The question in this case is whether a stock distribution made by the Eastman Kodak Company in 1959, in the ratio of one share for each share of common stock then outstanding, should be allocated to the income of trusts created by the decedent’s will, rather than to the principal of the trusts.
The decedent’s will created various trusts and provided, with respect to them, that “ [a] 11 stock dividends received shall be considered income and distributed as such”. The testatrix died on August 6, 1956, and her will was probated shortly thereafter.
(1) Transferred to the common stock capital account at $10 per share for each share
issued .................................. $67,522,470
(2) Transferred to the capital surplus account.. 257,587,353
Total .............................. $325,109,823
On April 13, 1959, the Eastman Kodak Company decided to double its outstanding common stock by distributing one new share of common stock for each share then outstanding. In accordance with this resolution, 19,191,123 shares of common stock were issued and distributed. To cover these shares at $10 par value each, the sum of $191,911,230 was transferred from the company’s capital surplus account to its common stock capital account. The capital surplus account from which the transfer was made consisted chiefly (in fact, all but two million of it) of the transfers theretofore made during the preceding 11 years from earned surplus, in connection with the stock dividends discussed above.
Twenty-five hundred additional shares were received by the trustees of the trusts created under the decedent’s will, as a result of the share-for-share stock distribution.
The question presented is whether the stock distribution is a stock dividend within the meaning of the quoted provision of the will directing that all stock dividends be allocated to income.
The Surrogate answered the question in the negative, stating: ‘ ‘ This Court believes that in such situations earnings capitalized to support prior stock dividends lose their identity as such and consequently any stock distribution based on a capitalization of such capital surplus belongs to trust principal ’ ’.
When the one-for-one stock distribution took place in 1959, there was no transfer of any earnings. There was only a transfer from one capital account to another (from the capital surplus account to the common stock capital account) to cover the par value of $10 per share of the new stock. No part of the earned surplus of the company was involved in the transaction. The distribution was therefore not a stock dividend within the meaning of the direction in the decedent’s will.
It is true that the capital surplus account, from which the $10 per share transfer was made in 1959, had originated in earnings but, as the Surrogate correctly stated, those earnings had lost their identity or character as such when they were transferred to capital surplus to support the prior stock dividends.
The appellant argues that we should go back of these transactions and treat the funds transferred to capital surplus as still retaining their character as earnings because, in his opinion, the transfer was unnecessary. The appellant maintains that all that it was necessary to do was to transfer to capital an amount equal to the par value of the stock issued as a stock dividend, and that there was no need to transfer an additional amount to capital surplus to cover the excess of the market value of the stock over its par value. It may well be that the transfer to capital surplus was not required by the corporation statutes, but it was required by the principles of sound accounting. (American Institute of Accountants, Accounting Research Bull. No. 43, Ch. 7[B]; Capriles and McAniff, The Financial Provisions of the New [1961] New York Business Corporations Law, 36 N. Y. U. L. Rev., 1239, 1259, 1267.) In any event, the appellant’s argument is wholly inapplicable to a publicly held company like the Eastman Kodak Company which is subject
The directors of the Eastman Kodak Company were therefore required to transfer the full market value of the shares issued as a stock dividend from earned surplus to capital accounts, not only in order to comply with sound accounting principles, but also in order to comply with the regulatory rules which were binding upon them. Furthermore, even if the directors were not bound to take this course, the fact remains that it was a proper and permissible course for them to follow and the directors decided, in good faith and in the exercise of their best judgment, to follow it, and their decision is binding in determining the nature of the capital surplus account of the company. (Matter of Strong, 198 Misc. 7, affd. 277 App. Div. 1157; Matter of Clark, 25 Misc 2d 506.)
