Kidd v. Puritana Cereal Food Co.

GOODE, J. (after stating the facts). The relation of plaintiff to defendant company is argued by her counsel to have been that of creditor, instead of shareholder, and, therefore, they, contend defendant was bound in every contingency, to pay the dividends semiannually as stipulated and whether its net earnings war-rated a' declaration of dividends, or even if its capital would have been impaired by paying them. The general rule of law is that holders of preference shares in a corporation are no more entitled to dividends, unless the earnings of the company justify the directors to declare and pay them, than are the holders of common shares; for dividends are payable only out of surplus earnings. [2 Clark & Marshall, Priv. Corp., sec. 529c and cases cited in note 226; Purdy’s Beach, Priv. Corp., sec. 476; Chaffee v. Railroad, 16 Am. and Eng. R. R. Cas. 408; In re London, etc., Co. L. R. 5 Eq. 525.] Usually the holders of preference shares are stockholders of the company, subject to the rights and liabilities attaching to that relation, and the principal privilege they enjoy is priority of claim to dividends as against the holders of common shares; which priority is the prominent characteristic of preferred stock. [Kent v. Mining Co., 78 N. Y. 159.] Without authority from the Legislature, an incorporated company cannot confer on holders of preferred shares a right to be paid ■ dividends, if the capital of the company will thereby be impaired or the demands of its creditors postponed. [Hamlin v. Trust Co., 78 Fed. 664; 2 Clark & Marshall, sec. 417c; Purdy’s Beach, sec. 476.] Instead of the issuance of preferred stock necessarily creating a debt, a standard treatise says such a transaction “is a mode by which a corporation obtains funds for its enterprises without borrows ing money or contracting a debt. Its holders {i. e. the holders of preferred stock) are a privileged class who are entitled to dividends of a certain per cent out of — 514 — the net earnings in priority to any dividends upon ordinary stock.” [Pierce, Railroad Law, 124.] (Italics ours.) But statutes have been enacted in language which was construed to invest a corporation with power to issue preference shares upon terms that made the holders of them not stockholders of the company, but its creditors, and entitled to payment of so-called dividends regardless of whether the earnings of the company sufficed to meet them or not, and entitled also to payment of the face value of the certificates by a certain date. Cases in which it was contended a person, nominally the holder of preference shares, in reality occupied the status of a creditor and should enjoy greater rights as such than he would as a stockholder have engaged the attention of the courts often enough for the principles upon which the point is to be determined to become settled; though, perhaps, not all the results reached nor all the remarks contained in opinions can be reconciled. The task of the court in such a controversy is one of interpretation; to deterine whether the essential nature of the agreement between the apparent shareholder and the company makes the former a stockholder or a creditor; and the answer to this question always depends on the language of the statute which authorized the company to issue preferred shares, as well as on the language employed in the certificates of shares. It has followed that while the same principles of interpretation are adopted by all the courts, the conclusions reached in the cases differ, because the statutes differ under Avhich the various companies sued had issued preferred certificates, or what were such in form. The Supreme Court of Georgia said, in dealing with a similar controversy, the question whether the holder of a certificate issued by a corporation is a member of the corporation, or the certificate is simply eAddence of a debt due by the corporation to the holder, is one depending on the peculiar facts of each case; and therefore the decisions relating — 515 — to the questions are only helpful in so far as they lay down general principles to guide in the determination of any case that may be for consideration. [Savannah Co. v. Silverburg, 108 Ga. 281, 288.] Nominal stockholders have been treated as actual creditors on several grounds. In some instances the statute involved obviously was enacted simply to empower the company to put out preferred shares and secure them by a lien on its assets, as an alternative mode of borrowing money in lieu of issuing bonds secured by a mortgage on the assets, as the company might' have done. [Burt v. Rattle, 31 Oh. St. 116; Heller v. Bank, 43 Atl. (Md.) 800.] In the first of those cases the statute entitled the holders of preference shares not only to have their demands secured by a mortgage on the assets of the company, but authorized the company to guarantee semi-annual dividends and full payment of the face value of the stock by a certain date, denied the holders the right to participate in the affairs of the company by voting, excluded them from either the profits or the losses of the