text:
    In the Matter of Leonard Capone, Respondent, against Robert C. Weaver, as State Rent Administrator, Appellant, and John Miller, Intervenor-Appellant.
    Argued May 28, 1959;
    decided July 8, 1959.

      Edward V. Alfieri and Nathan Heller for appellant.
    Where the tenant exchanges apartments with the landlord for the convenience of the landlord, he continues to be protected by the State Residential Rent Law. (Matter of Brettler v. Weaver, 14 Misc 2d 1031; Matter of Ashen v. McGoldrick, 17 Misc 2d 23; Matter of New York Post Corp. v. Leibowitz, 2 N Y 2d 677; Matter of Mounting & Finishing v. McGoldrick, 294 N. Y. 104.)

      Harold Gellman for respondent. I.
    The statute under consideration is clear and unambiguous. (Lawrence Constr. Corp. v. State of New York, 293 N. Y. 634; Meltzer v. Koenigsberg, 302 N. Y. 523.) II. The premises are not subject to rent control.

      Frank B. McGlynn for intervenor-appellant.
   Dye, J.

In this article 78 proceeding to review and annul a determination of the State Rent Administrator denying petitioner’s protest to the Administrator’s order fixing maximum rent, the Administrator and John Miller, intervenor-tenant, appeal as of right from an order of the Appellate Division, Second Department (7 A D 2d 1004), which (1) reversed an order of the Supreme Court, Queens County (Conroy, J.), affirming the Administrator’s determination; (2) annulled same, and (3) remitted the matter “ to the State Rent Administrator for further proceedings as indicated herein ”, it having ruled that on April 15, 1955, the date of renting, the apartment was decontrolled (State Residential Rent Law [L. 1946, ch. 274, as amd.], § 2, subd. 2, par. [h]). The appeal turns entirely on the applicable statute which, insofar as pertinent, provides: ‘ ‘ housing accommodations which are rented after April first, nineteen hundred fifty-three, and have been continuously occupied by the owner thereof for a period of one year prior to the date of renting ” are not subject to control. The provisions of subdivision 11 of section 9 of the New York State Rent and Eviction Regulations are to the same effect.

According to the record, the plaintiff-respondent is the co-owner of premises at 41-15 Ditmars Boulevard, Long Island City, New York, containing four rental units, three residential and a nursery school, all subject to the State Residential Rent Law. On or about March 1, 1954, the petitioner-respondent occupied the third-floor apartment, and the intervenor-appellant occupied a second-floor apartment. Because of his family situation, and to relieve a hardship, the petitioner landlord sought to get the second-floor apartment by offering to exchange with the tenant the third-floor apartment, with the verbal assurance that the tenant should have no fear that the exchange would result in an eviction. The tenant refused. The landlord then applied to the Rent Administrator for a certificate of eviction which, following a hearing, the Administrator granted on condition that petitioner landlord offer to the tenant his third-floor apartment in exchange for tenant’s second-floor apartment on the basis of a two-year lease. This was done. Thereafter, and on or about February 27, 1957, the petitioner landlord served tenant with a notice that his lease would expire April 15, 1957 and that, if he wished to remain, he could do so on a month-to-month basis at double the monthly rental. The tenant forthwith claimed a violation in the proceedings had thereon. The Administrator ruled, in effect, that, since the vacancy was created by the exchange of apartments for the landlord’s benefit, the exchange by the subject tenant of his controlled housing accommodations in 1955 for the landlord’s apartment was a mere substitution of controlled housing accommodations, and that, accordingly, the tenant’s present apartment was subject to rent control regulation until the tenant removed therefrom. This was on the theory that the exchange of the apartments was for the landlord’s benefit to relieve an alleged hardship at that time.

In ruling that the apartment was decontrolled, the court below quite obviously gave a literal effect to the statutory language because the landlord had occupied the third-floor apartment £ £ for a period of one year prior to the date of renting ’ ’ and thus, in a literal sense, met the statutory exemption. While it is true that, whenever the language of a statute is clear and unambiguous, we are required under ordinary rules of construction to give effect to its plain meaning (Meltzer v. Koenigsberg, 302 N. Y. 523; Lawrence Constr. Corp. v. State of New York, 293 N. Y. 634), this is not to say that literal meanings of words are to be adhered to or suffered to defeat the general purpose and manifest policy intended to be promoted (Matter of New York Post Corp. v. Leibowitz, 2 N Y 2d 677; People v. Ryan, 274 N. Y. 149; Matter of River Brand Rice Mills v. Latrobe Brewing Co., 305 N. Y. 36). In applying a statute, surrounding circumstances may not be ignored. In dealing with the landlord’s application for an eviction order, the Administrator quite properly took into consideration the circumstance that the landlord offered to expedite its issuance by an exchange of apartments with the tenant. At that time, the tenant’s possession of the second-floor apartment was under statutory tenure which he was loath to relinquish. The Administrator solved the impasse by imposing conditions which, if accepted—and the parties did accept them—had the effect of continuing the tenant’s tenure. Under ordinary circumstances, the statute would operate as written, for its underlying purpose was to assist owners of small properties such as one- and two-family houses and owner-occupied apartments which became vacant after April 1, 1953 but, at the same time, such exemption was not to affect any tenant in possession (Report of State Temporary Commission to Study Rents and Rental Conditions, March 5, 1953; N. Y. Legis. Doc., 1953, No. 43). Had the exchange of apartments been wholly voluntary, the exemption would undoubtedly have operated in favor of the landlord. Under the circumstances of this case, it cannot be said that the tenant voluntarily gave up possession of a controlled apartment in order to take over one that was decontrolled. This was all thrashed out before the Administrator and he, being convinced that the exchange -was for the benefit and advantage of the landlord to relieve a hardship, it may not now be said that the denial of his protest was unreasonable, arbitrary or capricious. The conflicting interests were fairly balanced. The landlord was allowed to have what he wanted and the tenant was afforded continued protection. Imposing conditions under such circumstances was an inherent prerogative of administrative authority. The fact that the tenant’s possession of the third-floor apartment was evidenced by a lease for two years does not change the character of his possession from tenure to decontrol. Several lower court decisions have upheld similar rulings by the Administrator, the theory being that when exchanges are made no additional housing accommodations are created and that it could not be the intent of the Legislature to penalize a tenant occupying a controlled apartment, who exchanges same with his landlord for the convenience of the latter (Matter of Brettler v. Weaver, 14 Misc 2d 1031 [Supreme Ct., Kings County]; Matter of Ashen v. McGoldrick, 17 Misc 2d 23). The ruling being reasonable under the circumstances, it should be sustained (Matter of Mounting & Finishing Co. v. McGoldrick, 294 N. Y. 104).

The order of the Appellate Division should be reversed and the determination of the State Rent Commission should be reinstated, with costs.

Chief Judge Conway and Judgefe Desmond, Fuld, Feoessel, Van Vooehis and Bubke concur.

Order of Appellate Division reversed and that of Special Term reinstated, with costs in this court and in the Appellate Division.


source: Caselaw Access Project

author: Froessbl, J. Fuld, J. (dissenting).

license: Public Domain

text:
    Hempstead Theatre Corporation et al., Respondents, v. Metropolitan Playhouses, Inc., et al., Appellants.
    Argued February 26, 1959;
    decided July 8, 1959.

      Milton C. Weisman, Adolph Kaufman and Lester Samuels for appellants.
    I. Under the leases the rental obligation in suit, in any event, is a percentage of income or profits from candy sales and not of total gross receipts therefrom. (Fleischman v. Furgueson, 223 N. Y. 235; Matter of James, 6 Misc 2d 849; First Trust Co. of St. Paul v. Commonwealth Co., 98 F. 2d 27; Goodrich v. Edwards, 255 U. S. 527; Eisner v. Macomber, 252 U. S. 189; Stanton v. Zercher, 101 Wash. 383; Niland, v. Niland, 154 Wis. 514; Gearns v. Commercial Cable Co., 293 N. Y. 105; Third & Lafayette Sts. Garage v. Globe Discount Corp., 133 Misc. 735.) II. Metropolitan fully discharged the rental obli - gation in suit by reporting and paying percentage rent on the license concession fees paid by vendors to Skouras. (Berkey v. Third Ave. Ry. Co., 244 N. Y. 84; Lowendahl v. Baltimore & O. R. R. Co., 272 N. Y. 360; Bartle v. Home Owners Coop., 309 N. Y. 103; Elenkrieg v. Siebrecht, 238 N. Y. 254; Chelrob v. Barrett, 293 N. Y. 442; Kirke La Shelle Co. v. Armstrong Co., 263 N. Y. 79; Goldberg, 168-05 Corp. v. Levy, 256 App. Div. 1086; Mutual Life Ins. Co. of N. Y. v. Tailored Woman, 309 N. Y. 248; Tuttle v. Grant Co., 5 A D 2d 370.)

      Milton Pollack, Bernard Bernstein, Stanley D. Halperin and Samuel N. Greenspoon for respondents.
    I. Skouras derived the gross receipts. (Kirke La Shelle Co. v. Armstrong Co., 263 N. Y. 79; Wilson v. Mechanical Orguinette Co., 170 N. Y. 542; Genet v. Delaware & Hudson Canal Co., 136 N. Y. 593; Anderson v. Abbott, 321 U. S. 349; Pepper v. Litton, 308 U. S. 295; Linn Timber Co. v. United States, 236 U. S. 574; Winestine v. Rose Cloak & Suit Co., 93 Conn. 633; Kramer v. Old, 119 N. C. 1; , Higgins v. California Petroleum & Asphalt Co., 122 Cal. 373; Berkey v. Third Ave. Ry. Co., 244 N. Y. 84; Chicago, M. & St. P. Ry. Co. v. Minneapolis Civic Assn., 247 U. S. 490.) II. Gross receipts are the agreed base on which percentage rental is calculable. (Friedman v. Handelman, 300 N. Y. 188; Seven Sutherland Sisters v. McInnerney, 24 Misc. 720; Levy v. Forma, 271 App. Div. 970, 297 N. Y. 848; Woolsey v. Funke, 121 N. Y. 87; Mandel v. Liebman, 303 N. Y. 88; People v. Supervisors of Niagara, 4 Hill 20; Eaid v. National Cas. Co., 122 Ore. 547; Mundy v. Van Hoose, 104 Ga. 292; First Trust Co. of St. Paul v. Commonwealth Co., 98 F. 2d 27; Utica City Nat. Bank v. Gunn, 222 N. Y. 204; O’Neil Supply Co. v. Petroleum H. & P. Co., 280 N. Y. 50; Lamb v. Norcross Bros. Co., 208 N. Y. 427.)
   Froessbl, J.

