Opinion
June Term, 1887
P. Henry Smythe and Joseph Anderson, for plaintiff.
Charles A. Clark, for defendant.
This is an action at law to recover from the personal representatives of George Greene 80 percent, unpaid upon 910 shares of stock issued to him by the Burlington, Cedar Rapids Minnesota Railway Company. The amount claimed is the sum of $65,523.20, with interest. It seems that George Greene was stockholder of said company, and also a member of a construction company by which the work of building had been done. The railway company was indebted to the construction company in the sum of $70,000, without any means of making payment of the same. The railway company was in fact insolvent. Its earnings were insufficient to pay the interest on its large bonded debt. It had a floating debt of over a half million of dollars which it could not provide for. It is sufficiently evident that the whole corporate property was insufficient to pay the bonded debt secured upon the property, and that the stock of the company had no market value. Under these circumstances, the railway company entered into an arrangement with George Greene and his associates, by which the company issued to them its stock at the rate of 20 cents on the dollar, in full payment and discharge of the debt of $70,000, which they held against the company. The stock was to be received as full paid. The shares of stock were $100 each, and George Greene received his proportion, amounting to 910 shares. It is to recover the unpaid $80 on each of these shares of stock, to be applied on the plaintiff's judgment, that the plaintiff, a creditor of the company, brings this action.
It appears that George Greene and his associates received the stock reluctantly, and with the hope by its means of raising the company from its crippled condition of insolvency. With this view they transferred the stock for a nominal consideration to John I. Blair, a large capitalist, by whom it was retransferred to his assignors upon finding that the task of getting the railroad company out of its difficulties was hopeless. the plaintiff, having recovered a judgment in a state court of Iowa against the railway company, and having caused execution to issue upon the same, which was returned nulla bona, now prosecutes this suit for the purpose stated. A jury was called pro forma, but the case was tried practically before the court upon facts not disputed by the parties, and upon pure questions of law. The jury were directed by the court to enter a verdict for the defendant upon the admitted facts.
Whoever, in my opinion, takes the stock of a solvent corporation, must receive it cum onere. He proposes to become a member of the corporation, and to participate in its rights, profits, and benefits en equal terms with other stockholders, in proportion to his stock, and he cannot take these advantages without assuming the burdens of the corporation in like proportion to the amount of his stock. This may not be true, indeed, I think it is not true, of the case of an insolvent corporation which is in the course of settlement or liquidation. I can. not see That the creditors of a solvent corporation, the assets of which are entirely adequate to the satisfaction of their claims, have any interest in compelling a particular stockholder to pay up his stock in full; but it is surely otherwise, as I will presently show, with the full-paying stockholders themselves.
These principles may be best illustrated by considering the relations which the taking of stock creates. The stockholder assumes a three-fold relation: (1) to the corporation itself; (2) to the creditors of the company; (3) to the other stockholders.
To the creditors he becomes a debtor to the amount of his unpaid stock, when the company becomes insolvent, and fails to pay its debts. To the other stockholders he assumes the relation of a quasi partner, in that he participates in the profits and advantages of the corporation, and takes its burdens to the extent of his unpaid stock. To the corporation itself he is bound by the contract by which he owns the stock which has been issued to him. He is a debtor to the corporation to the amount of his unpaid stock. What is the nature of the contract which the taking of stock in a corporation creates? What relations does it establish between the shareholder and the other stockholders, and also to the creditors and the corporation?
The taking and receiving of stock is a contract founded upon certain considerations to the stockholder. It is not a gift to hits. By the taking of the stock he becomes a member of the body corporate. He has a right to vote upon his stock. He entitles himself to his share of the profits, if any, and to the property of the corporation upon the final distribution in proportion to his holding of stock. Such arc the considerations flowing to the stockholder. And what are his undertakings in consideration of the rights and interests thus secured? His undertaking is to pay for the stock. Can a stockholder, by agreement with the corporation issuing the stock, lawfully stipulate that he shall pay less than the face value of the same, — say 10 or 20 cents on the dollar? It is manifest that the law will not permit any party to make a contract which necessarily works a fraud upon the rights of other parties. Now, if all the subscribers and takers of stock should be allowed, by contract with the company, to pay less than the face value of the stock, a fraud upon the creditors, in case of insolvency, would be the unavoidable result. Creditors, in dealing with The corporation, look to its means of payment, which is in part its capital stock, and its earnings. The stockholders are members of the corporations. They authorize the corporation, which is organized for their benefit and profit, to hold them forth to the world as contributors, to the respective amounts of their stock, to the assets and capital of the corporation. They thus give the corporation credit. They also take its earnings, in proportion to their shares, in the form of dividends. They receive these dividends in proportion to the full amount of their shares, and not upon any reduced basis founded upon their contract to pay into the corporation less than the face value. These earnings and dividend,, if not received by the shareholders, could be applied to the satisfaction of the claims of creditors.
