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In re Farm Industries, Inc.

Court of Chancery of Delaware, New Castle County

November 20, 1963

In the Matter of FARM INDUSTRIES, INC., a Delaware Corporation.

Page 583

[41 Del.Ch. 380] Hugh L. Corroon, of Berl, Potter & Anderson, Wilmington, and Wesley J. Liebeler, of Carter, Ledyard & Milburn, of New York City, for petitioners.

Howard L. Williams, of Morris, James, Hitchens & Williams, Wilmington, for defendants.

SEITZ, Chancellor:

The petitioner Herman Knaust has applied for a summary order for the election of directors of Farm Industries, Inc., a Delaware corporation. He alleges that he owns a majority of the outstanding Class A and Class B common stock of the corporation and that together with his immediate family he owns 73% of all the issued and outstanding stock. He further alleges that the annual meeting of stockholders which should have been held, according to the

Page 584

by-laws, on February 15, 1963, has never been noticed or held.

The defendants, John A. Bouvier, Jr., Joseph T. Garland, and Morris Rosenblum, are certain officers and directors of Farm Industries. They have filed an answer on behalf of themselves and the corporation and admit that the annual meeting has not been held.

They contend, however, by way of cross-claim against the petitioner and others, that under the terms of an agreement dated November 2, 1960, the Class B stock is entitled to elect five of the nine directors of the corporation at the annual meeting of stockholders. They further contend that under the above agreement of November 2, 1960, which was executed by all the holders of Class B stock, and also under a Voting Trust Agreement of August 21, 1961, which was [41 Del.Ch. 381] entered into by the petitioner and certain members of his family, the defendant, John A. Bouvier, Jr., is authorized to vote the Class B stock, or a majority thereof, as the holder of an irrevocable proxy or as voting trustee. They pray therefore that the relief requested by the petitioner be denied and that the court specifically enforce the obligations of the petitioner and the members of his family as aforesaid by compelling such persons to transfer an irrevocable proxy to Bouvier and to deposit with him their Class B stock as voting trustee.

Petitioner replies to the cross-claim admitting the execution of the agreement of November 2, 1960 and the Voting Trust Agreement of August 21, 1961 by himself and the others involved. He urges, however, that the cross-claim be dismissed on the grounds, inter alia, that the defendants in effect obtained such agreements by overreaching and later breached the purported contracts themselves. He invokes in this regard the equitable doctrine of unclean hands.

After the petitioner filed his reply to the cross-claim, the petitioner's wife, Katherine Knaust, and his sons, Warren Knaust and H. Karl Knaust, all of whom are named as defendants therein, submitted generally to the jurisdiction of this court. They have joined in the reply to the cross-claim, and reference hereinafter to the 'petitioner' shall be deemed to include all of these persons. Parenthetically, the Class B stock certificates held by the members of the Knaust family have been deposited with the court. Thus, at the present time all the signatories of the November 2, 1960 agreement and of the voting trust agreement of August 21, 1961 are now before the court as well as the certificates representing the shares whose voting rights are in issue.

The background for the issues presented by the cross-claim and reply are as follows. Prior to November 1960, Herman Knaust and his brother, Henry Knaust, owned all the common stock of two New York corporations, Knaust Brothers, Inc. and K-B Products Corp., in equal amounts, except for a few shares owned by their respective families. The Knausts were at one time the world's largest producers of mushrooms.

For reasons which do not appear in the record, the brothers Herman and Henry fell into disagreement. Herman was engaged in the [41 Del.Ch. 382] promotion of Iron Mountain Atomic Storage Corporation which was intended to provide storage facilities on a commercial basis for valuable documents. Admittedly, the Knausts' mushroom business had begun to falter financially although the parties herein are not in strict agreement as to the cause. In part at least the decline in the fortunes of Knaust Brothers and K-B Products has been attributable to severe competition in the domestic market by mushrooms imported from the island of Formosa.

In July of 1960, Herman was forced to withdraw from the management of the two mushroom companies at the instance of certain creditors. Henry, however, signed an agreement giving Herman an option to

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buy his fifty per cent interest in the two companies for $200,000 and certain other considerations. Herman was required to agree, however, that if he could not meet these terms, he would deliver his stock in trust to Henry. It was at this juncture that the defendants were invited to join the Knausts' business venture.

It is apparent from the record that the mushroom business was in serious need of working capital. Herman Knaust and his immediate family, however, not only could not meet such needs but were not then in a position to pay to Henry Knaust the purchase price for his half interest in the business. Also, Herman Knaust was personally indebted to the two mushroom companies in the amount of $300,000 which apparently had been expended in the organization of Iron Mountain.