This is an action for rent claimed to be due under written leases of four motion picture theatres. The leases provide for a fixed minimum rental and a graduated percentage rental on “ gross receipts”. The question presented is what the parties meant by their definition of “ gross receipts ” as related to the sale of candy and refreshments.

In 1948, the subtenant, Skouras Theatres Corporation, formed Circuit Vendors, Inc., for the purpose of conducting a candy and refreshment concession in said theatres. We are all agreed that upon this record Circuit Vendors was the alter ego of Skouras and may be treated as though Skouras itself operated the concession. Accordingly, we are called upon to decide whether plaintiffs-landlords are entitled to 20% of the total gross receipts of the concession without deduction of any kind, or 20% of the income derived therefrom.

It is not disputed that if the concession had been leased to a third party the percentage rental payable to the landlords thereon would be computed only on the amount paid by the third party to Skouras for the privilege of the concession.

In our judgment, the provisions of the lease, as related to the issue here presented, are clear. “ Gross receipts ” are first defined generally and broadly. There then follow specific provisions that such receipts shall include: (1) all box office receipts excluding taxes on admissions; (2) all rentals and/or income derived from apartments, stores, offices or rentable space contained in said theatres, and all income derived from concessions and advertising”. (Emphasis supplied.) In other words, while box office receipts (excluding admission taxes) and rentals are the basis upon which the landlords are entitled to 20%, only the income, and not the receipts, from concessions may form the basis of the landlords’ percentage rental. In differentiating between receipts ” on the one hand and “ income ” on the other, we must assume the parties had a purpose, and it seems to us that no belabored analysis is necessary to discover such purpose. Had they intended that all receipts from the candy and refreshment concession should be the basis on which to calculate the 20% additional rental, it would have been exceedingly simple to say so, as they did with regard to the box office. Not having done so, it would seem to follow that the “ income ” should be computed by deducting from the “ receipts ” of the candy and refreshments sold the cost thereof.

This construction seems to be the only reasonable one for, at a 20% rental in addition to the fixed rental, it could not have been within the contemplation of the parties that the tenant would have to pay this percentage upon the cost of the candy and refreshments sold. It concededly would not have to do so if it permitted an outsider to operate the concession, as was the case when People’s Candy Company had the concession. It should not be penalized if it operates the concession directly, after having paid a substantial consideration in 1949 to eliminate People’s Candy Company, and particularly so where, as here, the landlord has been benefited thereby.

Inasmuch as the record contains no evidence as to the cost of the candy and refreshments, it will be necessary for Special Term to take proof thereof and recalulate the amount due plaintiffs. The judgment appealed from should accordingly be reversed, with costs, and the matter remitted to Trial Term for further proceedings not inconsistent with this opinion.

Fuld, J. (dissenting).

My disagreement with the decision is basic, for, in my judgment, the majority has, under the guise of construction, rewritten the agreement which the parties made. Both the trial court and the Appellate Division found in favor of the plaintiffs on each of the issues presented and it seems to me that the facts in the record before us compel an affirmance.

The plaintiffs, owners of four motion picture theatres located in Nassau County, brought this action to collect rent claimed to be due under written leases. The defendant Metropolitan Playhouses is the tenant which signed the leases, the defendant Skouras Theatres Corporation is the subtenant operating the theatres and the defendant Circuit Vendors, a wholly owned subsidiary organized by Skouras to handle the selling of candy and refreshments in the theatres. Since Metropolitan and Skouras are equally liable, I refer to these defendants interchangeably as Skouras.

The leases in question call for a fixed minimum rent plus a graduated percentage rental based on “ gross receipts,” and the litigation revolves about the meaning to be ascribed to that term insofar as it relates to the sale of candy and refreshments in the theatres. Plaintiffs claim that the percentage rent is to be figured on gross receipts, that is, on the basis of all proceeds from such sales, while the defendants urge, first, that the percentage is to be calculated only on the basis of an alleged concession fee (of $20,000) paid by Vendors to Skouras and, second, that, if such fee be disregarded and Skouras itself treated as the seller of such candy, then, the percentage should be figured on the basis of net income, not gross receipts.

The leases go back many years. Prior to 1935, they provided for the payment of a fixed rent only. In 1935, however, the arrangement was modified so as to provide for a fixed minimum rent plus a percentage rental based on gross receipts, to put it simply, emanating from the leased premises. Twelve years later, in 1947, a Consolidation Agreement was executed which extended the tenancies to 1971; it called for a reduction in the amount of the.fixed rental and an increase in the rental based on the percentages. The period here involved is covered by both the 1935 and 1947 agreements, though to a far greater extent by the latter.

It was in 1948 that Skouras initiated the sale of candy in the theatres. For about a year, Skouras granted a concession therefor to People’s Candy Company. In June of 1949, however, concluding that it was more profitable for a theatre operator to run its own refreshment stands and itself sell candy, Skouras eliminated People’s and undertook the operation through its 100%-owned subsidiary Vendors. As the trial court found, although Skouras acted through Vendors, the latter “ exists only in name * * * [and] has no independent corporate life ”. In short, as the trial court put it, “ there was no concession in fact from Skouras to Vendors ”, for it was Skouras which received for itself every penny realized from the sale of the candy and refreshments.

This is very different, it is to be noted, from the arrangement effected between Skouras and Apex Beverage Corporation when the former licensed Apex to sell beverages in the theatres; the fee there agreed upon was 50% of the gross receipts,11 of all moneys derived through the sale of such beverages ”, and Apex was required to bear every item of expense to permit the business to be carried on, including all costs, taxes and license fees.

It is clear from what has already been said that the evidence supports the decision of the courts below that the claim of concession and license fee served to conceal the actual receipts realized by the defendants from the candy sales. And, since Skouras actually received the proceeds from the candy operation, it necessarily follows that it must pay its percentage rental on the basis of such proceeds and not on the basis of any pretended or unreal fee. Skouras was, of course, privileged to enter into a bona fide arrangement with a third party and, if it had done that, the percentage rental would be computable on the amount received from its concessionnaire, but, as already indicated, there was neither a concession nor a concessionnaire and the tenant could not avoid its lease obligation by creating a wholly owned subsidiary and interposing such subsidiary between itself and the landlord. (See, e.g., Higgins v. California Petroleum Asphalt Co., 122 Cal. 373.)

We need not become involved in any discussion of independent entities or of piercing the corporate veil. The simple fact is that Vendors was nothing more or less than the alter ego of Skouras or, in a term more earthy, its dummy. We are, therefore, all agreed that the receipts of Vendors are the receipts of Skouras, and its percentage rental must be figured on the basis of such an amount.

We come, therefore, to the question of whether the lease agreement provides that the stipulated percentage is to be computed on gross receipts, as both Special Term and the Appellate Division concluded, or on gross receipts less the cost of the candy and refreshments sold, as the court is now holding.

The contract, it is plain, provides that the base on which the percentage rental is to be computed is “ gross receipts,” as that term is ordinarily and reasonably understood. As here applicable, the lease agreement, after declaring that the tenant was to pay (in addition to the fixed rent) a sum of money equal to 20% “ of all * * * yearly gross receipts in excess of ” $1,000,000 for each year, goes on to define that term as follows:

“V. (A) ‘ G-boss Receipts’, as used in this agreement, shall be deemed to include all income and revenue arising from the operation of each of the demised premises, less such gross receipts taxes as may be levied, imposed or assessed against such gross receipts, including all receipts of whatsoever kind derived from each of said demised premises, and without limiting the generality of the foregoing, shall include: (1) all box office receipts excluding taxes on admissions; (2) all rentals and/or income derived from apartments, stores, offices or rentable space contained in said theatres, and all income derived from concessions and advertising; (3) all net receipts derived from the sale of admission or coupons outside of the box office.” (Italics supplied.)

And, then, dealing expressly with the subject of “ deductions,” the agreement continues:

í ¡ iphe Tenant shall be allowed no deductions whatsoever from the gross receipts, as hereinabove defined, excepting, only, that the Tenant shall be allowed to deduct therefrom the amount of assessments paid by the Tenant * * * the additional rent arising from and payable * * * pursuant to * * * lease * * * relating to the Calderons Theatre * * * [and] the additional expense incurred for actual salaries paid to vaudeville performers or stage performers, stage hands and musicians # * * and any and all other expenses incidental thereto ”.

The agreement could hardly have been phrased more broadly. The yardstick is gross receipts ”, and this term, by the contract ’s own definition, includes ‘ ‘ all income and revenue ’ ’ arising from the operation of the premises, less such gross receipt taxes as may be levied * * * against such gross receipts, including all receipts of whatsoever kind” derived from the premises. Indeed, the clause goes on to recite that, without limiting the generality of the foregoing,” gross receipts “ shall include ” (1) all box office receipts excluding only taxes on admissions; (2) all rentals from apartments, stores or rentable space in the theatres and all income from concessions and advertising; and (3) all net receipts from the sale of tickets outside of the box office.

In short, every bit of income — “ all income and revenue ” — is to be the base for the computation of the percentage rental excepting only the items specified, that is, excepting only gross receipts taxes, taxes on admissions, amount of assessments, adjustment for the building costs of the Calderone Theatre and expenses incurred for salaries paid to vaudeville performers, stage hands and musicians. In fact, the only reference in the agreement to a figure other than a “gross” amount is in clause (3)—that gross receipts include “all net receipts” derived from the sale of admissions or coupons outside of the box office — and its use therein unequivocally demonstrates that, if the parties had intended that the percentage rent should be computed on the basis of “ net ” income or of receipts “ less cost,” they would have so provided.

As is apparent, the provision defining gross receipts was designed to give it the broadest possible scope. This is plainly reflected by the phrasing; gross receipts, as used in this agreement, it is written, “ shall be deemed to include ” the items enumerated. And what are these items? The answer, supplied by the agreement, is clear: “ all income and revenue ” arising from the operation of the demised premises. And almost as significant as the language just remarked is the use of the word “ such ”. Gross receipts, we have seen, shall include “ all ” income and revenue, less “ such gross receipts taxes ” as may be levied or assessed against “ such gross receipts ”. The “ such” in the latter phrase is a reference back to the term “ all income and revenue ”, and the use of the phrase “ such gross receipts ” serves to accentuate the exceedingly broad reach of the term “ all income and revenue ”. In brief, as the writing makes plain, gross receipts were to include all revenue received by the tenant excepting only the several items listed and, as is equally patent, no provision was made for the deduction of the cost of candy or, for that matter, the cost of any other revenue-producing operation.

