KEENAN V ESHLEMAN AUTHOR: PAGCALIWAGAN

23 Del. Ch. 234 (Del. 1938) NOTES:

TOPIC: Requirements Relating to Derivative Suits Keenan – President of Consolidated
PONENTE: Marvin – Secretary of Consolidated
Brewer – Treasurer of Consolidated
The 3 are officers and majority directors of Sanitary.
FACTS:
 H.A. Stone & Company (Stone) is a corporation organized in 1915 for the purpose of financing small companies in
need of financial assistance.
 Stone’s plan was to sell on behalf of any company which it had accepted as a client, an issue of the latter’s preferred
shares, Stone receiving in payment for its services a majority of the common shares.
 Stone organized and owned all the shares of General Stabilizing & Guaranty Fund, Inc. (General), which, although
having no assets, made a practice of undertaking to guarantee the payment of dividends on the preferred shares of the
client companies of Stone.
 Sanitary Company of America (Sanitary) was one of the client companies of Stone and was engaged in the
manufacture of sewer pipe and plumbing supplies.
 Stone and General failed and their assets (consisting shares of common stocks of Sanitary and other Companies) were
taken over by a shareholders’ committee.
 These assets were transferred to Consolidated Management Association (Consolidated) – organized for the
purpose of attempting to salvage something for the shareholders of Stone.
 All the shares of Consolidated were issued to the appellants (Keenan and Brewer) as voting trustees and
controlled Sanitary because Consolidated owned a majority of the voting shares of Sanitary.
 By resolution of the directors of Sanitary, company agreed to pay $300 a month for management services to be
rendered by Consolidated.
 The total amount paid by Sanitary to Consolidated pursuant to this resolution is $28,800
 This amount was substantially identical with the amount paid by Consolidated to Keenan, Brewer, and
Marvin, who were its only officers and employees, with the exception of a part-time stenographer.
 During the same period Sanitary paid Keenan and Brewer substantial salaries and bonuses
 Minority shareholders of Sanitary brought a bill for an accounting claiming that in effect Sanitary paid Keenan and
Brewer double compensation for the same services and that Marvin participated in the wrong.
 After 3 years of the pending suit, the majority shareholders of Sanitary voted to ratify and confirm the action of the
directors and officers of Sanitary with respect to the matters complained of.
 The court held that the conduct of the appellants “constituted fraud on the corporation and that it was not in the power
of the majority of the stockholders to deprive the minority of their right to insist upon a ratification” The remaining
question is the issue.
ISSUE(S): WON only those shareholders who had not ratified the appellants’ acts should share in the recovery.

HELD: NO

RATIO:
The question is whether ratification of fraudulent acts by a majority of the stockholders inures to the benefit of the
appellants to the extent that the decree against them should be in such amount as to redress the wrong suffered by the
dissenting stockholders by causing to be paid to them a dividend of the recoverable amount as a dividend. The
misappropriations were a fraud on Sanitary, acts which the directors could not have authorized, and which the stockholders
could not ratify. To allow the defendants to retain a part of the misappropriations in proportion to the stock interest of the
ratifying stockholders would be to permit ratification of illegal acts to that extent.

In the circumstances it was ultra vires the corporation, its directors and stockholders, to make donations of corporate
assets. To allow the defendants to retain a part of their unlawful gains would constitute a gift.

The action here was a derivative one, brought on behalf of the corporation, and the complaint and the defenses are to be
considered as though the corporation itself were suing the appellants. If such were the action, releases to the individual
defendants by one or more stockholders would be without legal effect, and in a derivative suit, ratifications or waivers are
equally ineffective. To permit the recovery to be diminished by an amount in proportion to the stock holdings of the
ratifying stockholders would tend to encourage fraud.
Generally, where the action is a derivative one, brought for the benefit of a going corporation, equitable principles
demand that the theory of the action be recognized and that the recoverable amount be decreed to be paid to the
corporation, notwithstanding releases, ratifications or waivers after the event.
CASE LAW/ DOCTRINE: Generally, where the action is a derivative one, brought for the benefit of a going
corporation, equitable principles demand that the theory of the action be recognized and that the recoverable
amount be decreed to be paid to the corporation, notwithstanding releases, ratifications or waivers after the event.
DISSENTING/CONCURRING OPINION(S):