To permit stockholders to pay 10 or 20 per cent. on their stock, and receive dividends on it at the rate of 100 per cent., would work manifest injustice to creditors. To permit the stockholders and the corporation to hold the stockholders out to the world as responsible for $100 upon each share of stock, and, by a private agreement between the corporation and the shareholders, to allow the latter to pay only ten or twenty dollars on each share, would work manifest fraud upon the creditors of the corporation. Hence the law would not permit such a contract between the company and the shareholders. It is equally clear that it would work wrong and injury, pro tanto, to creditors, in case of insolvency, to permit any one stockholder to receive dividends upon full stock, and pay only a small per cent. upon it into the treasury of the company. If there is anything fundamental, respecting both corporations and private partnerships, it is that creditors have a right to satisfaction before any member of the firm or corporation is entitled to appropriate the earnings or profits.
But supposing that creditors should have no right to complain, assuming that the assets of the corporation should be sufficient to pay all debts, — we must still consider the relation of stockholders to one another, and the results that would flow from a rule permitting the corporation to issue stock to particular persons at less than the face of the stock. Of course, the original subscribers of stock, and all others not exempt by contract with the corporation from full payment, would be compelled to pay dollar for dollar of their stock; for such would be the contract involved in their subscription to the capital stock. This might result in the grossest inequality and injustice between different classes of stockholders. While one class would be required to pay only perhaps 10 or 20 cents on the dollar, and another dollar for dollar, all would participate equally in the profits and dividends, and in the final distribution of the corporate property. In case of insolvency, one set of stockholders might be compelled to pay in, for the benefit of creditors, 100 cents on the dollar, and another favored class only perhaps 10 or 20 cents on the dollar. I am not, therefore, able to see how a solvent corporation could, without the consent of the stockholders, lawfully issue stock to other parties exonerated from the payment of its full face value. The president and directors are but trustees for the creditors and stockholders, and, as such, they must, in the absence of express law, do what justice and equity require; and equity certainly requires equality of both benefits and burdens among stockholders.
But the question before the court in the present case is whether or not the principle in question is of universal application. Does the doctrine that the president and directors of a corporation cannot lawfully issue stock exonerated from full payment, apply to all possible cases? Does it apply at all to a corporation in a state of insolvency, using its stock without other means of payment, to satisfy and discharge the debt of a particular creditor? The supreme court of Iowa have, in a majority opinion in the case of Jackson v. Traer, 64 Iowa, 469, 20 N.W. Rep. 764, as I understand their judgment, laid down the broad and sweeping doctrine that it is absolutely illegal for the president and directors of a corporation to issue stock to any party with a stipulation exempting the stockholder from full payment of the stock, so far as creditors are concerned. Such a stipulation is simply void. The stockholder is bound to pay up the full face value of the stock, notwithstanding the agreement of the corporation with him to the contrary. The general principles laid down, and strongly enforced in the majority opinion, stand, no doubt, upon impregnable ground. They are stated with marked ability and fullness in that opinion. But I incline to think the majority were in error in applying the principle to the case then before them which, indeed, was the very case now before the court. I am of opinion that there may be some exceptions in the application of that principle just and most salutary as it undoubtedly is; and that the case before us is one of those exceptions.