That this was the understanding of Skouras itself is, indeed, confirmed by its conduct before any controversy developed. The theatres had other operations, besides the sale of candy, from which the tenant realized revenue and, in connection with each of these operations, the tenant, in figuring and reporting the sum on which the percentage rental was to be calculated, fisted the “ full ”, the “ whole ”, amount of income received without deducting a penny of cost or expense incurred in producing such gross income. Here we have practical construction, of the term gross receipts, of a most impressive and persuasive character.

How, then, does the court seek to avoid the compulsion of language, logic and practical construction and reach the conclusion that, insofar as the candy operation is concerned, the percentage rental is to be figured not on the entire gross receipts from the candy sales, but on such gross receipts less the cost of such merchandise? It argues that, “ if the concession had been leased to a third party the percentage rental payable to the landlords thereon would be computed only on the amount paid by the third party to Skouras for the privilege of the concession ” (opinion, p. 313). This, of course, is so, but I fail to perceive ■what it has to do with the case before us. There was here no grant of a privilege to sell candy, the prerequisite to the existence of a concession. The business of selling candy and refreshments was a self-operation, the very antithesis of a concession. Since, then, there vyas no concession, the agreement makes it unequivocally clear that the percentage rental is to be calculated on “ all income and revenue ” arising from the operation of the theatres — without deduction of any kind “from the gross receipts ” — and not, under clause (2), on the basis of “income derived from concessions. ’ ’

The argument that the parties could not have intended a rental based on gross receipts because such an arrangement would have been unprofitable for the tenant is beside the point. As the trial court most aptly observed, “Whether ‘ gross receipts ’ applied to sales of candy would make such an undertaking profitable is a matter for bargaining, and in any case there is nothing to show that it is unprofitable.” As a matter of fact, the record before us demonstrates that considerable thought had been given to the selection of “ gross receipts ” as the base for computation and to the fixation of the particular percentages specified. The formula ultimately decided upon, the fixed minimum rent plus a percentage of gross receipts on a graduated scale, had been designed, it was said, to assure that the deal would be “ on a partnership basis ” and that landlord and tenant would, as nearly as possible, be ‘ ‘ on a fifty-fifty basis in the final operation of these properties ”. Such an objective would, of course, be defeated if the percentage rental were to be calculated on the basis of net income rather than of gross receipts.

In point of fact, the argument that the parties could not have intended a rental based on gross receipts because of its unprofitability for the tenant, even if relevant, lacks weight, since under certain circumstances the tenant would make a greater profit from self-operation than from a concession, even though its obligation is to pay rental on the entire gross receipts in the case of self-operation. It is not necessary to demonstrate that self-operation would always be more profitable to the tenant than a concession arrangement; it is sufficient merely to show that, under some realistic circumstances, the tenant would derive greater profit from self-operation than from a concession, even though under the necessity of paying a percentage on all gross receipts. For example, if we assume that the gross receipts from the candy sales amount to $1,000 and the cost of operation to $400, then, in case of a concession under which the concessionnaire pays $400 (40% of gross receipts), the tenant would receive a net benefit of $320 after paying $80 to the landlord, whereas under self-operation, despite the fact that the tenant would pay $200 (20% of gross receipts), his net benefit would, nevertheless, amount to $400.

Since the tenant could thus be the recipient of a greater profit from self-operation than from a concession, it was perfectly reasonable for it to choose self-operation, despite the fact that this would require it to pay a greater rental to the landlord than it would pay in the case of a concession. This is clearly in accord with the percentage rental concept under which the parties share in the benefits. The tenant is not penalized, as suggested by the court (opinion, p. 314), when it pays a larger amount to the landlord, because it is also receiving a larger net benefit. If there is more to share, it is not unreasonable that the landlord should also profit. If the circumstances are such that a tenant believes that it would receive a greater net benefit by a concession operation, it is free to choose that alternative. If it turns out that its calculation was erroneous, this is a risk which it has chosen to take. That does not, however, give the tenant the privilege of demanding the benefits under each of the two inconsistent alternatives, that is, retaining all of the profits realized from self-operation while at the same time insisting on paying the landlord a percentage on a portion only of the gross receipts, viz., the profits, instead of the entire gross receipts.

Finally — and this might well have been our point of beginning— if the base be not gross receipts, then, the agreement supplies no method or predicate for figuring the percentage rental on the sales from candy. If gross receipts from such sales are not to be accounted for, if the computation is not on the basis of gross receipts, there would be no measure for determining the amount to be paid on these sales and, as the trial court recognized, Skouras “ would have had a source of income from the operation of each of the demised premises ’ without paying anything for it.” The agreement carefully lists “gross receipts taxes,” “taxes on admissions” and “the amount of assessments ” as the items “ allowed ” to be deducted from gross receipts, but it makes no mention of any item of cost or expense incurred in the sale of candy or other merchandise. A court should not rewrite the agreement either to provide for their deduction or to specify the particular item of “ cost ” or “ expense ” to be deducted. The very impossibility of arriving at a figure representing net income from the candy operation further confirms the construction which has been accorded by the courts below to the term “ gross receipts ”.

In brief, then, the lease agreement requires Skouras to pay a percentage rental on the sales of candy and refreshments, not on the alleged license fee of $20,000 from its wholly owned subsidiary Vendors, and that percentage is to be computed on the basis of gross receipts, not gross receipts less the cost of the merchandise or any other base.

The judgment of the Appellate Division should be affirmed.

Chief Judge Conway and Judges Dye and Van Voobhis concur with Judge Froessel; Judge Fuld dissents in an opinion in which Judges Desmond and Burke concur.

Judgment reversed and a new trial granted in accordance with the opinion herein, with costs to appellants in all courts.

      . In this connection, it is interesting to note that the Apex Beverage Corporation, to whom Skouras had granted the beverage concession, agreed to, and did, pay Skouras 50% of its gross receipts, 50% of “all moneys derived through the sale of [its] beverages ”, without deductions of any kind whatsoever, it being expressly agreed that the concessionnaire Apex was to pay not only the entire “ cost of supplying and furnishing of cups, beverages, syrup”, etc., but every other conceivable expense incurred in connection with the sale of the beverages, and yet there is nothing to indicate that the deal proved unprofitable for Apex.


author: Fuld, J.

text:
    In the Matter of Leonard Marx, Appellant, against George M. Bragalini et al., Constituting the Tax Commission of the State of New York, Respondents.
    Argued May 18, 1959;
    decided July 8, 1959.

      Harry Janin and Joseph H. Grown for appellant.
    I. The Appellate Division erred in failing to follow the fixed rule which allows a return to petitioner of his capital investment in Larchmont stock in determining the amount of taxable gain derived from the portion of the distribution which was not out of earnings or profits. (Matter of Good Humor Corp. v. McGoldrick, 289 N. Y. 452; People ex rel. Conway Co. v. Lynch, 258 N. Y. 245; Commissioner of Internal Revenue v. Gross, 236 F. 2d 612, 23 U. S. T. C. 756; Randall v. Bailey, 288 N. Y. 280; Weiss v. Wiener, 279 U. S. 333.) II. The Legislature with deliberate intent followed the Federal income tax law in the mode of taxation of corporate distributions. The Tax Commission’s regulations in this area were virtually identical with the Federal regulations. In such circumstances, the principle of conformity with the Federal law should be the touchstone of interpretation in this proceeding. (People ex rel. Clark v. Gilchrist, 243 N. Y. 173; Matter of Weiden, 263 N. Y. 107; People ex rel. Klauber v. Wendell, 196 App. Div. 827; People ex rel. Keim v. Wendell, 200 App. Div. 388; People ex rel. Home Trust Co. v. Law, 204 App. Div. 590, 236 N. Y. 607; People ex rel. Mosbacher v. Graves, 254 App. Div. 438, 279 N. Y. 793.) III. The Appellate Division erred in approving the legal conclusion of the Tax Commission (that the distribution did not constitute a return of capital) while rejecting the premise upon which it was based; in advancing a new premise to support the legal conclusion, the Appellate Division misconceived the scope and application of article 66 of the regulations.

      William G. Warren, amicus curice, in support of appellant’s position.
    I. The provisions of the Tax Law defining “ dividends ” and specifically requiring their inclusion in “ gross income ” are the exclusive criteria for taxing corporate distributions. II. Although “gross income” is defined in broad terms, the includibility of corporate distributions must be determined under the portion of the definition which is specifically applicable to them. (Allen v. Stevens, 161 N. Y. 122; Matter of Smathers, 309 N. Y. 487; Matter of Sacharoff v. Corsi, 294 N. Y. 305.) III. Tax-free cost recovery in respect of corporate distributions not out of “ earnings or profits ” is the intended result of the “ earnings or profits ” limitation, as well as its only conceivable function. (People ex rel. Studebaker Corp. v. Gilchrist, 244 N. Y. 114.) IV. The exclusion from “ gross income ’ ’ of corporate distributions other than ‘1 dividends ’ ’ has been uniformly recognized, both administratively and judicially. (Commissioner of Internal Revenue v. Gross, 236 F. 2d 612; 23 U. S. T. C. 756; People ex rel. Conway Co. v. Lynch, 258 N. Y. 245.) V. The “return of capital” concept relied on in the decision below must be applied consistently with the statutory definition of “ dividend ” and does not constitute an independent test of the taxability of corporate distributions. (Matter of Good Humor Corp. v. McGoldrick, 289 N. Y. 452; Matter of Barry v. O’Connell, 303 N. Y. 46; People ex rel. Brewster v. Wendell, 196 App. Div. 613; Woodsam Associates v. Commissioner of Internal Revenue, 198 F. 2d 357.) VI. A distribution out of surplus created from mere unrealized appreciation in value is not a distribution out of “ earnings or profits ” within the meaning of subdivision 8 of section 350. (People ex rel. Brewster v. Wendell, 196 App. Div. 613; Lumber Mut. Fire Ins. Co. v. Malley, 256 F. 383; Baldwin Locomotive Works v. McCoach, 221 F. 59.) VII. The term “ earnings and profits ” is used elsewhere in the personal income tax law in a context which could not possibly include unrealized appreciation. VIII. Courts of other jurisdictions have held that a distribution out of unrealized appreciation is not a distribution out of “ earnings or profits. ’ ’ (State ex rel. Hansen v. Cary, 191 Wis. 153; Sears v. Commissioner of Corporations & Taxation, 322 Mass. 446.) IX. The authorities do not support the Attorney-General’s position with respect to the definition of a “ dividend ” for purposes of the personal income tax law. (Randall v. Bailey, 288 N. Y. 280; People ex rel. Wedgewood Realty Co. v. Lynch, 262 N. Y. 202, 262 N. Y. 644.) X. The Attorney-General’s interpretation would lead to severe administrative difficulties in applying subdivision 8 of section 350.

