#### James N. Richards, Respondent, *v.*Ernst Wiener Company, Appellant.

First Department,

June 2, 1911.

Contract — illegal act — presumption — corporation — contract to purchase its own stock — section 664, Penal Law — burden of proof as to surplus.

A contract which calls upon a party to perform an illegal act is void and unenforcible. /

But the law will not presume that a person intends to do an illegal act or make an illegal contract.

Where plaintiff subscribed for 100 shares of defendant’s preferred stock at par, $3,000 to be paid at once, $5,000 in six months and the balance within nine months, and the defendant in consideration thereof agreed to employ him at a fixed salary, reserving, however, the right to discharge him if he failed to pay the second installment on the stock, but further agreed that if in that case he should not want to have the first installment paid considered as the purchase price in full of thirty shares of the stock, then it would repurchase those shares from him at par, and the contract also provided that if the plaintiff - during or at the end of the first six months should discontinue his services voluntarily and fail to pay the $5,000, then the $3,000 already paid should be considered as the purchase price of thirty shares of stock without any obligation . on the defendant’s part to repurchase, the plaintiff who was discharged by the defendant before he paid the second installment is entitled at his option to a return of his $3,000.

*354Suah. contract is not void and unenforcible as violating section 664 of the Penal Law, which forbids a corporation to purchase shares of its own ■ stock except out of surplus profits, for- the law reads into the contract a provision that the purchase should be made *only*if at the time there was a surplus out of which it might lawfully be done.

In an action to enforce the contract and to compel .the corporation to repurchase the stock at par, the burden is upon the defendant to show that such purchase would be illegal, for there is no presumption as to ■the existence or non-existence of a surplus.

Ingraham, P. J., and. McLaughlin, J., dissented, with opinion.

Appeal by the defendant, the Ernst Wiener Company, from a judgment, of the Supreme Court in favor of the plaintiff, entered in the office of the clerk of the .county of New York on the 25th day of November,. 1910, upon the verdict of a jury, and also from an Order entered in said clerk’s office on the 8th day of December, 1910, .denying- the defendant’s motion for a new trial made upon the minutes.

*J. Woolsey*Shepard,--for the appellant.

*Nathan*D. *Stern,*for the respondent.

'Scott, J.:

Defendant appeals from a judgment and order denying a motion for a new trial in an action for damages for non-fulfillment of a contract.

In October,. 1908, plaintiff and defendant entered into a contract to the following effect:

Plaintiff subscribed for 100 shares of defendant’s preferred. stock at the price of $10,000, of which he agreed to pay $3,000 immediately, not-less than $5,000 within six months, and 'the balance within nine months, In consideration of this subscription defendant agreed to employ plaintiff in its business and to pay-him a certain salary and commissions. If the plaintiff should fail to pay the second installment the defendant reserved the option to discharge him “ and if in this case you should not want to have the first installment paid by you considered as the purchase price in full for 30 shares of our preferred stock, then we shall repurchase these 30 shares of stock from you at par within 6 months thereafter.” It was further provided that if at any time during the first six months, or at the end *355thereof, plaintiff should discontinue his services of his own account, *and*fail to pay the $5,000, “then-the first installment of $3,000 paid in by you shall be considered as the. purchase price in full for 30 shares of our preferred stock without any obligation on our part to repurchase same. ” Plaintiff did not pay in the second installment of $5,000 and his services were discontinued on August 14, 1909, whether by his act or that of defendant being in dispute, and plaintiff now seeks to recover back the $3,000 he has paid, offering to return the thirty shares of stock.

The first defense is that plaintiff discharged himself. Upon this question the jury found in his favor upon conflicting evidence. The weight of the evidence accords with the verdict, and it is thereby established that plaintiff was discharged by defendant on August 14, 1909. According to the terms of the contract, if it is enforcible, plaintiff thereby became entitled a his option, which he exercised, to a return of the $'3,000 paid by him, or, as the conntract has it, to the “repurchase” of the thirty shares of stock. The second defense, and the one which presents .a serious question, is based upon section 664 of the Penal Law (formerly section 594 of the Penal Code), which reads as follows: “A director of a stock corporation, who concurs in any vote or act of the directors of such corporation, or any of them, by which it is intended: 7⁄8 5⁄8 3⁄8 5. To apply any portion of the funds of such corporation, except surplus profits, directly or indirectly, to the purchase of- shares of its own stock, is guilty of a misdemeanor.” The argument,' of course, is that a contract which calls upon a party to perform an illegal act is itself illegal and void and cannot be enfprced. There is no fault to be found with this rule, the only question being whether it applies to the present case. It will be observed that the statute does not forbid a corporation to purchase its own stock, nor does it forbid it to enter into a contract to do so. What it does forbid is the consummation of such a contract by making the purchase otherwise than out of surplus.. It was, therefore, perfectly legal and competent for the defendant to agree to repurchase the stock from plaintiff, provided, and this is a proviso which the statute reads into the contract, that said defendant should have when the time came a surplus *356out of which the purchase could lawfully be made. .The law will not presume, unless forced' to do so, that a person intends to do an illegal act. It will not, therefore, presume that the parties intended to .make an illegal contract. The contract itself, therefore, was perfectly legal, subject to certain limitations upon its enforcibility. If, when the time ca'me, defendant had a sufficient surplus the contract could .be unforced. If it had not, the contract could not be enforced. In defending against plaintiff’s attempt to enforce it the burden rested upon defendant to show that it would be illegal to do so, for there is no presumption one way or the other as to the existence of a surplus. The defendant assumed this burden, but failed in' sustaining it, for it was unable to show by competent evidence that it has no surplus. • Under these circumstances I think that plaintiff was entitled to recover.'