business, and exempted them from liability to creditors of the company. It is plain those attributes, particularly enjoyment of immunity from any losses of the business and the right to be paid back the amount invested by a certain date, wrere germane to a loan rather than to a subscription for stock. For the same and other even more cogent facts tending to show the preferred stock was in truth simply a loan made by the company in that form, the judgment in Heller v. Bank treated the nominal stockholder as a creditor. In Savannah Co. v. Silverberg, supra, the decision that the nominal shareholder was in fact a creditor, was rested principally upon the binding obligation of the company to redeem the preferred shares by a given date and the circumstances of embarrassment under which they were issued. It is to-be noted, however, that while the court held he was a creditor, it said the dividends — 516 — to which the certificate said he wag entitled semiannually, though really interest, were not meant “to be paid absolutely and at all events, but simply in the event the corporation earned a sufficient amount to pay each holder of such certificate;” a singular remark. The question in that case was whether the holder could collect the full value of the certificate when it matured, and the court decided he could. In another case to which we have been cited, and the one mainly relied on by plaintiff, the statute was held on grounds not clear to our minds, to have been enacted to enable the company to borrow money for the discharge of debts, by issuing preferred stock, and hence the holder of such stock was treated as a creditor and not as a stockholder. [Williams v. Parker, 136 Mass. 204.] An attempt to distinguish the statute on which that decision was given from the one on which Field v. Lamson, 166 Mass. 388, was determined, was attempted in the opinion in the latter case, wherein the preferred shares were treated as stock and not as an evidence of debt. The distinction was put on the ground that the statute involved in Field v. Lamson required the dividends to be paid out of the net earnings — an important distinction if properly drawn; but the like requirement might have been implied in the earlier case; and, indeed, has been implied on a statute using similar language, as Avill appear from an excerpt infra from the opinion in Elkins v. Railroad, 36 N. J. Eq. 233. Before scrutinizing the Indiana statute, it may be well to say merely denominating shares “preferred stock” in a legislative act, does not per se, define the rights and character of the holder of such shares, which depend on the essential qualities of the transaction authorized by the statute. [Elkins v. Railroad, Burt v. Rattle, supra; Miller v. Ratterman, 47 Oh. St. 141.] And the circumstance that the installments to be paid on the shares annually or semi-annually, were called “interest” in the statute instead of “dividends,” or that the two terms — 517 — were used interchangeably, is not regarded as conclusive of the question of Avhether the installments are in fact dividends or interest. [Williston v. Railroad, 95 Mass. 400; State v. Railroad, 16 S. C. 524; Sturge v. Railroad, 31 Eng. Law & Eq. Rep. 406; Corry v. Railroad, 29 Beav. 263.] Nevertheless, the name employed by the Legislature to designate the shares, is one badge of the legal character intended to be given to them, for the words of a statute are to be taken in their ordinary sense unless a different one is called for by the context. [R. S. 1899, sec. 4160.] The court applied this rule of interpretation in dealing with the very question before us, in State v. Railroad, 16 S. C. 524; and in determining whether or not shares were stock of an evidence of debt, attached weight to the fact that the Legislature had called the shares “preferred stock.” Whatever influence the name employed in the Indiana statute to designate these shares should have in determining whether the certificate was one for stock or an evidence of debt, favors the former character. But there are weightier reasons for holding it stock. An examination of the statute and of the certificate itself, makes it apparent that by no semblance of reason could we hold defendant became indebted to plaintiff for the face value of the shares; that is to say, $500. This is so because1 defendant did not bind itself to pay the face value of the shares to plaintiff at any time, but only reserved an option to pay at its pleasure after ten semiannual dividends had been paid and before the twentieth matured. The essence of a debt is a legal liability on the part of one person to pay money to another at some time, which liability is enforcible by a judicial action. [Lockhart v. Van Alstyne, 31 Mich. 76, 78.] The only plausible contention for plaintiff is that the obligation to pay semi-annual dividends at maturity was absolute add created a debt; that the so-called dividends were not technically such, but installments of interest the company was bound to pay whatever befell. — 518 — A company may bind itself to pay interest instead of dividends on stock, but its power to