Story Case

The Empire Bicycle Manufacturing Company was in poor financial condition. The diminished sale for bicycles had greatly reduced its sales; it had a very large plant upon which the taxes were high, and so much of its machinery and equipment had been bought with money borrowed upon bond issues that now the reduced income was barely able to pay the interest on these bonds. The stockholders had been required to put in the full amount of their subscriptions and were receiving no dividends. The directors already feared that before long they would be unable to pay the bondholders, in which event they knew that the property of the corporation would be put in the hands of a receiver and sold at public sale. In this situation, the directors received an offer from a rapidly growing and very profitable automobile company, which wanted to establish a factory in the town. The automobile company offered to lease the buildings and machinery, for a period of twenty years, at a rental which would provide for all the obligations of the Empire Bicycle Company and perhaps give some return to the stockholders. The offer was at once accepted by the unanimous action of the board of directors, and the lease was signed in the name of the corporation. Subsequently, the automobile company found that it was not in such need as it had supposed, for an immediate increase of output, and that the new factory might not be desirable. Its officers, therefore, notified the Empire Bicycle Mfg. Co. that it would not be bound by the lease and would not take possession of the factory. The Empire Bicycle Co. started suit for the first quarter's rent, which was now due, and also for damages for the breach of the agreement. The defense of the Ward Automobile Company was that the contract was never binding, because the bicycle company did not have the power to divert all its assets from the business of manufacturing bicycles and turn them over to a different business, nor to convert the corporation into nothing more than a landlord.

If the lease would not be binding upon the Empire Bicycle Manufacturing Company, the Ward Automobile Company should not be required to fulfill it; therefore, the question for the Court was whether or not it was within the power of the bicycle company to make the lease of its whole plant.

Ruling Court Case. Abbot Vs. The American Hard Rubber Company, Volume 33 Barbour's New York Reports, Page 578

The American Hard Rubber Company was formed to manufacture products of a "hard rubber compound" to which it had acquired the patents. It had a large plant and was doing a growing business. Four of the directors, being a majority of the board, passed a resolution and executed it, selling the whole plant, including the real estate, machinery, patent rights, tools, fixtures and stock, for $120,000, to a firm called Poppenhusen, Konig and Funcke. These directors had an arrangement with that firm by which the plant was to be put into a corporation to be formed, in which the directors were to be included. The plaintiff, Abbot, was a stockholder in the American Hard Rubber Company, and also a director. It was against his vote that the sale had been made, and he brought this action, to be for the benefit of all other stockholders, to have the sale declared fraudulent and void.

Mr. Justice Allen delivered the opinion of the Court. It was held that the transaction could not be allowed to stand. As far as outsiders or even the state, the corporation would doubtless have the right to sell all its property and go out of business. But its stockholders have a right to insist that the capital they have put in shall continue to be used in the business. It is beyond the powers of the directors to dispose of all the assets of the corporation, against the objection of any one stockholder. Not even a majority of the stockholders can thus end the activities of the corporation, as against minority stockholders. The Court said, "After this transfer, although the corporation still remained in form, with property which might be applied to some purpose, the existence of the company was nominal, its substance was taken from it, its property was valueless, as a "Hard Rubber Company" it had no existence. Its stockholders have invested for the manufacture of hard rubber, and it is no satisfaction to them to say that the name of the corporation is left, with a capital that may be applied to the manufacture of shoe-pegs or calico or any other article. To change the business of the corporation is not within the power of the directors. Boards of directors are agents of the corporation to manage its affairs, and carry out the purpose and object of its formation, not to inflict upon it political death. An act which takes from a corporation the power to fulfill the purposes of its organization is not consistent with its charter."

Upon these principles, the Court decided that the transfer to Poppenhusen, Konig, and Funcke was unauthorized and void, and judgment was given for the plaintiff, Abbot.

Ruling Law. Story Case Answer

A corporation formed to carry on a business can not make its chief activity that of investing for profit. When the whole capital of the corporation is loaned out at interest, or when the property is leased to someone else, or when the more common thing occurs in this sort of case, that is, a sale of all the assets and a division of the money among the shareholders, the corporation does really cease to exist as a business enterprise. Against the objection of any one of its members, the corporation does not have the right to turn its property back into money and to refund the money to the subscribers. It accepted its charter and it accepted its capital from the shareholders for a certain definite purpose, and it must continue to carry out that purpose. But a wholly different situation presents itself where the corporation has proved a failure. In that case, the purpose will fail to be realized in any event. Either the capital will be wholly consumed in the unprofitable business, and the plant will have to close for want of money to pay the current expenses, or a liquidation will be forced upon it, either by creditors or stockholders. A corporation which has passed through a "bad" failure or a receivership is practically dead, as far as future benefit to its stockholders is concerned, so it is not much of a concession to allow its activities to be ended in some other way. Where a sale of the assets or a lease of the plant is clearly a desirable thing for all concerned, and is the only practical way of preventing a bankruptcy or dissolution of the corporation, then those things are wholly within the power of the corporation, although they would not ordinarily be permitted. Indeed, it is then within the power of the directors also, and a minority of the stockholders would not be allowed to have the transaction set aside, as they would in any case where it was not an emergency measure. The power of a corporation to sell all its assets, or to lease its whole plant, is denied as the general rule, in order to insure the continued existence of the corporation. Where that would not be secured in any event, then the power is conceded.

It is so clearly the best possible thing for the Empire Bicycle Manufacturing Company in the Story Case, to make this lease, that the emergency power fully includes it. Even a minority stockholder could not have the lease cancelled. Since it will be binding on the Empire company, it can not be retracted by the Ward Automobile Company, and the Empire company should recover the rent, and additional damages, unless the Ward company undertakes to perform the rest of the lease.