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Precision Extrusions, Inc. v. Stewart

MARCH 28, 1962.

PRECISION EXTRUSIONS, INC., PLAINTIFF-APPELLEE,

v.

PHILIP B. STEWART II, BELTON E. HALL AND SAMUEL H. DUHL, DEFENDANTS, THIRD PARTY PLAINTIFFS, APPELLANTS. WYCKOFF-ANDERSON, INC., THIRD PARTY DEFENDANT.



Appeal from the Superior Court of Cook County; the Hon. PHILLIP F. LOCKE, Judge, presiding. Affirmed in part, reversed in part and remanded with directions. MR. PRESIDING JUSTICE MCCORMICK DELIVERED THE OPINION OF THE COURT.

Rehearing denied and opinion modified April 26, 1962.

A summary judgment in the sum of $12,500 was entered in the Superior Court of Cook County in favor of Precision Extrusions, Inc. (hereafter referred to as plaintiff) against Philip B. Stewart II, Belton E. Hall, and Samuel H. Duhl (hereafter referred to as defendants). It was alleged that the three defendants were directors of Stewart-Hall Corporation at the time it had purchased 1,275 of its own common shares from Monogram Glass Co., Inc. in alleged violation of sections 6 and 42 of the Business Corporation Act. The judgment for plaintiff was predicated on its second amended complaint, as amended. The trial court denied the defendants' motion to dismiss, and afterward they filed an answer and a counterclaim alleging setoff. No reply to the answer and no answer to the counterclaim were filed by the plaintiff. The court denied a petition for summary judgment in favor of the defendants.

The defendants' theory, as stated in their brief, is that the second amended complaint, as amended, did not state a cause of action; that the trial court should have sustained defendants' motion to dismiss; that the court erred in entering a summary judgment on plaintiff's motion because there existed disputed material issues of fact; and that the court erred in denying summary judgment in favor of the defendants.

The plaintiff contends that its second amended complaint, as amended, stated a good cause of action; that the summary judgment entered on plaintiff's amended motion for summary judgment was properly granted; that the court in entering the summary judgment on the motion had a right to and did consider defendants' answer to plaintiff's second amended complaint, as amended, defendants' counterclaim and affidavit of Stewart attached to the answer, together with the affidavits of John F. Arnold, Simon H. Alster and Roy H. Johnson in support of the motion for summary judgment, together with exhibits attached thereto, and in addition portions of the discovery deposition of Stewart, plaintiff's request for admissions, and defendants' answer thereto.

The plaintiff contends that the court properly entered a summary judgment since there were no disputed material issues of fact.

The plaintiff in its second amended complaint, after the formal allegations with reference to the adjudication in bankruptcy of the Stewart-Hall Corporation (hereinafter referred to as Stewart-Hall) and the assignment by the trustee, pursuant to order of the referee, of the chose in action (the basis of the present suit), alleged that the defendants were directors of Stewart-Hall and in such capacity on December 22, 1954 unanimously voted that Stewart-Hall purchase from Monogram Glass, Inc. (hereinafter referred to as Monogram) 1,275 shares of Stewart-Hall capital stock at the price of $10 per share and that Stewart-Hall should hold such shares in the treasury as treasury stock; that Stewart-Hall gave its check to Monogram for $12,750 as consideration for the purchase of said shares; that Monogram cashed the check and assigned and delivered to Stewart-Hall the certificate for the said stock. The complaint further alleges, in paragraph 5, that "on said date, the net assets of Stewart-Hall Corporation were less than the sum of its stated capital, its paid-in surplus, any surplus arising from unrealized appreciation in value or revaluation of its assets and any surplus arising from surrender to Stewart-Hall Corporation of any of its shares." In paragraph 9 it is alleged that "said purchase was not for the purpose of eliminating fractional shares, collecting or compromising claims of Stewart-Hall Corporation, or securing any indebtedness to Stewart-Hall Corporation previously incurred, paying dissenting shareholders entitled to payment for their share in the event of a merger or consolidation or a sale or exchange of assets, or effecting the retirement of its redeemable shares by redemption or by purchase." Paragraph 10 in the second amended complaint, as amended, alleged that such purchase was in violation of section 6 of the Business Corporation Act of the State of Illinois and, by reason thereof and by reason of the provisions of section 42 of the said Act, Stewart-Hall suffered damages in the amount of $12,500 and the defendants became liable to the said corporation therefor; and that plaintiff as the assignee of the aforesaid trustee in bankruptcy of Stewart-Hall is entitled to have and recover of the defendants the damages suffered as aforesaid.

