Opinion
Submitted July 31, 1908.
Decided August 27, 1908.
1. Under Corporation act 1896 ( P.L. p. 293 § 47) giving the corporation capacity to confer on the directors the power to fix the amount to be reserved as working capital, and the amendatory act of 1901 ( P.L. p. 246 § 2) conferring such power on the stockholders unless otherwise provided in the certificate of incorporation or in a by-law, it is primarily the function of the stockholders to fix the amount to be reserved, over the capital stock paid in as working capital: and the incorporators in the certificate of incorporation and the stockholders in the by-laws may confer power on the directors to fix the amount of the working capital.
2. The charter of a corporation provided that preferred stock should be entitled to an annual dividend in preference to the payment of dividends on the common stock, and authorized the directors to alter the by-laws and to fix the amount to be reserved as working capital. The directors reserved annually sums for additional working capital, which were not used as actual working capital, but were invested in securities. — Held. that such sums did not become actual working capital, but remained under the control of the directors, who might use the same for the payment of a dividend on the preferred stock.
3. Corporation act 1896 ( P.L. p. 293 § 47) as amended in 1901 ( P.L. p. 246 § 2) authorizes the stockholders unless otherwise provided in the certificate of incorporation or by-laws, to fix the amount to be reserved as working capital. The charter of a corporation provided that the preferred stock should be entitled to an annual dividend out of any surplus net profits, and authorized the directors to amend the by-laws and to fix the amount to be reserved as working capital. The directors annually reserved sums for additional working capital, which were invested in securities, and not used as actual working capital. — Held, that, though such sums be considered as actual working capital the directors could appropriate a part thereof for a dividend on the preferred stock.
4. Where the charter of a corporation provided that preferred stock should be entitled to an annual dividend, and authorized the directors to fix the amount to be reserved as working capital, and where the by-laws authorized the directors to amend the by-laws and fix the amount of the working capital, an amended by-law permitting them to fix and from time to time increase or diminish the amount of working capital did not add to the powers of the directors to appropriate sums reserved as working capital for the payment of dividends on preferred stock.
5. Corporation act 1896 ( P.L. p. 293 § 47), as amended in 1901 ( P.L. p. 246 § 2) confers on stockholder the power, unless otherwise provided in the certificate of incorporation to fix the amount to be reserved as a working capital. The charter of a corporation provided that preferred stock should be entitled to annual dividends out of any surplus net profits, when declared by the directors, in preference to any dividend on the common stock and declared that the common stock should be subject to the rights of the preferred stockholders. The directors reserved annually sums for additional working capital, not used as actual working capital but invested in securities. Subsequently the directors voted to use a part of such sums for the payment of dividends on the preferred stock. — Held, that the reduction of the working capital did not belong to the common stockholders, but might be used for the payment of such dividends.
6. The charter and stock certificates of a corporation, which provide that preferred stock "shall be entitled out of any and all surplus net profits," when declared by the directors, to dividends authorize the directors to use any surplus profits arising from the operation of the corporation's business, whenever made to pay dividends on preferred stock, no matter when they shall have been declared, and such dividends for any fiscal year need not be declared out of the profits of that year.
On motion for preliminary injunction, on bill and demurrer.
The bill in this case is filed to restrain the defendant corporation from paying a dividend which it has declared in favor of its preferred shareholders. The dividend is at the rate of one and three-quarters per cent., and is for the last quarter of the fiscal year ending May 31st, 1908. It is payable on September 1st, 1908. It requires in cash $218,750 to satisfy the dividend so declared. The balance sheet taken from the company's books as of May 31st, 1908 (the last day of the last quarter of the fiscal year), showed to the credit of profit and loss applicable to dividends only $16,024.45. On July 2d, 1908, the board of directors, by a formal resolution, transferred $209,896.64 from an account known as "Reserve for additional working capital" to the credit of "profit and loss," increasing that credit to $225,921.09, out of which the dividend in question would be paid.
The complainant, who is a large holder of the common stock, objects to this course of procedure and seeks to enjoin the payment of the dividend, upon the ground that the directors are endeavoring to make the payment out of moneys which had been reserved by the company in preceding years for a working capital, and in which the common stockholders alone have a proprietary interest; in other words, that the directors are about to pay to the preferred stockholders a dividend out of moneys which belong to the common stockholders.
