15 Del. Ch. 147 | New York Court of Chancery | 1926
This case presents the question of whether the defendant may against the protest of preferred stockholders, the preferences of whose stock are such as the statement of facts shows, declare dividends on its common stock when, by reason principally of the depletion of ore bodies, the capital assets are impaired to the extent of about seven million dollars. In another form the question is, whether, there being a ¿Efficiency of net as
The question has been discussed from two points of view, viz., how stands the matter in the absence of statutory provisions, and, second, what is the answer where a statute is involved? The defendant contends that under the conception which the general law gives to the term “profits” when applied to a corporation of this type, the above method of calculating the same is permissible, and that when the same term appears in the Delaware statute the same import is to be given it that had theretofore been ascribed to it by the general laye In examining this argument, I shall first look into the general law upon the question without regard to our special statutory provisions, and then refer to the Delaware statute and its bearing on the subject.
The general rule is that corporations cannot declare dividends except out of profits. This rule requires that the invested capital shall be kept intact. 1 Morawetz on Private Corporations, (2d Ed.) § 435; 6 Fletcher’s Cyclopedia of Corporations, §§ 3660, 3685; 5 Thompson on Corporations, (2d Ed.) § 5305; 2 Machen on Modern Law of Corporations, § 1313; 2 Cook on Corporations, (8th Ed.) § 546. As I read the briefs there is no dispute between the solicitors for the respective parties upon the proposition that this is the rule for corporations generally. But the defendant contends that if the corporation be a mining company or an oil company, or a concern that is exploring a patent or a leasehold, profits may exist notwithstanding there be a depletion of the corporate capital. Companies of this kind are said to be wasting asset corporations. It is understood by everybody that such concerns live on themselves; they thrive by consuming their capital. Every ton of ore taken from a mining company’s mine and every barrel of oil taken from an oil company’s wells depletes the capital pro tanto. So does the mere passage of time deplete the assets of a company organized to exploit a patent or a leasehold. In this respect wasting asset cor
Now, aside from all statutory provisions, is there any authority to the effect that proceeds derived in reality from capital assets, in the form of ore, may be regarded as available for dividends ? If so, it is apparent that in the case of a mine the day is sure to arrive when the continued operation of the mine will have exhausted it, and the stockholders will find that all their capital has been paid out to them in installments-in the form of dividends. If there is only one class of stock, so far as stockholders are con
If, therefore, there is no statute to interfere, and creditors are not involved, it may with some reason be argued that a so-called wasting asset corporation ought to be permitted to writeoff nothing "for its depleted capital assets when there are no preferences among stockholders, because unless this be so the only alternative would be for it to accumulate great cash reserves simply to abide the approach of a distant day for final distribution. Why not, reason suggests, permit the cash equivalent of consumed capital to be distributed to its ultimate owners pari passu with its accumulation, instead of compelling the mining or oil producing corporation to turn itself into what the solicitors for the defendant describe as a huge investment trust for the investment of accumulated cash reserves — an activity entirely unrelated to the sort of enterprise which the corporation and its officers are supposed to be especially equipped for?
In line with this reasoning the defendant cites the English case of Lee v. Neuchatel Asphalt Co., (1889) 41 Ch. Div. 1, 58 L. J. Chan. Div. 408 (1889), as authority for the proposition that value of the ore in place and removed need not be charged off against receipts from which dividends may be declared. That case does so hold. It appears to be the leading authority on the subject. As I read that case, however, it has no persuasiveness as an authority (' in the instant one. This is for two principal reasons. First, the facts of that case show that the capital was not only not depleted, but on the contrary had increased. Here there is a large depletion. I And second, though there were two classes of shares, viz., prefer
I do not find that the Neuchatel Asphalt Case lays down any doctrine that makes such a result possible. That case also was concerned with certain peculiar articles of association between the stockholders evidencing what the corporation might do in respect to so-called earnings. Before leaving that case it is not inappropriate to observe that, though it has since been approved in England, yet, notwithstanding it presents no such feature of a violation of the preferences obtaining between stockholders as this one does, the wide application of its language has met with some adverse comment from English judges and at least one’eminent English text-writer. Dorey v. Corey, [1901] A. C. 447; Bond v. Barrow Halmatite Co., [1902] 1 Ch. 353; Sir Francis Beaufort Palmer, English Company Law, (12th. Ed.) 227.
