Rosenfeld v.

Fairchild | Emerson
July 8, 1955
WILLIAM ROSENFELD, on behalf of himself and all other stockholders of Fairchild Engine and Airplane
Corporation, similarly situated, appellant, vs.
FAIRCHILD ENGINE AND AIRPLANE CORPORATION et al., respondents, et al., defendants.
Froessel, Judge:
SUMMARY: The Fairchild faction initiated a proxy contest to wrest control of the corporation from the incumbent
management. Both factions incurred substantial expenses in their campaign for control of the corporation. The
Fairchild faction won control of the corporation, but prior to that, the losing incumbent directors had their campaign
expenses reimbursed from corporation funds. When the Fairchild faction assumed control, they also authorized the
corporation to reimburse their campaign expenses. They also gave pay-outs to the losing incumbents. The
stockholder Rosenfeld filed a derivative suit to recover these amounts in behalf of the corporation. The trial referee
and the New York appellate division denied the claim, on the grounds that Rosenfeld failed to particularly show which
expenses were improper and that the reimbursements were ratified by the stockholders. Appellate Division also found
that the two factions indeed incurred needless expenses such as entertainment, PR, and limousines for solicitation of
proxies. On appeal to the CA of New York, a divided court upheld the dismissal of the claim, on the ground that
Rosenfeld failed to adduce sufficient and particular proof of the impropriety of the items reimbursed. Thus the CA
ruled that absent such proof, the directors as a general rule were allowed to incur reasonable expenses in waging
their proxy contests over policy issues affecting the corporation, subject to the scrutiny of the courts. The ponencia
was a minority opinion.
DOCTRINE: When the directors act in good faith in a contest over policy, they have the right to incur reasonable and
proper expenses for solicitation of proxies and in defense of their corporate policies, and are not obliged to sit idly by.
The courts are entirely competent to pass upon their good faith in any given case, as well as the nature of their
expenditures when duly challenged.
In a contest over policy, as compared to a purely personal power contest, corporate directors have the right
to make reasonable and proper expenditures, subject to the scrutiny of the courts when duly challenged,
from the corporate treasury for the purpose of persuading the stockholders of the correctness of their
position and soliciting their support for policies which the directors believe, in all good faith, are in the best
interests of the corporation.
2 instances where expenses for proxy contests cannot be reimbursed from corporate funds: 1) Money was spent for
personal gain and not in the belief that the expense is made for the benefit of the stockholders and the corporation; 2)
Where the fairness and reasonableness of the amounts are duly and successfully challenged. [see also dissent]
NATURE: Appeal to the New York Court of Appeals. Originally a stockholders derivative action.
FACTS (pieced together from the 3 opinions)

Two factions fought over control and management of the FAIRCHILD Engine & Airplane Corporation.
o The central issue in the controversy involved the long-term salary and pension contract entered into
with a former principal executive officer and director of the corporation, J. Carlton Ward, Jr., by the
old board (the MANAGEMENT FACTION)
o A faction of insurgent stockholders (FAIRCHILD FACTION), led by the corporations largest
stockholder Fairchild, wanted the contract terminated.

A proxy contest ensued, which was won by the Fairchild faction, by a vote of 2 to 1.

The two factions spent a total of $261,522 in the proxy contest.

o The management faction spent $133,966, while the Fairchild faction spent $127,556.

The corporation reimbursed the following amounts to the two factions.

o $106,000 to the Management faction to defend their positions. This was paid by authorization of the
old board while they were still in power [in effect they used corporate funds to finance their
campaign].
o $28,000 was paid to the Management faction by the new board after the Fairchild faction took over.
[Note: Both payments to the Management faction were not put to a stockholders vote.]
o $127,000 was paid to the Fairchild faction as reimbursement for their expenses in the proxy
contest. This payment was ratified by a 16 to 1 majority vote of the stockholders.

William ROSENFELD, who owned 25 out of the corporations 2.3 million shares, filed a derivative suit to
compel the return to the corporation of the $261,522 paid out to the two factions.
o ROSENFELD: It was illegal for the directors to spend corporate money beyond the amounts
necessary to give stockholders bare notice of the meeting and the agenda to be discussed/voted
upon at such meeting, unless approved by unanimous consent of the stockholders.
o DEFENDANTS (FROM THE 2 FACTIONS): The proxy contest related to disputes over corporate
policies. It was thus proper for the corporation to shoulder not only the expenses of serving formal
notices and routine proxy solicitation, but also the thorough information of the stockholders.

