Northern Fire Apparatus Co. v. Commissioner

NORTHERN FIRE APPARATUS CO., PETITIONER, v. COMMISSIONER OF INTERNAL REVENUE, RESPONDENT. Northern Fire Apparatus Co. v. Commissioner Docket No. 8960. United States Board of Tax Appeals 11 B.T.A. 355; 1928 BTA LEXIS 3823; April 2, 1928, Promulgated *3823 Under the evidence in this case, certain certificates held to be preferred stock rather than evidences of indebtedness. Frank J. Albus, Esq., Clarence T. Lowell, Esq., and Leslie C. Swift, Esq., for the petitioner. Brice Toole, Esq., for the respondent. LOVE *356 This proceeding is for the redetermination of deficiencies in income and profits tax for the years 1919 and 1920 in the amounts of $192.93 and $1,394.94, respectively. The question at issue is whether certain certificates issued by petitioner in 1917, and denominated preferred stock certificates, were stock certificates or evidences of indebtedness, and hence whether the dividends paid thereon were in fact dividends or interest. Petitioner contends that such payments were interest and deductible as such. The respondent contends that they were dividends and not deductible. FINDINGS OF FACT. The petitioner is a Minnesota corporation. Prior to 1913 it had been operating at a loss and had become involved in serious financial difficulties. Two of its stockholders, A. W. Armatage and Alexander Campbell, decided that if they could procure all the stock, that they would*3824 loan the corporation money and thus finance its operation in the hope of ultimately making it profitable. In 1913, they had acquired all of said stock. From that time on for several years, when the expense account exceeded the income for a given month, Armatage and Campbell each would give his check for one-half the deficit, and take the corporation's check as evidence of such loan and hold it. When these checks accumulated to as much as $5,000 they would cancel the corporation check and take its notes in lieu of the checks. Interest was paid regularly on those notes, at least was credited on the books to the respective holders of the notes. By 1917, the amount of those notes and outstanding checks had reached $45,000. After consulting their attorney, Armatage and Campbell decided to take preferred stock as authorized by the amended articles of incorporation in lieu of the notes, and they did so exchange their notes and outstanding checks for such preferred stock, class A. The articles of incorporation were amended as follows: Resolved: 1: That section 1 of Article III of the Articles of Incorporation of the Northern Fire Apparatus Company be amended so as to read as follows, *3825 to-wit: 1: The amount of the capital stock of this corporation shall be Two Hundred Thousand Dollars ($200,000) divided into two thousand (2000) shares of the par value of One Hundred Dollars ($100.00) each; said stock shall be divided into three classes, as follows, to-wit: Class A Preferred Stock, consisting of five hundred (500) shares, of the par value of One Hundred Dollars ($100.00) each; Class B Preferred Stock, consisting of five hundred (500) shares of the par value of One Hundred Dollars ($100.00) each; Common Stock consisting of one thousand (1000) shares, of the par value of One Hundred Dollars ($100.00) each; *357 The holders of Class A Preferred Stock shall be entitled to and shall be paid a guaranteed yearly dividend at the rate of seven per cent (7%) per annum, and no more, payable quarterly, on dates to be fixed by the directors; each and every certificate of Class A Preferred Stock shall be subject to redemption, and may at the option of the directors, on any quarterly dividend date, at any time after five years from the date of the issuance of such certificate, be called and retired at the price of $105.00 for each share and the amount of dividends*3826 accrued and unpaid at the date of redemption. Notice of the intention to call and retire a certificate shall be given to the holder thereof ten days before the quarterly due date of interest at which the same is to be retired. Such notice shall be deemed given when served personally upon the owner of the certificate, or when placed in an envelope, postage prepaid, addressed to the holder of the certificate at his address as the same appears upon the books of the corporation, and deposited in any United States Post Office or mail chute. Class A Preferred Stock and all dividends to which it is entitled shall be a first lien on the assets of the corporation. In the event of any liquidation or dissolution or winding up, whether voluntary or involuntary, of the corporation, the holders of Class A Preferred Stock shall be entitled to be paid in full, both the par amount of their shares and the unpaid dividends accrued thereon, before any amount shall be paid to the holders of other stock, and after such payment to the holders of Class A Preferred Stock, the remaining assets of the corporation shall be divided and paid to the holders of other classes of stock as hereinafter provided. *3827 The holders of Class B Preferred Stock shall be entitled to have and receive, when, and as declared from the surplus or net profits of the company, cumulative yearly dividends at the rate of six per cent (6%) per annum, and no more, payable quarterly on dates to be fixed by the directors. Class B Preferred Stock and all dividends to which it is entitled shall be a second lien on all the assets of the corporation; in the event of any liquidation or dissolution or winding up, whether voluntary or involuntary, of the corporation the holders of Class B Preferred Stock (holders of Class A Preferred Stock having previously been paid as aforesaid) shall be entitled to be paid in full, both the par amount of their shares and the unpaid dividends accrued thereon, before any amount shall be paid to the holders of the common