It therefore follows that when a transfer was made from the capital surplus account in 1959 to cover the par value of the new stock issued at that time, this did not constitute a transfer of earnings. “If capital surplus thus derived is subsequently transferred to the capital stock account to support a further issuance of stock”, this “does not constitute a capitalization or distribution of earnings”. (Matter of Payne [Bingham], supra, p. 11.) The stock distribution therefore did not constitute a stock dividend, under the generally accepted ‘ ‘ transfer of earnings ” test.
As a matter of fact, as Judge Fuld points out in his opinion in the Payne (Bingham) case, if such a stock distribution were treated as a stock dividend and were allocated to income, this ‘ ‘ would actually represent a double distribution to the income beneficiary of the identical earnings!” (Matter of Payne [Bingham], p. 11.)
The stock distribution in this case was in the nature of a stock split, rather than a stock dividend. If the number of shares had been doubled without any transfer from any of the company’s accounts to support the new shares (the par value per share having been correspondingly reduced), the distribution would clearly have been a ‘ ‘ pure ’ ’ stock split. A stock
The Lissberger case is directly in point. In that case, there was a transfer from capital surplus to capital stock in the amount necessary to cover the par value of the new stock; yet the court held that the stock distribution was a stock split and not a stock dividend and that therefore the income beneficiary was not entitled to any part of the distribution under a direction in a will similar to that in the will in our case.
It is the settled law that a stock distribution which may properly be characterized as a stock split is not a stock dividend within the meaning of a direction in a will that all stock dividends shall be considered income. (Matter of Fosdick, 4 N Y 2d 646, supra; Matter of Lissberger, supra; Matter of Horrmann, 3 A D 2d 5; Matter of Berger, 6 Misc 2d 468.) See, generally, Dean Niles’ article on 11 Fosdick, Cunningham and Chaos ” (vol. 98 Trusts and Estates, p. 924).
Unfortunately, the first paragraph of the letter which the Eastman Kodak Company sent out under date of April 13, 1959, with respect to the stock distribution, was not worded accurately.
The appellant correctly asserts that the rule of Matter of Osborne (209 N. Y. 450) is inapplicable to this case. The Osborne rule provided that stock dividends should be apportioned between income and principal on the basis of the time when the earnings which were the source of the stock dividends were accumulated. The Osborne rule applies only to trusts created before May 17,1926 the date on which section 17-a of the Personal Property Law was amended by chapter 843 of the Laws of 1926. The trusts in this case were created upon the death of the testatrix on August 6, 1956. In the absence of an express direction to the contrary in the will, the trusts would have been governed by section 17-a, which provides that all stock dividends shall be treated as principal. The effect of the direction in the will in this case was to render section 17-a inapplicable and to require that all stock dividends be treated as income. Both section 17-a and the Osborne rule being thus inapplicable, the income beneficiaries would be entitled to all stock dividends, whether they were supported by a transfer of earnings accumulated prior to the creation of the trusts or by a transfer of earnings accumulated thereafter.
Furthermore, it does not follow from the fact that the Osborne rule is inapplicable, that, as the appellant argues, the eases decided under that rule are of no relevance in the determination of the problem presented in this case. On the contrary, the distinction between stock dividends and stock splits drawn in the Payne (Bingham) case and in the other cases dealing with problems arising under the Osborne rule, is not only relevant but controlling here. The result in this case necessarily follows from the reasoning of the Payne (Bingham) case. (Cf. Note, 60 Col. L. Rev. 557, 561.) The Court of Appeals held in the Payne (Bingham) case, with respect to a trust created before 1926, that a stock distribution supported by a transfer from capital surplus, which had in turn been created by a capitalization of earnings to support prior stock dividends, is not a stock dividend calling “ the Osborne rule into play ” (Matter of Payne [Binghami], supra, p. 11.) Neither is it a stock dividend calling into play the direction in a will made after 1926 that stock dividends should be treated as income.
The decree appealed from should therefore be affirmed.
Bastow, J. P., Goldman, McCltjsky and Henry, JJ., concur.
Decree insofar as appealed from unanimously affirmed, with costs to each party filing a separate brief payable out of the corpus of the trust.