Everett v. Phillips , 288 N.Y. 227 ( 1942 )

At all the times of which we write, the individual defendants controlled both Long Island Lighting Company and Empire Power Corporation. In dealings between those corporations these individual defendants sat on both sides of the table. They caused Empire Power Corporation, from November, 1930, to February, 1933, to loan Long Island Lighting Company $5,330,000 on the latter's unsecured notes. These notes and various renewals thereof were all made for periods of less than a year. (See Public Service Law, § 69.) Interest has been paid regularly but, up to the beginning of this action, nothing was ever paid on principal. The lighting company needed these moneys — and used them — to pay off, from time to time, notes held by banks which were asking for payment. In 1930, when Empire made its first loan to the lighting company, the latter owed the banks more than $10,000,000 and found it increasingly difficult to persuade the banks to accept renewals of their unsecured notes. The banks had suggested to the individual defendants that the lighting company discontinue paying cash dividends, so that it might accumulate in its treasury funds with which to pay off the bank loans. This the individual defendants, who owned or controlled half of the lighting company's common stock, were unwilling to do. An application to the Public Service Commission for authority to issue mortgage bonds to raise money to pay off the banks was pending but undetermined. There was only one other convenient source of funds. A lender had to be found who would supply, without security and without question, the cash needed from time to time to satisfy the banks. Such a lender was ready at hand in Empire Power Corporation, completely controlled by these individual defendants themselves.

During 1930 and 1932 these defendants arranged loans aggregating $4,500,000 from the power corporation to the lighting company, most, if not all, of the proceeds going to pay off the bank loans. In March, 1932, when the lighting company owed the power corporation about $4,500,000 and the banks about $8,750,000, an agreement was made between the lighting company and the banks whereby the latter accepted renewals of their notes for six months, and agreed to accept renewals for another six months if necessary, on condition that the lighting company make certain payments which were intended to come from, and did come from, Empire Power Corporation. It was part of this arrangement that the whole of the lighting company's debt to Empire Power Corporation should be postdated to that of the banks, postdated rather than subordinated because it was felt that subordination "would be openly subject to attack on account of the unity of interest between Empire Power and Long Island Lighting."

A little later Empire's directors passed a resolution agreeing on behalf of Empire "to extend and keep extended the time of payment" of the lighting company's notes to Empire Power Corporation until the banks should be paid in full. An agreement to the same effect was made by defendant Phillips on behalf of Empire, in 1933, and approved by Empire's board of directors. Later that same year the Public Service Commission granted permission to the lighting company to sell the issue of bonds above referred to, but sale at the stipulated price was found to be impossible. Again the bank notes had to be renewed, and again Empire Power Corporation was caused to agree to subordinate its claims to those of the bank. Finally, in 1934, the authorized bond issue was sold by the lighting company under a contract which provided that the indebtedness to Empire Power Corporation would not be paid, discharged or secured by the issuance of any bonds of the lighting company secured by a lien prior to or on a parity with the lien of the bond issue. All of the proceeds of this bond issue went to the banks, none to Empire Power Corporation. In 1936 the lighting company paid off all its unsecured indebtedness, except that owing to Empire Power Corporation. Among the debtors so paid off were the common directors of the two corporations and their relatives and corporations controlled by them. Thus Empire Power Corporation, starting out with short term loans to the lighting company, ended up with what amounted to a "permanent investment" of $5,000,000 in the lighting company, in the form of unsecured notes, payment of which, if this suit fails, must await the pleasure of the defendants.

