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Braun v. Fleming-Hall Tobacco Co.

Supreme Court of Delaware

November 4, 1952

BRAUN
v.
FLEMING-HALL TOBACCO CO., Inc. et al.

Page 303

[33 Del.Ch. 248] SOUTHERLAND, Chief Justice, and WOLCOTT and TUNNELL, Justices, sitting.

Appeal from a final judgment of the Court of Chancery approving the compromise settlement of certain derivative stockholder suits. A motion to dismiss the appeal denied. The Court of Chancery affirmed on the merits.

Russell J. Willard, Jr. (of Hastings, Stockly, & Walz), of Wilmington, for appellant Max Braun.

John Van Brunt, Jr. (of Killoran & Van Brunt), of Wilmington, for Herbert W. Salus, Jr., the plaintiff-below.

Edwin D. Steel, Jr. (of Morris, Steel, Nichols & Arsht), of Wilmington, for Fleming-Hall Tobacco Co., Inc., defendant-below, appellee.

David F. Anderson (of Berl, Potter & Anderson), of Wilmington, for Sol C. Korn, defendant-below, appellee.

TUNNELL, Justice.

Fleming-Hall Tobacco Co., Inc., a corporation, hereinafter called 'Fleming-Hall', was organized under the laws of the State of Delaware in 1945.

From the time of Fleming-Hall's origin one Sol C. Korn, hereinafter called 'Korn', has been its president. Since 1947 Korn's salary has been $2500 per month, plus expenses. The most recent employment contract with Korn retains his services to the company at the above-stated salary for a further period of five years, beginning on January 1, 1950.

Fleming-Hall, as the major feature of its general business of manufacturing and selling tobacco products, has heretofore manufactured and sold two brands of cigarettes called 'Sano' and 'Encore', respectively. These brands are little known to the public,

Page 304

During the years since 1945 Korn has, for various such expenses for gifts and entertainment, and for his own travel, received large sums of money, the exact amounts thereof, however, being a matter of dispute. No vouchers or invoices were required in respect to any of these sums so paid to Korn from time to time, and no method was employed which would record any particulars as to the said money, such as on whom, when, where, or for what, it was spent. Korn would testify, [1] however, that he spent all these monies for company purposes, and the total expenses of Fleming-Hall for promotion and advertising has borne approximately the same relation to its volume of sales as is the case with a number of Fleming-Hall's competitors.

The company has always suffered financial difficulty. It lost money every year except in 1949, when the profit it made was, however, of little consequence when compared with the losses before and after 1949.

In 1948, purportedly in an effort to retain its personnel in the face of an unpromising future, the corporation extended to Korn and a number of other individuals affiliated with the company as directors, officers, or employees, options for the purchase of 135,000 shares of the common stock of the said corporation. The options were to purchase the said stock at $1.00 per share. In 1948 the market price of the stock was from 50cents to 60cents per share. The option plan provided for subscribing for the stock by a down-payment of one cent per share, and by the giving of notes to the company representing the balance of the purchase price. The shares so subscribed for under the plan were to be held by the company as collateral for the payment of the notes, but the personal credit of the optionees was not bound for the payment thereof.

[33 Del.Ch. 250] Pursuant to the above option plan, Korn, on the 15th day of October, 1948, entered into an agreement securing to himself an option to purchase 80,000 shares, and he ultimately took over either the options of other persons for 12,500 additional shares or that number of actual shares subscribed for by others under the plan. Of the remaining 42,500 shares, 31,000 were purchased by members of the board of directors and 11,500 by employees who were not on the board.

In July of 1950 the company offered to all of its stockholders an option to purchase 79,414 shares of authorized but unissued capital stock of the corporation at $1.25 per share. After the said offer to stockholders had remained open for two months without any person availing himself thereof, Korn, on August 31, 1950, offered to subscribe for any of the said 79,414 shares which others would not take up within the period during which the company's offer to stockholders was limited. In due course, on February 2nd, 1951, promptly upon the expiration of the term of the public offering, the company accepted Korn's offer and permitted him to subscribe for the residue of the lot of stock, being 62,364 shares, taking from him a payment of one cent per share, and taking his note for the balance of the purchase price.

All options above mentioned were exercised before the 9th day of March, 1951 and the transfer agent had at that time duly issued certificates of stock for the same, stamping each certificate so as to indicate that the shares were only partially paid.

Page 305

On March 22, 1951, after at least a month of preliminary negotiation, [2] Fleming-Hall entered into a contract with United States Tobacco Company to sell to the latter corporation substantially all of Fleming-Hall's assets for the sum of $4,325,000, subject to certain minor adjustments in the price at settlement.