stock, and after such payment to the holders of the Class B Preferred Stock, the remaining assets of the corporation shall be divided among and paid to the holders of the common stock according to their respective shares. Neither the holders of Class A Preferred Stock nor the holders of Class B Preferred Stock shall be entitled to any voice in the management of the*3828 corporation, or to any voting powers at any stockholders' meeting. The sole management of the corporation shall be in the hands of the holders of common stock, and they alone shall be entitled to vote at any meeting of the stockholders of the corporation. No holder of Class A Preferred Stock or Class B Preferred Stock shall be entitled as a matter of right to subscribe for or purchase from the corporation any further or other stock in the corporation, or participate in any increase in the stock of the corporation. Only holders of common stock shall have the right to hereafter subscribe for or buy or receive from the corporation any stock hereafter issued by the corporation, whether of the stock heretofore or hereby authorized, or in case of any increase in the stock of the corporation in any one or more classes or otherwise. No Class B Preferred Stock shall be redeemed, called or retired while any of Class A Preferred Stock is outstanding, except by and with the unanimous *358 consent of all holders of Class A Preferred Stock. After the redemption and retirement of all Class A Preferred Stock, or with the unanimous consent of all holders of outstanding Class A Preferred*3829 Stock, each and every certificate of Class B Preferred Stock may at any time be called and retired at par, plus the amount of dividends accrued and unpaid at the date of redemption. 2: That Section 2 of Article III of the Articles of Incorporation be amended so as to read as follows, to-wit: Section 2: The capital stock of this corporation shall be sold and paid in at such time and in such amounts as the Board of Directors shall determine. 3: That Section 3 of Article III of the Articles of Incorporation be amended so as to read as follows, to-wit: Section 3: The highest amount of indebtedness to which said corporation shall at any time be subject is the sum of One Hundred Thousand Dollars ($100,000). 4: That said Article III of the said Articles of Incorporation be further amended by adding thereto another section, which shall be known as Section 4 thereof, and shall read as follows, to-wit: Section 4: This corporation shall have the power to redeem call and retire stock as hereinbefore provided. 5: That Section 2 of Article IV of the Articles of Incorporation be amended so as to read as follows, to-wit: Section 2: Arthur W. Armatage shall be the president of said*3830 corporation; Alexander Campbell shall be the vice-president; Lewis O. Kuhn shall be the secretary, and Daniel S. Hunter shall be the treasurer thereof, and they shall hold their officers until the next annual meeting of the stockholders of said corporation; and until their respective successors are elected and shall have qualified. The annual meeting of the stockholders of the corporation shall be held on the third Tuesday of January of each and every year hereafter, at the hour of two o'clock in the afternoon, at the office of the company in Minneapolis, Minnesota. No notice of the annual meeting need be given to the stockholders. 6: That Section 3 of Article IV of said Articles of Incorporation be amended so as to read as follows, to-wit: Section 3: The Board of Directors shall be elected annually, and each holder of common stock of the corporation shall be entitled to one vote for each share of common stock held or owned by him, and the stock may be voted in person or by proxy. Holders of stock other than common stock shall not be entitled to vote at any meeting of the stockholders of the corporation, nor shall they be entitled to have any voice in its management. *3831 A certificate of the Secretary of State shows that the foregoing amended articles were filed in his office on May 23, 1913. The pertinent provisions of the certificate of stock are as follows: NORTHERN FIRE APPARATUS COMPANY Capital Stock $200,000.00 $50,000.00 Class A Preferred $50,000 Class B Preferred THIS CERTIFIES THAT ALEXANDER CAMPBELL is the owner of One Hundred shares, of the par value of $100.00 each of the Class A Preferred Capital Stock of the Northern Fire Apparatus Company, fully paid up; subject to the conditions printed on the back hereof. This stock is transferable only on the books of the company in person or by attorney on surrender of this centificate. *359 IN WITNESS WHEREOF the duly authorized officers of the company have hereunto subscribed their name and caused the corporate seal to be hereto affixed. This First day of October A.D. 1917 L. O. Kuhn, Secretary (Signed) A. W. Armatage President. (On back of certificate.) CLASS A PREFERRED STOCK This stock is issued subject to the Articles of Incorporation and By-Laws of the Northern Fire Apparatus Company, all whereof are hereby referred to and made a part hereof. The*3832 holders of Class "A" Preferred Stock shall be entitled to and shall be paid a guaranteed yearly dividend at the rate of seven per cent (7%) per annum, and no more, payable quarterly on dates to be fixed by the Directors; each and every Certificate of Class "A" Preferred Stock shall be subject to redemption, and may at the option of the Directors, on any quarterly dividend date, at any time after five years from the date of the issuance of such certificate, be called and retired, at the price of $105.00 for each share and the amount of dividends accrued and unpaid at the date of redemption. Class "A" Preferred Stock and all dividends to which it is entitled shall be a first lien on the assets of the corporation. No holder of Class "A" Preferred Stock