Cornell v. Seddinger , 237 Pa. 389 ( 1912 )

Opinion by

Mr. Justice Potter,

This was a bill in equity filed by Howard E. Cornell, Receiver of the Neafie & Levy Ship and Engine Building Company, Penn Works, Philadelphia, againstc Mathias Seddinger, John H. Watt, Eli Kirk Price, Somers N. Smith and Laurence B. Levy, Administrator of Edmund L. Levy, deceased. . ’The purpose of the bill was to compel the .defendants to repay to the company certain sums which it was alleged the defendants, as directors had wrongfully declared as dividends, when as a matter of fact there were no profits to divide, and the so-called dividends were paid out of capital.

During the proceedings, John H. Watt died, and his executors were substituted. Separate answers were filed on behalf of each of the defendants. Issues were joined, and after hearing, the learned chancellor in the court below found the facts substantially as follows: the Neafie & Levy Ship and Engine Building Compapy, Penn Works, was incorporated under the Act of April 29,1874, P. L. 73, on March 5,1891, with an authorized capital of $800,000, and carried on business in Philadelphia until December 9, 1904, when it was placed in the hands of receivers under proceedings in Court of Common Pleas No. 5, of Philadelphia County. On January 1, 1901, Somers N. Smith, Mathias Seddinger, John H. Watt, Eli Kirk Price and Edmund L. Levy were elected directors of the corporation, and they all continued in office until April, 1904. Levy died November 2, 1905, intestate, and Laurence B. Levy is administrator of his estate. Mathias Seddinger was elected president, and Somers N. Smith vice-president from year to year from 1900 to 1904 inclusive. The former received a salary of $10,000 per annum, and the latter, who was also general manager, $15,000 per annum. The dividends which are here in question, were declared by the directors as follows:

> On November 25, 1901, one of 3 y2 per cent., $28,000

On April 2,1902, one of 6 per cent., ...... 48,000

On March 30,1903, one of 6 per cent.,..... 48,000

These dividends were in each case paid shortly after they were declared. During the period from 1900 to 1904, the company was engaged in building three torpedo boat destroyers, and a cruiser for the United States Government, and the business was carried on at a loss. The original capital of $800,000 was largely impaired, being depleted by a sum in excess of $760,000, leaving only a nominal amount. The dividends above referred to were paid, not out of profits, but out of capital. In placing the responsibility for this action upon the directors, the trial judge distinguished between the directors Seddinger and Smith, who-were executive ofificers of the company, and the other three directors, Price, Levy and Watt, and held that the former were liable for the amount of the dividends improperly declared and paid, but the other three, he relieved from responsibility, and directed that as to them, the bill be dismissed. Whether or not he was correct in maldng this distinction is the important question raised by this appeal. Exceptions were filed by-the plaintiff, which were overruled, and a final decree was entered, dismissing the bill as to Directors Price and Watt and the Levy estate.

The plaintiff has appealed. Eighty-five assignments of error have been filed, all of which except the first are to the dismissal of exceptions filed by plaintiff. These assignments are not in proper form, because neither the exceptions nor the orders of court dismissing them are set forth totidem verbis, as required by the rule. The first assignment of error, however, is to the final decree of the court below, dismissing the bill as to the three defendants, Price, Watt and Levy, and under this assignment all questions relating to the liability of these defendants may be considered.