The facts are these: The defendant corporation was organized on March 3d, 1899, under the General Corporation law of 1896. It has an authorized capital of $30,000,000, divided equally between common and preferred shares. Only $25,000,000 of this stock has been issued, and this is equally divided between preferred and common shares.
The fundamental agreement between the shareholders touching the relative rights and duties of the two classes of stock, is found in the following extracts from the charter and by-laws:
Charter, paragraph 4:
"The preferred stock shall be entitled out of any and all surplus net profits whenever declared by the Board of Directors, to non-cumulative dividends at a rate not to exceed seven per cent. (7%) per annum for the fiscal year beginning on the first day of June, 1899. and for each and every other fiscal year thereafter, payable in preference and priority to any payment of any dividend on the common stock for such fiscal year. In the event of the dissolution of the corporation the holders of the preferred stock shall be entitled to receive par value of their preferred shares out of the surplus funds of the corporation remaining after the payment of its debts, before any payment shall be made therefrom to the holders of the common stock.
"The common stock shall be subject to the prior rights of the holders of the preferred stock as herein declared. If after providing for the payment of full dividends for any fiscal year on the preferred stock there shall remain any surplus net profits for such year, any of such net profits of such year, and of any other fiscal year, after the full dividends shall have been paid on the preferred stock, shall be applicable to such dividends upon the common stock as from time to time shall be declared by the Board of Directors, and out of any such surplus net profits after the closing of any fiscal year, the Board of Directors may pay dividends upon the common stock of the corporation for such fiscal year, but not until the dividends upon the preferred stock for such fiscal year shall have been actually paid or provided for and set apart."
Charter, paragraph 7:
"The Board of Directors shall have the power, without the assent or vote of the stockholders, to make, alter, amend and rescind the by-laws of the corporation; to fix the amount to be reserved as the working capital," c.
The bill states that after the organization of the corporation by-laws were adopted by the stockholders, by which it was provided that the directors should have the power, without the assent or vote of the stockholders, to make, alter, amend and rescind the by-laws of the corporation, and to fix the amount of the working capital, and that in 1906 the by-laws in this last particular were amended by the directors so as to permit them "to fix and from time to time increase, diminish and vary the amount of working capital of the corporation in their absolute judgment and discretion," which amendment was never acted upon by the stockholders, excepting that at the annual meeting of the stockholders in 1907 there was passed a general ratification of all of the acts of the directors during the preceding year.
By-laws, article XII.:
"The directors of the corporation after reserving over and above its capital stock paid in as a working capital such sum, if any, as shall have been fixed by the directors, shall either annually. Semi-annually or quarterly, as in the discretion of the directors may seem best, declare a dividend or dividends on the preferred stock of the corporation provided, however, that the aggregate amount of dividends so declared in any fiscal year shall not exceed the sum of seven per cent (7%) on the preferred stock of the corporation."
When the company was organized there was provided in addition to the capital invested a working capital of $1,720,000. From time to time as the operations of the company went on dividends were declared to the preferred stockholders and large sums were set apart to the credit of an account known as "Reserve serve for additional working capital," until the amount to the credit of that account was the sum of $2,459,896.64.
The following table shows the amount of dividends paid to the preferred stockholders and the amounts added to the reserve for working capital for each year since 1900:
Year: Dividends. Reservations. 1900 .................... $656,250 00 $289,826 85 1902 .................... 250,000 00 546,717 69 1903 .................... 500,000 00 728,724 29 1904 .................... 500,000 00 732,169 77 1905 .................... 875,000 00 ........... 1906 .................... 875,000 00 162,458 04 1907 .................... 875,000 00 ........... 1908 .................... 875,000 00 ........... ___________ ___________ $5,406,250 00 $2,459,896 64
The amount reserved for additional working capital is in cash and quickly convertible assets.
