Stokes v. . Continental Trust Co.
1906 N.Y. LEXIS 1112, 186 N.Y. 285, 78 N.E. 1090 (1906)
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Rule of Law:
An existing stockholder has an inherent, preemptive right to purchase a proportionate share of any new issue of capital stock for money. A corporation cannot defeat this right by selling the stock to an outside party without the stockholder's consent.
Facts:
- Stokes was a stockholder, owning 221 shares of the original 5,000 shares of capital stock in the Continental Trust Co. of the City of New York.
- The corporation's directors decided to increase the company's capital stock from 5,000 to 10,000 shares.
- A third party, the investment banking firm Blair & Company, offered to purchase the entire new issue of 5,000 shares at a price of $450 per share.
- A special meeting of the stockholders was called to vote on the stock increase and the proposed sale to Blair & Company.
- At the meeting, Stokes voted against the resolution to sell the stock to Blair & Company.
- Stokes protested the sale and demanded the right to subscribe and pay for his proportionate share of the new stock (221 shares).
- Despite Stokes's protest and demand, the majority of stockholders voted to approve the sale of the entire new stock issue to Blair & Company.
- The corporation proceeded with the sale to Blair & Company, denying Stokes the opportunity to purchase his proportionate share.
Procedural Posture:
- Stokes sued the Continental Trust Co. in the New York Supreme Court, Special Term (the trial court).
- The trial court entered a judgment in favor of Stokes.
- Continental Trust Co. appealed to the Appellate Division of the Supreme Court (an intermediate appellate court).
- The Appellate Division reversed the trial court's judgment.
- Stokes, the appellant, then appealed the decision of the Appellate Division to the Court of Appeals of New York (the state's highest court).
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Issue:
Does an existing stockholder have a preemptive right to purchase a proportionate share of a new issue of stock for money, which cannot be defeated by a majority vote of the other stockholders and the board of directors?
Opinions:
Majority - Vann, J.
Yes, an existing stockholder has an inherent, preemptive right to purchase a proportionate share of a new issue of stock for money. This right is a vested property right that cannot be defeated by a majority vote of other stockholders. The court reasoned that a stockholder's ownership includes a share in the power to control the corporation through voting and a right to a proportionate share of its assets. Allowing a majority to issue new stock to outsiders against a minority stockholder's will would dilute their voting power and their interest in the corporate surplus, which are fundamental rights of property. While stockholders can set reasonable conditions for the sale, such as a fixed price or a public auction, they cannot deprive a dissenting stockholder of the opportunity to purchase their pro-rata share. Because Stokes protested the sale and did not waive his right, the corporation's action of selling his proportionate share to a third party was wrongful.
Dissenting - Haight, J.
No, under these specific circumstances, the stockholder's claim should fail because he effectively waived his right. While agreeing with the general principle of preemptive rights, the dissent argues that Stokes's conduct was unreasonable. Stokes demanded the right to purchase his shares at par value ($100) when the offered price was $450. This demand was not a good-faith attempt to exercise his right but an effort to profit at the expense of his fellow stockholders and to obstruct a beneficial corporate transaction. This unreasonable demand was tantamount to a refusal to pay the established price of $450, thereby waiving his right to purchase the shares. To allow his claim would be unjust, as it would have defeated the very purpose of the stock increase and awarded him damages based on a stock value that was created by the transaction he sought to prevent.
Analysis:
This case is a landmark decision in American corporate law that firmly establishes the common law doctrine of shareholder preemptive rights. By defining this right as an inherent and vested property right, the court provides strong protection for minority shareholders against dilution of their voting power and financial stake in the corporation. The decision creates a default rule for corporations, meaning that unless a company's charter explicitly states otherwise, existing shareholders have the first option to buy new shares. This ruling has had a lasting impact on corporate finance and governance, influencing how companies raise new capital while balancing the interests of majority and minority shareholders.
