129 N.J. Eq. 264 | N.J. Ct. of Ch. | 1941
Are corporate directors entitled to indemnification or reimbursement from the corporation for their reasonable expenses necessarily incurred by them in defending a stockholder's derivative suit in which an accounting was sought against them because of alleged dereliction of duty and in which suit they were vindicated? This question arises because of an application on notice made by counsel for the defendant Herman A. Fenning, subsequently joined in by counsel for the other individual defendants, for an order reserving to *265 the defendants the right to apply for counsel fees against the corporate defendant, A. Hollander Son, Inc. The matter was argued in the presence of all counsel appearing in the main cause and was fully briefed. In addition, I was furnished with several articles treating with the subject of counsel fees in stockholders' derivative suits. The question necessarily calls for an answer at this time, for if under the circumstances of this case there be no right of indemnification or reimbursement in favor of the director defendants, then there is no need for granting the reservation sought and the application should be denied. On the other hand, if such right is found to exist then it is quite appropriate that it be reserved by adequate provision.
In order that the question here considered may be clearly understood, a brief statement of the pertinent facts is needed. The present suit was brought by a stockholder suing in the right of the corporation and the corporation itself was joined as a defendant. The bill of complaint and the intervenor's supplemental complaint charged the individual directors with negligence, mismanagement, diversion of assets and fraud and sought an accounting from them both for damages alleged to have been sustained by the company and profits and business opportunities alleged to have been illegally diverted from it. The defendant directors in their answers denied the acts charged against them and claimed that as directors of the company and also in their various other capacities they always served the company with fidelity and discharged their duties honestly, loyally and impartially and with due regard at all times to the rights and interests of the company and its stockholders. I found and decided that the directors had been faithful to their trust and that they had fully sustained the burden cast upon them by law satisfactorily to explain all corporate transactions in which there was charged some personal interest on the part of the individual director. Solimine v. Hollander,
It is important to remember the true nature of a suit of this character. The stockholders, suing and intervening, do not prosecute the cause in their own right and for their own benefit but in the right of the corporation and for its benefit. *266 While nominally the company is named as a defendant, actually and realistically it is the true complainant, for any avails realized from the litigation belong to it and it alone. The only circumstance under which the individual stockholder is permitted to bring the suit is either the refusal of those in control of the company to bring the proceeding or the fact that their relation to the subject of complaint is such that demand upon those in control to bring the suit would be futile. Whatever be the circumstances furnishing license to the individual stockholder to bring a class action of this kind, the fact remains that when suit is brought and determined on its merits the company must be treated in all respects, including liability for costs and counsel fees, as any other complainant in the ordinary cause.
There has been a regrettable lack of unanimity in the rather few decisions outside of this state on the question of whether directors who are ultimately successful in a suit of this character are entitled to be reimbursed for their reasonable costs and counsel fees in the litigation. No authority in this state has been submitted to me on the point and my own research has disclosed none. However, there can be no doubt that even as counsel for the complainant stockholder is not entitled to be paid a counsel fee in advance of a successful result, so the defendant director or officer is not entitled to indemnification or reimbursement in advance of his vindication. This rule has the virtue of making the ultimate result of the litigation the test of the right to counsel fees and expenses and presupposes that until the ultimate result is achieved the complaining stockholders on the one hand and the defending directors and officers on the other litigate at their own tentative and conditional outlay. "There is a vast difference between letting a director fight the battle at his own expense — with reimbursement if he is vindicated — and using the power of the corporation to aid in the fight before it is shown whether or not he is a faithful servant who deserves indemnity. * * * The rule under discussion is designed to produce fair play — to prevent the plaintiff from being overwhelmed by the company's financial power before the real defendants have shown their guilt or innocence."Washington, *267 Litigation Expenses of Corporate Directors in Stockholders'Suits (1940) 40 Columbia Law Rev. 431, 438. It is this idea which underlies the decision of the Supreme Court of Minnesota inMeyers v. Smith,
My attention has been directed to a decision of one of the New York inferior courts in Wood v. Noma Electric Corporation, not officially reported, New York Law Journal, October 10th, 1936, p. 1121 (City Court). That was a suit by a director to compel his company to reimburse him for attorney's fees expended by him in defending a stockholder's derivative action in which fraud and waste were charged and which class action was discontinued during trial. The court dismissed the complaint seeking reimbursement, citing two New York decisions holding that a director found guilty of wrongdoing was not entitled to reimbursement for his counsel fees. This decision is in harmony with the principle that a director is not entitled to be reimbursed for his costs and counsel fees unless and until he is judicially cleared of the charges brought against him. While an adjudication of wrongdoing is, of course, clearly dispositive against the right to reimbursement, a discontinuance before judgment, though carrying with it no taint of wrongdoing, is equally dispositive, for in neither situation has the cause resulted in acquittal.
