Case ID: ad_142/html/0148-01.html
Source: Caselaw Access Project
Author: {"author": "Smith, P. J.:", "license": "Public Domain", "url": "https://static.case.law/"}
Date Created: 2024-08-24T03:29:51.129683

Horace Cottrell, as Trustee in Bankruptcy of Schuylerville Paper Company, a Bankrupt, Appellant, v. Albany Card and Paper Manufacturing Company, Respondent.
    Third Department,
    January 4, 1911.
    Appeal — dismissal on opening—defective record — practice •—corporation— illegal dividends — bankruptcy—right of trustee to recover — bad faith.
    Where upon an appeal from a judgment entered on a.dismissal of the complaint upon the opening of plaintiff’s counsel, bis address is not set out in the appeal book, it will be assumed that it followed the lines of the complaint, and a statement of defendant’s counsel as to plaintiff’s claims, printed in the record, does not bind plaintiff except as he specifically assents thereto.
    Under such circumstances the question on appeal is whether the complaint contains allegations sufficient to constitute a cause of action, when considered in connection wdth certain admitted facts.
    The capital stock of a corporation is intended as a fund for the ultimate security and payment of all its creditors, both "present and future. " •
    Dividends paid from the capital are unlawful, notwithstanding that the assets of the corporation still equal its liabilities.
    Where in an action by a trustee in bankruptcy against the sole stockholder of an-insolvent corporation to recover certain dividends alleged to have been paid out of capital the complaint alleges that when the dividends were-declared two of the three directors of the bankrupt were also officers of the defendant company; that they and the defendant knew that the dividends were paid from
    ■ capital and not from profits, and further alleged that the assets of the bankrupt after adjudication were insufficient to pay its creditors, it is error to dismiss the complaint upon the opening on the ground-that it does not appear that the payment of the illegal dividends rendered the bankrupt insolvent at the time, or because it does not appear but that any recovery -would inure to the benefit of the defendant, although plaintiff’s counsel concedes that the payment of the dividends did not at the tirne cause the insolvency of the' bankrupt- . ''
    
      A trustee in bankruptcy is authorized, under section 70e of the Bankruptcy Act, to bring such action, for the illegal dividends are property of the corporation unlawfully diverted, which might have been recovered by the creditors.
    Where capital stock is withdrawn deliberately, with full knowledge, and diverted in violation of the statute, bad faith will be presumed, and, immediately upon the receipt of the dividends, there is an obligation on the part of the stockholders to repay them to the corporation or its creditors.
    As the diversion-of assets was in bad faith, no demand before suit for the return of the dividends was necessary.
    Houghton, J., dissented.
    Appeal by the plaintiff, Horace Cottrell, as trustee* etc., from a judgment of the Supreme Court in favor of the defendant, entered in the office of the clerk of the county of Saratoga on the 20tli day of August, 1910, upon the decision of the court, rendered after a trial at the Saratoga Trial Term, before the court without a jury, dismissing the complaint as resettled by an order entered on the 31st day of August, 1910 ; also from an order entered on the 17th day of June, 1910, as resettled, directing the dismissal of the complaint, and also from an order entered on the 20th day of August,, 1910, granting the defendant an extra allowance.
    
      Edgar T. Brackett and Luther A. Wait, for the appellant.
    
      Hun & Parker [Marcus T. Hun of counsel], for the respondent.
   Smith, P. J.:

This is an action brought by a trustee in bankruptcy against the sole stockholder of the bankrupt company to recover certain dividends amounting to $17,600 paid by it between December 27, 1902, and January 8, 1907, both inclusive, upon the ground that such dividends were paid in violation of the statiite as being paid out of the capital and not out of the profits of the company. It is alleged in ^ the complaint that defendant at such times owned all the capital stock of said bankrupt company; that during such times said company had three directors, two of whom were officers of defendant company and that both they and defendant company well knew that said dividends were paid from the capital of the bankrupt company and not from its profits that the Schuylerville Paper Company, a domestic corporation, was adjudicated a bankrupt on or about July 28, 1908, and that the assets of said bankrupt are insufficient by more than $25,000 to pay its creditors. The answer sets up denials and the Statute of Limitations. The complaint was .dismissed upon the opening of counsel upon the ground that it did not appear that the payment of the dividends in question rendered said bankrupt company insolvent at the time, and also that it did not appear but that any recovery had in this action would inure 'to ‘ the benefit of the stockholder of said' company. Inasmuch as the complaint was dismissed upon the opening of counsel and that opening does not appear in the appeal book it must be assumed that his opening followed the lines of the complaint. The statement of. defendant’s counsel as to plaintiff’s claim which appears in the record in no way binds the plaintiff, except as. specifically assented by plaintiff’s counsel. The question thereupon, arises as to whether said complaint contains allegations sufficient to constitute a cause of action in connection with the admitted fact that the payment of the dividends did not at that time cause the insolvency of the company.

It seems clear that the capital stock of a corporation is intended as a fund for the ultimate security and payment of all its creditors, both present and future. Thus section 28 of the present Stock Corporation Law (Consol. Laws, chap. 59 ; Laws of 1909, chap. 61) prohibits directors from declaring dividends “ except from the surplus profits arising from the business of such corporation,” and sections 62, 63 and 64 provide in detail for the reduction of the capital stock of a corporation, the provisions of all of these sections having long been the law of this State. In Williams v. Western Union Tel. Co. (93 N. Y. 162, 187, 188) Judge Eabl says': “These provisions were intended to prevent the division, distribution, withdrawal and reduction of the property of a corporation below the sum limited in its charter or articles of association for its capital, but not to prevent its increase above that sum. The purpose was to prevent the depletion of the property of the corporation thereby. endangering its solvency. , * * * All these provisions show that it was the purpose of the Legislature, by means of them, to create a property capital for the corporation, and then to keep that intact so as to secure the solvency of the corporation and its responsibility to its creditors.” The same holding . appears in Hutchinson v. Stadler (85 App. Div. 424, 432, 436):

Among the obligations resting upon directors, one is tó keep the corporate property intact, in order that it may remain solvent for the purpose of being answerable to the creditors of the corporation, and also that it may be kept intact as a going concern to enable it to carry out the purposes of its creation for the benefit of its shareholders, as was designed when the interests were united, and for which the incorporators and shareholders contributed their funds. It has long been settled that the directors are not authorized to declare dividends out of .the capital stock of the corporation as between it and its creditors. Such distribution depletes the fund upon which the creditors have the right to rely for the payment of their obligations, and upon the faith of which the debts were contracted. (Williams v. Western Union Tel. Co., 93 N.Y. 162.) ” Defendant strongly urges that no recovery can be had in the case at bar inasmuch as there is no claim that the present debts of the corporation were such at the times of the making of these unlawful dividends. But the idea of the capital stock of a corporation being a fund for the benefit of its creditors seems to apply with equal force to future as well as to present creditors. If a wrong is done to its present creditors by secretly decreasing the total assets out of which payment of its debts could be enforced by them, no less a wrong is done to persons who subsequently become its creditors without notice of the depletion of such assets and who consequently will have a right to assume that the directors have not violated the express terms of the statute regarding unauthorized dividends. In the case of Williams v. Boice (38 N. J. Eq. 364), which was an action by a receiver to recover dividends paid out of capital,'the chancellor says (at pp. 370, 371) : “Another objection is that there is no allegation that any of the debts which now exist were debts or liabilities at the time of the payment of the dividends. * * * Although there are cases in which it has been said that recovery can only be had in cases of this kind by creditors whose debts existed at the time of the withdrawal of the funds, that view is not to be adopted. The distinction is not well founded. The capital of a corporation is a fund pledged for the payment of its debts. Each person who gives credit to it does so in the confidence that that fund exists for his protection and security against loss. If the stockholders secretly withdraw it, under the false pretense of dividends of profits when there are none, it is' obvious that as great a wrong may be done to future creditors as to existing ones. In either cáse the stockholders hold a part of that fund, which is pledged to the payment of thé creditors. The injury to the existing creditor is obvious. That to the future creditor is the sanie, for the stockholder holds out to him that the capital is of the nominal amount, while in fact he has secretly withdrawn part of it. If all who should, become creditors after the withdrawal had notice of the fact that the capital had been reduced—that the dividend had been paid out of the capital—then the distinction-might, perhaps, be maintained, but they not only have no such notice, but in fact are led to believe that the capital is what it nominally purports to be.”