bind itself to pay installments of either kind in priority to the demands of creditors, must be found in a clear legislative grant. [1 Cook, Corp. (6 Ed.), sec. 277; City of Covington v. Covington, etc., Bridge Co., 10 Bush. (Ky.) 69.] It is unusual and anomalous for companies to bind themselves absolutely to pay installments periodically on shares, instead of as dividends are earned; and we think this company ought not to be held to have agreed to do that unless, upon a fair interpretation of the statute and contract, the conclusion that the installments were payable absolutely must be deduced. "We regret the necessity of expounding the statute of another State unaided by an interpretation by its courts of last resort; and it is with diffidence we announce our opinion that the Legislature of Indiana did not intend to make the simi-annual installments accruing on preferred shares of stock in a manufacturing company interest and a debt, any more than it intended to make the principal of the shares a debt; and this was not intended to be a debt necessarily, because the statute does not declare a company’s liability for the principal shall have a date of maturity in favor of the holder, but makes it subject to redemption upon such terms as the certificate shall provide (sec. 5067). The certificate under review provided for redemption at the pleasure of the company after ten dividends had been paid and before the twentieth fell due; and this reservation of an option to redeem is consistent with the statute. No provision regarding the installments can be found in the several sections of the statute, which tends to fasten on them the character of a debt in a way peculiar and distinctive, in comparison with the character the statute gives to the principal of the shares, except the fixed dates of maturity of the installments. As to this matter the certificate issued by the company obligates it to pay a semi-annual dividend of three per cent. But the — 519 — statutory language is not imperative, and only binds a company which issues preferred shares to pay a dividend on them before setting aside anything for the common stock; that is, does not compel payment at stated intervals whatever happens. The circumstance that installments have a maturity date cannot alone be regarded as conclusive in favor of their being absolute obligations, or else all dividends stipulated to be paid at definite intervals would be payable without regard to a company’s earnings; a conclusion opposed to the adjudicated cases. In our judgment the meaning of the statute is that the installments partake of the nature of the principal, and if the latter is stock,, they are dividends on stock and affected by the common incidents of dividends; that is, they will be postponed to debts and are declarable in the discretion of the directors, exercised in good faith. Besides the decisive reason already advanced against regarding the principal as a debt, that no time is fixed in which it shall fall due, other reasons may be invoked. The Indiana- statute does not authorize companies to issue preferred shares merely as a mode of borrowing money and only in the contingency of a necessity to borrow; no authority is given a company to secure preferred shares by mortgage or other lien on its property, as was the case in Heller v. Bank, 43 Atl. 800, and Burt v. Rattle, supra. Moreover, the statute authorizes the issue of preferred shares in double the amount of the common stock of the company, and it is improbable the Legislature meant to empower companies to borrow twice as much as their capital. But this would be the effect of construing the act to make preferred shares a debt instead of part of the capital stock of a company. All issues of preferred stock must be reported to the Secretary of State with particulars, and the shares of such stock are subject to redemption at whatever time shall be provided in the certificate, but, as already said, need not be redeemed at any time unless the company agrees they — 520 — shall be. As pointed out supra, section 5067 does not bind a company to pay semi-annual dividends on preferred shares, but says it shall be bound to pay dividends in the sums expressed in the certificate, not exceeding four per cent, before any dividends shall be set aside or paid on the common stock. We take that language to mean the dividends shall be paid out of the surplus earnings and after creditors have been satisfied, but before dividends are declared or paid on common stock. The section goes further and says in case of insolvency or dissolution of the company, its debts and other liabilities shall be paid in preference to preferred stock. This language makes the preference shares participate in business losses; whereas the last clause of section 5068 prevents them from participating in profits beyond interest or dividends, and says, in effect, they may take out of the assets of the company only their face value and arrearages of dividends or interest. The most important inquiries in cases like this relate, firstly, to whether a date is fixed within which a company is