At the recommendation of one of the defendants, Joseph Garland, who is a son-in-law of Herman Knaust, John Bouvier was brought into the Knaust enterprises to provide managerial skills as well as the required financial assistance. The outcome of the negotiations among the interested parties is evidenced in part by the agreement of November 2, 1960. Under the terms of that agreement Herman Knaust and the members of his family agreed to raise $125,000 for the purpose of purchasing the outstanding stock interest of Henry Knaust in Knaust Brothers and K-B Products. The balance of $75,000 was to be raised by the defendants Rosenblum ($50,000) and Bouvier ($25,000). Herman Knaust also agreed to cause Iron Mountain to secure a loan of $300,000 to be used by the parties under the terms of the agreement [41 Del.Ch. 383] to stabilize the financial condition of the two mushroom companies. The purchasers were to share in the stock acquired from Henry Knaust in proportion to their respective cash investments. Thus, Rosenblum, for example, was to have a one-fourth interest in the purchased stock and a one-eighth interest in the entire business.

Next, the parties mutually agreed that they would cause a Delaware corporation to be formed which would have both Class A and Class B common stock. Both classes were to be identical in every respect except that the Class A would be authorized to elect four of the proposed board of nine directors and the Class B to elect five. The parties further agreed that their Knaust Brothers and K-B Products shares should be exchanged share and share alike for the Class A and Class B stock of the proposed Delaware corporation when organized.

Herman Knaust further agreed that he would transfer all his stock in Iron Mountain to Knaust Brothers in exchange for the cancellation of his personal indebtedness to the two mushroom companies of $300,000 and for a non-interest bearing note in the amount of $60,000.

Finally, it was provided, inter alia, that when the Delaware corporation was organized and the stock issued, all the holders of the Class B stock would give an irrevocable proxy to Bouvier to be surrendered by him only when all the bank debts of Farm Industries and its subsidiaries were paid off and other past due accounts made current. Other provisions specified the duties attaching to the various executive positions in the proposed corporation and designated the particular office that certain of the parties joining in such agreement were to hold when the corporation was duly organized. To the extent that these provisions become relevant to the matters in issue discussed later herein, they are set forth in greater detail.

Farm Industries was thereafter duly organized under the laws of this State. As noted later herein, a technical error was made in the incorporation process in that the special voting rights of the two classes of stock were not set forth in the certificate of incorporation though subsequently included in the by-laws.

[41 Del.Ch. 384] Later events may be described briefly. Bouvier, as provided by the agreement, became the president of Farm Industries and its subsidiaries, Knaust Brothers and K-B Products. Herman Knaust became chairman

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of the board though, as agreed, he was also in charge of the Iron Mountain subsidiary. In general, Bouvier as president provided active executive direction to the corporation while Herman Knaust was its 'elder statesman'. This was so even though Bouvier was absent in Europe during part of 1961 and only returned in the month of August. During his absence he corresponded on a confidential basis with Garland, then Executive Vice President and later General Manager, who kept him informed as to the progress of events. In view of the difficult financial situation Bouvier's primary task appears to have been the arranging of loans sufficient to provide needed working capital for the mushroom subsidiaries. In order to secure the necessary funds Bouvier was obliged to guarantee personally the repayment of certain substantial obligations of Farm Industries or its subsidiaries. I refer particularly to a bank loan of $500,000 in the spring or summer of 1961 which appears to have led to the execution of the Voting Trust Agreement in August of that year.

The downward trend in the fortunes of the two mushroom companies continued after the organization of Farm Industries and the shift in management to Bouvier and Garland although efforts were made to increase production and lessen costs. Dissension began to develop between the Knausts on the one hand and the Bouvier group on the other. Largely this resulted from the fact that the 1960 agreement placed control of what had been a family business in the hands of newcomers who sought to implement policies of their own. The adverse financial situation obviously aggravated the difficulties.

Late in August 1961, Garland was appointed General Manager of the mushroom operation by Warren Knaust, then Vice President in charge of production. This in effect put Garland in control in the production area. Next, in the summer and fall of 1961, efforts were made by the Bouvier group to prevent Herman Knaust from interfering with the lines of operational command established by the new management. Ultimately this led to a request that he 'absent' himself from Farm Industries for several months. Thereafter, on November [41 Del.Ch. 385] 29, 1961, he was removed as president of Iron Mountain by the board of that subsidiary, and Bouvier was elected in his place. Apart from the changes referred to above, however, the executive arrangement remained as set forth in the November 2, 1960 agreement. The ...

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