305 F.2d 572
In August 1957, Essex Universal Corporation, a Delaware corporation, learned of the possibility of purchasing shares in Republic Pictures Corporation from Herbert J. Yates, a California resident who served as president and chairman of the board of Republic, a New York corporation with 2,004,190 shares of common stock outstanding listed on the New York Stock Exchange.1
Negotiations led to a contract signed on August 28, 1957, under which Essex agreed to buy and Yates agreed to sell between 500,000 and 600,000 shares at eight dollars per share.2 The contract provided for a partial payment of three dollars per share at the closing scheduled for September 18, 1957, with the balance due in twenty-four equal monthly installments thereafter, and included a clause allowing Essex to request the resignations of a majority of Republic's directors and the election of its own nominees in their place.3
Yates later specified that he would deliver 566,223 shares, representing 28.3 percent of the outstanding stock, and Essex formally requested the director replacements as permitted by the contract.4 The procedure involved eight of the fourteen directors resigning seriatim, with each being replaced by an Essex nominee elected by the remaining directors, a method permitted under Republic's charter and by-laws.5
On the closing date, Essex tendered bank drafts and cashier's checks totaling $1,698,690 payable to its banker Benjamin C. Cohen, but Yates rejected the tender upon advice of counsel, stating that there could be no deal.6 Essex commenced an action in New York Supreme Court seeking $2,700,000 in damages, which was removed to the United States District Court for the Southern District of New York based on diversity of citizenship.7 Yates moved for summary judgment solely on the ground that the provision for immediate transfer of director control was illegal per se and tainted the entire contract.8 The district court granted the motion, and Essex appealed to the United States Court of Appeals for the Second Circuit.9
Whether, under New York law, a contract for the sale of 28.3 percent of the stock of a corporation is invalid as against public policy solely because it includes a clause giving the purchaser an option to require a majority of the existing directors to replace themselves, by seriatim resignation, with nominees designated by the purchaser?10
Under New York law, a contract for the sale of a substantial block of stock is not rendered illegal per se by a provision for immediate transfer of board control through seriatim resignations when the block carries practical voting control.11 Persons enjoying management control hold it on behalf of the corporation’s stockholders.12 No harm to the corporation is shown.13
No. The rule announced in Barnes v. Brown permits a seller of controlling stock to facilitate immediate board replacement when the purchaser acquires the equivalent of majority ownership.14 Applying the rule to the established facts, Essex contracted to purchase 566,223 shares representing 28.3 percent of Republic's 2,004,190 outstanding shares from Yates who was president and chairman.15 The contract contained paragraph 6 conditioning closing on seriatim resignations of eight of fourteen directors and election of Essex nominees.16 A procedure permitted by Republic's charter and by-laws.17
The tender of 1,698,690 dollars was rejected without any allegation of looting or injury to Republic or its remaining shareholders.18 The absence of any threat to corporate interests distinguishes the transaction from cases such as Gerdes v. Reynolds where liability attached only after harm occurred.19 Therefore the clause does not invalidate the contract on its face.20
The contract is not invalid as against public policy solely because of the director replacement clause.21
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Circuit Judge Clark concurs that summary judgment was improper because Barnes v. Brown teaches that not all such contracts are necessarily illegal.22 The action should be remanded for trial on the facts of each case with the normal presumption that the party asserting illegality must prove it.23 Clark emphasizes that the record does not present a naked transfer of corporate office.24
A management holding 28.3 percent ordinarily possesses working control absent an unlikely proxy battle.25 Further hypothetical findings on control should not affect the outcome.26
Circuit Judge Friendly concurs in reversal but would hold a provision like paragraph 6 violative of public policy except when the seller owns more than 50 percent of the stock.27 Stockholders are entitled to expect that vacancies will be filled by remaining directors exercising fiduciary responsibility rather than by mass seriatim resignation dictated by the seller at the purchaser's direction.28 Friendly notes that sudden shifts of control have caused injury in recent cases.29
Refusal to enforce such clauses provides a stronger prophylactic than requiring proof of the seller's knowledge of looting intentions.30
Whether the provision for immediate transfer of director control is separable from the remainder of the stock sale contract?31
No. The separability rule requires examination of whether the parties intended the stock sale to stand independently of the control transfer term.34 Applying the rule to the established facts, the contract stated that the resignations were to be delivered upon and as a condition to the closing of this transaction.35 Essex formally requested the replacements before closing.36 The price of eight dollars per share reflected the premium for immediate control rather than a deferred transfer at the next annual meeting in April 1959.37
The most elementary application of the parol evidence rule forbids any claim that the clause was a mere afterthought.38 New York precedents such as Manson v. Curtis treated similar combined provisions as integrated.39 Therefore the director replacement term cannot be severed to enforce the stock sale alone.40
The provision for immediate transfer of director control is not separable from the stock sale contract.41
Whether the legality of the contract provision depends on factual determinations regarding whether the purchased stock block confers practical majority control?42
Yes. The rule requires the party attacking legality to prove that the purchased block would not have assured election of a majority of directors in due course.45 Applying the rule to the established facts, Yates delivered 28.3 percent of Republic stock in a company listed on the New York Stock Exchange with more than 1,500 shareholders.46 A percentage commonly recognized as carrying working control in the absence of another organized opposing block.47
The contract price reflected that practical power.48 On remand Yates would bear the burden of showing some concretely foreseeable reason why Essex would not have prevailed in shareholder voting.49 Such as another organized block of sufficient size or cumulative voting provisions that could prevent control.50 Therefore the legality determination properly awaits factual resolution rather than summary disposition.51
The legality of the contract provision depends on factual determinations regarding whether the purchased stock block confers practical majority control.52
Related opinions on this issue
Circuit Judge Clark would not make the outcome turn on any district court determination of working control.53 The contract already provides for transfer of 28.3 percent together with effective board control.54 There is no evidence at this stage that the vendor's power to transfer control of the board was to be secured unlawfully, as for example by bribe or duress.55 Clark emphasizes that in the normal course of events a management which has behind it 28.3 percent of the stock has working control absent perhaps a pitched proxy battle which might unseat it.56
The court cannot foresee such an unlikely event or predict its outcome.57 Clark concludes that the trial judge should explore all issues which the pleadings may eventually raise without limiting the scope of the remand to the control question.58
Circuit Judge Friendly would reverse the summary judgment and remand solely for consideration of defenses other than the claim that paragraph 6 renders the contract void.59 The practical certainty test is difficult to apply and depends on many factors beyond the proportion of stock held.60 These include whether the other stock is widely or closely held, how much of it is in street names, what success the corporation has experienced, how far its dividend policies have satisfied its stockholders, the identity of the purchasers, the presence or absence of cumulative voting, and many others.61
Friendly would leave development of doctrine in this area to the New York courts rather than attempting to draw a line short of majority ownership.62