The Neuchatel Asphalt Case has been cited by courts and textwriters in this country as authority for the broad proposition that a wasting asset corporation may, for dividend purposes, consider as profits all its receipts less cost of producing, marketing and overhead without any charge or reserve for depletion of capital. It seems to me, however, to be contrary to the plainest principles of just and fair dealing among stockholders, with ranking capital preferences, to hold that the rule laid down in that case should apply to them. I cannot think that textwriters of such deserved repute as Cook, Fletcher, Machen and Morawetz, who are referred to as laying down the rule of the Neuchatel Asphalt Case as generally applicable and who cite that case among the authorities sustaining their text, can ever have meant to have approved of it except where it is sought to apply it to facts similar in principle to those found in the case where it was laid down. Until some acceptable authority is produced in which a wasting asset corpora
Is there any authority anywhere sustaining the applicability of the rule contended for by the defendant to a case of the instant kind? The textwriters referred to simply state the rule with a citation of cases. They do not discuss it in all its possible applications. It would seem desirable, therefore, to examine the cases upon which the general language of the textwriters is based for the purpose of ascertaining whether <pr not there is any judicial sanction for this rule in its application to a case where as here one class of stock is preferred as to capital assets over another.
I shall not make detailed reference to the English cases. What has already been said in connection with the Neuchatel Asphalt Case is sufficient with respect to them and need be supplemented only by the following brief observations — that no English case to which my attention has been called involves such an inter-relationship between stockholders as we have here; that, the distinction which English courts draw between floating and fixed capital, a distinction which so far as I am aware is not recognized in this country, may play some part in the reasoning of the English judges; and finally the English Companies Act together with.the articles of association evidencing the contract between the stockholders in a given case need to be carefully examined before cases, decided under that act are accepted as pertinent authorities in American jurisdictions.
Let us then turn to the American cases with the view of ascertaining whether the wasting asset rule has been held in its wide application to apply to a case where dividends may be declared to common stockholders in the face of a capital preference in favor • of objecting preferred stockholders and where a capital deficit is admitted.
The earliest case upon this subject appearing in the American courts is that of Excelsior Water & Mining Co. v. Pierce, 90 Cal.
The next case to arise in this country was that of People v. Roberts, 156 N. Y. 585, 51 N. E. 293, decided in 1898. That case cannot be regarded as an authority for the defendant here. The question there was whether for taxation purposes a certain investment had been made out of surplus or capital. The court referred to the rule laid down by the English case of Lee v. Neuchatel Asphalt Co., supra, with apparent approval to be sure. But such reference was purely incidental, and was made simply to rebut the inference which the Attorney General drew in his argument that if a mining corporation paid dividends without setting aside a charge for removed ores, it must necessarily have accumulated no surplus. The case need not be commented upon further than to observe that the tax question involved in it and the manner of deciding it are of no help in determining what should be the answer in a controversy between classes of stockholders.
