Essex Universal Corporation v. Herbert J. Yates
13 A.L.R. 3d 346, 1962 U.S. App. LEXIS 4631, 305 F.2d. 572 (1962)
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Rule of Law:
A contract for the sale of a substantial minority stock interest in a corporation is not illegal per se under New York law merely because it includes a provision for the immediate transfer of control of the board of directors. Such a provision is permissible if the stock block represents de facto or 'working' control, meaning it is of a sufficient size that the purchaser would, as a practical certainty, be able to elect a majority of the board in a regular shareholder election.
Facts:
- Herbert J. Yates was the president and chairman of the board of Republic Pictures Corporation, a publicly traded company.
- In August 1957, Essex Universal Corporation negotiated with Yates to purchase a controlling interest in Republic.
- On August 28, 1957, Yates and Essex signed a contract for the sale of at least 500,000 shares of Republic stock at $8 per share, a premium over the market price.
- The contract contained a clause giving Essex the option to require Yates to deliver the resignations of a majority of Republic's fourteen directors and to cause the election of Essex's nominees in their place.
- Prior to closing, Yates confirmed he would sell 566,223 shares, constituting 28.3% of Republic's outstanding stock.
- Essex exercised its option, requesting the replacement of a majority of the board of directors through a process of seriatim (sequential) resignations and appointments.
- On the closing date, Essex tendered the agreed-upon down payment.
- Yates, upon advice from his lawyer, rejected the tender and refused to complete the transaction.
Procedural Posture:
- Essex Universal Corporation filed a lawsuit against Herbert J. Yates in New York Supreme Court, a state trial court, for breach of contract.
- Yates removed the case to the United States District Court for the Southern District of New York on the basis of diversity of citizenship.
- Yates moved for summary judgment in the district court, arguing the contract was unenforceable as illegal per se.
- The district court granted summary judgment in favor of Yates, dismissing Essex's claim.
- Essex Universal Corporation, as the appellant, appealed the district court's decision to the United States Court of Appeals for the Second Circuit. Yates was the appellee.
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Issue:
Does a contract for the sale of a 28.3% block of corporate stock violate New York public policy solely because it includes a clause requiring the seller to cause a majority of the board of directors to resign and be replaced by the buyer's nominees?
Opinions:
Majority - Lumbard, C.J.
No. A contract for the sale of a substantial, though non-majority, stock interest is not per se illegal because it provides for the immediate transfer of board control. The legality of such a provision depends on whether the block of stock being sold constitutes effective 'working control.' While it is illegal to sell corporate office alone, it is permissible to sell a controlling block of stock and to facilitate the immediate transfer of control that such ownership implies. The law should not require a new controlling shareholder to wait until the next annual meeting to exercise control. Here, 28.3% of the stock in a widely held public company is often tantamount to majority control. Therefore, the case must be remanded for a factual determination of whether this block of stock would give Essex the practical certainty of electing a majority of directors in due course. The burden of proof lies with Yates, the party challenging the contract, to show that Essex could not have achieved this control.
Concurring - Clark, J.
No. The contract is not illegal on its face, and summary judgment was improper. While agreeing with the need for a trial, this opinion expresses concern about announcing abstract moral principles that may not align with business realities and could serve only to excuse a defaulting seller. The opinion disagrees with creating a specific test around 'working control,' arguing that in the normal course of events, a 28.3% block of stock in a public company constitutes working control, and it is difficult to see what further evidence could clarify the issue. The presumption should be that the contract is legal unless proven otherwise.
Concurring - Friendly, J.
No. While personally believing that such contract provisions should be held contrary to public policy unless the seller owns over 50% of the stock, existing New York precedent is not clear enough to justify striking down the contract. A mass seriatim resignation dictated by a seller is a wrong to the other shareholders, as it bypasses the board's fiduciary duty in filling vacancies. However, as a federal judge tasked with predicting state law, there is insufficient authority to declare the provision illegal. The 'practical certainty' test proposed by the lead opinion is also problematic and difficult to apply. Therefore, the most appropriate course is to simply overrule the defense of illegality in this case and allow the state courts to develop the doctrine in this area.
Analysis:
This case is significant for replacing a rigid, formalistic view of corporate control (requiring over 50% of shares) with a more flexible, realistic standard of 'working control.' It acknowledges the reality that in a large, publicly traded corporation, a substantial minority block of stock is often sufficient to control the company's affairs. The decision, particularly the lead opinion's test, creates a fact-intensive inquiry for future cases, increasing uncertainty but better reflecting the practicalities of corporate governance. The disagreement among the judges highlights the ongoing tension between promoting the free transfer of corporate ownership and protecting minority shareholders from potentially harmful transfers of control.
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