Opinion
No. 26847
Decided May 18, 1938.
Corporations — Optional plan of recapitalization not enjoined, when — Preferred stockholders permitted to retain stock or exchange it for new prior preferred — Exchange of old stock for new stock authorized — Section 8623-22, General Code — Dissenting shareholders' remedy available where terms and conditions of stock changed, when — Section 8623-72, General Code — Statutory remedy not exclusive, when.
1. An optional plan of recapitalization of a corporation, which provides that preferred stockholders may either retain their stock or exchange it for a new prior preferred stock by waiving their right to accumulated and unpaid dividends, in the absence of fraud, will not be enjoined in an action by minority stockholders if the plan does not violate the statutes or provisions of the articles of incorporation.
2. The provisions of Section 8623-22, General Code, authorize the exchange of old stock for new stock in a corporation.
3. When there is a change in the terms and conditions of stock by reason of an amendment to the articles of incorporation, dissenting shareholders have a remedy under the provisions of Section 8623-72, General Code. If fraud or illegality is found in the enactment of the amendment, the remedy under that section is not exclusive.
APPEAL from the Court of Appeals of Cuyahoga county.
The National Refining Company, an Ohio corporation, on October 8, 1936, submitted to its shareholders a plan for recapitalization. On December 9, 1936, the plaintiffs, who were minority holders of the preferred stock, instituted this action to enjoin the directors of the company from placing the plan in operation, and prayed for a mandatory injunction to compel the corporation to declare and pay a dividend on the preferred stock.
Thereafter the board of directors of The National Refining Company did declare a dividend of $8 per share, payable December 21, 1936, to the preferred shareholders of record at the close of business December 14, 1936.
On December 22, 1936, an amended plan of recapitalization was submitted to the shareholders of The National Refining Company. The terms of the amended plan are identical with the former plan submitted, except the payment of the dividend declared was taken into consideration.
The amended plan of recapitalization contemplated an amendment to the corporate charter which was voted upon at a special meeting held January 19, 1937, in Cleveland, Ohio. At that time there were issued and outstanding 49,864 shares of non-callable 8% preferred stock, and 463,295 shares of common stock. Of this number, 34,891 shares of preferred stock and 398,310 shares of the common stock were voted in favor of the amendment, which constituted a majority of more than two-thirds of the holders of each class of stock. The amendment was therefore declared adopted.
On February 18, 1937, the plaintiffs, who owned 2,628 shares of the preferred stock, and who had not voted in favor of the amendment to the articles of incorporation which sought to carry out the amended plan of recapitalization, filed an amended and supplemental petition seeking to enjoin the action of the board of directors, as well as praying that a dividend be declared.
The articles of incorporation, in reference to the preferred stock, provide as follows:
"(1) The common stock shall be subordinate to the rights of the preferred stock, except that both preferred and common stock shall have equal voting powers.
"(2) The corporation shall not be at liberty, without the consent in writing first obtained of the holders of two-thirds (2/3) in amount of the preferred stock issued and outstanding —
"( a) To create or issue any other or further shares ranking in any respect pari passu with or in priority to the aforesaid issue of preference shares.
"( b) Nor to create any charge except arising in the ordinary course of business and necessitated thereby, upon the net profits of the corporation which shall not be subordinate to the rights of the preference shares.
"( c) Nor to reserve a surplus fund which shall not be chargeable with the payment of the accrued dividend on the preference shares.
"(3) The said preference shares shall carry and be entitled to a fixed cumulative preferential dividend at the rate of, but never exceeding eight per centum (8%) per annum on the par value thereof, and such dividend shall be declared quarterly in January, April, July and October in each year, or at such other times as the board of directors shall see fit and determine.
"If in any year dividends amounting to eight per centum (8%) per annum shall not be paid on such preferred stock, the deficiency shall be a charge on the net profits and be payable, but without any interest, before any dividends shall be paid upon or set apart for the common stock.
"(4) The balance of the net profits of the corporation after the payment of said cumulative dividend at the rate of eight per centum (8%) per annum to the holder of the preferred stock, may be distributed as dividends among the holders of the general or common stock, as and when the board of directors shall in their discretion determine." (Italics ours.)
The amendment adopted provided for the issuance of 66,500 shares of prior preferred stock without par value, 50,000 shares of preferred stock with a par value of $100 per share, and 1,200,000 shares of common stock. The prior preferred stock was to be redeemable at $105 per share.
The amended plan of recapitalization proposed that holders of the preferred stock who desired to exchange their 8% stock would receive in exchange one and one-third shares of the new prior preferred callable stock, and three-fourths of a share of common stock. If the holders of the preferred stock did not desire to make the exchange, they were to be permitted to retain their 8% preferred stock, which, while it would be preferred to the common, would be secondary to the prior preferred stock to be issued.