On the 8th day of June, 1951, and on the 20th day of June, 1951, one Herbert W. Salus, Jr., a beneficial owner of certain shares of the common stock of Fleming-Hall, instituted two separate derivative actions in the Delaware Court of Chancery, both suits [33 Del.Ch. 251] naming Fleming-Hall as the nominal defendant and Korn as the real defendant. In the first suit it was sought to bring Korn into court under the provisions of Para. 4374, Revised Code of Delaware, 1935. In the second suit personal service upon Korn was obtained.

On the 20th day of June, 1951, the stockholders voted approval of a proposal to dissolve the company and distribute its assets to the shareholders. Thereafter a first liquidating dividend of $1.00 per share was paid on the common stock.

On the 12th day of September, 1951, a third derivative action was filed by the same plaintiff against the same two defendants, but also against fifteen non-residents [3] of the State of Delaware as additional co-defendants. These fifteen individuals were alleged to have served as directors or officers of Fleming-Hall or to have been affiliated with the company in some other connection as employees or favored customers, and were alleged to be the persons who, along with Korn, had acquired stock in the company as a result of the above-described 1948 stock option plan. No personal service was obtained on any of these fifteen additional defendants, and jurisdiction over them is predicated solely upon Para. 4374, Revised Code of Delaware, 1935.

Since all three of the said suits involve common issues of fact and law, pursuant to a stipulation of counsel under Rule 42(a) of the Court of Chancery, on the 16th day of October, 1951, the Chancellor entered an order consolidating the three actions into a single proceeding.

Taking in the aggregate all of the allegations of the three complaints, it appears that there were three specific charges of irregularities.

In respect to the 1950 option, the complaints allege that Korn purchased his 62,364 shares only after he had 'acquired knowledge of the willingness of the United States Tobacco Company to negotiate for the purchase of substantially all the assets of the corporate defendant'. It is averred, further, that Korn bought the stock only for the purpose of 'increasing his participation in the liquidation' of the corporate defendant and for the [33 Del.Ch. 252] purpose of unjustly enriching himself at the expense of the minority stockholders of the corporate defendant, all in violation of his fiduciary obligations.

In respect to the stock options of 1948, the complaints allege, (a), that the purported subscriptions of all sixteen individual defendants are irregular and void as being in violation of Para. 2068, Revised Code of Delaware, 1935, forbidding a corporation to lend money to its officers, and (b), that 'the said subscriptions, in practical effect,' were without consideration. In respect to these shares the complaints also allege the same improper motive and breach of fiduciary duty charged against Korn alone in respect to the 1950 option.

Finally, the complaints charge that Korn simply used the above-described 'expense account' system as a device for dishonestly lining his own pockets, and that he actually retained large sums of these monies as his own. An accounting from Korn is, therefore, demanded.

Before the causes came on for trial in the Court of Chancery, however, counsel for the plaintiff, for Fleming-Hall, and for Korn, agreed upon a compromise settlement.

Page 306

The said compromise was reduced to a formal agreement, the essence of which was as follows:

1. Korn was to surrender for cancellation the entire lot of 62,364 shares he had purchased as a result of the 1950 option plan, taking in exchange therefor the sum of 25cents per share, which, together with the $1.00 per share he had already received as a liquidating dividend, would refund to him the price of $1.25 he had paid the company for each of those particular shares.

2. Korn was to surrender for cancellation 57,636 of the shares he had purchased as a result of the 1948 option plan. Since he had paid $1.00 for each of those shares and had received $1.00 as a liquidating dividend, no money was to pass at settlement in relation to this item.

3. Korn was to have his salary reduced for the three months, October-December, 1951, from $2500 per month to $1500 per month. All salary payments to Korn were to cease as of Dec. 31, 1951.

[33 Del.Ch. 253] 4. As of Oct. 1, 1951, Korn was to cease drawing any reimbursement for expenses.

5. Korn was to release Fleming-Hall from his employment contract, which, as above noted, under its terms did not expire until Dec. 31, 1954.

6. Korn was to pay his own costs, expenses, and counsel fees in connection with the instant litigation.

7. Fleming-Hall was to release all defendants from all liability in connection with the matters specifically charged in the three complaints.

8. The suits were to be dismissed with prejudice.

Upon entering into the said compromise agreement, the parties petitioned the Court of Chancery to approve the terms thereof, and, in preparation for the hearing, all stockholders of Fleming-Hall were formally notified to appear in the Court of Chancery in Wilmington on the 20th day of November, 1951, to show cause, ...


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