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Urnest v. Forged Tooth Gear Co.

NOVEMBER 14, 1968.




Appeal from the Circuit Court of Cook County, County Department, Chancery Division; the Hon. DANIEL A. COVELLI, Judge, presiding. Judgment affirmed.


This is a so-called shareholders derivative suit brought by the plaintiff, Charles Urnest, as a minority shareholder of The Forged Tooth Gear Company, one of the defendants. The remaining defendants are The Cornell Forge Company, which is the principal shareholder of The Forged Tooth Gear Company, and three individuals, A. Nelson Cornell, Alverin M. Cornell and Arthur M. Cornell, who are the principal shareholders of The Cornell Company, as well as officers and directors of that company and the Forged Tooth Gear Company.

The alignment of the parties and the nature of the controversy can best be explained by a chronological account of the events which led to the lawsuit.

For some 35 years, The Cornell Company has been in the business of manufacturing and selling small steel drop forgings. It is an Illinois corporation, and has its office and factory in Chicago. In about 1938, The Cornell Company began to manufacture a new product, known as forged tooth gears. These gears were fabricated or forged at The Cornell Company, and then were sent to Western Metal Products Company for final machining and heat treating. Western Metal was another Illinois corporation controlled by the three individual defendants, who owned or controlled 49% of its stock. Cornell Company would pay Western Metals for its services, and this expense would be included by Cornell in the price it charged for its forged tooth gears.

In 1952, the individual defendants organized another Illinois corporation, known as The Forged Tooth Gear Company, hereinafter referred to as "FTG." The total initial capital of FTG was $1,000, divided into 1,000 shares, all owned by The Cornell Company. The corporation was entirely inactive until 1958, and it appears that the purpose for its organization by the individual defendants was to protect the corporate name in the hope that forged gears would eventually become a successful product. During this period of inactivity of FTG, the three individual defendants served as its officers and directors.

In about 1957, problems arose between the personnel of The Cornell Company and Western Metal Products Company, with resultant difficulties in the production of forged tooth gears. The individual defendants, as officers of The Cornell Company, felt that they needed to retain the services of a gear expert, and the plaintiff was recommended to them as a man who could probably help them solve their problems. The plaintiff had been involved for a number of years in all phases of the manufacture of gears, at several different plants. He had worked at one gear company for twelve years, starting as a machine operator, and finally becoming a production manager.

Plaintiff and the individual defendants had a number of discussions in the summer of 1957, with the result that plaintiff went to work for the Cornell Company in July of that year, on a temporary or trial basis, at a salary of $200 per week. His duties were to work out the technical problems at Western Metals Company, to assist in the design and production of gears, and to help in the promotion and sale of forged tooth gears by The Cornell Company. There was no written contract of employment, and no designated period of employment. The arrangement apparently worked out well, and plaintiff continued with The Cornell Company on this basis until April of 1958. During this period of time, however, plaintiff made it known that he was interested in acquiring some interest in the business which would give him an opportunity for capital gain, rather than ordinary income, and a consequent tax advantage. Finally, after a series of discussions with the individual defendants, it was agreed that the inactive corporation, FTG, would be activated for the purpose of giving the plaintiff this opportunity for capital gain as opposed to ordinary income. All parties agree that the only reason for activating FTG was to give plaintiff this opportunity for capital gain.

Following these discussions, in 1958, the articles of incorporation of FTG were amended so as to authorize the issuance of a total of 100,000 shares. On June 10, 1958, 19,000 shares of FTG were issued to The Cornell Company, so that Cornell then owned a total of 20,000 shares. An additional 10,000 shares were issued to the plaintiff. The purchase price was $1 per share, payable in cash.

In the activated FTG then, 29,000 additional shares of stock were issued, of which Cornell Company owned 20,000 shares, for which it paid $20,000 and the plaintiff owned the remaining 10,000 shares, for which he paid $10,000. On June 10, 1958, at a special meeting of the shareholders of FTG, plaintiff was elected a director to fill a vacancy left by the resignation of Arthur M. Cornell, and, on the same day, at a special meeting of the directors, plaintiff was elected president of FTG. It was further decided to pay plaintiff an annual salary of $13,000, together with a bonus.

Thereafter, the production and sale of forged tooth gears was conducted in substantially the same manner it had been before the activation of FTG. The Cornell Company still manufactured the initial forging, Western Metal Products still did the machining and heat treating, and The Cornell Company still did the selling. FTG had no role whatever in the process. However, Cornell Company paid FTG a portion of its receipts from the sale of forged tooth gears. There was no fixed percentage which went to FTG, and it appears that the amount was almost arbitrary. The price of the gear to the Cornell customer was determined by adding the basic cost incurred by Cornell, the payments made to Western Metals for machining and heat treating, and as much of a mark up for profit as the circumstances of the individual sale would allow. A portion of this mark up went to Cornell and a portion of it went to FTG. Prior to the activating of FTG, the FTG portion had simply been retained by Cornell as part of its own profit.

FTG had its own bank account, and it deposited therein all of the checks it received from Cornell Company. It was from this account that plaintiff's salary was paid. FTG had no equipment or machinery of any kind. Its only asset was cash in the bank. It did not have an office, but used space in the office of The Cornell Company, for which it reimbursed Cornell Company. FTG had no letterheads or stationery but used those of Cornell Company. It had no customers of its own, and no source of income other than its receipts from The Cornell Company. It had no telephone number, but used the telephone of Cornell Company. All billings were made by Cornell Company directly to the customer. The customer in turn sent back its check made payable to Cornell Company who in turn would divide the check between Western Metal, FTG and itself. The record bears out the finding of the Master that "all of its activities of every kind were conducted by and through Cornell Co."

There was never any written employment contract between plaintiff and the Cornell Company, nor between plaintiff and FTG. There was no definite term fixed for his employment. Nor was there any written agreement between Cornell Company and FTG. There was no agreement of any kind whereby Cornell Company agreed to continue its relationship with FTG or to do business with FTG for any specific period of time. Neither was there any agreement as to how much Cornell Company should pay to FTG.

This arrangement continued until about March of 1959. Up to that time, the activated FTG had accumulated, by virtue of the payments from Cornell Company, $33,704.04, after payment of its expenses during that period. Thus, its net worth had increased from its original capital of $30,000 to a total of $63,704.04.

At the end of March, 1959, A. Nelson Cornell informed the plaintiff that the arrangement between Cornell Co. and FTG was to be discontinued, and plaintiff's employment was to be terminated. He offered to return to plaintiff his original $10,000, investment in FTG, plus an additional $1,000 or $2,000 "to compensate him for the use of his money." On April 17, 1959, a special meeting of the directors of FTG was held, at which a resolution was adopted removing plaintiff ...

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