shall be entitled to any voice in the management of the corporation, or to any voting powers at any stockholders' meeting; nor shall he be entitled as a matter of right to subscribe for or purchase from the corporation any further or other stock in the corporation. Section 7480 of the General Statutes of Minnesota provides: Any corporation whose original or amended certificate of incorporation so provides, may issue and dispose*3833 of Special and Preferred and Common Stock, or Special or Preferred and Common stock; and any corporation, without change of its certificate of incorporation, when its Board of Directors are so authorized by majority vote of its stockholders at its annual meeting, or at a meeting called for that specifically stated purpose, may issue its capital stock part special, part preferred and part common, or part common and part either special or preferred, and give such preference as it deems best to such special or preferred stock, or to such special and preferred stock. The minutes of a special meeting of the board of directors on October 1, 1917, recite, among other things: Alexander Campbell and A. W. Armatage agreed, at this meeting to surrender the company's notes held by them, and to take therefor, in payment, Class A Preferred stock of the company to the amount of 225 shares. Of the class A stock there were issued to Armatage 225 shares and to Campbell 225 shares. OPINION. LOVE: The only question at issue in this proceeding is whether or not the certificates of the 450 shares of class A preferred stock of the corporation taken by Armatage and Campbell were in fact stock*3834 of the corporation or were evidences of indebtedness. *360 The use of the words "preferred stock" is not controlling. It is the substance of the thing dealt with and not what it is called that is important. If the transaction that brought into existence these "preferred stock" certificates, resulted in the creation of the relation of debtor and creditor, as regards the essential characteristics of that relation, then that relation exists, regardless of the name given those certificates. The foregoing proposition is so well established that we deem it unnecessary to cite authorities, except one from Minnesota, as evidence that the same doctrine prevails in that State. See . The characteristics of stock of a corporation are evidence of a right to participate in the net profits of the corporation, proportionate to the stock held; the right to participate in the management of the corporation commonly designated as voting rights; the right to share, proportionately, in the distribution of net assets on liquidation of a corporation. Preferred or special stock may possess any or all of the foregoing characteristics, *3835 and may, and usually does possess other features; that is, any lawful feature which the issuing corporation may see proper to insert. The charactertistics of a note, that is an evidence of indebtedness, are: A definite obligor; a definite obligee (either by name or by designation); a definitely ascertainable obligation; a time of maturity, either definite or that will become definite. It may possess other features such as provision for interest, attorney fees, security, etc. An ordinary note, or bond of a corporation, possesses none of the elementary or ordinary characteristics of stock, as such. However, in view of the doctrine known as the "freedom of contract" it may be that a corporation could incorporate in a bond eo nomine, rights and conditions, that would in fact render such bonds a certificate of stock. In a number of cases, certificates denominated stock certificates have been held to be in fact evidences of indebtedness and to all intents and purposes bonds. The document in question, in each case, must be examined in reference to its own recitations, as well as in the light of circumstances and conditioons that moved the parties to its execution and acceptance*3836 as those circumstances and conditions may aid in construing the expressed provision in the document, and its actual nature determined, and thus its legal status determined. In the instant case the certificates in question lacked one essential element of a bond, that is, evidence of indebtedness, to wit, a date of maturity either certain in terms or capable of being made certain by the holder. While they purported to grant a first lien on the assets of the corporation to secure their payment, we fail to discover any authority in the statutes of Minnesota to grant such a lien as would supersede the *361 rights of creditors. There is no evidence in the record to show that these certificates were registered in the recorder's office of the home county of the corporation to serve creditors with constructive notice of such lien, if any. It may be that the corporation intended that lien to take precedence over creditors and it may be that the holders thought they had such precedence, but what they thought about the situation is not controlling. The weight of authority is to the effect that preferred stock, in the absence of statutory authority, where the manner of its issuance*3837 and sale is prescribed, may not take precedence over creditors, either secured or unsecured. See Cook on Corporations, vol. 1, par. 271, and authorities there cited. In law there are material differences between corporate stock and corporate bonds. Boards of directors are presumed to know those differences and when such board issues certificates, the name or designation given such certificates by the board of directors should begiven effect, unless there is convincing evidence that the board did not say what it intended to mean, and further that what it intended to say is evidenced so clearly and publicly, that creditors will not be misled. Reviewed by the Board. Judgment will be entered for the respondent.