Hobgood v. Ehlen.

| N.C. | May 16, 1906

The first ten exceptions appearing in the record relate to matters connected with the relations existing between Ehlen and his codefendants prior to the organization of the Ronda Lumber and Manufacturing Corporation. It is insisted that such matters are not material to the issues, and that the evidence was irrelevant and calculated to prejudice the jury against Ehlen. We think the evidence was material and the exceptions are without merit. In order to show the motives and purposes which prompted the parties in forming the corporation, and the fraudulent character of the transaction, it was material to show the antecedent steps and how the defendant Ehlen came in to the enterprise.

The remaining exceptions raise the question of the sufficiency of the evidence. The defendant insists that the court should have instructed the jury that there was no evidence as to him to warrant an affirmative answer to the fifth issue, which involved the question of fraud. We think the whole controversy hinges on the correctness of that ruling. The corporation known as the Ronda Lumber and Manufacturing Corporation was organized by the defendants under the laws of the State of Delaware, which contains the following provision: "Section 14. Any corporation existing under any law in this State may issue stock for labor done or personal property or real estate or leases thereof; (347) in the absence of fraud in the transaction, the judgment of the directors as to the value of such labor, property, real estate, or leases shall be conclusive." Public Laws of Del., vol. 2, part 1, 1901, p. 292. The liability of the defendant, as an organizer and stockholder, for the debts of the bankrupt corporation is, therefore, to be determined by the law of Delaware, the domicile of the corporation. Thompson Liability of Stockholders, sec. 89.

In consequence of the ruling of the judge below, it is unnecessary that we should determine that constructive fraud is sufficient to support the finding of the jury. Upon this issue the court charged as follows: "The law under which this case is to be tried is the law of Delaware, and I charge you that where fraud is referred to in that statute, `actual' and not `constructive' fraud is meant. Constructive fraud, as distinguished from actual fraud, is inferred from illegal or improper acts that result in loss or injury to others. Actual fraud is established by competent proof of corrupt purposes, wicked or unlawful intent to cheat another or others. Applying it to this case, constructive fraud would be that kind of fraud that might be inferred from an overvaluation of property conveyed to the corporation, in the absence of proof of actual intent to defraud. The directors of the Ronda Lumber and Manufacturing Corporation having placed a valuation on the property conveyed and set over to said corporation, and issued stock therefor, if you believe the evidence, their action in that matter is conclusive as to the value of said property, unless you find that this was done in actual fraud. It is not enough for the jury to find that the property was valued at too much by the directors of the Ronda Lumber and Manufacturing Corporation, but in order to answer the fifth issue `Yes' you would have to go further and find fraudulent overvaluation."

