# THEATTORNEY GENERAL

OP TEXAS

PRICE DANIEL AUHTIN 11. -~-EXAE
.4TTOFlNEY

GENERAL August 29, 1952

Hon. Sack Ross Secretary of State Austin, Texas

Dear Sir: Opinion No. V-1520
Re: Issuance of stock dividends out of surplus. created by an appreciation in thevalue of corporate assets.

tion: your office has requested an opinion on the follo+ng &es-

“Can appreciation in the value of the assets of a corporation form the consideration for the issuance of additional capital stock by means of ‘, a stock dividend to its stockholders 7” According to the records and information furnished with **your** request, the fact situation out ofwhich the above question arose is as follows: A corporation chartered in Texas in 1923 with capital stock of $250,000 has made application to increase its capital stock to $500,000. The increase is to be made by means of a stock dividend aggregating $250,000, to be,distributed to present stockholders in the same proportion as their present stock ownership. The assets of the corporation have been recently appraised by an independent and reputable firm’ of appraisers, and based on present values theappraisal shows the corporation’s surplus tobe in excess of the $250,000which it proposes to convert into capital stock. You have stated thatyou are satisfied that the assets are presently worth the resppraiaediraluez.All ofthe stockholders ofthe corporation and all ofthe directors have authorized the proposed increase.

Itappears from the factual statement submitted by the corporatlon tbat a portion of tbe surplus has resulted from investment of earnings in plant expansions, We have notbeen furnislied with prior financial statement6 ff the corporation, and consequently we do notknow to what extent the stated surplus has resulted from ap-, preciation in the value of amet since the date of tI+acquisftion. However, **your** question aecrssmdly **spumes** %hat **a** portion of the stated surplus repraents appreciation in the value of corporate assets.
**ArticJe** XII. Section 6 d the Texas Comtitutlon provides:.’

_,

.:~:

,’

. Hon. Jack Ross; page 2 (V-1520)

“No corporation shall issue stock or bonds except for money paid, labor done or property actually received, and all fictitious increase of stock or indebtedness shall be void..
Article 1353,V.C.S., reads:
“No corporation shall issue any stock whatever, except for money paid, labor done,which is reasonably worth at least’the sum at which it was taken by the corporation, /orproperty actually received reasonably worth itleast the sum at which it was taken by the cornPiny. Any corporation which violates any provision of this article shall, on proof thereof in any court of.competentjurisdiction, forfeit its charter, permit or license, as the case may be, and all rights and franchises which it holds under, from, or by virtue of the laws of this State.”
There are no cases by the Supreme Court of Texas directly in point onthe question ofwhether appreciation in the value of the corporate assets fulfills the constitutional and **statutory** requirements of **money** paid, labor done or property actually received is the consideration for the issuance ofa stock dividead.

In O’Bear-Nester Glass Co. v. Anti-Explo Co., 101 Tex. 431,108 S.W. 9b7 m) the Supreme Court said with regard to gection 6 of Article XIII

:: ,438 The purpose of the convention in enacting ~t~p&vision of the Constitution was to secure creditors as.well as stockholders of corppratfons against the practice which was too **common, of**  cdrporatiom @suing **fic~titiom,,stock** and.stock, uponan insufficient consideration, whereby the actual capital was much less than~the amount reprisented by the shares issued and sold by the car**poration.** The **terms** inwhich this section of the Constitution is expreseod indicates the purpose that,the assets of the corporatfon should bo something substantial, and of such **a** character that they,

.’ could be subjected to the payment of **claims** igainst the corporation as well as to secure the ahareholders in their rights in thecapital dock.” ,’
in Cattlemen’s Trust Co. of ,Ft. Worth v. Turner, l&3**S.W. (Tea**  **Civ. AAT**  **reverse on**  **0** er **groun s.**  urns3 **v.**Hon. **Jack** Ross, **page** 3 (V-1520)

Cattleman’s Trust Co,, 215S.W. 831(Tex. Comm. App. 1919).the
**Court** explained the purpose ofthese constitutional and etatutoiy provisions as follows:

-By the common law of the land owners ,of stock in corporations are entitled to a’ratable share in its assets, and,the evident purpose of the constitutional and statutory provisions under consideration was to protect the purchasing public in the acquisition of stock ,orbands of earporations thatwas not represented by an equiva-, lent’.inthe way of assets belonging to thecorporation issuing the stock,

. . .”
Ifthe only purpose of the constitutional and statutory pr,ovisions is to protect present and prospective creditors and stockholders against a fictitious increase invalues, as these two cases indicate, it is difficult to see how the proposed stookdfvfdend in the present case would be illegal. ,In**order** to ascertain if there will be a possibility of **harm,,**to stockholders or creditors, it is ne.eessary to understand the nature of a stock dividend. In **a** recent opinion (Letter Opinion to Hon. JohnBen Shepperd dated April 11,1951).this office approved the following deftnition of a stock ,divfdendas stated in 13Am.Jiir.. Corporations, 8 648:

“In its ordinarily accepted meaning a **stock** dividend is a dividend payable in stock instead of cash, thedeclaration ofwhich involves the **creation** or issuing of new stock tobe distributed pro **rate** to the shareholders as evidence ofthe contemporaneous transfer of an equivalent amount of the surplus earnings or profits tothe capital fnnd of the corporation. **A** cash dividend differ@ matrrklly **from** a stock,divfdend in thata cash dividend, being declared onthe thenexisting capital **dock,** subtracts so much from the trea-sury~, ofthe corporation and transfers’it to the **pocket** ofthe stockholder, while a stock dividend takes nothing from the property of the corporation and adds nothin%tothe interests of the rtockbolders. A **hxk~dividmd implies**  a continuance ofthe cork 

### porath *itb the Bama asmetsand the lame Ul+iities, The title ta all corporate property remins in the

### corporaUoia a8 bofwe, bt+cOrpora~ pQfi* or surplus ir prunaently 

## l pproprkbd to fixed capital, the shareholders receiving merely symbols or evidences of such appropriation. Where a **atack** dividend issues, Uw t%nterpriserem&s the same; the **increase** Pncapital **dock** simply dilutes tha **shares** as they aatMOd’-Lur-’Hon. Jack Ross, Rage 4 (V-1520).

You state thatyou are satisfied thatthe assets ofthe eorporation are worth the reappraised value, Inthe light of the above explanation ofthe nature of a stock dividend, we fail to see a likelihood of injury from the proposed increase in capitalization.

Neither the O’Bear-Nester case nor the Turner case mentions increase in capitalization or issuance of stockd on an enhancement inthevalue of the corporate assets. Two opinions by Courts of Civil Appeals have said that increased value of the assets could not support a stock issue.

In Houston Cemetery Co. v. Drew, 36S.W. 802 (Tex. c,iv. App. 1896,error dism.), the question decided by the Court of’Civi1 Appeals was whether the district court had actad’properly in aI;- pointing a receiver for the corporation Rendinga hearing on the merits. One,ofthe grounds uponwhich the appointment was sought was that the corporation had issued watered stock. On this point the court said by way of dictum:

.

. . . The capital stock was afterwards increased to $100,000, uponthe estimated increase invalue of the land bought for the purposes of the cemetery; and the certificates of stock were issued to the shareholders at the ratio of 16of‘thenew shares for 1of the old. This was apparently within the inhibition of the constitution (article 12,8 6) against the issuance of stock except for money Raid, labor done, or property actually received.”
In Cole v. Adams, 49 SW. 1052(Tex. Civ. ARp. 1898).tbe receiver of an insolvent corporation brought suit to compel payment by the stockholders of thebalances alleged to be due upon the stock issued to them. The corporation had been chartered on September 27, 1889,and after organization the defendants conveyed certain real estate, for which they had paid $14,000,and certain contract rights tothe corporation. On May 22, 1890,it wae estimated that theactual value of the property, rights, and franchisee,tiien owned by the corporation,,,inqluding .enhan~ementin value of.the.real property ‘air@ tts con&+% to $he...&ovbofat.fon, over and above’ite~ini
, debtednessi was $28,000: Basti on that+aluation, the corporation issued 40 shares having a par value ,,of$100to each of the seven defendants, Between that date and September 1, 1890,six of the defendanta: had contributed $500 each to the corporation, and thattogether with $10,000out of earnings of the corporation had been invested in further plant expansions. On September 1,by agreement of the stockholders, the corporation issued 10additional shares : .toeach nf, six of the defendants. Tbe receiver sued each ofthe defendants for 50,**per** cent ofthe **par** value of the shares issued to him, upon**thetheory~that** the defendants were not entitled to credit for “estimated enhanced value of the properties ofthe **corporation,contracts,**Hon. Jack Ross, page 5 (V-1520)

proceeds, extensions made, and earnings from operation of the plant between the dates ofthe charter and the issuance of the stock.” The Court of Civil Appeals sustained the receiver’s right to recover for amounts based on enhanced value:

“The appellants, under their first and second assignments of error, submit these,two propositions: (1) The corporators who were not subscribers for capital stock were entitled to shares of Raidup capital stock tothe full value of the property and effects owned and held,by the corporation over and above its indebtedness at the time the stock was issued. (2) The corporators and stockholders of a corporation are the real and beneficial owners of all the property and effects held by the corporation, and they are entitled to full paid up shares of stock for thevalue of the property and effects of the corporation over and above the liabilities of the corporation. We cannot assent to either ofthese propositions. The relation of the corporators to thecorporation in respect to its capital stock is not different from that of subscribers for the stock. Stockcan be issued to neither, except for money paid, property conveyed or sold to thecorporation, **or** labor done for it. The stock, it is well settled, which is unsold, is to be held a$ a security for the creditors of the corporation; and
an enhancement of thevalue of the properties of the corporation will notauthorize an additional issue of the etook to either corporators or subscribers for the stock.