An Official Referee dismissed the suit. Rosenfeld appealed the case.

The Appellate Division of the New York Supreme Court affirmed the dismissal.
o The controversy was based on an understandable difference in policy between the two factions.
o Rosenfeld failed to prove with sufficient particularity which pay-outs were reasonable and which
were not (and therefore ultra vires).
o The stockholders had ratified the payment to the Fairchild faction; but the payments to the
management faction for reasonable expenses need not be ratified, because these were for the
purpose of informing the stockholders about corporate affairs.
Rosenfeld appealed to the New York Court of Appeals1.

ISSUE (HELD): W/N the amounts paid to the two factions should be reimbursed to the corporation (NO)
RATIO

The pronouncement in Lawyers Advertising Co. v. Consolidated Railway to the effect that publication of
certain notices in behalf of the management faction was not a corporate expenditure which the directors had
the power to authorize, when the proxy contest was by one faction against another for control of the
corporation is obiter.

It has been held that management may look to the corporate treasury for the reasonable expenses of
soliciting proxies to defend its position in a bona fide policy contest.

Rosenfeld does not argue that the payouts were fraudulently obtained. He even concedes that the charges
were fair and reasonable but argues that the corporation cannot reimburse them. This is therefore not a
case where a stockholder assails specific items as improper.

If directors of a corporation may not in good faith incur reasonable and proper expenses in soliciting proxies
in these days of giant corporations with vast numbers of stockholders, the corporate business might be
seriously interfered with because of stockholder indifference and the difficulty of procuring a quorum, where
there is no contest.

If there is a proxy contest and the management group is not allowed to incur expenses to defend its
positions with respect to corporate policy for the information of stockholders, the management group and the
corporation would be at the mercy of well-funded persons seeking to wrest control for their own purposes.

The test is clear: When the directors act in good faith in a contest over policy, they have the right to incur
reasonable and proper expenses for solicitation of proxies and in defense of their corporate policies, and are
not obliged to sit idly by. The courts are entirely competent to pass upon their good faith in any given case,
as well as the nature of their expenditures when duly challenged.

Members of the Fairchild group could be reimbursed by the corporation for their expenses by affirmative
vote of the stockholders. With regard to them, the Appellate Division correctly ruled that there was no duty to
set forth the facts, with corresponding obligation of the corporation to pay such expense.

However, where a majority of the stockholders chose to reimburse the successful contestants for achieving
the very end sought and voted for by them as owners of the corporation, we see no reason to deny the
effect of their ratification nor to hold the corporate body powerless to determine how its own moneys will be
spent.

The rule then which we adopt is: In a contest over policy, as compared to a purely personal power
contest, corporate directors have the right to make reasonable and proper expenditures, subject to the
scrutiny of the courts when duly challenged, from the corporate treasury for the purpose of persuading the
stockholders of the correctness of their position and soliciting their support for policies which the directors
believe, in all good faith, are in the best interests of the corporation.

The stockholders have the right to reimburse successful contestants for the reasonable and bona fide
expenses incurred by them in any such policy contest subject to like court scrutiny.

This is not to say that the directors can always look to corporate funds for funding their proxy contests.
Where it is established that such moneys have been spent for personal power, individual gain or private
advantage, and not in the belief that such expenditures are in the best interests of the stockholders and the
corporation, or where the fairness and reasonableness of the amounts allegedly expended are duly and
successfully challenged, the courts will not hesitate to disallow them.
DISPOSITION: Judgment of the Appellate Division affirmed. (Conway, C.J., and Burke, J., concur.)
Desmond, J., concurring:

The New York Court of Appeals is the highest court in the state of New York. Unlike most other U.S. states, New York calls its trial and intermediate
appellate courts the "Supreme Court." New York's Supreme Court is not the court of last resort. This sometimes leads to confusion. Appeals are taken
from the four departments of the New York Supreme Court, Appellate Division to the Court of Appeals. (Wikipedia) #walalang

