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Higgins v. Shenango Pottery Co.

decided: May 29, 1958.

ALICE S. HIGGINS, PLAINTIFF ON BEHALF OF HERSELF AND OTHER STOCKHOLDERS OF SHENANGO POTTERY COMPANY, SIMILARLY SITUATED, APPELLANT, HARRY BARKBY, INTERVENOR-APPELLANT,
v.
SHENANGO POTTERY COMPANY, A CORPORATION, AND JAMES M. SMITH, JR., GEORGE B. ZAHNISER, CHARLES W. READ, DANIEL H. TRELOAR, JR., ZENO J. PFAU, JOHN B. MCCARTY AND ALVAH M. SHUMAKER, INDIVIDUALLY AND JAMES M. SMITH, JR., GEORGE B. ZAHNISER, CHARLES W. READ, DANIEL H. TRELOAR, JR., ZENO J. PFAU, JOHN B. MCCARTY AND ALVAH M. SHUMAKER, TRADING AS CASTLE ENGINEERING COMPANY, A PARTNERSHIP, LYNNE ANDERSON WARREN AND PEOPLES FIRST NATIONAL BANK AND TRUST CO., EXECUTORS OF ESTATE OF JAMES M. SMITH, JR., DECEASED.



Author: Mclaughlin

Before GOODRICH, McLAUGHLIN and KALODNER, Circuit Judges.

McLAUGHLIN, Circuit Judge.

The plaintiff and intervenor in this stockholders' derivative suit appeal from the district court dismissal of three defendants at the close of the plaintiff's evidence.

The basis of the action is the alleged diversion from the Shenango Pottery Company by Smith, Jr., its president, Zahniser, vice president in charge of manufacturing, and Read, another vice president*fn1 (all three also being directors) of a government business opportunity, the making of non-metallic land mines, to the defendant partnership, Castle Engineering Company, formed for the purpose of obtaining the particular government business. Recovery for Shenango of Castle's net profits from the operation plus incidental damages is sought.

The matter arose during the second world war. At that time over half the Shenango stock was owned by Smith, Jr., Zahniser, Read, and their families. The corporation was making hotelware and dinnerware. It was the world's largest manufacturer of vitrified china. From May 15, 1931 to February 4, 1949 there were no stockholders meetings of Shenango and minority stockholders were refused financial information of company affairs.

In 1942 the United States Army started a non-metallic, non-magnetic antitank land mine project. Shenango's chief competitor, Onondago Pottery Company and other concerns were given research and development contracts in this connection. Onondago was in production of the mine by late 1943 or the first part of 1944. It manufactured the ceramic parts, purchased the other parts and itself put these together, completing the mines. Around that time Shenango was asked by the Pittsburgh Ordnance District if it was interested in producing similar mines. It was sent the mine plans and advised it would be given complete information concerning them. The mines were being developed and produced by the various contractors as war projects with all knowledge as to the mines made available to any other manufacturers so engaged.

It can be readily inferred from the evidence on behalf of the plaintiff that Smith, Jr. learned of the Ordnance approach to Shenango and both he and defendant, Treloar, began efforts to obtain the business for the concern which later became Castle Engineering Company. Smith, Jr., Zahniser and Love, another officer and director of Shenango, on February 5, 1944 inspected Onondago's mine project, decided Shenango should not be interested and so reported to the other directors who did not object. There was no report to the stockholders. Within ten days after the inspection Castle submitted a bid for the business which contemplated a profit of $73,000. The request for that bid had actually come to Shenango. Castle's address was given as care of Shenango and Smith, Jr. was named as its negotiator. Castle then was not organized, had no facilities, assets or plant. Shenango was listed as its ceramic parts supplier. The ceramic element of the mine was its most expensive item and was a new and difficult production for Shenango. It is indicated that elaborate negotiations with suppliers of the other necessary parts were conducted by Smith, Jr. and Treloar in the name of Shenango. In February, 1944, Castle was incorporated with Smith, Jr., Treloar, Pfau, Zahniser, Shumaker and John W. McIlwraith, listed as directors. An affidavit stating that $5,000 capital had been paid in, was filed. The money was not so paid and the corporation was abandoned the following month.