A careful examination of the evidence shows that the learned chancellor was abundantly justified in the general conclusion which he reached, and stated as follows: “I find as matter of law, that at the time of the declaration of the several dividends exhibited by the proofs, there had been an impairment of the capital of the corporation, which impairment was increasing, in increasing volume from time to time as and when additional dividends were made, estimating the depletion as arising on or about the 25th of November, 1901, the 2nd of April, 1902, and the 30th of March, 1903.” These dates, it will be noticed, were those of the declaration of the dividends of which complaint is made. It may be regarded as settled law, that directors of a corporation are trustees, or quasi trustees of the capital of the company, and liable as trustees for any breach of duty with respect to the application of it. The capital of a company may not lawfully be used for the payment of dividends. It was so used, in the present case. At whose instance and direction was this done?. Obviously by the board of directors. But, says the learned chancellor, three o'f the members of the board were not practical ship builders, or were not personally familiar with the processes of construction, and therefore they were excusable for accepting the reports at their face value, without further inquiry. We are not able to accept this theory as applicable to the facts of the present case. No special knowledge of the details of ship building was required in order to determine whether or not a dividend might properly be declared. Certain reports of the treasurer were presented to the directors at the meeting of the board. These reports were made up by the treasurer partly from the books and partly from information from the executive officers as to the inventories of stock on hand, work in progress, etc. These items included very large amounts which were not available as assets in any proper sense of the word, as a basis for the declaration of dividends. For instance, it was shown that under the head of “Work in Progress” it was the custom to charge up all the money expended for the construction of certain vessels, without any regard to the price at which these vessels had been sold. On three torpedo boat destroyers, the company received under its contract less by more than $180,000 than the vessels cost to build. Yet the total cost was carried upon the books as an available asset, under the head of “Work in Progress.” Any inquiry into the make-up of this item would have disclosed its hollowness in so far as its fitness to be considered as a basis for dividends was concerned. The method of accounting was entirely wrong. Inflations of various kinds were in existence, of so glaring a nature that any fairly competent mar., who paid any attention to the make-up of the items appearing upon the face of the reports, would have found that instead of apparent profits, there was in reality an impairment of the capital. The defense of Directors Price, Watt and Levy was that they relied upon the face of the reports of the treasurer, as showing profits, without making any inquiry as to the nature of the items reported as available assets. Directors can hardly be regarded as discharging their duty, and protecting the trust imposed upon them, when they accept a report which upon its face calls for explanation and analysis, and after a glance at it, to see that it purports to show profits, proceed without further investigation to .declare dividends. Yet it is admitted that this is practically what was done. Nor was the general condition of the company such as to blunt the senses of the directors to the need of scrutinizing the reports. The minutes show that at the time these various dividends were declared, there was a shortage of working capital, and the directors were considering the necessity of borrowing money, both upon notes and by mortgaging the real estate. It is admitted that two of the directors had personal knowledge of the real condition of the company, and after a careful examination of the evidence, we cannot avoid the conclusion that the other directors might, by the exercise of common prudence, have readily ascertained the worthless character of much that was carried upon the reports of the treasurer as assets. As well might a board include the expense account of a corporation as a basis for dividends, as that which was reckoned by this board as part of thef assets of the company. As a matter of course, any such account must be deducted from the apparent profits before a basis for considering the declaration of a dividend, can be reached. The failure of the directors to investigate the character of the items of the report, led them to declare dividends when there was no surplus of profits to divide. This action was not merely an error of judgment, but was the result of lack of attention to the real condition of the company. Mere, ignorance of facts which they could easily have ascertained cannot excuse them for the performance of illegal acts, in declaring dividends out of capital. It was the duty of the directors to inform themselves as to the actual condition of the company before declaring dividends. If they had made full inquiry and reasonable examination, and had been misled by erroneous information on which they had the right to rely, that might have served as an excuse for distributing capital instead of profits. But nothing of the kind appears from the evidence.

The bill in this case was not filed to secure payment by the directors of the debts of the corporation, but its purpose was to compel the directors to replace funds of the company which they wrongfully paid out as dividends. It is suggested in the argument of counsel for appellee Price, that the report of the receiver showed that the assets exceeded the liabilities when the company passed into the hands of the receiver. An inspection of this report shows, however, that in making it up, the capital stock was not taken into consideration as a liability.

The first assignment of error is sustained, and the decree of the court below is reversed, in so far as it directs the dismissal of the bill of complaint against John H. Watt and Eli Kirk Price and Laurence B. Levy, as administrator of the estate of E. L. Levy, deceased. It is adjudged that all the directors by their conduct rendered themselves jointly and severally liable under the terms of the bill, and the plaintiff is entitled to the same relief with respect to all of the defendants as was extended to him with respect to the defendants' Seddinger and Smith. It is further ordered that the record be remitted to the court below, in order that a decree may be entered in accordance with this opinion.

Fell, C. J., dissents.