excluding any representation for minorities which would otherwise be able to elect a director. It is likewise evident that the classification of directors and their election for staggered terms do not purport to affect the legal right of a stockholder to vote his shares cumulatively, and that the right of cumulative voting does not pretend to assure a minority a representation in any event.

It is true, as defendants urge, that the constitutional provision does not insure a voting strength which is precisely proportionate to stock ownership, and that the actual operation of the provision in a particular situation will depend upon three variable factors: the total number of shares, the number held by the stockholder, and the number of directors. But these variable factors are inherent in the language of the constitution. Their presence does not, we think, authorize us to sanction the introduction of another variable which is not inherent, — classification of directors by terms.

In determining whether the effect of classification in mathematically increasing the percentage of votes required for representation on the board is a substantial denial of the constitutional right of cumulative voting, it is appropriate to consider the mischief designed to be remedied and the purpose sought to be accomplished by the provision. Since the language to be construed is a constitutional provision, the object of inquiry is the understanding of the voters who adopted the instrument. In this connection it is appropriate to consider the historical background for the inclusion of section 3 and the debates of the members of the convention, as well as explanations of the provision published at the time. As we stated in Burke v. Snively, 208 Ill. 328, at 344-345: "In construing constitutional provisions the true inquiry is, what was the understanding of the meaning of the words used by the voters who adopted it? Still, the practice of consulting the debates of the members of the convention which framed the constitution, as aiding to a correct determination of the intent of the framers of the instrument, has long been indulged in by courts as aiding to a true understanding of the meaning of provisions that are thought to be doubtful."

The United States Supreme Court employs the same technique in interpreting the Federal constitution. In the words of Chief Justice Marshall, "In expounding them [the words of the Federal constitution], we may be permitted to take into view those considerations to which courts have always allowed great weight in the exposition of laws. The framers of the constitution would naturally examine the state of things existing at the time; and their work sufficiently attests that they did so." The Chief Justice continued: "Great weight has always been attached, and very rightly attached, to contemporaneous exposition. * * * The opinion of the Federalist has always been considered as of great authority. It is a complete commentary on our constitution; and is appealed to by all parties in the questions to which that instrument has given birth. Its intrinsic merit entitles it to this high rank; and the part two of its authors performed in framing the constitution, put it very much in their power to explain the views with which its was framed." (Emphasis supplied.) (Cohens v. Virginia, 6 Wheat. 264, 416-418; cf. Transportation Co. v. Wheeling, 99 U.S. 273, 280; United States v. Southeastern Underwriters Ass'n, 322 U.S. 533, 551.) While there is no such historic source as the Federalist Papers to aid in the interpretation of the Illinois constitution, we do have relevant data in the explanations which appeared in the press.

There was prevailing throughout the 1860's popular indignation at the excesses and frauds of certain railroad managements, and the press was vehement in its denunciation of the "rings" which controlled many of the railroad companies which defrauded minority stockholders. Prior to the Constitutional Convention, the moving force behind the idea of minority representation in political and corporate elections in Illinois was a group known as the Minority Representation Society of which Joseph Medill, publisher of the Chicago Tribune and one of the framers of the controverted constitutional provision, was a leading member.

A news item in the Chicago Tribune for December 31, 1869, reports the proceedings of the annual meeting of the Minority Representation Society at which Medill stated that he proposed to offer the convention a bill for minority representation, which he referred to as "proportionate representation" and which would not be confined to political matters only but which would include corporate bodies in which the minority would have their due representation.

Medill became the leading advocate of cumulative voting for both political and corporate elections, and introduced the cumulative voting provision for the election of directors soon after the convention assembled. In May, 1870, the Committee on Miscellaneous Corporations submitted a report recommending the present constitutional language. From the ensuing reported debates the intention of the framers may be gleaned.

Medill himself referred to the provision as proportional representation and in introducing the proposal, stated: "The subject of proportional representation is attracting the earnest and anxious thought of the ablest statesmen and writers in Europe as in America." (Constitutional Debates, pp. 563-564.) In expounding the section he described a system of proportional representation: "Suppose a company with a capital stock of $100,000 elect ten directors. At present, under the ordinary method of electing directors, stockholders holding five hundred and one shares elect the entire board, and those holding four hundred and ninety shares cannot elect a man to represent their interests. After these ten directors are thus elected, they can proceed to create an `executive committee,' to run the institution, the members of which may not represent a quarter or a fifth of the stock. Thus we have the whole interests of the company controlled by $25,000 or $30,000 of stock. On the plan here proposed the holders of $49,000 by clubbing their votes together could elect four of the ten directors, and if shares to the amount of $10,000 were held by one stockholder he could elect one director to protect his interests." (Constitutional Debates, p. 1666.)

Another delegate, Mr. Coolbaugh, in illustrating the proposal, also described proportional representation and stated: "The principle is precisely this: If I am an individual owner of one third of the capital stock of an incorporation organized for pecuniary profit, it would enable me to have representation in the board of directors equal to my interest in the stock of that corporation. For instance, if a company is organized with a capital stock of $100,000, with nine directors, and I am the owner of one third of the aggregate capital of that company, I will have the privilege of electing three of those directors, and have an influence on that board of directors equal to my interest in the company. I can see no wrong in that, but I can see that it is just and fair and equitable, and that it secures, beyond any doubt or peradventure, the interests and rights of minorities in these corporations." (Emphasis supplied.) Constitutional Debates, p. 1667.

Contrary to appellants' interpretation of Medill's position, it is patent from the editorial in the Chicago Tribune of May 14, 1870, that he did mean that section 3 of article XI required the whole number of directors to be elected at one time. The editorial states: "In all incorporated companies every stockholder shall have the privilege of voting as heretofore, for as many Directors as are to be elected, or of casting the whole number of his shares, multiplied by ...

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