      Louis J. Lefkowitz, Attorney-General (Robert W. Bush of counsel), for respondents.
    I. The corporate distributions received by petitioner are within the meaning of the statutory definition of gross income and they were not a return of capital so as to be exempt from taxation. (McDonald v. Williams, 174 U. S. 397; People ex rel. Fox Film Corp. v. Loughman, 259 N. Y. 30; Matter of Calder v. Graves, 261 App. Div. 90, 286 N. Y. 643; Foster v. United States, 303 U. S. 118; People ex rel. Wedgewood Realty Co. v. Lynch, 262 N. Y. 202, 262 N. Y. 644, 263 N. Y. 669; Randall v. Bailey, 288 N. Y. 280; Williams v. Western Union Tel. Co., 93 N. Y. 162; Equitable Life Assur. Soc. v. Union Pacific R. R. Co., 162 App. Div. 81, 212 N. Y. 360; Roberts v. Roberts-Wicks Co., 184 N. Y. 257; People ex rel. Cowan v. Graves, 258 App. Div. 699, 284 N. Y. 628.) II. The distributions fall within the sweeping definition of. gross income under subdivision 1 of section 359 of the Tax Law. (People ex rel. Conway Co. v. Lynch, 258 N. Y. 245; Matter of Steinbeck v. Gerosa, 4 N Y 2d 302; Matter of Appleby v. Bates, 278 App. Div. 12, 303 N. Y. 1011; Commissioner of Internal Revenue v. Gross, 23 U. S. T. C. 756, 236 F. 2d 612; Wilshire-La Cienega Gardens Co. v. Riddell, 148 F. Supp. 938; Commissioner v. P. G. Lake, 356 U. S. 260; Lynch v. Hornby, 247 U. S. 339; Peabody v. Eisner, 247 U. S. 347; Southern Pacific Co. v. Lowe, 247 U. S. 330.)
   Fuld, J.

The question presented is whether a distribution in cash by a corporation to its shareholders from unrealized appreciation in the value of its assets is taxable income to a receiving shareholder under article 16 of the Xew York Tax Law, to the extent that it does not exceed the cost or basis of his stock in the distributing corporation.

The facts are undisputed. In 1942 Larchmont Apartments, Inc., purchased an apartment house for approximately $1,745,000 from the Federal Housing Administrator to whom it gave a mortgage for $1,682,000. In 1950, by reason of the appreciation in the value of the real estate, the corporation obtained a new mortgage of $2,000,000 from an insurance company and paid off the existing one. As a result of this transaction, the corporation was left with net proceeds of $824,810.60. On July 27, 1950, it made a distribution to stockholders of $735,000, which was equal to $700 a share, and of this amount Leonard Marx, a stockholder and resident of New York, received $389,588.89. At the close of its fiscal year, January 31, 1951, the company’s accumulated earnings were $77,911.31 (before considering the distribution of $700 a share) which equalled approximately 10.6% of the distribution.

In his 1950 Federal and New York personal income tax returns, Marx included $41,296.42, representing 10.6% of the total distribution to him, in gross income as a dividend, subject to tax as ordinary income. He reported the balance of the distribution, $348,292.47, in the capital gains schedule of his return, treating $346,117.85 thereof '(the amount eqivalent to the cost of his stock) as a return of capital to be applied against the basis of his stock, and reporting the excess of $2,174.62 as capital gain.

The Federal Internal Revenue Service approved Marx’s treatment of the distribution. However, the New York State Income Tax Bureau did not; it treated the entire distribution as ordinary income and assessed additional taxes against Marx. The State Tax Commission agreed with the bureau’s decision, concluding that the entire distribution was includible in gross income and subject to normal tax. The taxpayer thereupon commenced this article 78 proceeding and, following the Appellate Division’s nonunanimous confirmation of the determination, appealed to this court as of right.

Since the appellant acknowledges that $41,296.42 is taxable as a dividend — as it represents his prorata share of the corporation’s accumulated “earnings or profits” — and since he concedes, for the purpose of this appeal, that $2,174.62 — the portion of the distribution exceeding the cost of his stock — is taxable as ordinary income rather than capital gain, we need concern ourselves only with the taxability of the remaining $346,117.85. It is the State Tax Commission’s contention that this amount is includible in gross income either (1) because it is a “ dividend ” under subdivision 8 of section 350 of the Tax Law or (2) because, even if not considered a “ dividend,” it is, in any event, “ gross income ” within the broad definition of that term in subdivision 1 of section 359.

Subdivision 1 of section 359 of the Tax Law which defines gross income expressly includes “ dividends ” within such definition and subdivision 8 of section 350 defines “ dividends ” as distributions made by a corporation to its shareholders out of “ earnings or profits Therefore, whether or not the distribution here in question was a dividend depends upon whether unrealized appreciation in value of a corporation’s assets, or the borrowing of money by the corporation, secured in part by such appreciation, increases its earnings and profits.

The phrase “ earnings or profits ” in an income tax statute is a term of art and must be construed in light of the basic concepts underlying such a statute, and one of the most fundamental concepts is that of realization. It is settled that, for income tax purposes, mere appreciation in the value of assets cannot result in a profit until that appreciation has been realized through a sale or other disposition. (Cf., e.g., People ex rel. Brewster v. Wendell, 196 App. Div. 613, 617.) Indeed, well before the passage of the New York Personal Income Tax Law in 1919, it was clear that for Federal income tax purposes' unrealized appreciation in the value of corporate property was not part of earnings and profits. (See, e.g., Lynch v. Turrish, 247 U. S. 221, 230, 231 [1918]; Lumber Mut. Fire Ins. Co. v. Malley, 256 F. 383, 384 [1916]; Baldwin Locomotive Works v. McCoach, 221 F. 59, 60 [1915]; see, also, Report of House Ways and Means Committee, H. R. Rep. No. 767, 65th Cong., 2d Sess., p. 4 [1918].) In 1918, for instance, the House Ways and Means Committee declared that, under Federal decisions (Report, p. 4),

"an addition to surplus through reappraisement of assets is not made out of earnings or profits, and therefore a distribution of the amount so added to surplus would not be a taxable dividend, since not made out of earnings or profits.”

That the Legislature of this State deliberately and intentionally adopted this fundamental concept is established by the fact that, when it enacted the New York Personal Income Tax Law in 1919 (L. 1919, ch. 627), it modeled it after the Federal Revenue Act of 1918. (See, e.g., Minutes of Special Joint Comm. on Taxation and Retrenchment, Conference with Experts, Feb. 20-March 15,1919, pp. 413-417, 511, 512; Report of Special Joint Comm. on Taxation and Retrenchment, N. Y. Legis. Doc. No. 57 [1921], pp. 24-27; Report of Special Joint Comm. on Taxation and Retrenchment, N. Y. Legis. Doc., No. 72 [1922], p. 72; Tanzer, State Income Taxation, with Special Reference to the N. Y. Income Tax Law, Proceedings of the Twelfth National Conference of the National Tax Association [1919], pp. 386-387, 390.) For instance, the Joint Committee responsible for the income tax laws of this State declared (1921 Report of Special Joint Comm., op. cit., pp. 24, 27):

‘ ‘ It was thought desirable * * * to harmonize our taxes so far as possible with the Federal system * * *. This consideration was paramount in determining the form of the bill.
• * •
“ In defining and measuring the income on which the tax was to be laid, care was taken * * * [that] the Federal Law should be followed whenever possible.
‘ ‘ The bill accordingly followed for the most part the provisions of the Federal Law, defining gross incomes ”.

Moreover, one of those who actually had a hand in drafting the laws explicitly noted that the State statute — subdivision 8 of section 350—■“ defines the term * dividend ’ in the same terms as the Federal Law. * * * It is the same definition as the Federal Law”. (Minutes of Special Joint Comm., op. cit., pp. 413, 417.) And, indeed, the State statute, just like the Federal act, included dividends within the definition of gross income and limited the definition of dividends to distributions “ from earnings or profits ”. It necessarily follows, therefore, that it was the legislative design to adopt the same meaning of the term earnings or profits ” as was intended under the Federal law and to exclude from “ dividends ” distributions from unrealized appreciation in the value of corporate assets.

The term “ earnings and profits ” is used elsewhere in a related provision of article 16 — subdivision (9) of section 354 — in a way which cannot possibly include unrealized appreciation in value (see N. Y. State Dept. of Taxation & Finance, Personal Income Tax Regulations, art. 493-i; see, also, S. Rep. No. 627, 78th Cong., 1st Sess., p. 22 [1943]). And a familiar rule of construction recommends that the same meaning be given the words in both parts of the statute. (See, e.g., Mangam v. City of Brooklyn, 98 N. Y. 585, 592; People v. Gates, 56 N. Y. 387, 393; see, also McKinney’s Cons. Laws of N. Y., Book 1, Statutes [1942 ed.], § 236.)

In point of fact, the exclusion of unrealized appreciation from earnings and profits is so well established that in an action in the Federal courts relating to the taxability of a corporate distribution, similar to the one before us, the Commissioner of Internal Revenue actually conceded that unrealized appreciation did not increase earnings and profits. (See Commissioner of Internal Revenue v. Gross, 236 F. 2d 612, 617-618.) In commenting on this concession, the Federal Court of Appeals for the Second Circuit wrote (p. 618):

“ But even if the Commissioner had made these arguments there is no reason to believe that he would have prevailed. It seems well settled that unrealized appreciation does not increase ‘ earnings and profits ’. [Authorities cited.] ”

Nor does borrowing on the security of the appreciation in the value of corporate assets increase the corporation’s earnings and profits, for it effects no realization of gain or income and no increase in net worth. True, money is received by the corporation, but it retains the ownership of the appreciated assets and incurs an equivalent liability. (See Commissioner of Internal Revenue v. Gross, 236 F. 2d 612, supra; see, also, Woodsam Associates v. Commissioner of Internal Revenue, 198 F. 2d 357.)

