Estate of Smith ( 1891 )

Opinion,

Mr. Justice Clark:

Tbe question in this case arises upon the adjudication of the account of Alfred and Horace T. Smith, trustees under the will of Stephen Smith, deceased, who died in October, 1884. By his will the testator gave a portion of his estate in trust to pay the net income to his son Alonzo Smith, free from his debts, for life, with remainder over to his children, etc. Included in this part of his estate were fifty-six shares of the capital stock of the Frankford & Southwark Passenger Railway Company. The whole capital stock of the company was #750,000; that is to say, 15,000 shares, of the par value of #50 per share. On the 4th December, 1888, however, it was agreed at a meeting of the stockholders to issue 5,000 additional shares, at the par value of #50 per share, the existing stockholders, as they were registered 2d January, 1889, to have the right, at any time before 2d February thereafter, to subscribe one share for every three of their respective holdings on the day designated.

The trustees of Stephen Smith’s estate exercised the privilege, and bought eighteen shares, for #900, which, for the time, they borrowed from the income fund in their hands, but in their account they have made good the income, and have treated this sum as so much taken from the capital. On the 18th February, 1889, the directors declared a dividend of #11 per share on the whole 20,000 shares. This dividend was made exactly to cover the price of the extra shares, less the state and city taxes as follows:

Subscription to 5,000 shares, at #50 . . #250,000

Less state and city taxes, about . . . 30,000

#220,000

Dividend 20,000 shares, at #11 . . . #220,000

In the meantime, on the 12th January, 1889, Alonzo Smith, the life-tenant, died, leaving to survive him two children, Laura M. and Mary E. Smith, both of whom were minors. The appellant, Alfred Percival Smith, is the administrator of his estate, and the appellees are the guardians of his children. The dividend on the seventy-four shares yielded to the estate #814; it was declared after the decease of Alonzo Smith, and was applied to those entitled in remainder. Upon a sale of the eighteen shares, the profit realized was $8,870, and the trustees accounted for this as capital. To this method of accounting the administrator of Alonzo Smith’s estate excepted, claiming that this sum must be treated as income, and as such that it constituted part of the assets of that estate. The auditing judge, as well as the Orphans’ Court, held the $3,870 to be capital, and not income, and this is the error assigned.

The appellant’s contention is that accumulated profits, when distributed as dividends, belong to the holder of the stock at the time of the distribution, although they may have been earned during a prior ownership; a shareholder having no absolute right to such profits before a declaration of a dividend thereof. But it is well settled in this state that, when the stock of a corporation is by the will of a decedent given in trust, the income thereof for the use of a beneficiary for life, with remainder over, the surplus profits, which have accumulated in the lifetime of the testator but which are not divided until after his death, belong to the corpus of his estate; whilst the dividends of earnings made after his death are income, and are payable to the life-tenant, no matter whether the dividend be in cash, or scrip, or stock.

The leading case in Pennsylvania is Earp’s App., 28 Pa. 368. The residuary estate of Robert Earp, who died in November, 1848, embraced stock in a manufacturing company upon which large surplus profits, over and above the current dividends, had accumulated both before and after his decease. In July, 1854, the capital stock was increased from $200,000 to $500,000, by creating 6,000 additional shares, of $50 each, which were paid for out of the accumulations. At the testator’s death, these surplus profits were near $300,000 ; when the stock issued, they had increased to $700,000. The market value of the stock at his death was $125 per share; when the new stock issued its value was $80, but the number of shares belonging to the estate was 1,350 instead of 540. As the new shares were therefore in part paid from the surplus existing at the death of Robert Earp, and partly from the accumulations after his death, they were properly apportioned between the life-tenant and those entitled in remainder. It was held (a) that the surplus profits accumulated at the death of the testator, as respects the estate were essentially part of the stock itself, and were subject to the trusts in the will as so much principal; and (5) that the accumulations after his decease, when they come to bo divided, are income in like manner as the current dividends, and therefore belong to the life-tenant, no matter whether the division or distribution thereof be in cash, or scrip, or stock. “ In the case before us,” said the Chief Justice, “ the testator has not made a bequest of the stock itself to the appellants; on the contrary, he has given them only the income of it for life. Their interests commence after the death of the testator. They have no right whatever to claim the income which had accumulated before his death.....It is equally clear that the profits arising since the death of the testator are income, within the meaning of the will, and should be distributed among the appellants.”