The case of Booth v. Summit Coal Mining Co., 55 Wash. 267, 104 P. 207, 19 Ann. Cas. 1255, decided in 1909, is also cited by the defendant. But the controversy in that case was quite different from what we have in this case. There the sole question had to do with the meaning of the word “profits” as used in a contract between individual parties. Furthermore, all stockholders were of the same class, a circumstance which as before indicated should be allowed great weight as a feature distinguishing the case from the instant one, if, as was not the case, the question had been whether profits for common stock dividend purposes could exist in the face of a capital deficit, where anothér class of stock enjoyed a capital
The defendant relies with much confidence on the case of Mellon v. Mississippi Wire Glass Co., 77 N. J. Eq. 498, 78 A. 710 (1910). I do not regard that case, however, as one which sustains the defendant’s position. In the first place it does not appear that there was a capital deficit in the financial condition of the company there involved. Here there undoubtedly is. But, aside from that, the case was one where a preferred stockholder sought to compel the corporation tocreate and maintain a sinking fund for the benefit of the preferred stock before any dividends could be declared on the common stock. The Vice-Chancellor held, and correctly so I think, that the contract between the corporation and the preferred stockholders did not provide for such a fund and there was no power in the court to compel it and thus make a new contract between the parties. Here there is no attempt to compel the creation of a sinking fund. What is sought is simply to restrain dividends to common stockholders out of a portion of the capital until the capital is brought up to the paid in value. To be sure, this means the creation of a reserve fund if cash is held by the company. But cash need not be held. Other capital assets consisting of mines may be purchased by the cash if desired. At all events no sinldng fund is sought to be forced upon the corporation. The Vice-Chan-cellar in the New Jersey case relied upon the Neuchatel Asphalt Case for his authority. But that case, as I have before observed, dealt with a corporation whose stockholders were of one class only, and' does not therefore have any pertinency where stockholders exist having amongst themselves priorities with respect to capital. It seems to me that all that was necessary for the decision of the New Jersey case was to consider the terms of the contract which the Vice-Chancellor pointed out and that the Neuchatel Asphalt Case was not in point. Nor can I find anything in the case of Goodnow v. American Writing Paper Co., 73 N. J. Eq. 692, 69 A. 1014, to which the Vice-Chancellor referred, in any wise approving the principle of the Neuchatel Asphalt Case as stated by him.
The defendant also cited in support of its position the case of Van Vleet v. Evangeline Oil Co., 129 La. 406, 56 So. 343, decided in
Another case cited by the defendant is Stratton’s Independence, Ltd., v. Howbert, 207 F. 419, decided in 1912, by the District Court of the United States in the District of Colorado. This was a tax case and presented the question of whether the value of ore in place that was extracted from the plaintiff’s mining property was allowable as “depreciation” in estimating the net income of the plaintiff subject to taxation under the Act of Congress (36 Stat. 112). The District Court discussed the meaning of the phrase “net income,” and said that in the case of a wasting asset corporation “net income” does not contemplate an allowance for such extracted ore. The opinion referred to People v. Roberts, supra, and certain English cases, among which Lee v. Neuchatel Asphalt Co., supra, was cited; and apparently approved of the rule announced in those cases. But it is to be noted that this was a taxation case and stockholders’ relative rights were in.no wise involved. It is interesting to observe the manner in which this case was disposed of when it reached the Supreme Court of the United States. See 213 U. S. 399, 34 S. Ct. 136, 58 L. Ed. 285. By a divided court, the Chief Justice and two justices dissenting, it was held, as in the District Court, that the value of the extracted ore could not be deducted as “depreciation.” The decision, however, turns on what was held to be an objectionable mode of calculating the extent of the claimed depreciation based on depletion of the ore supply, and expressly refused to state what the holding would be if the claimed depreciation had been based on depletion of the ore supply extracted in some other mode. The views of the District Court with respect to the reasoning based on the Neuchatel Asphalt Case and other cases cited by it were disregarded.
That the language of the federal cases which seems to bear on the subject in hand, but which appears in connection with the federal revenue statute referred to in them, is not pertinent in connection with such stockholders’ controversies as we have in
The foregoing constitute all the cases to which the defendant has called attention as supporting its position. I find nothing in them which supports that position. It seems clear to me that on fundamental principles of right and justice, the complainants as ■ preferred stockholders possessing a prior claim on capital assets have an equity which entitles them to protection against the proposed whittling away of those assets for the benefit of the less l favored common stockholders.
To the suggestion that the contentions of the complainants, if sustained, might result in the creation of what the defendant, as before stated, describes as an investment trust for the investment of large reserves, two things are to be said. They are, first, that cash or securities need not be hoarded, if other mines are desired to be purchased, or if not and it is undesirable for any reason that the directors should invest the cash, preferred stock may be purchased on the open market or the capital stock may from time to time be reduced in accordance with the provisions of the act in that behalf.
There being no right under general principles for the corporation to pay out dividends to the common stockholders under the present financial condition of the company, is there anything in our statute authorizing the proposed dividends? This is the next question to be answered.