"VVe regard the Tax Commission’s reliance on Randall v. Bailey (288 N. Y. 280) and People ex rel. Wedgewood Realty Co. v. Lynch (262 N. Y. 202, motion to amend remittitur denied 262 N. Y. 644) as misplaced. Nothing decided or said in either of those eases easts doubt on the proposition that unrealized appreciation does not increase earnings or profits. In Randall v. Bailey (288 N. Y. 280, supra), the court merely held that the declaration of a dividend from surplus resulting from a realistic revaluation of assets did not violate the prohibition contained in section 58 of the Stock Corporation Law against payment of a dividend which would impair capital. And in the Wedgewood Realty Co. ease (262 N. Y. 202, supra), the court held no more than that a distribution made out of unrealized appreciation of assets was a dividend for purposes of computing or measuring the franchise tax to be imposed upon a distributing corporation. However, as is apparent, the statutes involved and construed in the Randall and Wedgewood cases did not limit the definition of dividends to distributions from earnings or profits ” as the Tax Law does, and this thoroughly distinguishes those decisions; in neither of those cases was the court called upon to consider whether corporate distributions from unrealized appreciation of assets are distributions from “ earnings or profits ”.

The exclusion of unrealized appreciation from 11 earnings or profits ” as a source of taxable dividends is soundly and wisely based, for to make the determination of the corporation’s “ earnings or profits ” at the time of each corporate distribution depend upon a revaluation of all the corporate assets would create serious administrative difficulties. There is probably no problem in the administration of the tax laws which is fraught with more uncertainty, is more time-consuming and expensive, or leads to less satisfactory results than the problem of the valuation of property. Nothing short of a clear legislative mandate would persuade us to decide that it is necessary to have a current valuation of all corporate assets, wherever located, for the purpose of determining the taxability of corporate distributions.

In short, the term “ earnings or profits ” used in defining “dividends” in the New York Personal Income Tax Law was drawn from the Federal Income Tax Law, and no good reason has been advanced for adopting a different meaning of that term for New York State income tax purposes than has been adopted and consistently applied from the beginning in the construction of the Federal statute. And we but observe that the decisions of the courts of other States are to the same effect. (See, e.g., Sears v. Commissioner of Corporations & Taxation, 322 Mass. 446, 451; State ex rel. Hansen v. Cary, 191 Wis. 153, 156.)

The commission’s second argument is that, even if the distribution is not a dividend within the meaning of that term as used in the definition of “ gross income” in subdivision 1 of section 359, it must, nevertheless, be treated as “ gross income ” under other and broader provisions contained in that definition, such as, for example, the sweeping phrase “ income derived from any source whatever ”.

A consideration of the legislative history of the New York and Federal Personal Income Tax statutes clearly demonstrates that distributions other than from earnings and profits were considered as a return of capital to the extent that they did not exceed the basis of the receiving shareholder’s stock. As previously indicated, the New York Personal Income Tax Law was modeled on the Federal law and the definition of gross income paralleled that in the Federal act. Prior to the enactment of the New York law, article 1549 of regulation 45 of the Federal Regulations provided:

“In general, any distribution made by a corporation other than out of earnings or profits * * * is to be regarded as a return to the shareholder of part of the capital represented by his shares of stock ”.

At the time of the enactment of the New York Tax Law, the term “gross income” as used in the Federal statute did not encompass corporate distributions from sources other than earnings and profits except to the extent that such a distribution exceeded the basis of the receiving shareholder’s stock. The inclusion of virtually identical definitions of “ gross income ” and “ dividends ” in the State law manifests a legislative intent to adopt this concept and the administrators of the Tax Law took this same position in article 66 of the Personal Income Tax Regulations. This regulation was adopted in 1920 and was patterned almost verbatim on article 1549 of regulation 45, quoted above, and it has continued in substantially the same form up to the present. The principle embodied in this regulation for almost 40 years, and in the Federal regulations on which it was fashioned, must be deemed to have received legislative sanction.

Actually, the precise contention here advanced by the State Tax Commission was rejected in Commissioner of Internal Revenue v. Gross (236 F. 2d 612, supra). In that case, as here, corporate distributions were made, based on unrealized appreciation in the value of improved real estate, and the sources of these distributions were in part moneys borrowed on the security of the real estate. The Commissioner of Internal Revenue argued, exactly as does the State Tax Commission, that the payments fell within the broad compass of “ gross income.” The Court of Appeals for the Second Circuit, called upon to construe provisions which served as the models for the ones before us, flatly repudiated the Government’s position, stating (p. 617):

“ we are unable to accept the Commission’s argument that a corporate distribution not out of earnings and profits may be * * ordinary income. It may well be that the earnings and profits requirement is subject to criticism and that a more satisfactory method of taxing corporate distributions could be devised. * * * But we must work within the framework * * * provided. ’ ’

And, shortly after this decision was handed down, the Commissioner of Internal Revenue recognized the soundness of the court’s ruling by announcing his acquiescence therein (see 1957-2 Cum. Bull. p. 5; Rev. Rul. 57-357, 1957-2 Cum. Bull, p. 900). Thus, it is clear that under Federal law the sum of $348,292.47 paid to Marx did not represent income and, in fact, as already noted, the Internal Revenue Service actually so ruled in approving the taxpayer’s return.

It has long been the policy of our courts to adopt, whenever reasonable and practical, the Federal construction of substantially similar tax provisions. (See, e.g., Matter of Rogers, 296 N. Y. 676, affg. 269 App. Div. 551, 555 et seq.; Matter of Russell, 294 N. Y. 99,103; Matter of Weiden, 263 N. Y. 107, 110; Matter of Bank of Richmondville v. Graves, 259 App. Div. 4, 10, affd. 284 N. Y. 671; People ex rel. Mosbacher v. Graves, 254 App. Div. 438, 439, affd. 279 N. Y. 793; People ex rel. Klauber v. Wendell, 196 App. Div. 827, 829-830, affd. 232 N. Y. 549.) The doctrine is in furtherance of the legislative policy of maintaining uniformity in the administration of the two tax laws. As this court observed in Matter of Cregan (275 N. Y. 337, 341), we give great weight to the Federal decisions ‘ ‘ ‘ for the purpose of maintaining uniformity of administration of the Tax Law which the Legislature has sought to achieve.’ ” The reasons for applying the doctrine are particularly strong and persuasive, where, as here, the State act and regulations were modeled upon the Federal law and regulations and both statutes and regulations closely resemble each other. In light of this policy, and the long-continued administrative practice evidenced by article 66 of the Tax Commission’s regulations, there can be no doubt that we should follow the Federal rule announced in the Gross case (236 F. 2d 612, supra) and hold, contrary to the position taken by the commission, that the distribution, insofar as it did not exceed the taxpayer’s cost or basis, is not includible in gross income.

The Appellate Division seemed to recognize that realization is a fundamental concept underlying the Income Tax Law, but it asserted that, although there was no realization of income by the corporation in this case, there was such realization by the taxpayer. This conclusion was apparently based on the theory that, by means of the distribution, the corporation accelerated the payment to its stockholders of anticipated future earnings. However, as was pointed out by the court in the Gross case (236 F. 2d 612, supra), to say that the distribution is in payment of anticipated future earnings and, by reason thereof, is income, only confuses the basic issue as to whether unrealized appreciation can be the source of a corporate distribution taxable as income. Since it would be unsound to hold that unrealized appreciation or depreciation in value is to be taken into account in determining earnings or profits, it would also be unsound to hold that a corporate distribution is taxable because it is a distribution of anticipated future earnings based upon unrealized appreciation. “Paper profits” being what they are, there is no assurance, and there can be none, that the corporation will have future earnings or profits. But it is even more important to observe that, if the anticipated profit is eventually realized on the sale of the property, the realized gain would then become a part of the corporation’s earnings and profits, and a subsequent corporate distribution from those earnings and profits would be taxable to the shareholders. The court expressed the thought in this way in the Gross case (p. 617):

“ if we tax the distribution of unrealized appreciation and also use the realization of the appreciation to increase earnings and profits at a later date, we tax the same earnings twice as ordinary income to the stockholders.”

The Appellate Division believed that the distribution here under consideration ought to be treated as an exception to the rule that a corporate distribution not out of “ earnings or profits ” is a return of capital, because no ‘ ‘ corporate purpose ’ ’ was served in “ getting together cash and distributing it to stockholders through a form of realization of the increment of value of corporate assets without selling them.” As we have already observed, the corporate borrowing on the security of the appreciated property was not, in our view, a realization of the appreciation. And we find no warrant in the statute for making the income tax treatment of a corporate distribution depend upon whether the funds distributed were acquired by the corporation with a corporate purpose other than the making of the distribution. The distribution was a valid one, and we are aware of no public policy which would require it to be treated differently from any other corporate distribution which is not out of earnings or profits of the distributing corporation.

The pattern of taxing corporate distributions is clear. To the extent that they are made out of £< earnings or profits,” they are £< dividends” and are thereby included in ££ gross income.” To the extent that they are not made out of ££ earnings or profits,” they are treated as a recovery of the cost or other basis of the shareholder’s stock; and only the excess over such basis is taxable. No other result would be compatible with the clear legislative design, the Federal decisions, the regulations under which the New York Tax Law has been administered since 1920, as well as reason and policy. We conclude, therefore, that the amount in issue, $346,117.85, is not includible in gross income, that rather it is to be treated, under the commission’s rules (Personal Income Tax Regulations, art. 66; see, also, People ex rel. Conway Co. v. Lynch, 258 N. Y. 245, 253), as a “return to the stockholder of part of [his] capital ” and applied against the basis of the appellant’s stock. Consequently, the appellant is required to pay a tax only on the excess over such basis, here $2,174.62.

The order of the Appellate Division should be reversed and the determination of the State Tax Commission annulled, with costs in this court and in the Appellate Division, and the matter remitted to the State Tax Commission for further proceedings in accordance with this opinion.

Chief Judge Conway and Judges Desmond, Dye, Froessel, Van Voorhis and Burke concur.

Order reversed, etc.

      . The refinancing had, of course, no effect on the corporation’s surplus account or capital account, since the increase in cash was offset by an equally large rise in liabilities (“Mortgage payable”).

      . Subdivision (9) of section 354 provides that under certain specified conditions a shareholder, who receives appreciated property from a corporation in complete liquidation, may elect — instead of paying an immediate capital gains tax based on the amount of the appreciation—to delay the recognition of his gain by paying ordinary income taxes on “so much of the gain as is not in excess of his rateable share of the earnings and profits of the corporation”. Quite obviously, if the corporate earnings and profits were to include unrealized appreciation in the value of the corporate assets, the shareholder’s “ rateable,” or prorata, part of corporate earnings and profits would likewise include appreciation in value and the section would be meaningless since it would permit the shareholder no delay in recognizing his gain on the appreciated property. Earnings and profits, therefore, do not include unrealized appreciation for the purposes of subdivision (9) of section 354.

