Story Case

The Continental Southern Railroad was subjected to severe competition along part of its route by a smaller road, the Lexington, Springfield and Toledo Railroad. To eliminate this, its directors authorized the purchase of stock in the smaller road, and finally acquired a controlling interest. This stock was voted in the name of the Continental Southern, for its interests, and while the corporate organization of the Lexington, Springfield and Toledo Railroad continued undisturbed, it was operated not for its own profit but so as to feed to the Continental Southern. One of its stockholders brought a bill to have the ownership of the stock by the Continental Southern declared illegal and terminated.

Has the Continental Southern Railroad power to own the stock?

Ruling Court Case. Franklin Bank Vs. Commercial Bank, Volume 36 Ohio State Reports, Page 350

Two hundred shares of the capital stock of the Commercial bank had been issued to Foote, and he pledged the certificate with the Franklin Bank to secure it upon a loan made to him. The Franklin Bank applied to be registered, as the holder of the stock, upon the books of the Commercial Bank, and upon the refusal of the latter, brought this action to compel the registry. The Commercial Bank asserted that it was not in the power of the Franklin Bank to acquire the shares and that it was justified in not registering it as the owner.

Mr. Justice Boynton delivered the opinion of the Court. It was held, that without a special provision in the statutes, one corporation had no right to become the owner of stock in another. If it could do so, there would be nothing to prevent its acquiring control of the latter and taking over the entire management of its business. In this way, a bank could become the operator of a railroad or the proprietor of a manufacturing business. The management of its business does not require that it acquire interests in other business, whether in the same kind of industry or not. Even granting that the corporation may take shares in payment of debts or upon the foreclosure of liens, it should not attempt to hold them, but should realize upon them as soon as possible. To become the registered owner, would carry the right to vote the share and the liability for assessments and calls. As this is not proper for the corporation to assume, the refusal to register it violated none of its rights and did not make the defendant liable. Judgment was given for the defendant.

Ruling Law. Story Case Answer

Once again, it must be noted that this question is here being considered, apart from the express power to hold stock in other corporations, a right which is very often conferred. Without that, the question as to the existence of any implied power to hold stock must be considered in three forms: (1) Is it part of the proper business of the corporation? (2) Will it lead to a diversion of the capital into a different business, against the rights of the shareholders'? (3) Will it lead to a monopoly or restraint of competition which would be against public policy and unlawful? Any one of these grounds would be sufficient to make the transaction improper on the part of the corporation.

As to the first, it is clear, that investing in stocks is not part of the business of the ordinary commercial or industrial corporation, and equally clear that taking stock as security for or in payment of its ordinary debts is a part of its business. Such ownership should not continue for a long time, but will not be objectionable as a temporary matter. Permanent investment of its funds with other companies is not a proper thing with most corporations, but even if it should be, under a particular charter, the second question will often arise, and the investment will be valid, only if it is in the particular kind of business authorized. The third question is one of the general law of contracts, but it is peculiarly apt to arise in these cases. The purchase of all the stock of a parallel line is a common method of relieving competition in railroad traffic, and the courts have held that even express power to hold the stock of other companies will not make this legal. But without the express power, it would be held illegal, independently of the monopoly feature, because it would be an unauthorized diversion of the capital from the business of railroading to the business of supplying capital. A corporation can hold stock in other corporations, only as a temporary and necessary means of performing its chief purposes as set forth in its charter.

The Continental Southern does not have the power to hold and vote the stock of the Lexington, Springfield and Toledo Railroad. Either a stockholder of the Continental or of the Lexington companies is interested and may have the relief of the Court in preventing the continuation of the ownership. The Court should order a public sale of the stock.