Sumrall v. Commercial Building Trust's Assignee

CHIEF JUSTICE HAZBLRIGG

delivered the opinion of the court.

The Commercial Building Trust is a’ corporation organized in February, 1892, under chapter 56 of the General Statutes. The general nature of its business was to “lend its money to its stockholders, especially with the view of aiding them to procure homes, and, in case of a surplus not needed by the stockholders, to other persons.” Articles of Incorporation, p. 8. The object of the corporation was “to afford its members a safe and profitable investment for their earnings, and an opportunity to obtain loans upon easy terms, to purchase homes, and establish themselves in business.” By-laws, p. 9.

The capital scock was to consist of $10,000,000 — 100,000 shares, of the par value of $100 each — of preferred stock; and $1,000,000 — 1,000 shares, of the par value of $1,000 each — of common stock. The former, or preferred stock, was to be subscribed for and paid in upon such terms, and at such times, as the by-laws might prescribe; being in installments of small amounts, payable periodically or in larger payments, at the election of the subscriber. The common stock was to be subscribed for and paid in upon such terms, and at such times, as the board of directors might, from time to time, determine, and it might be issued in monthly or other periodical series. We conclude, there*fore, that the business of the concern, to all practical intents, was that of an ordinary building and loan associa; tion, so extended and amplified, however, as to embrace objects and purposes wholly foreign to such associations proper, and which have been condemned by this court in numerous cases.

The articles of incorporation provide that “the preferred stock is guaranteed by this corporation to mature, and be payable, in seven years from the date of the payment of the first installment paid on said stock.”

And a by-law provides that the funds of the common stock “shall constitute the guaranty for the maturity of the preferred stock.”

This preferred stock was to be issued in various classes, in some of which the dividend to be paid was at the rate of 8 per centum per annum, and in others at the rate of 10 per centum per annum, all payable semi-annually.

As soon as organized, the corporation began business, and issued, from time to time, both common and preferred stock. Becoming, insolvent, however, it made, in June, 1897, for the benefit of its creditors, an assignment of all its assets to the Columbia Finance & Trust Company. In the administration of the trust, the question was presented to the chancellor, in a suit brought for a settlement of the estate, whether, there not being enough money to pay the alleged preferred stockholders in full, the entire funds of the corporation should be distributed to them, to the exclusion of the common stockholders.

The chancellor answered this question by holding “that none of the stock of the defendant corporation is entitled to a preference over other stock in said corporation, and that all stockholders, indiscriminately, shall share equally in the distribution of the assets of the corporation in the hands of the assignee, in proportion to the amounts paid into the corporation by them, respectively, on their stock, after the payment of its debts, and the proper costs, expenses, and charges of the assignee in the execution of the trust.”

The correctness of this judgment is the sole question presented on this appeal. Without reference, for the present, to certain interesting questions ably discussed by counsel, involving the validity of the issual of preferred stock by this, corporation, we turn at once to a consideration of the terms of the contract by which the corporation guaranteed that its preferred stock should “mature and be payable in seven years from the date of the payment of the first installment paid on said stock.”

This is the only provision on the subject of guaranty to be found in the articles of incorporation, and it seems to apply only to installment stock. So construing it, the provision means simply that, upon the subscriber for this stock making his monthly payments of 60 cents per share for the period of seven years, or $50.40 in the aggregate, the corporation guaranteed that the dividends thereon would so accumulate as that the stock would be worth $1 per share. Putting the guaranty in another form, the corporation guaranteed that it would declare, at the end of seven years, a dividend of $49.60 on each share of preferred installment stock, but this stock is to be paid for in monthly installments of 60 cents per month.

In the by-laws,' however, there is a further provision, by which the corporation “guaranteed the maturity of class T) installment stock in seven years from the date of the first month’s dues paid thereon, andi class E installment stock in ten years from the date of the first month’s dues paid thereon, and class F paid-up stock in seven years from the date of its issuance. Here, again, is merely a guarantee that dividends sufficient to mature certain classes of installment stock and a class of paid-up stock would be declared at the end of seven years. The subscribers to this stock were members of the association, and participants in the scheme of so loaning out its funds as that the usurious rates were to be realized. It Was by reason of the unlawful and usurious character of this scheme, which was adopted by the association with the approval and by the votes of these members or their representatives, that the enterprise failed of execution; and, when it failed, the so-called “guarantee” was at an end.