      . Tt may not be amiss to note that a distribution which is a dividend for purposes of the law of corporations is not necessarily a dividend for purposes of the income tax law and that, conversely, what is not a dividend under corporate law may be a dividend under tax law. (See, e.g., Paul, Ascertainment of “ Earnings or Profits ” for the Purpose of Determining Taxability of Corporate Distributions, 51 Harv. L. Rev. 40, 51-52, and cases cited, n. 56.)

      . In the Gross case, it was said (p. 616); “The Commissioner's argument that the distribution of these mortgage Windfalls is  an anticipation of future profits’ obscures the fact that the basic problem here is merely a somewhat novel manifestation of the much mooted question whether unrealized appreciation in value can be the source of a distribution taxable as ordinary income.”

      . As noted above (supra, p. 327), we are not called upon to decide whether that excess over cost is ordinary income or capital gain, since the appellant, in view of the small tax liability involved, $68.50, conceded for the purpose of this appeal that such excess was to be treated as ordinary income.


author: Dye, J. Fboessel, J. (dissenting).

text:
    Harold Ross et al., Appellants, v. Food Specialties, Inc., et al., Defendants, and John Godston et al., Respondents.
    Argued February 23, 1959;
    decided July 8, 1959.

      Murray T. Koven for appellants.
    I. Mutual mistake is an issue of fact which, when properly proven, warrants reformation. The latter remedy merely corrects the contract by inserting that which the parties had intended but had omitted by such mistake. (Curtis v. Albee, 167 N. Y. 360; Greene v. Dickinson, 119 Ala. 346; Hearne v. Marine Ins. Co., 20 Wall. [87 U. S.] 488; Barry v. Lewis, 259 App. Div. 496; Seidman v. New York Life Ins. Co., 162 Misc. 560, 253 App. Div. 804; Baird v. Erie R. R. Co., 210 N. Y. 225.) II. Concededly, the right to reformation must be proven by clear, positive and convincing evidence. Ross readily met this burden by the proof he offered and which the court of first instance believed. (Amend v. Hurley, 293 N. Y. 587; Southard v. Curley, 134 N. Y. 148; United States v. Munroe, 5 Mason 572; Sawyer v. Hovey, 3 Allen 331; Simmons Creek Coal Co. v. Doran, 142 U. S. 417.) III. A conflict in evidence is no bar to recovery in an action for reformation. Without such conflict there would indeed be no litigation. To bar reformation, the conflicting evidence offered must be believed. (Devereux v. Sun Fire Off., 51 Hun 147; Jenkins v. Lefaiver, 55 Hun 612; Ward v. Hewitt, 196 Misc. 624; Amend v. Hurley, 293 N. Y. 587; Voci v. Page, 123 Misc. 766.) IY. The trier of the facts, who heard the evidence and observed the demeanor of the witnesses, was in the most advantageous position to decide which version of the facts was true. His finding, based on substantial evidence, should not be disturbed. (Danker v. Prudential Ins. Co., 243 App. Div. 527; Boyd v. Boyd, 252 N. Y. 422; People ex rel. Herzog v. Morgan, 287 N. Y. 317; Matter of Rich, 151 Misc. 852; Brunstein v. Brunstein, 273 App. Div. 847.) Y. Upon the finding of reformation, Grodston and Westbury were properly enjoined from violation of the restrictive covenant as reformed. (Blattmacher v. Brown, 163 Misc. 389; Richmond Hill Realty Co. v. East Richmond Hill Land Co., 246 App. Div. 301; Hornstein v. Podwitz, 254 N. Y. 443; Elk St. Market Corp. v. Rothenberg, 233 App. Div. 243; Advance Music Corp. v. American Tobacco Co., 296 N. Y. 79; Opera on Tour v. Weber, 285 N. Y. 348.) VI. The award of damages against Godston was fully consonant with applicable rules of law. (Wakeman v. Wheeler & Wilson Mfg. Co., 101 N. Y. 205; Brady v. Erlanger, 188 App. Div. 728, 231 N. Y. 563; Dunkel v. McDonald, 272 App. Div. 267, 298 N. Y. 586; Bagley v. Smith, 10 N. Y. 489; MacGregor v. Watts, 254 App. Div. 904; Duane Jones Co. v. Burke, 306 N. Y. 172; Present v. Glazer, 225 App, Div. 23; Manuszewski v. Keele, 257 App. Div. 1036; Bates v. Holbrook, 89 App. Div. 548.)

      William A. Smith for John Godston, respondent.
    I. Plaintiffs failed, as matter of law, to sustain the burden of the high degree of proof required in an action for reformation based on a claim of mutual mistake. (Salomon v. North British & Mercantile Ins. Co. of N. Y., 215 N. Y. 214; Amend v. Hurley, 293 N. Y. 587; Albany City Sav. Inst. v. Burdick, 87 N. Y. 40; Ward v. Hewitt, 196 Misc. 624; Strong v. Reeves, 280 App. Div. 301, 306 N. Y. 666.) II. Failure to read a written instrument before signing is gross negligence and in the absence of proof of fraud or mutual mistake binds the signers and precludes reformation. (Knight v. Kitchin, 237 App. Div. 506; Metzger v. Aetna Ins. Co., 227 N. Y. 411; Moran v. McLarty, 75 N. Y. 25; Pimpinello v. Swift & Co., 253 N. Y. 159.) III. Failure to prove that a mistake was made in transferring the intent of the parties to a written instrument purporting to express that intent is a bar to reformation. (Miller v. Stuart, 107 Md. 23; Henderson v. First Nat. Bank, 229 Ala. 658; Weiss v. Turney, 173 F. 2d 617; Adkins v. Arsht, 50 F. Supp. 761; Prince v. Friedman, 202 Ga. 136.) IV. The attempted reformation of paragraph “8” by inserting the words 11 or under any other trade name ” was inconsistent with the unreformed basic agreement of sale and created a contract that was invalid as being a restrictive covenant not ancillary to or coextensive with the business being sold. (Gray v. Breckheimer, 193 App. Div. 231; Goldsmith v. Goldsmith, 272 App. Div. 1011; Ru Ton v. Everitt, 35 App. Div. 412.) V. The granting of injunctive relief against defendant, Godston, in the judgment reversed by the Appellate Division was erroneous as matter of law. VI. The award against defendant Godston for breach of the restrictive covenant as reformed was based upon an erroneous theory of damages and cannot be sustained. (Wakeman v.
      Wheeler & Wilson Mfg. Co., 101 N. Y. 205; Strough v. Conley, 164 Misc. 248; Present v. Glazer, 225 App. Div. 23; General Paint Corp. v. Seymour, 124 Cal. App. 611.)

      Stephen J. Ohalek for Westbury Products Corp., respondent.
    I. It is error to charge Westbury Products Corp. with obligations which were not agreed to by nor chargeable to Westbury as a party. (Blattmacher v. Brown, 163 Misc. 389.) II. Knowledge alone and of itself in any person who may also be a director or a stockholder of another corporation is not sufficient to pierce the corporate veil. (Gerard v. Empire Sq. Realty Co., 195 App. Div. 244; Knapp v. Rochester Dog Protective Assn., 235 App. Div. 436; Berkey v. Third Ave. Ry. Co., 244 N. Y. 84; Rapid Tr. Subway Constr. Co. v. City of New York, 259 N. Y. 472; Lowendahl v. Baltimore & Ohio R. R. Co., 247 App. Div. 144; Stone v. Cleveland C. C. & St. L. R. Co., 202 N. Y. 352.) III. Injunction against Westbury cannot lie because it was not a party to the contract. (Paige v. Faure, 229 N. Y. 114; Nassau Hotel Co. v. Barnett & Barse Corp., 162 App. Div. 381, 212 N. Y. 568.)
   Dye, J.

By written instrument dated February 2, 1955, Food Specialties, Inc., a New Jersey corporation, then engaged in the manufacture of bulk and packaged food items, sold certain of its trade names, trade-marks, copyrights, designs and formulas for a variety of its products, as listed on an attached schedule, together with the good will attached thereto, and nothing else, to the appellants Boss. All items so sold were absolutely warranted as to title and freedom from incumbrance (Contract, pars. 1, 4,10). Among the items so sold was a line of Chinese condiments marketed under the brand name of Dai-Day ”.

The contract contained a restrictive covenant in the following terms: “ 8. The Party of the First Part for itself and for its officers, Jerome Stein and John Godston, covenant and agree to and with the Parties of the Second Part, their representatives and assigns, that neither the said Party of the First Part nor Jerome Stein nor John Godston will engage directly or indirectly in any capacity whatsoever in the business of manufacturing or selling Chinese condiments under any trade name heretofore employed by the Party of the First Part, anywhere in the United States of America for a period of two (2) years from the date hereof.”

The appellants Ross have brought this action to reform the contract (first cause) on the ground that, by mistake and inadvertence, the restrictive covenant was not correctly worded and, as worded, failed to express the true intent and agreement of the parties in that it omitted between the words “ party of the first part ” and “ anywhere in the United States of America ” the words “ or under any other trade name ”; that in its correct and intended form the restrictive covenant should read: ‘ ‘ that neither the said Party of the First Part nor Jerome Stein nor John Godston will engage directly or indirectly in any capacity whatsoever in the business of manufacturing or selling Chinese condiments under any trade name heretofore employed by the Party of the First Part, or any other trade name anywhere in the United States of America for a period of two (2) years from the date hereof”.

For a second cause, the appellants seek incidental injunctive relief and damages against the defendant Godston as an individual and the Westbury Products Corp. joined as a defendant in this aspect of the case, although not a party to the contract in any way whatsoever, because no doubt of Godston’s personal interest in that company.

We should note too that, at the time the contract was made, Food Specialties was wholly owned by Harold Goldman and respondent, Jerome Stein, his son-in-law, both lawyers, and who, for business reasons, desired to improve the company’s operation by eliminating certain of its lines, including Chinese condiments. While Godston was president of the corporation, he owned no stock. During all times the interested parties, including Ross, knew that Godston was engaged professionally as a food specialist and consultant; that he rendered advice and services to other food manufacturers; that he was actively connected with the Westbury Products Corp. as a stockholder, officer, and personally supervised and managed its manufacturing and selling operations of ingredients for Chinese condiments which it sold under its own brand name “Mil” as well as in bulk to others, and that for some time it had been processing, labeEing and shipping condiments for Food Specialties. Godston did not participate in the preEminary negotiations leading to the making of the within contract. He was called in at the closing. When the subject of a restrictive covenant was brought up, Grodston took the position that he would not sign anything restricting his own activities in the field, stating: “ I would be putting my neck in a noose if I did.” Nonetheless, he was willing to sign, provided the covenant was limited in its application to any trade name heretofore employed”. The attorneys for the principal parties then prepared the covenant now sought to be reformed and included same in the contract which was signed and the deal closed.