I)

**. ,**  **. ‘** **From what** **we have** **said, it**  follows that we thfnkthe 

### court did **not err**  in refusing to consider the alleged enhancemsnt in the value **of** the franchises and properties of the corporation between the **datas** of the acquisition if [sic] its properties and that of the issuance of 8toFr me corporators, as any part of the cqneideration for which the stock **was** sold.

. . .”
Inan **earlier** opinion involving the same fact situation, Cole v. **Adams,** 92 Teat, 171,46 S.W. 790 (1898), the Supreme Court **in** answering **certified questions**  bad made’statements which, taken alone, 

### wewouldbe fnelined 

### toconstrue as holding that enhancement in value between thetime the property was transferred to the **cor** poration and m time the stock was issued could constitute the consideration **for** the issuance of **stock.** But the Court of Civil Appeals evidently did

### hot so construe tbe Supreme Court’s answers to its questions, and we do uot feel at liberty to substitute our interpretation of theholding for that nnde **by** the Court of Civil Appeals.Hon. Jack Ross, pnge 6 (V-l520),

The recent case’of Adams v. Farmers Gin Co., 114S.W.,, i2d ~583(Tex. Civ. App. 1938),indirectly supports tbe ho ir

# rgin:

,~ Gole v, madams. Tnthat case the corptirath had issued apprtiimatelyres of stock at;a par value of $25 per share. or an aggregate value,of about $3,ObO. Subeequently~ the gin &ieh the corporation owned and operated bad burned, and the corporation bad’received $&O,OOO in insurance. This sum, together with’ the land onwhjch the gin stood, constituted the corporationfd assets at thetime a stockholders’ meeting was held to decide whetber the cor’poration should dissolve or should rebuild and contfnue in operation. At that meeting, it was agreed that the stockholders would “loan” to thecorporation the amount which theywould have received~upon dissolution (about $125parsebare) and that the cbrporation would build another gin and repay the “loana” out of future profits. Certain ,ofthe 

### stockholders sued to recover the 10- Raid portion ofthe so-called y108ns.eand in the alternative they, contended that.the agreement amounted to thedeclaration of a stock dividend. The Court of Civil Appeals rejected this conhntion in the following language:

-Article 12,section 6, of the Constitution of Texas, quoted abwe, is. we~think, a completeanswer to plaintiffs’ proposition No. 1,that is, their contention tbat a stock dividend was declared. A finding that a stock dividend was declared would not have ,foundclupportin either the pleadings or evi-~ dence. The charter fixed the amount and par value ofthe stock. No action for the creation of preferred stock was taken. No amendment ofthe charter and the approval and filing of same by the Secretary of State, as required by article 1314,is shown. Plaintiffs paid no **money** and performed no labor and the corporation received no property from ,themas a ,. legal basis for the issuance of stock. No net profits are shown to have been earned and unpaid on May 1. 1926. As heretofore stated, the corporatiop then held and owned the insurance money and all other aesets. There was no transfer or conveyance of prop erty, either actually, or in legal e~ffect,,‘fromthe ’ 

### etockholdore to the corpordion 

### asa lawfulbaeir for
a debt or for,stock of the corporation. An agreement to pay tho stockhdders cannot be enforced as a declared dividend or otherwise6 except upondissolution of the corporation, Dividends may be paid oat of profits but not outof thwcapital aeswtu oftlae

### cot-, poration.g .-

Hon. Jack Rotis, page 7 (V-UZO)

Inthe three cwer lart cited, thwcourt &Ieach inetance unmistakably indicated thatan iacreare intbe value of the corporate ascletawould not support UIe dochratbn ofa dock **divi** dend. Ar against the gonerel rtabmenta in the O’Bear-Neater and Turner casen, we mwt accept #here exprereiona as being **more-y** decisive of tlw #cope of the prohibition contained in Saction 6 ofArticle XII oftbe ConaWuUon. Consequently, it is our opinion thatthin sectia, ofthe Constitution forbid6 the issuance of additional capital 

### l twk ia the form d a stock divi-’ dend baaed on the appreciated valw of corperati awets.

**SUMMARY**

**Art.** 

### XII, Sec. 6ofthe T-8 Coastitutlon prohibits a corporation 

### from iomdagaphl dock based onthe appreckted tilw of the

### corporate assets.

APPROVED:

‘E. Jacobrat **Reviewing Asclirtant** 
Chnrles D. Mathewe 

### Fir& Ad&ant

.

.’ .. . Youm 

### very truly,
PRECE DANIEL Attorney 

### General

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