In this suit plaintiffs on behalf of Empire Power Corporation asked the court to compel Long Island Lighting Company to repay the moneys loaned to it by the Empire Corporation, to compel the individual defendants, as directors of Long Island Lighting Company, to pay that indebtedness if the lighting company does not, and to restrain the individual defendants from further extending the time of payment. Special Term found, as stated in its opinion, that the conduct of the individual defendants, in making and renewing these loans, was biased in favor of the lighting company, and ordered judgment for plaintiff. The Appellate Division reversed on the law and the facts and rendered final judgment dismissing the complaint. Contracts between two corporations having common officers are, of course, not void perse (Burden v. Burden, 159 N.Y. 287; Continental Ins. Co. v. N.Y. H.R.R. Co.,187 N.Y. 225), but are voidable by either corporation, irrespective of the balance of benefits (Globe Woolen Co. v. Utica Gas Elec. Co., 224 N.Y. 483; Munson v. Syracuse, G. C.R.R.Co., 103 N.Y. 58), or by a court of equity at the instance of either corporation (or its stockholder), where it appears that such a contract was made in bad faith, fraud, other breach of trust or under circumstances preventing "an unprejudiced exercise of judgment." (Sage v. Culver, 147 N.Y. 241; Farmers L. T.Co. v. N.Y. Northern Ry. Co., 150 N.Y. 410; Kavanaugh v.Kavanaugh Knitting Co., 226 N.Y. 185; Geddes v. AnacondaCopper Mining Co., 254 U.S. 590; United Copper Securities Co. v. Amalgamated Copper Co., 244 U.S. 261, 264; Koral v.Savory, Inc., 276 N.Y. 215.) A court will not attempt to pass upon questions of expediency or to control the corporate managers in the faithful exercise of their discretion. (City Bank FarmersTrust Co. v. Hewitt Realty Co., 257 N.Y. 62; United CopperSecurities Co. v. Amalgamated Copper Co., supra; Burden v.Burden, supra.) To make a case for the invalidation of such a contract there must be shown circumstances tending to prove that the contract was made in bad faith, fraud or other breach of trust, including a biased exercise of judgment. (Globe WoolenCo. v. Utica Gas Elec. Co., Sage v. Culver, United CopperSecurities Co. v. Amalgamated Copper Co., Koral v. Savory,Inc., supra.) Given such a showing, the burden is then upon those who would maintain the contract to establish its fairness (Sage v. Culver, supra), particularly when they themselves are shown to have exercised the dominating influence in effecting the contract. (Geddes v. Anaconda Copper Mining Co., supra.) Whether the particular contract between these two corporations having the same directors was or was not made under circumstances amounting to a breach of the directors' fiduciary duty, is a question of fact.

Here the individual defendants who arranged the loans by Empire Power Corporation to Long Island Lighting Company, were completely aware of the latter's financial difficulties at the times the loans and renewals were made. They and their families owned the majority of the lighting company's stock; they directed its policies and managed its affairs; some of them were unsecured creditors of the lighting company in substantial amounts. It was to their interest, individually, that the lighting company's urgent need of funds to pay its unsecured and demanding bank creditors be met. They met it by loaning Empire's money to Long Island on such terms that Empire's capital funds were used to pay off Long Island's bank loans in part, then these loans were made subordinate to the balances owing to the banks and finally remained wholly unpaid when all Long Island's other creditors of the same class were taken care of by the proceeds of a bond issue. The inference is unescapable that in the making of these loans, and renewals, the welfare of Empire Power Corporation was ignored and that the purpose of defendants was to benefit Long Island Lighting Company, and themselves. It is no answer to all this that Empire's financial structure may have resilience enough to absorb the risk or the damage of the loans, or that the individual defendant's stake in Empire is large and the plaintiff's small. Plain disclosure of the inequity of the situation and of the unfairness of the risk to the Empire Corporation, makes a strong appeal to the conscience of the court. It is not answered by defendants' protestations that Empire has a good investment in these loans, that they would surely be paid on a liquidation of the lighting company, that the lighting company's credit is good, etc., or by the provision in Empire Power Corporation's charter concerning contracts between that corporation and other corporations with the same officers or directors.

A court of equity in such a case as this does not stand aside and await the outcome of defendants' conduct. It acts promptly and effectively. It sets the whole transaction aside without waiting, or compelling minority stockholders to wait, to see whether those who unlawfully put a corporation's property at risk, may possibly at some undetermined time, have the skill, or luck, to get it back intact for the corporation.

The judgment of the Appellate Division should be reversed and that of the Special Term reinstated, with costs.

LOUGHRAN, LEWIS and CONWAY, JJ., concur with LEHMAN, Ch. J.; DESMOND, J., dissents in opinion in which FINCH and RIPPEY, JJ., concur.

Judgment affirmed.