On July 2d, 1908, the board of directors passed a resolution, which, after reciting that the company had since its organization opened upon its books an account known as "Reserve for additional working capital," and has set aside out of net earnings and placed to the credit of that account $2,459,896.64, and had used that fund as additional working capital in the business of the company, and that under the present conditions the company did not need, over and above its original working capital, an additional working capital in excess of $2,250,000, resolved that such additional working capital should be diminished by withdrawing therefrom the sum of $209,896.64, and that the same should be credited to the profit and loss account, and that the treasurer should make such entries upon the books of the company as should carry out the purpose and intent of the resolution. In this way the fund was provided out of which the dividend declared to the preferred shareholders could be paid.
Mr. John R. Hardin, for the complainant.
Mr. Richard V. Lindabury, for the defendant.
The difficulties arising out of the above state of facts are principally those of interpretation. We must ascertain the nature and character of the fund known as "Reserve for additional working capital," and we must understand the relation which the statutory provisions bear to the engagements that the shareholders have entered into among themselves, in the company's charter and by-laws, in order to determine the character of this fund.
Primarily, it is a function of the stockholders to fix the amount to be reserved, over and above the capital stock paid in, as a working capital. Corp. act 1896 § 47, P.L. 1901 p. 246. The act of 1896 gave the corporation capacity to confer this power upon the directors. The act of 1901 confers the power on the stockholders unless otherwise provided in the original or amended certificate of incorporation, or in a by-law adopted by at least a majority of the stockholders. While there are some important differences between section 47 of the act of 1896 and section 2 of the act of 1901, above referred to ( Stevens v. United States Steel Corporation, 68 N.J. Eq. ( 2 Robb.) 373), yet for the purposes of the case in hand they are not of consequence, because in this case the incorporators in the original certificate of incorporation and the stockholders in the by-laws conferred the power to fix the amount of the working capital upon the directors.
The directors as early as 1900 opened an account in the company's books of the character known among professional accountants as a representative account, which they denominated "Reserve for additional working capital," to which they appropriated large sums of money in the years 1900, 1902, 1903, 1904 and 1906. These appropriations aggregated the sum of $2,459, 896.64. This fund seems never to have been used as actual working capital; that is, it was never invested in book accounts, plant, machinery, fixtures or materials. It was always invested in securities, which were quickly convertible into cash, and as far as the case shows, bore no relation whatever to those activities in which the company was engaged and for the prosecution of which it was formed.
The complainant does not complain of this action on the part of the directors. I take it that he accords to the directors under the charter and by-laws the right to pile up this "reserve" in their discretion, but, having once appropriated the money to that account, he denies their right to reduce the amount of such reserve, unless the whole sum so withdrawn shall be given to the common stockholders. He contends that when the fund is once created it cannot be disturbed except by vote of the common stockholders, and that its appropriation to working capital perforce changed its character and function to such an extent as to withdraw it wholly from the reach of the preferred shareholders. Concerning this contention two remarks may be made — first, this fund never became actual working capital. It was never actually employed in the business in which the company was engaged. It has always remained in cash or securities. It has always been a mere creature of bookkeeping and, although as a matter of account merely, it was set apart and tagged with a new name, its physical condition and character were never changed. When it was returned to profit and loss account by the resolution of July 2d, 1908, the return was effected by the treasurer by a mere bookkeeping entry as the resolution directed. It was what the directors called it when they opened the special account — a reserve — which might be used as actual working capital in case it should be needed for that purpose. In order to so use it, it would require the further action of the directors to take the amount so found to be necessary from this account by solemn resolution, and by like resolution to exchange it for machinery or materials. The resolution which declares that the fund had been used as a working capital does not state the facts. Second, this fund was once "Surplus net profits," else it could not have been dealt with as the directors did deal with it. It was originally a fund which was applicable to dividends and during the five years above mentioned could legally have been applied to pay full seven per cent, dividends to the preferred stockholders. I fail to see how its character as "Surplus net profits" can be changed by calling it "Reserve for additional working capital" and doing nothing more about it.
If the fund is of this nature and character, then it is under the full control of the directors and may be used by them for the payment of the dividend in question. They may diminish it for lawful purposes and in a lawful manner in their discretion. They may open other accounts with other names on their books and appropriate the whole or any part of it thereto. But whatever they do about it, so long as it is not actually paid out, it must remain in fact "Surplus net profits." Mere bookkeeping entries cannot affect it.