The complaint of the appellant here was dismissed upon the opening principally upon the ground that appellant disclaimed that the dividends in question, although paid out of capital, rendered the corporation actually insolvent at such times.' But if the capital of. a corporation be regarded as a fund for - the ultimate .payment of creditors, and so to be kept intact unless diminished in the manner prescribed by statute, the mere fact that the assets still remain equal to the liabilities cannot justify dividends such as these. The statute does not allow capital'to be depleted by means of dividends Up to the very point of insolvency; on the contrary, the capital is to be kept intact and unimpaired and creditors have a right to rely upon this policy of' the law in their dealings with corporations. The argument of respondent, if admitted, would manifestly put a premium upon fraud, as then the entire net assets of a corporation, including capital paid in, over and above its actual debts and liabilities at any one time, could be secretly withdrawn by its stockholders in the form of dividends, thus forcing its creditors to bear all the risk of insolvency arising from any slight business loss or shrinkage ■ of assets. * ‘

Respondent further claims that, appellant as trustee in bankruptcy is not authorized to bring the action. But section 70, subdivision e, of the Bankruptcy Act (30 U. S. Stat. as Large, 566, as amd. by 32 id. 800, § 16) seems to allow an action such as this if any creditor could have brought the action, and this irrespective of whether the action be based expressly upon fraud or not. The unauthorized dividends are in effect property of the corporation unlawfully diverted and as such property recoverable by creditors, or by the trustee in bankruptcy as representing them. In Cook on Corporations (6th ed. p. 1496) it is said : “ Hence the rule has been firmly established that, where dividends are paid in whole or in part out of the capital stock, corporate creditors, being such when the dividend was declared or becoming such at any subsequent time, may, to the extent of their claims, if such claims are not otherwise paid, compel the stockholders to whom the dividend has been paid to refund whatever portion of the dividend was taken out of the capital stock.” The courts have sometimes refused to apply this rule when either the directors or stockholders, or both, have made and received the dividend in good faith, that is, not knowing or supposing it to have been paid out of profits, but such is not this case. It is alleged in the complaint that at the time of these dividends two of the officers of the stockholding Company composed a majority of the directors of the bankrupt company, which fact would of itself be sufficient to charge the stockholding company with any knowledge possessed by its officers in their capacity of directors of the bankrupt company. It is further alleged both that such officers and the stockholding company knew that said dividends -were not paid from profits. These allegations, if proved, would seem conclusive as to the actual fraud of the defendant as against the creditors of the bankrupt. When corporate stock deliberately and with full knowledge is withdrawn and diverted in violation of the statute bad faith must necessarily be present, and such bad faith raises immediately upon the receipt of the unlawful dividends an implied obligation to repay such dividends to the corporation or to its creditors. The diversion of assets being in bad faith no demand before suit is necessary, and accordingly after bankruptcy the trustee, without more, may sue at once for the recovery of the assets so diverted.

The judgment should, be reversed and a new trial granted, with costs to abide the event.

All condurred, except Houghton, J., dissenting.

Judgment and order reversed and new trial granted, with costs to appellant to abide event.