The defendants had filed a motion to strike the first amended complaint of the plaintiff, which motion was by order of court ordered to stand against the second amended complaint, as amended. In the portions of that motion applicable the defendants have alleged that section 6 of the Business Corporation Act "constitutes a penalty" and an action under that section is barred by the two-year statute of limitations; that section 6 does not create an action for damages against the directors or officers of the corporation; that the trustee in bankruptcy had no cause of action which he could assign to the plaintiff since it appears from the amended complaint that the defendants did not receive the proceeds of the transaction complained of, and even if the trustee had a cause of action against the defendants it was not assignable under Illinois law.

The court overruled defendants' motion to strike, and the defendants thereupon answered the complaint.

It is, of course, the rule that a party pleading over after an adverse ruling on his objection to a complaint waives the right to object to the pleading or the ruling on the motion. However, this rule does not apply where the complaint totally fails to state a cause of action, and under such circumstances it is open to attack even though the defendant has pleaded over. 30 ILP Pleading, sec 236; People v. Powell, 274 Ill. 222, 113 N.E. 614; Wright v. F.W. Woolworth Co., 281 Ill. App. 495. The rule in subsection (5) of section 48 of the Practice Act, providing that pleading over after a denial by the court of a motion under the section does not waive any error in the decision denying the motion, is not applicable here.

In the instant case the defendants on appeal contend that the second amended complaint, as amended, failed to state a cause of action. The complaint is based upon paragraphs 157.6 and 157.42 of chapter 32, Ill Rev Stats 1953, which chapter contains the Act commonly known as the Illinois Business Corporation Act. Section 6 provides that a corporation shall have power to purchase its own shares provided "that it shall not purchase, either directly or indirectly, its own shares when its net assets are less than the sum of its stated capital, its paid-in surplus, any surplus arising from unrealized appreciation in value or revaluation of its assets and any surplus arising from surrender to the corporation of any of its shares, or when by so doing its net assets would be reduced below such sum. Notwithstanding the foregoing limitations, a corporation may purchase or otherwise acquire its own shares for the purpose of: (a) Eliminating fractional shares. (b) Collecting or compromising claims of the corporation, or securing any indebtedness to the corporation previously incurred. (c) Paying dissenting shareholders entitled to payment for their shares in the event of a merger or consolidating or a sale or exchange of assets. (d) Effecting, subject to the other provisions of this Act, the retirement of its redeemable shares by redemption or by purchase at not to exceed the redemption price." Section 42(a) provides: "Directors of a corporation who vote for or assent to the declaration of any dividend or other distribution of the assets of a corporation to its shareholders shall be jointly and severally liable to the corporation for the amount of such dividend which is paid or the value of such assets which are distributed if, at the time of such payment or distribution, the corporation is insolvent or its net assets are less than its stated capital." Section 42(b) provides that if a declaration of a dividend or distribution of assets of a corporation renders the corporation insolvent, etc., the directors who vote for or assent to such action shall be jointly and severally liable. Section 42 further provides that a director shall not be liable under either subparagraph (a) or (b) of this section if he relied and acted in good faith upon a balance sheet and profit and loss statement of the corporation represented to him to be correct by the president or the officer of such corporation having charge of its books of account, or certified by an independent public or certified public accountant or firm of such accountants to fairly reflect the financial condition of such corporation, nor shall he be so liable if in good faith in determining the amount available for any such dividend or distribution he considered the assets to be of their book value.

Under the law as it existed in Illinois before the adoption of the statute a corporation had the right to purchase its own shares where the purchase was made in good faith and without element of fraud and when the corporation was solvent. Commercial Nat. Bank v. Burch, 141 Ill. 519, 528, 31 NE 420, 422; Republic Life Ins. Co. v. Swigert et al., 135 Ill. 150, 25 N.E. 680; Freedman v. Madison & Kedzie State Bank, 259 Ill. App. 519. In giving the right to the corporation to purchase its own shares section 6 merely reenacted the common law previously in existence. 6A Fletcher, Cyclopedia Corporations, secs 2848 and 2854 (Perm Ed); Clapp v. Peterson, 104 Ill. 26; Bunker Hill Country Club v. McElhatton, 282 Ill. App. 221; Brown v. Fire Ins. Co. of Chicago, 265 Ill. App. 393. The limitations set out in the statute were an attempt to spell out the corporation funds from which such purchase could be made. Section 6 in general provides that the purchase of a corporation's own shares may be made out of earned surplus, and in the notes on the section, in 1 Illinois Business Corporation Act Annotated, sec 6, p 51 (2d ed), it is said: "Because of the difficulty in framing an adequate definition of earned surplus, the rule was stated indirectly, forbidding purchases `out of' stated capital and various types of surplus other than earned surplus." In a critical survey of the Illinois Business Corporation Act by Henry Winthrop Ballantine in 1 U of Chicago L Rev, p 365, it is stated: "The Illinois draftsmen, however, have avoided the use of the term `earned surplus' on account of the difficulty of framing any statutory definition of this accounting term, and have deemed it best to back into the concept by a process of elimination. . . . An Illinois corporation is not expressly limited in any way, even by solvency, in the purchase of its own shares for certain special purposes. . . ." (An amendment to section 6 not in effect at the time of the instant transaction now prohibits a corporation from purchasing its own shares under any circumstances when it is insolvent.) The complaint negatived the existence of all conditions under which the shares might have been purchased from defendants out of funds other than earned surplus.