Moreover, the guarantee' on the part of the company that it would declare, in a given time, certain dividends, or dividends sufficient to mature certain stock, or an agreement that it would set apart certain other stock as a guarantee of such dividends, can not be enforced unless there are net profits — dividends proper — out of -which the guarantee can be made good and the dividends paid. The reason is because the contract does not, and can not, in the nature of things, create the relation of debtor and creditor. The member is a shareholder in the association — a preferred one, it is true — when there are profits out of which he may be paid; otherwise, not. Mr. Cook, in his work on Corporations, says (section 271): “The law is now clearly settled that a preferred stockholder is not a corporate creditor.. A contract that dividends shall be paid on the preferred stock, whether any profits are made or not, would be contrary to public policy, and void. An agreement to pay dividends absolutely and at all events, from the profits when there are any, and from the capital when there are not, is an undertaking which is contrary to law and is void. Public policy condemns, with emphasis, any such undertaking on the part of a corporation as to its preferred or guaranteed shares.” (See, also, Taft, Trustee, v. Hartford, &c., R. R. Co., 8 R. I., 310; Lockhart v. Van Alstyne, 31 Mich., 76, [18 Am. R., 156].)

The contract then is a guarantee of dividends sufficient to mature the stock, and is enforceable only if there are profits sufficient for that purpose. In this insolvent association there are no profits, and there can be no dividends, a guarantee to the contrary notwithstanding. This may not be very material to appellant, as he is reaching after the capital and all assets on hand not profits. But it follows, from what we have said, that the guarantee has reference solely to a preference in the distribution of dividends. It has no reference to a distribution of assets apart from dividends, and especially no reference to such distribution on the winding up or insolvency of the concern. The agreement to make enough profits to mature the preferred stock in seven years, and a pledge of the common stock for that purpose, looked to a going concern; at least, it was expected to be a live and running association for seven years. It is not contended the guarantee was that the corporation was to last for that time. We think it clear that the period of winding up having arrived, with no profits on hand, the distribution of the capital and assets of the concern is not to be controlled by a provision or guarantee looking solely to the maturity of stock, or, what is the same thing, the distribution of dividends, in due course, in a running or going association.

In re London India Rubber Co., 5 L. R., Eq., 519, there was a provision in the company’s charter securing to preferred stock a bonus or dividend out of money produced by the sale of certain property, not required by the company in the conduct of its business. This property was, in effect, pledged to the preferred stockholders, to secure this bonus or dividend, just as it is argued here we have a charge on the common stock to secure the maturity of the preferred stock by dividends large enough to mature it. It was argued in that case that the bonus or dividend should be paid out of the proceeds of the property when sold. The court, however, said: “But I -think it is plain that the 161st clause is directed to a going or continuing concern. It does not, in the slightest degree, contemplate a breaking up of the company, and is not intended to define the rights of the parties in the happening of that unfortunate event. This clause has no application to the event which has happened. The fund is not dividend. It represents the capital of the company, and, not being otherwise provided for, it must, in my opinion, as I originally decided, be divided among the shareholders pro rata, according to the amount of capital which each shareholder has in the concern; in other words, among the two classes of shareholders equally. I wish it to be considered that I decide the case upon this principle: That where there is a provision for preferential dividends, but no provision for the division of capital, upon the breaking up of the concern any surplus must be distributed among the shareholders according to their capital, without reference to tlieir rights in respect to dividends.”