Moss’s App., 83 Pa. 264, distinctly recognizes the doctrine and authority of Earp’s Appeal, but, as the facts were different, a somewhat different result ensued. Earp’s Appeal differs from Moss’s Appeal, in this: In the former, the new issue of stock was paid for entirely from the surplus profits. There was an actual distribution of profits, as profits, in the form of stock, — profits which had accumulated both before and after the testator’s death; whilst in Moss’s Appeal there was merely a right to subscribe and pay for new shares at their par value, and it did not appear what, if any, portion of the existing surplus was accumulated after the death of Henry Lazarus, or that the value of the stock had advanced after that time until the new stock was issued. No profits were declared or distributed ; the stock was purchased at a price, the object being, not to divide profits as such, but to increase the capital. The right to subscribe for shares was, we think, an interest attaching to the stock, and neither the amount received from the sale of that right, nor the stock purchased with the proceeds, can, under the facts of that case, be considered as a product or profit for the life-tenant. The par value of the stock, as we have said, was $100, but it had a market value of $240: it turned out, however, that the new issue of shares depreciated the shares to $170. It required the addition of the forty new shares to the old to maintain the integrity of the investment. One hundred shares, at $240, were worth $24,000, whilst one hundred and forty shares, at $170, were worth only $23,800 ; so that in fact there was no profit. Our Brother Paxsox, in the opinion, says: “ It requires but a cursory examination of this transaction to show that no profit has been made, except upon paper. As before observed, the corporation had declared no profits, and distributed none. It merely allowed the holder of each share of the old stock to subscribe for a corresponding share of new stock, and to pay the company the par value thereof. .... If the company had gone into liquidation the day before the issue of the new stock, the one hundred shares of original stock would have realized $24,000; if it had gone into liquidation the day after, the one hundred and forty shares would have realized nearly the same sum. Where, then, was the profit ? ”

Biddle’s App., 99 Pa. 278, is in line with Moss’s Appeal. There was no division of surplus profits, or of earnings accumulated either before or after the death of the testatrix, Mary Condy, deceased; the transaction was simply an increase of stock to the stockholders, upon payment of the price at par, and ten dollars per share additional to go to the surplus fund. The market value of the old stock was not shown to have varied between the testatrix’s death, on the 29th June, 1880, and the issuing of the new stock, on the 15th November, 1880, and but a very slight diminution took place after the issue; there was, however, a loss in the intrinsic value to the amount of seventy-five cents per share. Instead of subscribing for the new stock, the executor sold the privilege, and the question was whether the sum realized should be treated as income or principal. In the opinion filed, this court said : “ The entire value of the stock, with all its incidents, at the death of the testatrix constituted the principal of the estate. On this principle the appellant was entitled to the income. Whatever value beyond par the stock then had, by reason of the large surplus fund of the company, or otherwise, attached to the stock and formed a part of the principal. The appellant was not given any part of this aggregate value of the stock; the income therefrom was all she was entitled to receive. Whatever was capital must remain capital.....It is not shown that the stock was of greater value on the 15th November than on the day of the death of the testatrix, nor that the surplus fund had been increased in the meantime.....The distinction between the surplus fund, existing at the time of the death of the testator, and a fund accumulated afterwards, is distinctly recognized in Earp’s App., 4 Cas. 368. That which had accumulated before the death of the testator was held to be part of the principal of the fund, and that which accumulated after his death to be income.”

The same rule is recognized, with special reference to Earp’s Appeal as authority, in McKeen’s App., 42 Pa. 479; in Vin-ton’s App., 99 Pa. 434; and in Philadelphia Trust Co.’s App., 24 W. N. 137; s. o. 1 Mona. 230. The last case bearing upon this question is the very recent one of Oliver’s Est., 136 Pa. 43. The contest there, as here, was between the life-tenant and the remainder-man, and the question whether the fund in the hands of the trustees was income or principal was settled in harmony with Earp’s Appeal, which is referred to as establishing the rule in this state.

Wiltbank’s App., 64 Pa. 256, in no way collides with the ruling in Earp’s Appeal. It may perhaps be to some extent inconsistent with Moss’s Appeal or Biddle’s Appeal, but it is in full accord with the well-settled rule that the life-tenant is entitled to the income accruing after the death of the testator, and that surplus profits accruing in his lifetime, when they come to be distributed, are principal, and not income. As the court said in Moss’s Appeal, that case must stand upon its own peculiar facts. It may be distinguished, if at all, from the cases mentioned, in this, that in the increase of the stock there was no impairment of either the actual or the market value of the shares.