The fourth paragraph of the charter provides that the preferred stockholders may be paid dividends "out of any and all surplus net profits." If the view above expressed is correct, then the present board of directors have express warrant in the charter for paying the dividend in question out of this reserve fund.
An almost conclusive argument in favor of the defendant's position lies in the fact that there yet remains in the account denominated "Reserve for additional working capital," $2,250,000, which is invested in quickly convertible securities and which the corporation management declare is sufficient for the company's purposes, but which has not yet been actually employed in the operation of the company's business. I understand from the case that the original working capital of $1,720,000 was actually invested in the purchase of materials or plant, or invested in book accounts, and that it has been and is treated as actual working capital. It is quite manifest that there is a wide difference between that original actual working capital invested in property necessary for the company's business and the reserve of $2,250,000 which is merely held as an investment of the surplus moneys belonging to the corporation.
But if the fund is of the character insisted upon by the complainant, viz., actual working capital, yet, in my opinion, the directors have been given full control of it by the charter and by-laws. The charter (paragraph 7) confers upon the board of directors the power without the assent or vote of the stockholders to fix the amount to be reserved for the working capital. The by-laws use the same expression. The complainant argues that this authority, as well as the like authority in the statute. ( P. L. 1901 p. 246 § 47 of the act of 1896) goes only to the extent of permitting the directors to establish by resolution an amount to which additions may be made from time to time by virtue of the same authority, but that the fund once built up may not be diminished except by the consent of the common shareholders.
The statute contemplates annual dividends. It likewise contemplates at the time these annual dividends are declared that the body to which the function may be committed by the charter or by-laws — either the directors or the stockholders — shall ascertain whether any additional working capital may be needed in the company's business, and if so, to provide it out of the profits of the business, and so annually to fix the amount which may be so needed. Manifestly this amount may vary. It may be large one year and small the next. In the case of a corporation which had issued common stock only there could be no question. In such a case the directors or stockholders, as the case might be, would reduce the working capital and divide the reduction as a dividend among the stockholders. The words of the statute are no different in the case of a corporation which has issued preferred stock, and the rule must be analogous.
The trend of judicial thought on this point will be found in Vice-Chancellor Stevenson's opinion in Stevens v. United States Steel Co., 68 N.J. Eq. (2 Robb.) 382.
I do not think that any important change was made in the power of the directors by the amendment to the by-laws in 1906, whereby specific authority was given to them to increase, diminish and vary the amount of the working capital, neither do I find in the statute or the documents in the case any direction to refer the question to the stockholders.
But, says the complainant, although the working capital may be reduced by the directors, the reduction belongs to the common stockholders, and must be divided among them, to the exclusion of the preferred stockholders. I find no appropriation of this kind in the statute nor in the charter or by-laws of the company. In my opinion, any amount taken from actual working capital, or from "reserve for additional working capital," is at once restored to the character that it originally bore. It was either "surplus" or "net profits" or "surplus net profits," when it was first dealt with by the directors, and probably appeared on the books in the profit and loss account as a surplus. It is now dealt with again. The bookkeeping process is reversed by an entry made by the treasurer, and this should restore the former situation. As a matter of bookkeeping, its place would be in the profit and loss account, or in some other special account in which it would show as a surplus; and it would be applicable to the payment of any and all dividends that the board of directors might lawfully declare.
It is claimed on the part of the complainant that the preferred stock dividends for any fiscal year must be declared and paid out of the profits made by the company during that same fiscal year; that is to say, that profits made during the fiscal year ending in 1904, cannot be paid out in dividends to the preferred stockholders which might be declared during the fiscal year ending in 1905 or 1906. This position is entirely at variance with the charter and the stock certificates, both of which provide that the preferred stock shall be entitled "out of any and all surplus net profits," whenever declared by the board of directors to non-cumulative dividends, c. I think that this means that the directors may use any surplus profits arising from the operation of the company's business, whenever made, to pay lawfully-declared dividends on the preferred stock, no matter when they shall have been so lawfully declared. The case of Elkins v. Camden and Atlantic Railroad Co., 36 N.J. Eq. (9 Stew.) 233, does not apply because of the difference in the wording of the charter.
I therefore conclude that the bill of complaint is without equity, and unless the complainant can amend in such manner as to avoid the objections now presented, it must be dismissed.