We think the facts and circumstances in evidence amply sufficient to be submitted to the jury upon the issue of actual fraud, and warranted their finding. It is very difficult to prove actual fraud in many cases. It is frequently necessary to seek out the earmarks or (348) badges of fraud and present them to the jury as evidence from which they may infer it. A bare recital of the facts which the evidence tends most strongly to prove will suggest to the impartial mind, it seems to us, that the animating purpose in forming the corporation was to float a lot of worthless stock with the design to cheat and defraud an unsuspecting public, as well as to give a fictitious credit to a worthless concern. Not only was Ehlen's stock issued to him in direct violation of the statute for so-called services to be performed, but the entire capital stock issued was "water," pure and simple. In or about April, 1902, the defendants, Hickerson and McElwee, as copartners, began a small lumber business in the town of Ronda, N.C. under the firm name of "Ronda Pin and Bracket Company," and this business was continued by McElwee and Hickerson until it was absorbed by the Ronda Lumber and Manufacturing Corporation. The tangible assets of this partnership were valued by the jury at $896.63. In September, 1902, the defendant Ehlen proposed to the defendants McElwee and Hickerson to form a corporation under the laws of the State of Delaware, with a capital stock of $50,000, and that the corporation should take over the assets and good-will of the partnership and pay therefor its total authorized stock, to wit, $50,000. The defendant Ehlen was to finance the corporation, and by the word "finance" it was meant that he was to loan to the corporation the money on which it was to do business and to take therefor the note of the corporation. This was agreed to by all the defendants, but in a few days this agreement was modified by increasing the capital stock of the corporation to $100,000 and agreeing that the defendants should receive that amount in payment for the assets of the partnership instead of $50,000. The only consideration for this increase in value was the agreement of Ehlen to finance the company to a larger extent — that is, he was to loan it more money on which (349) to do business. It was further agreed that Ehlen was to have 54 per cent of the stock, and the remainder to be equally divided between Hickerson and McElwee. In accordance with these contracts, the defendant Ehlen employed Messrs. Bayard Coe, of Baltimore, to organize the corporation, and these gentlemen obtained the services of the Delaware Charter and Guarantee Company to secure a charter under the laws of the State of Delaware, and the company did, on 29 September, 1902, obtain a charter for the bankrupt corporation with authorized capital stock of $100,000, divided into 2,000 shares of the par value of $50 each, and by the terms of the charter the amount of capital stock with which the corporation would commence business was fixed at $1,000, this being 20 shares. This stock was subscribed for as follows: Six shares by Richard H. Bayard, one of the attorneys employed by the defendant Ehlen; 6 shares by Josiah Marvel, an official or employee of the Guarantee and Trust Company of Wilmington, Delaware, and 8 shares by Andrew Marvel, also an official of the Guarantee and Trust Company. At the first meeting of the stockholders, held at Wilmington, Del., on 1 October, 1902, the stock subscribed for in the name of Andrew Marvel was assigned to W. E. Ferguson, private secretary of the defendant Ehlen. The organization was effected by the election of the following persons as directors: Richard H. Bayard, Josiah Marvel, and W. E. Ferguson; and at the directors' meeting, held on 13 October, the following persons were elected officers: Josiah Marvel, president; Richard H. Bayard, vice president; W. E. Ferguson, secretary and treasurer. The defendants thereupon presented to the stockholders and directors of this corporation the proposal hereinbefore mentioned; the directors accepted the proposition, valued the property of the Ronda Pin and Bracket Company at $100,000, and authorized the corporation to issue to the defendants its entire capital stock, to wit, $100,000, and in accordance therewith, on 14 October, a certificate was issued (350) to defendants for 2,000 shares of the capital stock, and thereupon the corporation took over the business of the Ronda Pin and Bracket Company. On 29 October, 1902, the certificate issued to the defendants was surrendered to the corporation and canceled, and in lieu thereof, and in accordance with the agreement between the defendants, certificates were issued in the amounts and to the following named persons: W. B. Ehlen, 1,006 shares; W. H. McElwee, 390 shares; Robert L. Hickerson, 390 shares; William E. Ferguson, 8 shares; Richard H. Bayard, 6 shares; Bayard Coe, 194 shares; Josiah Marvel, 6 shares. Prior to the formation of the corporation and on 19 September, 1902, the defendants Hickerson and McElwee took an inventory of the Ronda Pin and Bracket Company, and ascertained that the total value of the partnership property was less than $900. The result of this investigation was communicated to Ehlen. The directors who said that, in their judgment, this property was worth 100,000, knew nothing of the property they were valuing save such information as they gathered from the defendant Ehlen and the defendant McElwee; none of these directors were ever at Ronda, nor did they make any inquiries other than from Ehlen and McElwee. The proposition made by the defendants to the corporation and which was accepted by the corporation, and upon which the stock was issued, purported to convey, in consideration of the receipt of the stock, the property, assets, and good-will of the Ronda Pin and Bracket Company; but as a matter of fact the evidence shows there was an agreement in parol by which the corporation was to pay the owners of the Ronda Pin and Bracket Company, to wit, McElwee and Hickerson, in cash for all its tangible assets, and, after the organization of the corporation, this was done; so as a matter of fact, the only thing obtained by the corporation for its entire capital stock was the good-will of the Ronda Pin and Bracket Company. The defendant Ehlen did not own any of the property of the Ronda Pin and Bracket (351) Company, neither did he pay anything therefor; but he was to pay for his stock in the new corporation by his services in suggesting the scheme and loaning to the corporation the money upon which to do business. On 10 January, 1905, this water-logged craft, being no longer able to float, was forced into bankruptcy and plaintiff elected trustee. According to the finding of the jury, the concern owes about $19,000 to general creditors, exclusive of $20,000 to Ehlen.