bound to pay the preferred shares, for all true debts must fall due some time, and, secondly, to whether such shares are subject to losses of the business in the sense that the holders of them are postponed to creditors at large in case the company becomes insolvent, for such postponement is not easily reconcilable with the notion that the holders of what are nominally preference shares are in reality creditors. The proviso in section 5067, that preferred stock shall at all times have priority of payment out of the assets of the company for their full face value, together with all arrearages and interest thereon, over the common stock, appears to emphasize the only priority accorded to preferred shares; and the language of the section as a whole imports that other liabilities and debts of a company shall take precedence in payment over interest and dividends on preferred stock. Similar language was treated in Elkins v. Railroad, 36 N. J. Eq. 236, as equiv — 521 — alent to expressly declaring dividends on. preference shares should he paid out of net earnings, and as entitling the holder of those shares to payment of arrearages of dividends which had accrued in back years, before common stockholders could share in the profits; but not to entitle him to payment absolutely and without regard to earnings. The statute there involved was, at this point, like the one before us and reads: “That when so issued and declared to be preferred stock, the holders thereof respectively shall be entitled to receive dividends on the same not to exceed seven •per centum per annum, before any dividend shall be set •apart or paid on the other and ordinary stock of said company.” Loc. cit. 235. The portion of the Indiana statute which at first glance looks most favorable to plaintiff, is the one forbidding the company to mortgage any of its property without the written consent of the holders of - a majority of the preferred stock. Section 5068. One might think this proviso useless unless the preferred shares are intended to enjoy priority of payment over debts. But section 5067 expressly gives debts and liabilities the priority. This proviso about mortgages is an in•congruons one, and when narrowly observed, rather clashes in its own terms with the idea that preferred shares are to have absolute priority; for the assets may be mortgaged with the consent of a majority of the preferred shares against the will of the minority. Just what the purpose of the proviso was is difficult to say, but we suppose the Legislature apprehended preferred stock might suffer some detriment from a mortgage it would not suffer by merely postponing it to unsecured debts, if the company became insolvent. The gist of the argument for plaintiff is this: The statute authorized the company to guaranty payment <of dividends on preferred shares and deprived the holder of those shares of the right to vote; two facts which demonstrate the Legislature intended to make — 522 — the holder a creditor of the company. The statute nowhere clearly empowers the company to guaranty the dividends; but granting this power may be deduced, the reasoning for plaintiff would compel the untenable conclusion that the principal as well as the interest on the shares is a debt. Moreover, a guaranty of dividends by a company pursuant to statutory authority does not make the dividends a debt and payable absolutely. [Taft v. Railroad, 8 R. I. 310; Chaffee v. Railroad, supra; Lockhart v. Van Alstyne, 31 Mich. 76; Miller v. Ratterman, 47 Oh. St. 141; Field v. Lamson, 162 Mass. 308; Ulverstone, etc., R. R. v. Commr’s, 2 Hurlst. & C. 855.] And neither does denying the holder of preferred shares a vote, ipso facto, deprive him of the status of stockholder. [2 Thompson, Corp. 2281; Savannah Co. v. Silverberg, 108 Ga. 281, 287.] According to the general doctrine, a guaranty to pay dividends means the company binds itself to pay them out of such assets as are legally available for that purpose, that is, net earnings; and this is true whether the guaranteed payments are called dividends or interest. [1 Morawetz, Priv. Corp. 457; quoted and followed in Field v. Investment Co., 123 Mo. 603, 620.] The reasoning and authorities supra lead to the conclusion that plaintiff was a preferred shareholder and not a creditor of defendant, and her right to dividends depended on whether the earnings of the company justified the directors in paying them. The undisputed evidence shows the earnings were not sufficient to pay more than one dividend a year. Perhaps the inference might be drawn that one dividend could have been declared in 1907, had not the directors thought best to extend the business. Where it is clear a dividend ought to have been declared on preferred shares, a court of equity in a proper suit may compel this to be done or treat it as having been done. [Boardman v. Railroad, 88 N. Y. 157, 180.] But the present action is one at law, and — 523 — certainly a dividend cannot be recovered in a legal action until it has been declared. [2 Clark & Marshall, sec. 517b, and cases cited in note 9.] The judgment is affirmed. All concur.