The Castle bid was rejected February 21, 1944, either because Castle was not yet in existence or because its credit was not satisfactory to the government. Thereupon, at Smith's request Shenango on the same day bid for 100,000 land mines, Shenango to take the contract and Castle to execute it with Shenango to supply the ceramic parts. Shenango because of its reputation and ability was given a non-assignable contract for the work. Thereafter Castle in fact assembled the mines. All the fuse adaptors used for the mines of the first contract and a number of those under the second were bought and paid for by Shenango and billed later to Castle. This procedure was followed as to a great number of other parts used in both contracts.

In March 1944, $22,950 of the $50,000 cash capital was paid into the partnership and the Certificate of Limited Partnership signed. The latter was not filed until the following October. There is evidence that the Castle partners had been concerned with the land mine business since January 1944, that they knew the government proposition had been first given Shenango, that the all-important ceramic parts were to come from Shenango and that they were all advised of the progress of the land mine enterprise.

Castle assembled the mines with unskilled labor in an old leased skating rink.Its equipment consisted of a conveyor, work tables and two machines. The cost of the first contract machinery and equipment was $13,027.23. Shenango had originally furnished $3,926.83 of this. The production line was developed by Smith, Jr. He and Treloar took care of all executive and management duties. Information and help was received by Castle from other contractors doing the same sort of work.

The total cash capital paid into Castle by April 8, 1944 was $32,500. It had been estimated that $150,000 would be necessary to run the business. Smith, Jr., Treloar, Pfau and McCarty gave notes totalling $17,800 which they owed Castle for the balance of their partnership contributions and which they did not pay until August 18, 1944. From the beginning in March 1944 throughout the Castle operation Shenango furnished labor materials of all kinds, assembly operation parts, and the ceramic portions of the mines. Payment for these was not made until Castle had in effect been paid for the mines. On one occasion Castle's indebtedness to Shenango was $160,187.65. Usually Shenango paid Castle for the mines prior to receiving payment itself from the Government and without offsetting the large sums it was owed by Castle. On occasion Shenango had advanced funds to Castle covering checks issued by the latter. And Shenango on Castle's behalf paid for various materials unconnected with land mines.

Castle earned $148,541.13 on its first contract. It bid for $123,000 more mines and this was accepted at Shenango's request and because Castle had assembled the first group of mines under Shenango's contract. A third contract for 15,000 mines was also given Castle. The second agreement was stopped in October 1944, prior to completion. The third was terminated before any production had started. Castle's remaining profit from the mines amounted to $168,062.58 making a total of $316,603.71 for about nine months work and on an original investment of $32,200.

Plaintiff on July 20, 1948 demanded that the Shenango Board of Directors take action against Smith, Jr. and the other then unknown officers and directors involved in the diversion of the land mine business. No action being taken, plaintiff insisted on a stockholders meeting. That was held February 4 and 5, 1949. Plaintiff's resolutions for said action and for compliance with Pennsylvania law were voted down by the Smith, Jr., Zahniser, Read majority block. Smith, Jr. died subsequent to the start of this suit and his personal representatives have been substituted. After plaintiff and intervenor had rested subject to their right to introduce certain testimony and records, Shenango, Smith, Jr.'s estate, and Zahniser, who are all represented by the same counsel in this proceeding, unsuccessfully moved for a dismissal as to all of said parties. Additional motions for dismissal of defendants Pfau, Shumaker and McCarty were allowed, from which rulings this appeal is taken. These three defendants were purportedly limited partners in Castle but had no connection with Shenango.

Pennsylvania law governs the issues. Under it the Shenango directors and officers occupied a fiduciary relationship toward the company stockholders.*fn2 They were bound to act in the utmost good faith. They could not deal with the funds and property of Shenango nor utilize the influence and advantage of their offices for any but the common good. If they made a personal profit through the use of Shenango's assets they were accountable for it to the stockholders; they were not ...


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