The judgment and order appealed from should, therefore, be affirmed, with costs.

Laug-hlin and Clarke, JJ., concurred; Ingraham, P. J., and-McLaughlin, J., dissented.

Ingraham, P. J.

(dissenting):

I do not concur in the affirmance of this judgment.

The plaintiff undertook to subscribe for 100 shares of the six per cent stock of the defendant,, a domestic corporation, and finally made an agreement with the secretary of the' corporation which was contained in a letter dated October 24, 1908, by which the agreement that had been made between the-plaintiff and the corporation was stated as follows: Plaintiff was to subscribe for 100 shares of the six per cent preferred stocky par value $100, at the price of $10,000.. Plaintiff agreed to pay not less than $3,000 immediately, $1,000 at the time of signing the contract, and $2,000 on or before November 10, 1908; not less than $5,000 within six months from date, and the balance within three months thereafter, *i. e.,*nine months from date. In consideration of this subscription the defendant agreed to employ plaintiff in defendant’s business at a salary of $50 per week and a commission on all new business that plaintiff brought to the corporation. If, however, plaintiff should fail to pay the second installment of $5,000, the corpora*357tion to have the option to discontinue plaintiff’s employment, “and if in this case you should not want to have the first installment paid by you considered as the purchase price in full for 30 shares of our preferred stock, then we [defendant] shall repurchase these 30 shares of stock from you at par within 6 months thereafter.” This condition, according to the facts as found by the jury, .having happened, plaintiff tendered the thirty shares of stock to the defendant and demanded the $3,000 therefor which was refused and this action was brought to recover that amount. The main question presented on this appeal is whether this was a contract which the defendant had power to make or whether it was prohibited by law and, therefore, invalid. '

In discussing this question it must be noted that the contract is absolute and if sustainable it bound the defendant to pay not out of surplus earnings but absolutely out of any property belonging to the corporation which'could be reached by execution upon a judgment being obtained. So that a corporation although having capital stock subscribed and paid for might by a contract of this kind render the whole subscription nugatory and. impose upon the corporation a liability to those who had subscribed for the capital stock for the amount that-they had subscribed, thus leaving the corporation without funds to carry on its ordinary, operations or to secure its creditors.

A subscription to the capital stock of a corporation is regulated by article 4 of the Stock Corporation Law (Consol. Laws, chap. 59; Laws of 1909, chap. 61), which revised article 3 of the former Stock Corporation Law (Gren. Laws, chap. 36; Laws of 1892, chap. 688, as amd.). Section 53 (former section 41) of that act provides that if the whole capital stock shall not have been subscribed at the time of filing the certificate of incorporation, the directors named in the.certificate may open books, of subscription to fill up the capital stock; that at the time of subscribing every subscriber whose subscription is payable in money shall pay to the directors ten per centum upon the amount subscribed byhim in cash, and no such subscription shall be received 'or taken without such payment. This provision apparently contemplates an absolute subscription upon which ten per cent of the amount subscribed must be paid by *358the subscriber in cash and no such subscription could be received or taken without such payment. Section 54 (former section 43) provides for the payment of the subscription and for a forfeiture for the use of the corporation in case default should be made in the payment of any installment as required by á resolution of the board of directors, with a further provision that the stock if forfeited may be reissued or subscriptions therefor may be .received as in the case of stock not. issued or subscribed for. If such stock, however, be not sold for its par value., or subscribed for within six months after- such forfeiture, it shall be canceled and deducted from the amount of the capital stock, and if by such cancellation the amount of the capital stock is reduced below- the minimum' required by law the capital stock shall be increased to the required amount within three months thereafter or the business of the corporation maybe closed as in the case of ah insolvent corporation." Section 55 (former section 42, as amd. by Laws of 1901, chap. 354) provides that no corporation shall issue either stock or bonds except for money, labor done or property actually received for the use and lawful purposes of such corporation. Section 56 (former section 54, as amd. by Laws of Í901, chap. 354) provides that every holder of capital stock not fully paid'shall be personally, liable to its creditors to an amount equal to the amount unpaid on the stock held by him for debts of the corporation contracted while such stock was held by him.