After the $8 dividend was declared, and prior to the adoption of the plan, there were accumulated and unpaid dividends on each share of the old preferred stock amounting to $18 at the end of 1936. An additional $2 dividend was due January 1, 1937. The three-quarters of a share of common stock was conceded to be worth approximately $6.
The admitted purpose of the amendment adopted by the corporation was to eliminate the payment of the $14 of accumulated and unpaid dividends. On December 31, 1929, the company had a surplus, according to its books, of $6,985,713.18 and cash assets of $4,877,933.25. On December 31, 1935, the surplus was $2,263,334.50 and the cash available $2,347,730.57.
The purpose of the plan was set forth in the original letter to the stockholders from the president of the company wherein it is said: "Your board of directors is unanimous in the opinion that the payment of these back dividends on cash in the near future would dangerously impair the company's working capital. It has therefore come to the conclusion that the shareholders should be afforded an opportunity to vote on a plan of recapitalization whereby the articles of incorporation would be amended so as to create a new issue of preferred stock to be designated 'Prior Preferred Stock' and the holders of the present preferred stock would be given the right and option to exchange each share of their present stock for 1 1/3 shares of the new prior preferred stock and 3/4 share of common stock."
In the Court of Common Pleas the plan was enjoined although the prayer that a dividend be declared was denied. On appeal on questions of law and fact to the Court of Appeals, judgment was rendered in favor of the defendants and the injunction dissolved.
A motion to certify the record was allowed by this court.
Messrs. M.B. H.H. Johnson, Mr. John H. Watson, Jr., Mr. John T. Scott and Mr. Robert W. Wheeler, for appellants.
Messrs. Tolles, Hogsett Ginn, Mr. William B. Cockley and Mr. Louis S. Peirce, for appellees.
The sole question is whether the amended plan of recapitalization of The National Refining Company, which was adopted by more than two-thirds of the shareholders, is of such a character that a court of equity should prevent it from being placed in operation at the instance of minority holders of the present preferred stock.
If the plaintiffs, as minority stockholders, make the exchange proposed they will receive one and one-third shares of a six per cent prior preferred stock for their present eight per cent preferred stock. The stipulated income yield on the investment will, therefore, be the same after the exchange as before.
However, in place of the right to receive $20 in unpaid and accumulated dividends now past due, by making the exchange the stockholder will receive only three-quarters of a share of common stock, which was conceded to have a value of $6. The net loss to those who make the exchange will be approximately $14 per share. In addition, the preferred holder will have to surrender a non-callable stock for one which may be redeemed.
The Court of Common Pleas held that "the plan if adopted would destroy the rights of the holders of the presently existing preferred stock to the accumulated and unpaid dividends." In reaching this conclusion the court said: "We hold that there exists a vested right in such accumulation and in a provision contained in the articles of incorporation that the same shall be a charge upon the net profits. * * * We are also of the opinion that the plan proposed is compulsory in fact."
If the amended plan of recapitalization compelled the preferred shareholder to make the exchange and thereby suffer not only a loss of approximately $14 per share, but also have a callable stock substituted for a non-callable one, we would have serious doubts as to the validity of such a proposal.
It is generally held that when the statutes and articles of incorporation permit, a prior preferred stock may be issued upon obtaining the vote required either by the statute or articles. See Davis v. Louisville Gas Electric Co., 16 Del. Ch. 157; General Investment Co. v. American Hide Leather Co., 98 N.J. Eq. 326, 129 A. 244, 44 A. L. R., 60; 11 Cornell Law Quarterly, 78.
However, attempts by the majority to effect a compulsory exchange of stock that will eliminate either a sinking fund established for the benefit of the preferred holders, or to cancel unpaid accumulative dividends have been enjoined. Yoakam v. Providence Biltmore Hotel Co., 34 F.2d 533; Morris v. American Public Utilities Co., 14 Del. Ch. 136; Keller v. Wilson Co. (Del.), 190 A. 115; Johnson v. Consolidated Film Industries, Inc. (Del.Ch.), 194 A. 845; Pronick v. Spirits Distributing Co., 58 N.J. Eq. 97, 42 A. 586; Lonsdale Securities Corporation v. International Mercantile Marine Co., 101 N.J. Eq. 554,139 A., 50.
These decisions proceed upon the theory that a shareholder who holds preferred stock upon which there are past due and accumulative dividends has a vested right in the surplus and earnings of the corporation until the dividends are paid. These unpaid dividends are treated as if they were in the nature of a debt. 7 Fletcher, Cyclopedia of Corporations, 858, Section 3696.