We have consistently and repeatedly held that before reformation can be granted the plaintiff “ must establish his right to such relief by clear, positive and convincing evidence. Reformation may not be granted upon a probability nor even upon a mere preponderance of evidence, but only upon a certainty of error ’? nor may the plaintiff ‘ ‘ secure reformation merely upon a showing that he or his attorney made a mistake. In the absence of fraud, the mistake shown ‘ must be one made by both parties to the agreement so that the intentions of neither are expressed in it ’ ” (Amend v. Hurley, 293 N. Y. 587, 595; Salomon v. North British S Mercantile Ins. Co., 215 N. Y. 214; Strong v. Reeves, 280 App. Div. 301, affd. 306 N. Y. 666). Here, the proof falls far short of the requirements thus enunciated. Nowhere in the record does it appear that the terms sought to be substituted were ever so framed or mutually agreed upon. It may well be that Ross hoped to get an unlimited restriction, but Grodston, for good reason, did not wish to have his future activities restrained. Reformation is not designed for the purpose of remaking the contract agreed upon but, rather, solely for the purpose of stating correctly a mutual mistake shared by both parties to the contract; in other words, it provides an equitable remedy for use when it clearly and convincingly appears that the contract, as written, does not embody the true agreement as mutually intended.

Furthermore, the covenant as originally drawn was coextensive with the recital clause, the subject matter of the sale and the recapture clause, all of which have been approved by both purchaser and seller and stand unreformed and uncontradicted. Plaintiffs make no claim that the reformation should extend to any part of the contract other than the restrictive covenant as contained in paragraph 8. What they seek in effect is a new and radically different contract by converting the covenant as drawn from a limited to an unlimited restriction. Having failed to establish their right thereto, it necessarily follows that there is also no right to injunctive relief or for damage.

The judgment appealed from is affirmed, with costs.

Fboessel, J. (dissenting).

We dissent and vote to reverse, and to reinstate the final and interlocutory judgments of the Official Referee insofar as appealed from, upon the ground that the weight of the evidence clearly and convincingly supports the determination of said Referee rather than that of the Appellate Division.

The action is for reformation of a restrictive covenant entered into in connection with a contract of sale, and for other relief. The restrictive covenant as written is set forth in the prevailing opinion. It was reformed so as to relate not only to the manufacturing or selling of Chinese condiments “under any trade name heretofore employed ” by Food Specialties, Inc., but also to such condiments manufactured or sold “ under any other trade name ”. It was concededly limited in place to the United States and in time to a period of two years.

There is no dispute that defendant Jerome Stein, an attorney, who signed the contract on behalf of Food Specialties, Inc., acknowledged that the covenant as reformed was the one agreed upon. He also testified unequivocally that the defendant “ Mr. Godston said he would sign a restrictive covenant limiting him from engaging in the business of manufacturing or selling Chinese condiments anywhere in the United States for a period of two years Harold Goldman, the principal stockholder of Food Specialties, Inc., testified similarly.

Godston was president and general manager and practically in charge of all the affairs of Food Specialties, Inc., though he had no stock interest therein. He owned a half interest in defendant Westbury Products Corp. He at first was disinclined to sign the restrictive covenant, but, when Goldman promised to pay him the sum of $10,000, Godston agreed.

The covenant as originally written was pointless, because plaintiff, Ross, paid $85,000 for the Food Specialties business, which included the latter’s trade names, trade-marks, copyrights, designs and formulas, together with the good will attached thereto; its stock, inventory and equipment. Since he purchased these rights, he did not need a restrictive covenant from Stein or Godston, officers of Food Specialties, Inc., as to the “ Chinese condiments under any trade name heretofore employed by the Party of the First Part ”. The only sensible purpose of the covenant was to include Chinese condiments not under such trade name.

Godston recognized the mistake promptly, for a day or two after the closing on February 2, 1955 he consulted a lawyer concerning the scope of the covenant and then saw two other lawyers. He then learned he had not tied “ a rope around [his] neck ”. While it is true that he denied that there was a mistake, that does not make the evidence of plaintiff’s witnesses any less clear and convincing. If he had admitted it, there would of course have been no litigation.

Godston had first been offered the opportunity of purchasing said business by Goldman, the principal stockholder, but he declined. Goldman then asked him to help sell it to Boss, for which Godston was paid $10,000. As soon as the sale to Boss had been made, Westbury Products Corp., in which Godston had a half interest, went into competition with Food Specialties in the sale of Chinese condiments. The restrictive covenant as written at the time of the sale was clearly of no value whatsoever to Boss, for the purchase of the trade names, etc., gave him that protection. The only reasonable purpose of a restrictive covenant was to keep Godston from competing in Chinese condiments generally for the two-year period agreed upon.

In McKeon v. Van Slyck, (223 N. Y. 392, 397-398) Judge Ora^e stated the applicable rule of evidence as follows: ‘ ‘ In civil cases a plaintiff is never required to prove his case by more than a preponderance of evidence * * *. They [the jury] may, therefore, be properly instructed that to make out a preponderance, the evidence should be clear and convincing [citing case]. But all these instructions in the last analysis are mere counsels of caution. The responsibility of determining whether the evidence is clear and convincing must ultimately rest upon the jury subject, of course, to the power of the court to set aside their verdict”

The learned and experienced Official Referee, who saw Goldman, Stein and Godston on the witness stand and heard them testify, gave no credit to Godston’s claim that the written covenant expressed the true intention of the parties. As Judge Rippey said in Amend v. Hurley (293 N. Y. 587, 594): “ The advantages of the trial court who saw and heard the witnesses should be considered and, when truth hangs upon the credibility of witnesses, his decision should be given the greatest weight [citing cases].” (See, also, Roberts v. Fulmer, 301 N. Y. 277, 285.)

In our judgment, the evidence clearly, convincingly and overwhelmingly supports the determination of the Official Referee, and the majority of the Appellate Division were in error in reversing and making new findings.

The judgment appealed from should be reversed, and the interlocutory and final judgments of the Official Referee should be reinstated, with costs.

Judges Desmond, Van Voorhis and Burns concur with Judge Dye; Judge Froessel dissents in an opinion in which Chief Judge Conway and Judge Fuld concur.

Judgment affirmed.


author: Dye, J. Fkoessel, J. (dissenting).

text:
    West View Hills, Inc., Respondent, v. Lizau Realty Corp. et al., Appellants.
    Argued March 9, 1959;
    decided July 8, 1959.

      Richard A. Brown for appellants.
    I. The courts below were in error in holding that, upon the undisputed facts at bar, respondent’s president had implied or presumptive authority to institute suit in the name of the corporation against a majority of its directorate for alleged misconduct. (Sterling Inds. v. Ball Bearing Pen Corp., 298 N. Y. 483; Koral v. Savory, Inc., 276 N. Y. 215; United Copper Co. v. Amalgamated Copper Co., 244 U. S. 261; Bickford v. Menier, 107 N. Y. 490; Winstead Hosiery v. New Britain Knitting Co., 69 Conn. 565; Rothman & Schneider v. Beckerman, 2 N Y 2d 493; Matter of Paloma Frocks [Shamokin], 3 N Y 2d 572; Twyeffort v. Unexcelled Mfg. Co., 263 N. Y. 6; Hardin v. Morgan Lithograph Co., 247 N. Y. 332.) II. The president of respondent West View Hills was without authority to commence the instant litigation. (Tidy-House Paper Corp. of N. Y. v. Adlman, 4 A D 2d 619; O’Connor v. Virginia Passenger & Power Co., 184 N. Y. 46; Loew v. Interlake Iron Corp., 270 App. Div. 858; Sheehy v. Barry, 87 Conn. 656; Fanchon & Marco v. Paramount Pictures, 202 F. 2d 731.) III. Zaubler’s proper remedy for the disposition of his grievance is a stockholder’s derivative action.

      Benjamin Paul Goldman for respondent.
    I. Since there had been no direct prohibition by the Board of Directors, the president of plaintiff corporation had presumptive authority, in the discharge of his duties, to bring this action in the name of plaintiff corporation—especially since it was necessary to preserve plaintiff’s interests. (Rothman & Schneider v. Beckerman, 2 N Y 2d 493; Matter of Paloma Frocks [Shamokin], 3 N Y 2d 572; Matter of Bernheimer, 266 App. Div. 868, 4 Misc 2d 503; Warwick Sportwear Co. v. Simons, 4 Misc 2d 482; Regal Cleaners & Dyers v. Merlis, 274 F. 915; Lydia E. Pinkham Medicine Co. v. Gove, 298 Mass. 53; Elblum Holding Corp. v. Mints, 120 N. J. L. 604; Recamier Mfg. Co. v. Seymour, 15 Daly 245; Sterling Inds. v. Ball Bearing Pen Corp., 298 N. Y. 483; Tidy-

      House Paper Corp. of N. Y. v. Adlman, 4 A D 2d 619.) II. Plaintiff ’s moneys improperly paid for materials, work, labor and services on Lizau’s building. It is necessary and urgent that plaintiff sue to preserve its interests and recover its $200,000. Defendants seek deviously to avoid meeting the issue on the merits. (Koral v. Savory, Inc., 276 N. Y. 215; United Copper Co. v. Amalgamated Copper Co., 244 U. S. 261; Fanchon & Marco v. Paramount Pictures, 202 F. 2d 731.)
   Dye, J.

In this appeal, by permission, the question posed is whether the president of the plaintiff corporation, at the time the action was originally instituted, had the power, as president, to institute the action on behalf of the corporation. In answering such question in favor of the plaintiff both Special Term and the court below correctly applied the accepted principle that when there has been no direct prohibition “ the president has presumptive authority, in the discharge of his duties, to defend and prosecute suits in the name of the corporation ” (Rothman & Schneider v. Beckerman, 2 N Y 2d 493, 497; Matter of Paloma Frocks [Shamokin], 3 N Y 2d 572; Twyeffort v. Unexcelled Mfg. Co., 263 N. Y. 6; Hardin v. Morgan Lithograph, Co., 247 N. Y. 332).

This is as it should be for unless the president actually or impliedly possesses such power the corporate interests may be prejudiced if not entirely destroyed. While, ordinarily, the powers of the president of a corporation are often enumerated either in the articles of incorporation or in the by-laws, it is not usual to find in them any reference to the power to defend or institute litigation in the name of the corporation. However, such an omission does not mean that the power is nonexistent for, in situations requiring the exercise of such power to preserve and protect the interests of the corporation, it will be implied. This case presents such a situation.