From this hasty review of the cases, it will be seen that the ruling in Earp’s Appeal has, for more than the third of a century, been steadily maintained, without modification or change; in no subsequent case, we believe, has its authority been doubted, its practicability questioned, or the soundness of its doctrine impeached. It has not only been adhered to in this state, but it has been adopted and followed in nearly all of the states. It is referred to in the text-books as the Pennsylvania rule; but, as remarked by Mr. Cook in his very recent treatise on Stocks and Stockholders, etc., § 554: “ Inasmuch as it obtains in every state of the Union, excepting Georgia and Massachusetts, it might well be called the American rule.” The rule which prevails in Massachusetts and Georgia is to regard cash dividends, however large, as income, and stock dividends, however made, as capital: Minot v. Paine, 99 Mass. 101, whilst the English rule is that the intention of the corporation to declare a dividend, as such, is to govern, and therefore the ordinary or current dividends are regarded as income, and extraordinary dividends as belonging to the corpus: it matters nothing, in either case, whether the dividend be of cash, or stock, or property: See Cook on Stocks, etc., § 556, and cases there cited. It must be conceded, we think, that whilst the Pennsylvania rule may in some cases, perhaps, be more difficult in its application, when properly applied it arrives at results which are absolutely just, and secures to the life-tenant, and to those entitled in remainder, precisely what they of right are entitled to have, and this cannot be said of the practical operation of any other rule.

The appellant asks us to depart from this well-settled and salutary rule. His contention is that, as a shareholder has no absolute right to profits until a dividend thereof is declared, the ownership of profits, as between a life-tenant and a remainder-man, is in the person who is entitled to dividends at the time of the distribution, although they may have been earned during a prior ownership. “ Therefore, in this case,” he says, “ even if the profits for which this stock is issued were earned prior to the estate of the life-tenant, yet, being expended with the consent of the stockholders for betterments, they did not vest as earnings, and there was no absolute right to them until the amount had been declared as a dividend: and such amount, by the analogy of an assignor and assignee of stock, would in this case belong to the life-tenant.” To adopt such a conclusion would be to overrule the whole line of Pennsylvania cases, to which we have referred, and to adopt a method of distribution which wholly ignores the rights of the parties, and defeats the just and clear purpose of the testator; for it is perfectly plain that the value of the stock at the testator’s death was composed in part of these accumulated profits. If the trustees, in order to change the investment, had at the testator’s decease sold the shares, they would have received their value as affected by the surplus then undivided, and the amount received would, in that ease, have been the principal upon which the life-tenant would be entitled to receive income. Upon what principle of justice, then, should the act of the corporation, over which the parties had no control, be allowed to affect their rights, by taking from the remainder-men that which clearly belongs to them, and handing it over bodily to the life-tenant ?

The original capital of the company was $750,000: the new stock increased this to $1,000,000. The cost of construction and equipment of the road represented about $1,020,000. The 'testator died in October, 1884: on the 1st January following, the assets were $1,118,147.59; and on the 1st January, 1889, which was the day before the stock issued, the assets were $1,126,844.58. It is certain, then, that the profits of the business were, to the amount of the new stock, applied to betterments, and were actually thus capitalized in the testator’s lifetime. Under the Pennsylvania rule, therefore, when they come to be distributed, they should go to principal, and not to income.

As remarked by the auditing judge: “ The whole effect of the transaction in dispute was to enable the owners of the original shares, among whom are the parties in remainder, to realize upon their holdings what the shares were actually worth. It went upon the theory that the shareholders owned all the property of the corporation, but their stock did not properly set forth that ownership, and to the extent that it failed to represent the full value of such ownership it was unavailable. By the new issue the whole capital was made marketably available. It worked no injustice to the life-tenant; he got a dividend on new shares as on the old, and he was better off than before.”

It is true the market value of the shares was not greatly, if any, impaired by the increase, but the question of value is to be determined, not by the fluctuations of the stock market, but by the actual assets held by the corporation: Moss’s Appeal, supra; Biddle’s Appeal, supra. It is the intrinsic value of the shares, to be ascertained from the amount and value of the assets at the death of the testator, and at the time of the increase of the stock, which governs in the apportionment of the surplus profits. The market value may aid in the ascertainment of the actual value, and is therefore properly received in evidence on that issue: Earp’s Appeal, supra; Moss’s Appeal, supra. In the latter case, however, it was said that the market value rep resented the actual cash assets in the hands of the company. We are of opinion that this case was correctly decided, and

The decree of the Orphans’ Court is affirmed, and the appeal dismissed at the cost of the appellant.

April 13, 1891, motion for a re-argument refused.