Our pertinent statutory provisions are found in the General Corporation Law. They are as follows:
*161 “Sec. 13. [After authorizing the issuance of preferred stock and the payment of preferred dividends thereon, the section proceeds in this language:] And when any such quarterly, half yearly or yearly preferred dividend shall have been paid or set aside as herein provided, a dividend upon the common stock- may then be paid out of the remaining surplus or net profits of the company.” 29 Del. Laws, c. 113 § 7.
“Sec. 34. Dividends; Reserves: — The directors of every corporation created under this chapter shall have power, after reserving over and above its capital stock paid in, such stun, if any, as shall have been fixed by the stockholders, to declare a dividend among its stockholders of the whole of its accumulated profits, in excess of the amount so reserved, and pay the same to such stockholders on demand; provided, that the corporation may, in its certificate of incorporation, or in its by-laws, give the Directors power to fix the amount to be reserved.” Revised Code 1915, § 1948.
“Sec. 35. * * * No corporation created under the provisions of this chapter, nor the directors thereof, shall make dividends except from the surplus or net profits. * * *” Revised Code 1915, § 1949.
The case of Peters v. U. S. Mortgage Co., 13 Del. Ch. 11, 114 A. 598, was concerned with Sections 34 and 35 of the act, but is of no relevancy upon the point in controversy here. In that case, which it may be remarked was not a case of a wasting asset corporation, it was decided that for the purpose of ascertaining whether there was a surplus available for dividends, capital stock was to be listed at its paid in value rather than at its par value outstanding. The case was presented to the court with that question as the sole controversy in so far as the dividend dispute was concerned. What might be treated as profits or what might enter into surplus was neither decided by the court nor debated by the solicitors. Accordingly that case is laid aside as of no present assistance.
Now, what do our statutory provisions touching dividends mean? Sections 34 and 35 are the most important sections bearing on this question. Whatever meaning is given to the words “accumulated profits” in Section 34 and “surplus or net profits” in Section 35, will give color and complexion to the phrase “remaining surplus or net profits” as it appears in Section 13. I, therefore, address my attention to Sections 34 and 35 as controlling. In examining these sections their meaning with respect to corporations generally will be sought to be extracted without regard to whether the corporation is an ordinary industrial one or one known as a wasting asset corporation.
Now the word “or” being in the disjunctive, it is contended that the section points out two sources from which dividends, may be declared, viz., surplus if any, or even thpugh there is no surplus,, yet from net profits in any current,year in case such.are.earned. The force of this argument is particularly pointed out ip. this case, for it is contended that though -the company’s balance street .shows a capital .deficit, its profit and loss account for 1925, shows net profits in the sum of $3,440,000. To what extent, the value,of extracted ore which is not charged off against earnings contributes to this sum does not appear. But even if none were attributable to extracted ore, still a deficit exists.
Section 35 was taken from the New Jersey act (P. L. 1896, p. 277). Its counterpart in that act is Section 30. It is interesting to note that the New Jersey act has been amended since our act was adopted by making the language read “except from its surplus, or from its net profits.” The introduction of that word “from” after the disjunctive conjunction has the evident effect of, pointing out two funds from which dividends may be made. Goodnow v. American Writing Paper Co., 73 N. J. Eq. 692, 69 A. 1014. Our
“Although the change in language indicates that the Legislature made a distinction between surplus and net profits, it does not necessarily follow that net profits mean the difference between gross earnings and what may be called operating expenses. Such profits may be called annual profits, and it may be that by net profits the Legislature meant the net profits upon the whole of the company’s business from its organization. If either of these meanings is adopted, the declaration of the present dividend is justified.”
And so here, when the advantage to the dividend lacks the aid of those words “or from,” it may with more reason be said that by net profits is meant the net profits upon the.business from its organization. Taking Section 35 , in connection with Section 34 with which it of course must be construed, my conclusion is that the net profits are such as appear from the entire business of the company from its inception, and are not to be confined to one period and made synonymous with annual profits. This being the construction adopted, there are .no net profits, because the capital is heavily depleted.
