AUSTIN m. **TEXAS**

WILL BVJJSION AX-TORNKY **GSNFXZAL** January 13, 1960

Honorable William A. Harrison Opinion No. WW-778 Commissioner ofInsurance State Board ofInsurance Re: Whether dividends may be International Life Building paid by afire and casualty inAustin, Texas surance company out of the unrealized appreciation invalue of some of the corporation’s Dear Mr. Harrison: assets.

Inyour request for an opinion you have asked whether afire and casualty insurance company may pay dividends out ofasurplus arising from the unrealized appreciation in the market value of certain assets ofthe company over their cost or book value. You have cited an instance where dividends were so paid.

Article 21.31of the Texas Insurance Code provides inpart as follows:

“It shall not be lawful for any insurance company

organized under the laws of this State tomake any dividend, except from surplus profits arising from its business. In estimating such profits, there shall be reserved therefrom the lawful reserve on all unexpired risks and also the amount ofall unpaid losses, whether adjusted or unadjusted, and all other debts due and pay:ble, or tobecome due and payable by the company

. .. Article 8.14, applicable generally to casualty insurance companies, before its recent amendment provided as follows:

“The directors ofany such company shall not make any dividends except from the surplus profits arising from their business. ,.” By the provisions ofS.B. 180, Acts 1959, 56th Leg. R.S.. Article 8.14 was amended to read as follows:

“The directors of any such c’ompany shall not make any dividends except in compliance with Article 21.31 of this Code.” Thus, irrespective ofwhich ofthe several laws apply, fire and casualty companies are prohibited from paying dividends except. -- ..

Hon. William A. Harrison, page 2 (WW-778)

from “surplus profits arising from its business.” The term “surplus profits” implies among other things that payment of dividends may only be made to the extent of a c,ompany’s surplus and, additionally, that funds from which the payment was made arose from the profits ofthe company’s business. Since you have stated that the payments ofdividends were made from surplus, the only question for determination is whether the payments were also from profits of the business of such insurance company. In our opinion under the facts given the payments ofdividends were not from “profits arising from its business* and were th,erefore unlawful.

It must be conceded initially that the Legislature in using the term “profit” intended some meaning distinct from the term

“surplus” elsewise they would not have elected to use both terms. Hence, we conclude that aprofit is not the same thing as surplus.

The term “profit” has been defined by Webster’s New International Dictionary in the following manner:

“The excess of returns over expenditure in agiven transaction or series of transactions; as: a. the excess of the price received over the price paid for goods sold (115 Wis. 261) b. the excess of the price received over the cost of purchasing and handling, or of producing and marketing, particular goods (3Fed. 566, 569) c. the advantage derived (as in infringement ofpatents) from employing one process or machine in manufacturing instead of another.

“Excess of income over expenditure, as in a business or any of its departments, during agiven period of time; specif.: a. the income of invested property, not including an appreciation in market value (15 Wall. 63, 65; 198Pa. 216) b. usually in pt. with reference to Lands the sum of revenue yielded by it, or the proceeds derived from its use or enjoyment, as in case of leased property or land that is mined. Cf. profit prendre.

. .” These definitions all envision arealization ofthe benefits accruing from the given transaction. Stated differently, these definitions do not encompass abenefit or advantage that is yet tobe realized. The everyday business use of the term “profit” is compatible with these dictionary statements. Unrealiied appreciation ofassets does not enter into aprofit and loss statement, nor is it considered for income tax purposes. The general rule in other jurisdictions is that the unrealized appreciation invalue ofassets cannot be utilized in determining the funds available for distribution as dividends. 11Fletcher Encyc. Corp. (1958-.

Hon. William A. Harrison, page 3 (WW-778)

Revised) 1050 Sec. 5335.1; Berks Broadcasting Co. v. Craumer, 52Atl.Zd 571, (Penn.Sup. Ct. (C.C.A. - 4th - 1957 cert. den., 35; D.S. 949) ason, 8, and cases collected 55A.L.R. 8, 76A.L.R. 885 and 109A.L.R. 1381. Support inTexas tothis general rule is in some measure Granite Corp. v. Faubion, 18S.W.Zd 7377iven by the case of Dealers Aus.Civ.App. 1929) where, in determining the meaning of the term net profits as applied toa corporation, the Court stated:

“And the general rule seems tobe that increase in the value of lands held by a corporation cannot be considered as profits, at least until such lands are sold and the profits actually realized.” The adoption of arule permitting insurance companies to declare dividends on speculative profits would leave the financial soundness of the capital and required surplus accounts of insurance companies to the vagaries and uncertainties offluctuating market values. We believe that the courts of this state when the occasion arises will hold that “unrealized’* appreciation does not constitute profit. As stated inLoftis v. Mason, supra, on page 433:

”

.. .in the application of sound accounting principles, dividends may ordinarily be declared only out ofactual earnings or profits and not upon a theoretical estimate of an unrealized appreciation in the value ofthe assets.” A different view is held inNew York. (See Randall v. Bailey, 43 N.E.2d 43, (Ct. ofAp. 1942). It has been suggested that the New York position is determinative of the proper interpretation of the Texas provision because of certain similarities in the respective statutes. It is true that the New York general corporation laws over a lon# period ofyears, predating any ofthe Texas enactments, used the term surplus profits * in limiting the source available for dividends and that several of the New York cases suggest the possibility that this source may include unrealized appreciation in the value ofcorporate assets. But the only clear holding inNew York that unrealized appreciation is an available source ofdividends is the case of Randalrv. Bailey, supra, which was decided after the abandonment by the New York Legislature of the surplus profits test and under statutory language leaving no room for any other conclusion. Under these circumstances we do not believe that the New York decisions are particularly persuasive.Hon. William A. Harrison, page 4 (WW-778)

SUMMARY Unrealized appreciation in the assets of afire and casualty insurance company do not constitute “net profits arising from its business” available for distribution as dividends. Yours very truly, WILL WILSON Attorney General ofTexas 

# By&db-&’ Fred B. Werkenthin Assistant FBW:lmc APPROVED: OPINION COMMITTEE: W. V. Geppert, Chairman Arthur Sandlin Phocion Park Tom McFarling L. P. Lollar REVIEWEDFORTHEATTORNEYGENERAL BY: Leonard Passmore