What are the grounds and reasons of the doctrine that a stockholder cannot, by contract with the corporation, be exempt from the full payment of his stock? The sole reason and basis of the principle is that the capital stock, in common with the other property of a corporation, is a trust fund primarily for the satisfaction of its debts, and subject to the rights of creditors for the benefit of shareholders. Now, suppose it could be shown, in any given case, that an issue of stock by the company, with the right to the stockholder of partial payment, would prove a benefit rather than an injury to both creditors and shareholders what would there be to apply the principle in question to such a case? Of course, the burden of showing the beneficial character of such a transaction to creditors and shareholders would rest upon the holder of the stock. Suppose a creditor of an insolvent corporation should see fit, for any reason satisfactory to himself, to receive the worthless stock of the corporation as paid up stock, at 20 cents on the dollar, in full satisfaction of his debt, what possible injury could accrue to other creditors and stockholders? Would such a transaction not prove an absolute benefit to them? In the first place, such stock, in the possession of the company unissued, would be of no value whatever to creditors. It would produce nothing, and pay nothing. It would seem, therefore, that the payment of a debt by the issue of such worthless stock would be no possible injury to other creditors. On the contrary, it would seem to be a positive advantage to the other creditors to have a particular debt discharged by stock of no value, because the creditor so receiving the stock would have no right to claim pro rata payment out of the assets of the insolvent corporation. As to the stockholders of the corporation, how would they be injured by such a transaction? The corporation being insolvent, and its assets, including, of course, the capital stock, fully paid up, being insufficient to pay the debts, there would be nothing left for the stockholders. Their stock would be worthless. It could not be made less valuable by the payment of a particular debt with newly-issued stock. They would not be affected, one way or the other, by the transaction, since they would be compelled to pay their stock up fully for the benefit of the creditors, and nothing more could, in any event, be required of them.
The very case before the court presents an example illustrative of what I have just said. The railway company was insolvent. Its stock issued and unissued was worthless, but George Greene and his associates, for reasons peculiar to themselves, — reasons which would have influenced the conduct of no one else, — accepted the unissued stock of the company at 20 cents on the dollar, in payment of a debt of $70,000. If there was anything left in the corporation to be paid pro rata on its debts, the transaction was a positive benefit to the creditors holding such debts. It is safe to say that if Greene and his associates had known or believed the law to be such as to require them to pay 80 cents on the dollar upon the stock which they received, they never would have taken it. It would have remained unissued, without value, to creditors, in the possession of the corporation; and the debt of $70,000 would have remained to be paid pro rata with the other debts; and, as to the other stockholders of the insolvent corporation, I do not see how they could have been affected one way or the other by the transaction.
It seems to be a fair inference, from the facts that George Greene, who was a member of both corporations, entertained a hope that by taking the stock in question, and transferring it to John I. Blair, the corporation could be restored to solvency, and placed once more upon its feet. In this he failed, and the stock was returned to him by John I. Blair. But, if Greene had succeeded in this, the result would have proved highly beneficial to both the creditors and stockholders of the corporation. As, however, Greene failed in accomplishing his purpose, the stock which he received must have proved worthless in his hands, while the debt of $70,000 was wiped out.
It is argued, against this view, that the debt upon which the present suit is founded was contracted subsequent to the transaction between Greene and the corporation, and that the reasoning of the court cannot be sound when applied to the plaintiff in this case. This argument has been urged with singular plausibility and force, but I cannot regard it as conclusive. If the transaction between George Greene and the corporation was at the time beneficial to the creditors then existing, and if it was therefore legitimate I am not able to see how it could be rendered invalid by debts subsequently contracted. The issue of the stock to George Greene and his associates was not a secret transaction. It was open and public. The resolution authorizing it was spread upon the records of the corporation. The new creditor, taking the company's bonds, if he opened his eyes, must have seen that the stock issued to George Greene was delivered to him as paid-up stock. If the new creditor looked beyond the surface of the transaction, we are bound, in our own view, to hold that he discovered that the transaction was entered into in good faith; that it was beneficial to then existing creditors of the insolvent corporation; and that it was therefore legitimate and unimpeachable. We must assume that the new creditor took the obligations of the corporation with notice, and full view of these facts.
Again, it is urged that the Iowa statute law positively prohibited the transaction in question, so far as it was attempted to exempt the stock from full payment. But we answer that the statue must receive a reasonable construction; that its sole purpose was the protection of corporate creditors; that in the present case it would have worked positive injury to the creditors of the insolvent corporation to have given the Iowa statue the strict and rigid construction now claimed for it; that such a construction, applied tot he case in question, would have defeated the very purpose and policy of the statue; and that such could not therefore, have been the intention of the legislature in passing the law.