But even in New Jersey, where the vested right theory has been so frequently mentioned in a case where there was neither surplus nor earnings and the company was on the verge of bankruptcy, a consolidation was permitted which forced the preferred holders to waive their rights to accumulated and unpaid dividends. Windhurst v. Central Leather Co., 105 N.J. Eq. 621, 149 A. 36. Under a special statute in Delaware a similar result was reached. Harr v. Pioneer Mechanical Corporation, 65 F.2d 332.
A stock certificate forms a contract between the holder and the corporation, and nothing can be done to impair its obligation. Geiger v. American Seeding Machine Co., 124 Ohio St. 222, 237, 177 N.E. 594, 79 A. L. R., 614. Of course, it might well be argued that, so long as the majority keeps within the terms of that contract, its action should not be enjoined. Courts, as we have seen, have not permitted the majority to oppress the minority. Under the use of their equitable powers some courts have held that there are implied limitations, although not expressly mentioned, which will not permit a serious impairment of the rights of the minority. New Haven Derby Rd. Co. v. Chapman, 38 Conn. 56; Lathrop v. Stedman, 42 Conn. 583; Perkins v. Coffin, 84 Conn. 275; Allen v. Francisco Sugar Co., 92 N.J. Eq. 431,112 A., 887; Kent v. Quicksilver Mining Co., 78 N.Y. 159; In re Mt. Sinai Hospital, 250 N.Y. 103, 164 N.E. 871, 62 A. L. R., 564. See also, Wright v. Minnesota Mutual Life Ins. Co., 193 U.S. 657, 663, 48 L.Ed., 832, 24 S.Ct., 549; Polk v. Mutual Reserve Fund Life Assn. of New York, 207 U.S. 310, 52 L.Ed., 222, 28 S.Ct., 65; and 44 Harvard Law Review, 1049, at page 1068.
It is claimed that the cancellation of an accumulated and unpaid dividend of a preferred holder impairs a vested right. If there is a surplus, the action usually has been enjoined. If, on the other hand, there is a need for additional capital, the corporate necessity for continued existence overshadows the claims of the minority holders to dividends. In determining the questions courts have considered both the equities and the business situation, attempted to weigh and balance them, and then decided the controversy. Berle Means, The Modern Corporation and Private Property, 150, 151. Adoption of this view would negative any theory of a vested right.
A continued discussion of whether preferred shareholders have vested rights becomes purely academic so far as this case is concerned. In all of the cases cited, where equitable relief was obtained, a compulsory plan was proposed. In this case the plan is optional.
The plaintiffs in this case are not compelled to exchange their stock. They are at liberty to retain their present preferred stock upon the same terms and conditions as they now hold it.
If they do so, it will become a second preferred stock bearing an 8% dividend. When they acquired it originally they knew that by a two-thirds vote of the shareholders a prior preferred stock could be issued, and that their holdings would then become second preferred.
Since there was a right contained in the articles of incorporation to issue a prior preferred stock, by a two-thirds vote, it would follow of necessity that dividends would have to be paid on such stock. The dividends on that stock would be paid in preference to dividends on the present preferred.
The articles of incorporation which provide that if there are unpaid dividends on the present preferred stock "the deficiency shall be a charge on the profits and be payable, but without any interest, before any dividends shall be paid upon or set apart for the common stock," are perfectly clear. Nothing in the articles guarantee that unpaid accumulated dividends shall be paid before a prior preferred stock is issued. The only agreement is that the preferred dividends shall be a charge and payable before any dividends on the common stock are declared and paid. The preference is not disturbed if plaintiffs retain their stock.
Counsel for plaintiffs contend that "the preferred stockholders would be deprived, by compulsion, of about $12 per share of accumulated dividends, or a total of about $600,000, which would enure to the benefit of the common stockholders." If the plan were compulsory that would be true. If, however, plaintiffs retain their stock and the other seventy-five per cent of the present preferred holders exchange theirs, the benefit of $450,000 of accumulated dividends which are waived will enure primarily to the plaintiffs. No dividends will or can be paid to the holders of the common until the accumulated and unpaid dividends of the preferred holders are discharged.
While there will be a new prior preferred issue outstanding whose holders will receive a prior right to dividends, the present preferred holders agreed to permit such an issue if two-thirds of the shareholders so voted.
As was pointed out and remains unanswered, the effect of the plan is the same as if a new prior preferred stock was sold for cash, and with the proceeds the present holders were offered a price which would be based upon a waiver of the payment of the accumulated and unpaid dividends.
There were reasonable grounds for the directors and stockholders to feel that, in view of the business depression and the shrinking of the surplus, the stability of the company would be improved by a waiver of the past dividends. If the holders who exchange their stock feel that in order to enhance their chances of securing immediate dividends it is necessary to forego certain rights, the plaintiffs cannot complain. In fact the complaint of plaintiffs is in reality that a prior preferred stock should not be issued whenever there are dividends due and unpaid, no matter what the circumstances may be.