According to the complaint, the allegations of which we assume to be true, as and for a first cause of action, the plaintiff alleges that it had been wrongfully and improperly required to pay for work, labor and services entering into the construction of the Forest Hills apartment, owned and built by the defendant Lizau Realty Corp., amounting to approximately $200,000. For a second cause of action, the plaintiff alleges that the individual defendants had, by their wrongful and improper conduct in connection with the building of such apartment, violated their fiduciary duties as directors and officers of the plaintiff corporation; that the apartment house having been sold, the said individual defendants had, or are about to cause, the dissolution of Lizau Realty Corp., and to distribute its assets among themselves as the sole remaining stockholders. The president of West View, under the circumstances, would not have been justified in postponing action until such time as the board had affirmatively authorized commencement of suit. According to the complaint, they had their own selfish interests to protect which were contrary to the interests of the corporation. While there is no danger of a deadlock, as in Rothman (supra), the principle is the same in either event for it is the corporation whose interests are affected, and it was for the purpose of protecting and preserving the corporate interest that prompted the president to institute this suit.

We point out that in Rothman (supra), which dealt with an internal problem between equally divided interests in a close corporation, we recognized that a corporation is a separate, independent legal entity notwithstanding that, for convenience, the parties managed the corporation in disregard of accepted corporate procedures, much in the manner of a partnership. Here, the necessity of recognizing that a corporate entity has independent, separate legal rights is even more emphatic. Allegedly, West View had been charged with and required to pay for construction costs incident to a building in which it had no interest. The coincidence that the plaintiff and defendant corporations were owned by the same individuals who, in turn, constituted the respective boards of directors makes it even more imperative to recognize that West View, as a corporation, has an independent and separate cause of action.

This is not the classic situation requiring resort to a stockholders’ derivative action to protect minority interests. To be sure, President Zaubler, as an individual stockholder, is now in the minority, but that fact does not deprive him of his right and duty to perform the obligations and functions of his office as president, nor does it prevent the corporation, as a corporation, from commencing an action in its own behalf simply because a majority of its board of directors are in a position to withhold authorization.

Our holding in Sterling Inds. v. Ball Bearing Pen Corp. (298 N. Y. 483, 490) is not authority to the contrary, for there the holding was dictated by the circumstances of that case, since 1 ‘ Any actual or implied authority which [the president] may have had as president ’ ’ to bring suit was effectively 1 ‘ terminated when * * * the board * * * refused to sanction it ”. Thus, Sterling does not hold that under all circumstances the president is without authority to institute or defend litigation in the name of the corporation unless actually so authorized. Here the board has taken no action, since the parties limited the within issue to the question of the president’s power to initiate the litigation in the name of West View, they having stipulated that the present directors would take no further action in the premises pending the determination of that issue.

Absent a provision in the by-laws or action by the board of directors prohibiting the president from defending and instituting suit in the name of and in behalf of the corporation, he must be deemed, in the discharge of his duties, to have presumptive authority to so act. Under these circumstances, the within action was properly instituted by the president in the name of the corporation, in the exercise of his implied authority to protect and preserve the interest of the plaintiff corporation. The fact that the corporation was inactive for several years in no way serves to relieve or excuse him from duty.

The order appealed from should be affirmed, with costs, and the question certified answered in the affirmative.

Fkoessel, J. (dissenting).

The majority of the court is now holding that a minority stockholder, merely because he was president of a corporation, may now sue, upon the theory of implied authority and in the name of the corporation, the majority stockholders who are the two remaining directors. Such a decision in our opinion runs counter to the basic principles of corporate law and holds in effect that a corporation is to be managed by its president and not by its board of directors.

In three previous decisions, we passed upon the authority of the president (or secretary-treasurer who had all the powers normally devolving upon a president) to institute legal or arbitration proceedings, without first obtaining specific approval from the board of directors (Sterling Inds. v. Ball Bearing Pen Corp., 298 N. Y. 483; Rothman & Schneider v. Beckerman, 2 N Y 2d 493; Matter of Paloma Frocks [Shamokin], 3 N Y 2d 572). In all those cases, however, the directors were evenly split and corporate management was thns deadlocked. In authorizing the secretary-treasurer to bring suit in Rothman, and the president to institute arbitration proceedings in Paloma Frocks, the unarticulated premise was that in a deadlock situation corporate management is paralyzed and the need for allowing the president to institute a corporate suit, especially against ‘ ‘ outsiders ’ ’, is often urgent.

In the instant case, the president of a corporation which has been inactive for some four years seeks to prosecute an action in the name of the corporation against the individual defendants, who were two-thirds owners and constituted a majority of the board of directors, and against the corporate defendant, of which he was president and one-third owner and in which he sold his interest to the individual defendants. The authority to prosecute such an action must be either (1) actual, (2) apparent or (3) implied. There can be no question of actual authority, since a majority of the board of directors are defendants and obviously opposed to the suit, and the corporate by-laws do not authorize a single officer to institute suit on behalf of the corporation. Nor can there be apparent authority, since (as we noted at page 490 in the Sterling case) no rights of outsiders or third parties are involved. Thus the authority, if any, must be implied, i.e., presumptive or prima facie authority by virtue of the office of president.

In finding such presumptive authority, Special Term relied principally on a quotation from the Rothman case (2 N Y 2d 493, 497, supra), reaffirmed in Paloma Frocks (3 N Y 2d 572, 575-576, supra), that “ Where there has been no direct prohibition by the board, then, it has been held, the president has presumptive authority, in the discharge of his duties, to defend and prosecute suits in the name of the corporation.” However relevant the absence of direct prohibition may be in a deadlock situation, it can hardly be decisive where the president has actual knowledge that a majority of the board of directors oppose the suit. To consider it decisive would be to exalt form above substance to a degree never countenanced by this court. There can never be implied authority in a president to bring suit in the name and on behalf of a corporation where a majority of those entrusted by law with its management unquestionably oppose such action. This is especially so when the president seeks to use the corporation to sue, not outsiders, but those who constitute a majority of the board of directors.

The majority opinion states that “ it was for the purpose of protecting and preserving the corporate interest that prompted the president to institute this suit ”, and that he was not required to wait “ until such time as the board had affirmatively authorized commencement of suit ” (which obviously it would never have done), because the majority of the board had their own selfish interests to protect which were contrary to the interests of the corporation ”. But who is this corporation whose cause of action the majority of the court seek to preserve? It is three men, each of whom owns one third of the stock and each of whom is an officer and member of the board. If the two would withhold consent to this suit because of their own selfish interests ”, is it not equally apparent that the third is bringing suit for his own selfish interests? Who could possibly benefit from this action except plaintiff as the minority member of the corporation? It is perfectly obvious that it was his own personal selfish interests “ that prompted [him as] the president to institute this suit” on behalf of a corporation which has done no business whatsoever for several years.

To hold, under these circumstances, that the “ corporation is a separate, independent legal entity ” with rights of its own is to ignore the express mandate of section 27 of the General Corporation Law, to wit: “ The business of a corporation shall be managed by its board of directors ” and not by its president — and to close our eyes to stark reality. The president did not need a resolution from the board of this inactive corporation to know that he was not authorized to bring this action and, in prosecuting it in the face of the opposition of the board, the president was violating his duty as a. corporate officer.

As we noted at page 493 of the Sterling decision (supra), plaintiff’s proper remedy was a stockholder’s derivative suit. He was president and director of this corporation when all the acts of the two directors, of which he now complains, took place. He sold his interest in 10 active corporations, including defendant corporation, to the individual defendants for a sum approximating half a million dollars, and the only apparent reason why his stock in plaintiff corporation was not purchased was that it was valueless. It seems clear that he is now seeking for his sole benefit to use plaintiff corporation as an instrumentality against the majority of stockholders and directors in order to siphon money from a corporation in which he sold his interest to one in which he still retains an interest, and which was dormant and without assets. What he would be barred by estoppel from complaining of in a stockholder’s action, he has been permitted to do by way of a “ president’s suit

Special Term also relied upon the fact that “ a course of conduct developed through the years * * * whereby Zaubler, as plaintiff’s president, acted as spokesman and directive head of the corporation in all its activities, including litigation.” But there is a basic distinction between suits, in the name of the corporation, against outsiders, and suits against insiders, especially where the insiders constitute a majority of the board of directors. In Rothman (supra, p. 499) we emphasized the fact that “ the defendants before us, complete strangers to the corporation and actually charged with converting a portion of its assets, should not be permitted to question his authority and thereby frustrate the action.” (Emphasis supplied.) And in Fanchon & Marco v. Paramount Pictures (202 F. 2d 731, 733) the Second Circuit Court of Appeals wrote: “ It may be agreed that a president may authorize normal litigation without thereby finding justification for an action against the single other stockholder which will obviously disrupt corporate activities until terminated and which is known to be opposed by one-half the board of directors. The contention relied on seems too farfetched to deserve extended consideration, Sterling Industries, Inc. v. Ball Bearing Pen Corp., 298 N. Y. 483”. (Emphasis supplied.)

In Rothman (supra) we distinguished the Sterling decision (supra) on two grounds: (1) the suit in Sterling was against insiders, and (2) the board, when requested to act in Sterling, refused, by way of a tie vote, to give the president permission to institute suit. Here, the suit, as in Sterling, is not only against insiders but against a majority of the board, and their refusal to authorize the action against themselves is as obvious as it can be. In Paloma Frocks (supra, p. 575) we distinguished Sterling not only on the ground that permission had there been refused, but because of the more important difference ” that the directors had agreed in advance that corporate controversies should go to arbitration, and “ when a dispute did arise the submission thereof by president Bernstein to arbitrators was a routine step in the performance of an authorized contract.”

Not only are we unable to distinguish the instant ease from Sterling, but we feel it is far stronger. As we noted in Sterling (supra, p. 492): “ We have consistently held that section 27 of the General Corporation Law, which provides that the business of a corporation shall be managed by its board of directors, cannot be circumvented. [Citing cases.] ” By affirming here, we are, in effect, creating a further exception to our holding in the Sterling case, and are amending section 27 to read that the corporation shall be managed by its board of directors, except when one member of the board, who happens to be president, disagrees with the majority, in which case it shall be managed by the president. We cannot imagine a more drastic departure from basic principles of corporate law.

We would reverse the orders below, grant the motion to set aside the service of the summons and dismiss the complaint, with costs, and answer the certified question in the negative.

Judges Desmond, Fund, Van Voorhis and Burke concur with Judge Dye; Judge Froessel dissents in an opinion in which Chief Judge Conway concurs.

Order affirmed, etc.