The language of Mr. Justice Shiras in Lloyd v. Preston, 146 U.S. 630" court="SCOTUS" date_filed="1892-12-19" href="https://app.midpage.ai/document/lloyd-v-preston-93463?utm_source=webapp" opinion_id="93463">146 U.S. 630, comes to mind as being especially appropriate in reviewing the evidence in this case: "The bare statement of the facts pertaining to the organization of the company fully justifies the opinion that the entire organization was grossly fraudulent from first to last, without a single honest incident or redeeming feature."

We have not been cited to any decisions from the courts of Delaware defining the word fraud in the statute quoted, but his Honor construed it to mean actual fraud, and the defendant cannot complain of that ruling. In New Jersey it is held that "any device by which the stock of a corporation passes to a stockholder as fully paid without payment in full, either in cash or property purchased to the amount of the value of the stock, such as an intentional overvaluation of property on the understanding that a portion of the stock issued shall be returned for distribution among the directors voting for a purchase of the property without payment by them, constitutes actual fraud against the creditors of the corporation." Bank v. Brick Co., 70 N.J. Eq., 722" court="N.J." date_filed="1906-06-18" href="https://app.midpage.ai/document/easton-national-bank-v-american-brick--tile-co-8268749?utm_source=webapp" opinion_id="8268749">70 N.J. Eq., 722. It is also held that an owner of stock in a corporation issued in consideration of a transfer of property, the valuation of which is wholly speculative, visionary, and imaginary, is liable to creditors. Trust Co. v. Turner,111 Iowa 664" court="Iowa" date_filed="1900-05-24" href="https://app.midpage.ai/document/state-trust-co-v-turner-7109188?utm_source=webapp" opinion_id="7109188">111 Iowa 664. In Douglas v. Ireland, 73 N.Y. 100" court="NY" date_filed="1878-03-19" href="https://app.midpage.ai/document/douglass-v--ireland-3602100?utm_source=webapp" opinion_id="3602100">73 N.Y. 100, it is held that, to charge the stockholder with the debts of the corporation, it must be shown that the property was not only purchased at an (352) overvaluation, but it must be also shown that the purchase was in bad faith and to evade the statute; and that to show this it is only necessary to prove: first, that the stock issued exceeded in amount the value of the property in exchange for which it was given; and, second, that the directors or trustees deliberately and with knowledge of the real value of the property overvalued it, and paid in stock for it an amount which they knew was in excess of its actual value.

The general rule in all the States is that a subscriber to the stock of a corporation is under a liability to pay therefor, which liability, so far as creditors are concerned, can only be extinguished by actual payment or a valid release. South Milwaukee Co. v. Murphy, 112 Wis. 614" court="Wis." date_filed="1902-01-07" href="https://app.midpage.ai/document/south-milwaukee-co-v-murphy-8187175?utm_source=webapp" opinion_id="8187175">112 Wis. 614; 26 A. E. (2 Ed.), 912. This is founded upon the theory that the capital stock is the fund or resource with which the corporation is enabled to transact its business and upon the faith of which persons give credit to the corporation. It is a trust fund for the benefit of creditors. The public has a right to assume that the capital stock has been or will be paid for in money or money's worth when necessary to meet corporate liabilities. Has the stock of this corporation ever been paid for in money, or its worth, by any one? So far as we can see, not a single share has been paid for. The organizing directors were the agents and employees of these defendants, employed by them for no other purpose than to issue the stock and take over the insignificant concern known as the Ronda Pin and Bracket Company in payment of the entire 100,000 capital stock. The defendants were to all intents and purposes both buyer and seller. These "men of straw" were mere automatons that moved when defendants pulled the string. The will of the defendants was their will, and they exercised no independent judgment. There is no evidence that they paid a dime for the few shares of stock assigned to them. These were doubtless given to them in order to qualify them as directors, so they could pass the resolutions prepared in advance for them, and register the will of their employers. One of the most significant (353) indications of fraud is disclosed by the examination of McElwee. Notwithstanding the written agreement of 13 September, 1902, provides that the business and assets of the Ronda Pin and Bracket Company are to be turned over in payment of stock in the new corporation, and notwithstanding the directors of the latter so accepted it, there was at the same time a secret agreement between Ehlen and his codefendants that the latter were to be paid in cash $895.65, the total inventoried assets of the Pin and Bracket Company, and given their stock in addition. So it appears that the new corporation got nothing whatever from McElwee and Hickerson in payment for their stock except the so-calledgood-will of the Pin and Bracket Company. What was the good-will of this infant industry of only six months duration with assets under $900 worth? Plainly nothing. In Camden v. Stewart, 144 U.S. 104" court="SCOTUS" date_filed="1892-03-21" href="https://app.midpage.ai/document/camden-v-stuart-93303?utm_source=webapp" opinion_id="93303">144 U.S. 104, the Supreme Court of the United States places its estimates upon the value of such an asset in the following language: "The experience and good-will of the partners, which it was claimed were transferred to the corporation, were of too unsubstantial and shadowy a nature to be capable of pecuniary estimation in this connection."