• By these provisions regulating the subscription . to the stock of a corporation it was intended that a fund should be provided to enable the corporation to transact its business and to secure the payment of its debts. No subscription could be received until .ten per cent Of the stock subscribed for was .paid in at the time of making the subscription and that payment, must be one absolutely for the benefit of the' corporation. The remaining amount of the subscription must be. paid in within the time fixed by the board of directors, and in the event that the installments were not paid by the subscribers the stock was to be -forfeited for the benefit- of the ■ corporation; and such stock so forfeited must be sold or subscribed' for within six months after the forfeiture or the stock should be canceled and the amount of the capital stock reduced by the amount of the *359canceled stock, if by cancellation of stock the capital stock of the corporation was reduced below the minimum required by law the capital stock must be increased to such a minimum amount within three months thereafter or the corporation may be wound up as an insolvent corporation. These careful provisions seem to me to be entirely inconsistent with a subscription upon any other terms than that prescribed by the statute, and a contract for such subscription upon other .terms than that prescribed or a conditional subscription by which not only the sub • scription itself should be canceled but the subscriber after he had failed to pay the additional installment should have a cause of action against the corporation for the amount that he had paid upon his uncompleted subscription would be a violation of the statute.

By the contract here sought to be enforced the plaintiff subscribed for 100 shares of stock of the par value of $10,000, and paid therefor the sum of ten per cent of the amount. It was a cash subscription, and the only valid subscription that the company could receive was one by which the subscriber was to pay for the stock its par value in cash, but at the same time the corporation made, a contract by which at the option of the subscriber after the payment of $3,000 the company would buy back from him the stock for which he had subscribed and pay therefor the amount that the plaintiff had subscribed for it — a contract which it seems to me violates the express provisions, of the statute regulating such subscriptions and which, if such a contract was authorized,, would make the subscription to the stock of the corporation a sham and fraud upon the other stockholders and the creditors of the corporation.

And in addition, by section 664 of the Penal Law (formerly section 594 of the Penal Code) it is made a misdemeanor for a director of a stock corporation to concur in any .vote or act of the directors of such corporation or any of them by which it is intended to apply any portion of the funds of such corporation except' suiplus profits directly or indirectly to the purchase of shares of its own stock. This provision, it seems to me, clearly emphasizes thé intention of the Legislature to prevent any such contract as that here attempted by which a corporation should purchase from a subscriber to its *360' stock the stock so subscribed for unless the corporation should hare net earnings which could he applied to that purpose. Reading these provisions of the statute together it seems to me that any such arrangement as was attempted to be made in this case was one expressly prohibited by the. laws of the State and one that could not be enforced.

It is said in the prevailing opinion that the burden was on the defendant to show that it had no net earnings applicable to the payment to the plaintiff of the amount which he had subscribed for the stock. But this contract ■ in terms provides that the corporation shall purchase the thirty shares of stock for which the $3,000 was to be considered as the full purchase price. There was no restriction as to the source from which the funds required for this repurchase of the plaintiff’s stock was to be provided, but it became an absolute contract of the corporation to pay to the plaintiff the $3,000 that- he had subscribed for the 30 shares of stock or the $3,000 which he had paid upon the subscription to the 100 shares of stock. It was illegal for the directors to make any contract by which an absolute obligation was imposed upon the corporation which was not to be satisfied from surplus earnings. Thus, although the corporation may have had surplus earnings, if at the time the payment contemplated by the contract came to be complied with there .were no surplus earnings from .which the amount could be paid, undoubtedly the directors would be guilty of a misdemeanor under the provisión of the Penal Law. And so it seems to me that a contract made under which there was a legal liability of the company to pay a Ssum of money for the purpose of purchasing its own stock, not out of surplus earnings but generally out of its property, would be a contract within the prohibition contained in these provisions - of law, as the only contract which the directors could make which would not make them guilty of a misdemeanor was a contract to pay for the stock out of surplus earnings. Reading all these provisions of the statute together it seems to me that this was a contract that the corporation had’no power to make, and one that could not be enforced. If, however, the burden was on the defendant to establish the fact that neither at the time the contract was made nor at the time it was to be performed *361there were not earnings from which this payment conld be made, I think there was evidence which the court excluded which was competent to show that there were no net earnings. An officer of the company was called who testified that he had knowledge of all the business affairs of the corporation; had knowledge of its resources and liabilities; and was asked whethei there were net earnings of the company in existence at the time the contract was made or at the time it was to be performed. On objection of the- plaintiff he was not allowed to answer those questions and to that the defendant excepted.

I do not think, therefore, the judgment can stand and it should be reversed.

McLaughlin, J., concurred.

Judgment and order affirmed, with costs.