The cost of giving routinely necessary notice to stockholders is chargeable to the corporation, but payment
by a corporation of the expenses of factional contests for control of the corporation is ultra vires and
therefore unlawful. Such expenses cannot be ratified by stockholder vote.
The record of the case does not provide any basis for holding that certain payments in this case are unlawful
or improper, because Rosenfeld failed to adduce the appropriate evidence.
The appeal must be denied solely on the ground that Rosenfeld failed to sufficiently prove which among the
reimbursed items were improper or fraudulent. The burden was on Rosenfeld to provide particular proof of
the lawfulness or reasonableness of each of the specific expenses.
As to the issue being raised in the ponencia and in the dissent, it would suffice to quote from the Lawyers
Advertising case [partial quote only]: The remaining notices were not legally authorized and were not
legitimately incidental to the meeting or necessary for the protection of stockholders. They rather were
proceedings by one faction in its contest with another for the control of the corporation, and the expense
thereof, as such, is not properly chargeable to the latter.
[I]t would be altogether too dangerous a rule to permit directors in control of a corporation and engaged in a
contest for the perpetuation of their offices and control, to impose upon the corporation the unusual expense
of publishing advertisements or, by analogy, of dispatching special messengers for the purpose of procuring
proxies in their behalf. Such expenditures cannot be ratified by stockholders vote.

Van Voorhis, J., dissenting:

The decision of this appeal is of far-reaching importance insofar as concerns payment by corporations of
campaign expenses by stockholders in proxy contests for control.

It has been recognized that not all of the $133,966 in obligations incurred by the management group was
designed merely to inform stockholders; and this payment was not ratified by the stockholders.

The expenses of the management group included payment for a full-blown campaign to persuade and
cajole in a hard-fought contest for control of [the] corporation. Some of the expenses included:
o entertainment
o chartered airplanes and limousines
o public relations counsel
o proxy solicitors

These may be legitimate from the viewpoint of the stockholders, but most of them do not pertain to a
corporate function but are part of the familiar apparatus of aggressive factions in corporate contests.

The Appellate Division made a factual finding that the management group incurred a substantial amount of
needless expense. This should have led the Division to hold these directors accountable for at least an
explanation as to how these funds were spent, in consonance with the familiar rule that, where it has been
established that directors have spent corporate funds for their own purposes, the burden of proving the
propriety and reasonableness of specific items rests upon the directors.

Thus, as Rosenfeld was able to prove facts from which an inference of impropriety might be drawn, the
appeal should not have been dismissed with respect to the management faction, who should have been
made to explain and justify their expenses.

It was error for the Appellate Division to rule that the payouts to the Fairchild faction were ratified by the
stockholders, as it was natural for these stockholders to have voted in favor of reimbursing Fairchild since
they voted the faction into power in the first place. A resolution to reimburse the management group would
most certainly be voted down by these stockholders. [N]othing in the resolution to pay the expenses of the
[Fairchild faction] purported to authorize or ratify payment of the campaign expenses of their adversaries,
and certainly no inference should be drawn that the stockholders who voted to pay the [Fairchild faction]
intended that the incumbent faction should also be paid.

While it cannot be doubted that the management was duty-bound to inform stockholders of a contest for the
control of the corporation and such a case may warrant the circulation of information more detailed than
routine circularization the allowable expenses should be determined in accordance with the rule that the
burden of proof to prove the regularity and propriety of the expenses rests with the incumbent directors. In
this respect the case should have been remanded to the trial court.
RE: PAYMENTS BY FAIRCHILD FACTION TO MANAGEMENT FACTION

The issue with regard to this payment was whether or not it was for a corporate purpose. The ratification of
the stockholders was directed at this act of payment.

If unanimous stockholder approval was obtained, it would not have mattered if the act was ultra vires, i.e.,
not for a corporate purpose. On the other hand, such ultra vires act may not be ratified by majority, however
large. It has been held that a single stockholder may maintain an action to vacate an ultra vires agreement.

The resolution of the issue here must proceed from the rule enunciated in Lawyers Advertising that it is ultra
vires for a corporation to authorize the expenditure of mere campaign expenses in a proxy contest. The
statement in that case was not obiter. In that case and in all cases cited therein, the question concerned the