The rule that I gather from the cases is to the effect that where directors are charged with misconduct in office and are sought to be held accountable, the corporation is required to take and maintain a wholly neutral position, taking sides neither with the complaining stockholder nor with the defending *268
director. This is implicit in the holding of this court inGroel v. United Electric Company of New Jersey,
With the foregoing rules stated, I turn to the main issue presented — the right of the director to reimbursement from the corporation where he has defended a suit brought against him and judgment has been entered in his favor on the merits. InFigge v. Bergenthal,
In several cases the courts have sought to establish an additional test or requirement for the payment of litigation expenses to directors even where the latter have been successful in their defense. Some of these cases require a showing that the defense resulted in some benefit to the corporation or that some interest of the company was threatened. In the recent case ofNew York Dock Co. v. McCollom,
In Jessup v. Smith,
"* * * A trustee who pays his own money for services beneficial to the trust, has a lien for reimbursement. But if he is unable or unwilling to incur liability himself, the law does not leave him helpless. In such circumstances, he `has *271
the power, if other funds fail, to create a charge, equivalent to his own lien for reimbursement, in favor of another by whom the services are rendered.' (Schoenherr v. Van Meter,
"* * * He owed a duty to the estate to stand his ground against unjust attack. He resisted an attempt to wrest the administration of the trust from one selected by the testator and to place it in strange hands. He did more. By his cross-application, he procured the appointment of a third trustee, and broke a deadlock which threatened the safety of the estate. Plainly, such services, if paid for by the trustee personally, would justify reimbursement on his accounting before the surrogate. (Matter of Ordway,
In the case at bar the charges against the directors and officers were of such nature that had they been substantiated the defendants might have been removed from office. The directors and officers here not only had a right but were under a duty to stand their ground against all unjust attack and to resist the attempt to wrest the corporate trust estate from those hands to which the stockholders had previously committed it. In defending themselves they demonstrated to the investing public the honesty of the corporate management and thus they not alone served their own interests but also performed a duty which they owed to the beneficiaries of the trust — the stockholders. At least one of the counsel for the complaining stockholders in this cause was aware of this fact of benefit. In opposing an application to tax him with counsel fees in favor of the successful directors, he urged that the litigation had benefited the company and its stockholders in that it demonstrated the excellence and honesty of the services rendered by the directors and that, therefore, the directors' counsel should be paid out of the corporate treasury. *272 Other counsel for complaining stockholders did not dissent from this view. While I find that the company was benefited, I am not to be understood as holding that the fact of benefit to the company is an element of the directors' right to reimbursement or indemnification under such circumstances as are here present. However, with respect to such fact of benefit and in all other respects the instant case is indistinguishable in principle from that of the Jessup Case.
I am also mindful of the policy which dictates that directors, like executors and other trustees, should be encouraged to resist unjust charges in the confidence that ultimately, if their innocence be judicially established, they will be reimbursed for their necessary expenses of defense. Such a rule enables the director of limited means to enlist the professional service and aid of competent counsel who will be willing to undertake the defense upon the assurance that, if successful, payment would be forthcoming from the corporate treasury. The withholding of such assurance might well have the effect of denying the financially disabled director the opportunity of adequate representation in the suit against him. But what is more important than this is the fact that the right to reimbursement is a circumstance that would actuate and induce responsible business men to accept the post of directors, the emoluments of which would otherwise never be commensurate with the risk of loss involved in paying out of their own pocket the costs involved in defending their conduct. The right of reimbursement carries with it the added virtue that it is likely to discourage in large measure stockholders' litigation of the strike variety with which the courts are not unfamiliar. Such litigation is occasionally brought in the expectation that the accused directors and officers will pay something to escape not so much the risk of surcharge or removal as the substantial costs involved in adequate defense, particularly if the litigation is likely to be a prolonged one. These considerations and others like them are undoubtedly responsible for the many instances in which corporations have in recent years amended their by-laws so as to offer their directors contractual indemnity against the cost of unjustified suits. (SeeWashington, supra, 40 Columbia Law Rev. at p. 452.) As the *273 writer of that article states, such a step does much to encourage men of standing to undertake active responsibilities as directors. I recognize the validity of the suggestion that directors who have successfully defended their administration onthe merits of the suit should be reimbursed from corporate funds, the manner of reimbursement to rest in the discretion of the trial court. Even in the McCollom Case, supra, where the referee denied reimbursement, the suggestion was made by Judge Crouch that the application for reimbursement should be made to the court in the original action. He said (at p. 850): "In stockholders' actions where the plaintiff has been successful, the almost universal practice has been to apply for and secure reimbursement in the original action. The same practice should ordinarily be followed by successful defendants. Obviously the trial judge is in a much better position than any other judge to evaluate the alleged benefits to the corporation of the legal services rendered. * * *"
I, therefore, hold that the directors and officers who have successfully defended this suit on the merits and who have demonstrated honesty and loyalty to their trust are entitled to be reimbursed by the corporate defendant for their reasonable expenses and counsel fees either already expended or incurred in connection with this cause. The use of the word "reimbursement" presupposes previous payment by them. Following the idea and language of Judge Cardozo in the Jessup Case: "There must, therefore, be some other remedy where such payment is impossible. If that were not so, there would be no safety either for an indigent trustee or for the estate committed to his care. The law is too farsighted to invite such consequences." The corporate defendant may, if its directors so choose, pay such expenses and counsel fees directly without putting the directors to the necessity of paying in the first instance. This is more in the nature of exoneration than reimbursement, but either course is within the principle I have discussed and accomplishes the same just result. Counsel may present an order in conformity with these views. *274