Whether “net profits” is synonymous with surplus I shall not/ pause to discuss.. It may be argued that it is not, and if not, then two funds exist from either of which dividends could be made and the paid in capital left undisturbed. In other words it may be or-j gued that surplus can be created from a source other than profits,1 as for instance from sale of stock at a premium. In that event, though there are no net profits or accumulated profits from which to make a dividend, yet another fund, viz., the surplus, might be argued to exist to which resort may be had fo'r a dividend. And so on this argument, the statute may be construed as referring to two
But whatever might be the correct view upon the question of whether “surplus” ánd “net profits” are synonymous, I am of the opinion that in this case there áre no “net profits” within the meaning of the statute and certainly there is no “surplus.”
In this view of our statute there is thus nothing therein which against the preferred stockholders authorizes the dividend already declared or permits similar common stock dividends in the future so long as the capital is impaired.
. Having said this, the bill and its prayers call for nothing more. It is.not necessary to decide whether the general rule as to. dividends laid down by the statute is applicable to wasting asset corporations. If it is not, then it is solely because they constitute an exceptional class. The statute does not except such corporations from its general rule. If, therefore, they are to be excepted it is only because the courts have discovered such peculiarities in their nature as to warrant the conclusion that as a matter of reason, common business practices and sound policy, it was never intended that the ordinary rule of the statute should apply to them. jÍBut where a great injury would be done to one class of stockholders 1 and a correlative benefit conferred upon another class by allowing the exception, it would seem clear that to the extent at least of preventing the inequity of such a result courts which in the furth¿rance of justice have erected the exception ought in a like furtherance of justice refuse recognition to it.
Now whether the wasting asset doctrine should be accepted in this State as engrafted upon our statutory provisions concerning dividends, the present case as stated does not call upon me to determine, for, even accepting it, yet there is an equity in favor oi the preferred stockholders which forbids the doctrine’s application. But the declaration of a dividend on the preferred stock evoked some discussion concerning its propriety because if the doctrine referred to is not accepted here it is manifest that the preferred stockholders are not entitled to dividends so long as the capital deficit remains unrepaired. While the case does not call for an answer upon the point, yet it may not be inappropriate for
I am quite aware that this view may be criticised on the ground that the sections of the statute make no distinction between preferred and common stock dividends, and if there is no surplus or net profits for the latter there can consequently be none 'for the former. But this does not necessarily follow. Before the criticism can be sustained, it is necessary to reject those authorities hereinbefore reviewed which hold that with respect to wasting asset corporations, “profits” has a different meaning from that given to it in the ordinary case; or putting it in another way, that the rule confining dividends 'to profits as generally understood, whether that rule be founded on a statute or decisional law, has no application. Those authorities, as I have before pointed out, do not deal with .situations where priorities between stockholders are involved upon which such an equity is justly based as I have attempted to show. Hence, when it comes to the preferred stock of this corporation which has no superior ranking above it, it may well be that the rule of the authorites referred to is sound and should be allowed free application. But of this no more need be said because the case does not call for a decision on the point.
Upon the question of whether a charge should be made against receipts in order to cover depreciation of plants, only brief comment need be made. That such a charge should be set up against earnings before profits available for dividends can be ascertained would seem true. Whittaker v. National Bank, 52 N. J. Eq. 400, 29 A. 203. While a charge for depreciation may not be necessary in the case of every corporation, yet in the case of a mining company whose plant is located at a remote mine and can be of little or no value after the mine is exhausted, it is apparent that a method of calculating profits which disregards the prospective scrapping of the plant is clearly unsound. To what extent, if any, a failure to allow for depreciation has contributed to the capital deficit in this case does not appear. But the-want of a showing in this particular is of no present moment, for an admitted deficit exists, however it may have been occasioned. The course of the argument would seem to indicate that it has been due entirely or nearly so to a depletion of the ore values.
The demurrer will be overruled.-•
Nóte! — From an order overruling the demurrer an appeal was taken to the Supreme Court, the order of the Chancellor affirmed, and the cause remanded. See post ¿>.411. Thereafter the cause was pleaded to issue and full hearing had. For opinion after full hearing see post p. 351.