Clark v. Dodge
269 N.Y. 410, 199 N.E. 641 (1936)
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Rule of Law:
An agreement between all shareholders of a close corporation to vote for certain people as directors and officers is valid and enforceable, provided the agreement does not harm creditors, other third parties, or the public, and the impingement on the board of directors' statutory authority is slight.
Facts:
- Clark owned 25% and Dodge owned 75% of the stock in two corporations, Bell & Company, Inc., and Hollings-Smith Company, Inc., making them the sole shareholders.
- Clark was the general manager of the companies and the only person who knew the secret formulas for their medicinal preparations.
- Dodge, the majority shareholder, was not actively involved in the day-to-day management of the businesses.
- On February 15, 1921, Clark and Dodge entered into a written agreement.
- The agreement stipulated that Dodge would vote his shares to keep Clark as a director and general manager for life, provided Clark remained 'faithful, efficient and competent.'
- The agreement also guaranteed Clark 25% of the corporations' net income and required Clark to disclose the secret formulas to Dodge's son.
- Dodge subsequently failed to vote in a manner that would continue Clark as a director and general manager, leading to Clark's removal from these positions.
Procedural Posture:
- Clark (plaintiff) sued Dodge and the two defendant corporations for specific performance of their contract in the New York Special Term (trial court).
- The defendants moved to dismiss the complaint on the pleadings.
- The Special Term denied the defendants' motion to dismiss.
- The defendants appealed to the Appellate Division (intermediate appellate court).
- The Appellate Division reversed the Special Term's order and dismissed the complaint, holding the contract was illegal based on the precedent in McQuade v. Stoneham.
- Clark (appellant) appealed the dismissal to the Court of Appeals of New York (the state's highest court).
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Issue:
Does a contract between all shareholders in a close corporation, which requires them to use their voting power to continue an individual as a director and manager, violate public policy by improperly restricting the discretionary power of the board of directors?
Opinions:
Majority - Crouch, J.
No. A contract between all shareholders of a close corporation to control board decisions does not violate public policy where no harm is done to creditors, the public, or any non-consenting shareholders. The court distinguished this case from McQuade v. Stoneham, where a similar agreement was struck down because not all shareholders were parties to it. The court reasoned that when all shareholders of a corporation consent to an agreement, they can do as they choose with the corporate concerns, provided the interests of creditors and the public are not affected. The court adopted a 'damage test,' stating that if the enforcement of a contract harms nobody, there is no reason to hold it illegal. Here, the restrictions on the board were minimal and did not 'sterilize' its powers; rather, they were seen as beneficial arrangements in what was essentially a 'chartered partnership.' The agreement was thus deemed legal and enforceable.
Analysis:
This decision established a significant exception to the general rule that shareholders cannot by agreement control the statutory duties and discretion of a board of directors. By focusing on the unique nature of closely held corporations, the court prioritized contractual freedom among sole shareholders over a rigid application of corporate formalities. The ruling provides a flexible 'no harm' standard, allowing shareholders in close corporations to enter into agreements that protect their management and financial interests, so long as those agreements are unanimous and do not prejudice third parties. This case is foundational in the law of close corporations, validating shareholder agreements that might otherwise be void as against public policy.
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