If the plaintiffs retain their present stock, and in the future profits are made, but the directors fail to declare dividends on their stock, and the failure is not in good faith, adequate remedies are available to protect their interests. See Dodge v. Ford Motor Car Co., 204 Mich. 459, 170 N.W. 668, 3 A. L. R., 413; Wagner Electric Corporation v. Hydraulic Brake Co., 269 Mich. 560, 257 N.W. 884; Koral v. Savory Inc., 276 N.Y. 215, 11 N.E.2d 883; Tower Hill Connellsville Coke Co. v. Piedmont Coal Co., 64 F.2d 817.
From an examination of the record which shows a depleted surplus both the Court of Common Pleas and Court of Appeals found insufficient evidence to compel a declaration of a dividend. Since the declaration of dividends is largely a matter of discretion with the board of directors, we are unable to say that they acted in bad faith. See Moorehouse v. Crangle, 36 Ohio St. 130, 38 Am. Rep., 564; Lamb v. Lehmann, 110 Ohio St. 59, 65, 143 N.E. 276, 42 A. L. R., 437; Wabash Ry. Co. v. Barclay, 280 U.S. 197, 74 L.Ed., 368, 50 S.Ct., 106; Knapp v. S. Jarvis Adams Co., 135 F. 1008; and 76 A.L.R. 885.
It is charged that by reason of the family connections of various stockholders this amended plan is in reality a fraudulent scheme on the part of the common stockholders to force the plaintiffs to waive their rights to the past dividends. The Court of Appeals in its opinion said that it was "unable to see any trace of fraud on the part of the directors." An examination of the record by this court does not disclose any breach of fiduciary duty on the part of the directors.
The contention is made that the plan cannot be sanctioned because it is contrary to the provisions of Section 8623-22, General Code, which it is said does not permit new stock to be exchanged for old stock. It is sufficient to point out that the statute permits the issuance of shares for "money or other property, real or personal, tangible or intangible." Stock in the hands of a shareholder is certainly intangible personal property, and the statute is therefore broad enough, in the absence of an express prohibition, to include an exchange of old stock for new.
While the amendment was adopted under the provisions of Sections 8623-14 and 8623-15, General Code, the court is of the opinion that the plaintiffs did have the right as dissenting shareholders, under the provisions of Section 8623-72, General Code, to ask for an appraisal of their stock within twenty days after the vote on the amendment was taken.
If the purpose of the amendment is "to change the express terms and provisions of any outstanding shares having preference in dividend, redemption price or liquidation price over any other class of shares" dissenting shareholders if "substantially prejudiced thereby" shall have the rights provided under the appraisal statutes.
Only those changes in the terms and provisions of stock can be made which the law permits. Therefore, all changes which can be legally made are due either to express or implied reservations in the shareholder's contract. The words "terms and provisions" as used in Section 8623-15, General Code, are defined in Section 8623-4, General Code, in considerable detail.
If the plaintiffs make the exchange they will lose approximately $14 per share on dividends, and receive redeemable instead of non-callable shares. If they retain their stock, it becomes second preferred instead of first preferred, and payment of the unpaid accumulative dividends would be deferred. This would effect a change in the relative rights of the shareholders, and under the provisions of Sections 8623-4 and 8623-15, General Code, the plaintiffs, therefore, would have had all the rights of dissenting shareholders to ask for an appraisal under Section 8623-72, General Code.
The remedies provided under statutes similar to Section 8623-72, General Code, were never considered exclusive unless a sale of the concern was attempted. See Geiger v. American Seeding Machine Co., 124 Ohio St. 222, 237, 238. In instances where fraud and illegality are involved it was never intended that the statutory remedy should be exclusive. General Investment Co. v. Lake Shore Michigan So. Ry. Co., 250 F., 160, 174; 45 Harv. Law Rev., 233, 244, 247, 248; 30 Mich. Law Review, 645, 646, 647.
In this case, the plaintiffs have failed to show either fraud or illegality. The plan proposed violates neither the statute nor the articles of incorporation. It is purely optional in its nature, and the majority is therefore not dispossessing the plaintiffs of any property rights. If the plaintiffs suffer loss it will be either because they voluntarily surrendered rights or because, at the time of the acquisition of their stock, they agreed to permit the majority to do exactly the thing that was done. To compel the payment of all accumulated dividends before the new prior preferred stock is to be issued would cause a serious impairment of the company's reserves.
After taking into consideration the business conditions existing we are unable to find any equitable ground upon which the courts should intervene to prevent the enforcement of this plan of recapitalization.
The judgment of the Court of Appeals is therefore affirmed.
Judgment affirmed.
MATTHIAS, DAY, ZIMMERMAN, WILLIAMS and MYERS, JJ., concur.