[4-7] There are numerous cases in Illinois and elsewhere discussing the responsibility and liability of the directors of a business corporation. It is generally held that a director of a corporation, though not responsible for errors of judgment, is a fiduciary charged with the duty of caring for the property of the corporation and of managing its affairs honestly and in good faith. If this duty has been so violated as to result in an impairment of its assets or loss of its property he can, without the aid of statute, be compelled to make restitution. 3 Fletcher, Cyclopedia Corporations, sec 1011, p 514, (Perm Ed). Directors are liable for misappropriation of funds where they act ultra vires in authorizing the corporation to purchase its own stock. 3 Fletcher, Cyclopedia Corporations, sec 1022, p 529, (Perm Ed); Noyes v. Wood, 247 F 72; Uffelman v. Boillin, 19 Tenn. App. 1, 82 S.W.2d 545. In Lyons v. Corder, 253 Mo 539, 162 S.W. 606, it was held that where a loss results to the corporation because of the disregard of the duties of the directors as prescribed by statute the directors are liable. See also 3 Fletcher, Cyclopedia Corporations, sec 1046, (Perm Ed), citing Lyons v. Corder, supra, La Monte v. Mott, 93 NJ Eq 229, 107 A 462, 468. Ordinarily an action can be brought by the corporation against the directors, or in case of the insolvency of the corporation, by its receiver or assignee. 3 Fletcher, Cyclopedia Corporations, sec 1275, (Perm Ed).

In Aiken v. Peabody, 168 F.2d 615 (7th Cir), the court held the directors of the corporation would be liable under Illinois law when they authorized a declaration of dividends the payment of which would reduce the "capital stock" of the corporation, providing that they acted in bad faith or were guilty of gross negligence or inattention, and the court further held that, while the case was based upon a statutory violation, the principle was one which had existed at common law. In the present case had the directors authorized the repurchase by the corporation of its own stock under the same circumstance, they could have been held liable at common law. Section 6 of the statute formulates rules with regard to an authorization of the repurchase of its own stock by a corporation, which places a definite duty on the directors. When the directors violate that duty it is not necessary that the statute specifically provide that they can be held responsible. At common law an action against them by the corporation or creditors would lie, since the result of such repurchase would be to illegally withdraw and pay to a stockholder a part of the assets of the corporation. When liability is imposed upon a director of a corporation by statute, his common law liability for misfeasance and negligence in the performance of his duty is not thereby excluded. 3 Fletcher, Cyclopedia Corporations, sec 993, (Perm Ed); Niblack v. Munday, 218 Ill. App. 385; Aiken v. Peabody, supra.

The plaintiff further alleges in its complaint that the act of the directors was a violation of section 42 of the Act. Under that section it seems clear that a repurchase by a corporation of shares of its stock at a time when the corporation is insolvent or its net assets are less than its stated capital is a distribution of its assets in part. In Pace v. Pace Bros. Co., 91 Utah 132, 59 P.2d 1 (1936), the court construes a statute which made it a misdemeanor for any director "to divide, withdraw or in any manner, except as provided by law, pay to the stockholders, or any of them, any part of the capital of the corporation." It was held that the statute was violated when the directors authorized the corporation to repurchase its own stock. The court says: "We see no reason why the prohibition against `paying' to a stockholder a part of the capital does not include buying his stock. . . . Moreover, the phrase `or any of them' is convincing that it does not contemplate purely a division pro rata, but the prohibition goes to paying any of the capital to any stockholder or stockholders, whether one ...


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