The record discloses the proposition made by the defendants to their employees, the board of directors of the bankrupt corporation, to pay for the entire capital stock of $100,000 in the following manner:

1. To turn over the entire business and assets of the Ronda Pin and Bracket Company to the corporation.

2. To turn over to the corporation any and all options that defendants McElwee and Hickerson held upon timber land.

3. The defendant McElwee was to give his services for six months from the date of the organization of the corporation in obtaining options on timber rights.

4. The defendant Ehlen was to bear the expenses of the (354) organization of the corporation over and above $250 and was to "finance" it.

The corporation did not get the assets and business of the Ronda Pin and Bracket Company, but only its good-will, as we have already shown. The assets were paid for in cash and the good-will is worthless. McElwee and Hickerson owned no options at the time. They only had some "in view," and of those only one ever materialized. These "options in view" cannot support the issuance of the stock, for the statute uses the words "real estate or leases thereof." If the options had been "in hand," much less "in view," they would not come within the terms "real estate or leases thereof," for an option is neither. The defendant McElwee agreed to give his services for six months from the date of the organization in obtaining options on timber. This was a plain violation of the statute, which uses the words "labor done." The directors had no power to accept prospective services, which might be worthless to the corporation, in payment for its stock. Ehlen's proposition to finance the corporation means simply to loan it money, and his other proposition, to bear the expenses of the organization over and above $250, cost him nothing, as there is no evidence that he was called upon to pay a penny on that account. So it seems to us that the evidence is conclusive that this dummy board of directors at the instance of these defendants issued $100,000, the entire capital stock of the corporation, and received nothing whatever of value in payment for it. The law seems to be well settled, and the consensus of all the authorities is to the effect that, in the absence of charter restrictions, a corporation may take property, which is reasonably necessary for its legitimate business, in payment for its stock, but when so received the property must be taken at its reasonable monetary value. Although a margin may be allowed for an honest difference of opinion as to value a valuation grossly excessive, knowingly made, while its acceptance may bind the (355) corporation, is a fraud on creditors, and they may proceed against the stockholder individually, who sells the property, as for an unpaid subscription. Lloyd v. Preston, 146 U.S. 630. All the authorities are collected in 26 A. E. (2 Ed.), 1013.

Applying the settled principles of law to the facts of this case as found by the jury, we have no hesitation in holding that the defendants Ehlen, McElwee, and Hickerson are liable for their unpaid subscription to the capital stock of the bankrupt corporation to the extent that it is necessary to pay the just claims of its creditors. If it should turn out that the judgment rendered against these defendants is larger than is necessary for such purpose, it may be corrected in the future and the necessary order made upon petition to the Superior Court.

Affirmed.

Cited: Whitlock v. Alexander, 160 N.C. 468, 469; Bernard v. Carr,167 N.C. 482; Goodman v. White, 174 N.C. 401.