So, we think here, the by-laws providing that the funds, of the common stock shall constitute the guarantee for the maturity of the preferred stock means that the common stock fund was a guaranty for the accumulation — the earning — of sufficient profits or dividend to mature the preferred stock, in a continuing association, and continuing, too, on a plan or scheme well known to all its members. There is no provision in the corporation’s charter or its by-laws, or in any of the certificates of stock or indorsements or specifications accompanying the stock, declaring that there ■was to be any preference given one class of stock over another in the capital or body of the concern. In the absence of such a provision, the stock is preferred only in the sense that it has priority in the distribution of dividends.. The contract we are considering, then, by fair construction, refers only to preferential dividends, and this is the ordinary effect to be given the use of the words “preferred stock.”

In Cook on Stockholders (3d Ed.), sec. 267, it is said: “By ‘preferred stock’ is to be understood stock which entitles the holder to receive dividends from the earnings of the company before the common stock can receive a dividend from such earnings. In other words, it is stock entitled to dividends from the income or earnings of the corporation before any other dividend can be paid.” And the same author (section 278) says: “Upon the dissolution of a corporation, and the distribution of its assets among the shareholders after the payment of the corporate 1 indebtedness, it is the settled rule of law that, in the absence of any provision in the statutes, by-laws, or certificate to the contrary, preferred stockholders have no priority over common stockholders.”

See, also, Beach on Private Corporations, sec. 507; 2 Waterman on Corp., sec. 155; 2 Thompson on Corp., secs. 2278-2280.

When we bear in mind that the corporation we are dealing with is a building and loan association, with certain underlying principles of co-operation, equality, and mutuality in its-make-up not common to ordinary corporations, and which may be termed the “common law of its existence,” the objections to upholding preferential contracts among members become apparent.

All such attempts are absolutely void, as contrary to the natural law of such associations. If their managers may attract investors by selling them preferred stock — preferred either as respects dividends or capital — the burdens of maintaining the organization, and in all probability all the losses of the concern, in case of embarrassment or insolvency, will fall on the very class of members who were primarily intended to be benefited by such associations. In King v. Investment Union (Ill. Sup.) [48 N. E. 677], it was said: “The plan of issuing stock containing such agreements is entirely foreign to the purposes‘of the corporation contemplated by the statute under which the one at bar was organized, and we can but regard it as of no force and effect.” To the same effect are the cases of Trowbridge v. Hamilton (Wash.) 52 Pac. 328, and of Wierman v. Investment Union, 67 Ill. App., 550, although in these cases a by-law undertook to authorize the contract of preference. In the case of Latimer v. Building & Loan Co., 81 Fed., 776, the question arose as to whether or not a building association, established under the statutes of Missouri, substantially similar to those of Kentucky, could provide for the issuance of paid-up stock, and secure its redemption by a trust deed upon its assets. The court held that, independent of statutory provision, a building and loan company had an implied power to receive a prepayment of its stock, and to issue paid-up stock, but that any attempt to give a preference to such stock was against the policy of the common law governing such institutions, and was against the policy of the statute, and was absolutely void. In' passing upon the question in that case, the court said: “The next and last question to be considered is whether the complainant, as the holder of the certificates in question, is entitled to any preferential right in and to the property undertaken to be pledged to secure their payment. This must be answered by determining whether the defendant association had the power to make the contract so pledging such property. ‘The elementary working principle of the building association scheme/ according to Endlich (Bldg. Ass’ns, sec. 122), is ‘system of perfect mutuality and reciprocity and equality of all members.’ No provision is found in the organic law authorizing an association like the defendant to pledge any of its assets for the retirement or payment of any of its stock, nor is there any general power conferred by statute upon loan and building associations to issue preferred preferential stock, from which authority for pledging its assets to secure the payment of any of its stock may be inferred. Under such state of facts, it must, in my opinion, be held that the pledge of corporate assets for the retirement or payment of a certain class of its stock, in preference to others, is so violative of elementary requirements Of equality and mutuality as to be absolutely void.” We fully concur, therefore, in the chancellor’s judgment denying any preference to the so-called preferred over the common stockholders in the distribution of the assets of this association. The suggestion that the appellees have not in fact paid anything into the concern on their stock is guarded against in the orders below by requiring proof of all claims, in the usual way, before the master. The judgment is affirmed.

The whole court sitting.