reimbursement of a management group. Almost all the cases therein were decided under Delaware law,
which lays down a less stringent rule than New York law as was applied in Lawyers Advertising. The Court is
now called upon to choose between the less stringent Delaware rule and the strict New York rule.
In connection with the reimbursability of campaign expenses, the jurisprudence in New York and Delaware
seems to draw a distinction between campaigns over policy issues and out-and-out campaigns for corporate
control.
Reviewing the Delaware cases cited, it appears that such a distinction is impracticable. The most-cited
Delaware case thus says: It is impossible in many cases of intracorporate contests over directors, to sever
questions of policy from those of persons. A change in personnel is sometimes indispensable to a
change of policy.
This may be so, but the upshot of this reasoning is that inasmuch as it is impossible to distinguish between
policy and personnel as the dominant factor, any averment must be accepted at face value that questions of
policy are dominant, because those who primarily intend personnel change usually cite policy justifications
for such change. In common experience, this distinction is unreal. As in political contests, aspirations
for control are invariably presented under the guise of policy or principle.
CAB: The supposed policy issue here involved the propriety of the contract with Ward. The Fairchild faction
claimed that the corporation was able to cut costs and save money by terminating the contract. The Fairchild
faction was alleging that the payments to Ward should be reduced so that members of the incumbent faction
would not continue to profit personally at the expense of the corporation. If this were true, the disbursements
by the incumbent faction in the proxy contest would fall under the condemnation of the Delaware rule.
But this simply demonstrates the impossibility of distinguishing policy and personnel issues. It also
indicates that personal factors are deeply rooted in this contest.
There are indeed expenditures which may be made by management to inform stockholders, but these are
clearly different from expenditures by mere groups of stockholders, who are under no legal obligation to
manage the corporation.
They may want to overthrow the current management, regardless of whether that will be good or bad for the
corporation, but their success is not a determination that the corporation was mismanaged or that it may be
mismanaged in the future.
A change in control is in no sense analogous to an adjudication that the former directors have been guilty of
misconduct. The analogy of allowing expenses of suit to minority stockholders who have been successful in
a derivative action based on misconduct of officers or directors is entirely baseless.
Insofar as a management group is concerned, it may charge the corporation with any expenses
within reasonable limits incurred in giving widespread notice to stockholders of questions affecting
the welfare of the corporation. Expenditures on excess of these limits are ultra vires. The corporation
cannot defray the expenses of the insurgents. They were not charged with running the company. It is not
contended that such reimbursements may be made without stockholder ratification.
CAB: The Fairchild faction repeatedly stressed in their campaign literature that they were waging the proxy
contest at their personal expense.
If reimbursement of such expenses is made to depend upon stockholder ratification, no court would be able
to pass upon their propriety, because it would all depend on whether or not the insurgents would obtain
control of the corporation. It is not within the province of the courts to determine if the new management
would be beneficial to the corporation.
The fact remains that, under the judgment appealed from, success in the proxy contest is the indispensable
condition upon which the reimbursement of the insurgents depends. Unscrupulous groups of stockholders
may take advantage of such a situation, but stockholder factions will always be allowed to contest corporate
elections. However, if the insurgents choose to employ the costly tactics of mass persuasion, they should
look for reimbursement to themselves and their allied stockholders, not from the corporation.
If such successful insurgents can be compensated by the corporation, and only in case of success,
corporation elections would become a lot like political elections, a high-stakes game where the spoils belong
to the victor. Kontrolado mo na yung corporation, bawi mo pa gastos mo. Kung natalo ka, nganga. This
assumes more importance as the capital stock of corporations becomes more widely distributed. Magiging
palabigasan ng directors yung corporate funds. Especially this is true when campaign promises have been
made that the expenses would not be charged to the corporation.
Nothing in this opinion must be taken as a judgment upon the motives of the Fairchild group or the
incumbent faction. The rule in the state of New York is that expenditures may be incurred by the
management limited to informing the stockholders fully and fairly concerning the affairs and policies of the
corporation, including solicitation of proxies for stockholders in order to insure a quorum. Beyond these the
purely campaign expenses of a management group do not serve a corporate purpose, and paying them is
ultra vires. All expenses of the insurgent stockholders are ultra vires.

Fairchild should be ordered to reimburse $118,448.78, plus interest, to the corporation, with the director Allis
subsidiarily liable therefor. Fairchild and Allis should pay $9,107.10 to the corporation, representing the
payment to the losing director Bolton. An accounting should be made to determine what part of the $133,966
is improper, such amount to be paid by the defendant-members of the incumbent faction; and by defendants
Fairchild and Allis [new directors] as to amounts paid out after July 15, 1949. Costs against Rosenfeld.
(Dye and Fuld, JJ., concur.)