Source: http://supreme.nolo.com/us/139/417/case.html
Timestamp: 2019-04-26 14:02:38+00:00

Document:
An increase by a Kentucky corporation of its capital stock within the amount authorized by law is not invalidated by reason of the fact that no amendment of the charter authorizing such increase was ever recorded or published as required by the laws of that state.
When a stockholder in a corporation who assents to an increase in the capital stock of the corporation and its gratuitous distribution among the shareholders receives such stock as full paid stock, an obligation arises to pay for it in full, when called upon to do so by creditors whose debts are subsequent to the authorization of the increase, but this equity does not exist in favor of a creditor whose debt was contracted prior to such authorization.
An active corporation, finding its original capital impaired by loss or misfortune, may, for the purpose of recuperating itself and of producing new conditions for the successful prosecution of its business, issue new stock and put it upon the market, and sell it for the best price that can be obtained, and in such case no such trust in favor of a creditor arises against the purchaser who in good faith buys for less than par.
"at a meeting duly held for the purpose in May, 1886, unanimously resolved and ordered that the capital stock of said company be, and in fact it was, then increased to $200,000, in shares of $100 each, being an increase of 800 shares of stock of said company;"
that of the 800 shares then created, the defendant Handley subscribed for 86 3/4 shares, two of the other defendants for 15 shares each, and two others for 75 shares each, certificates of which were issued by the company, and delivered to and received by said subscribers, as they were respectively entitled, but that neither one of them ever paid to the company any part of the said shares, and they each, respectively, owe the said company the full par value of the shares of the said capital stock subscribed for and issued to them.
"We, the undersigned, subscribe for the amount set opposite our names, respectively, to bonds of the Clifton Coal Company, aggregating $50,000. It is agreed that $50,000 capital stock be distributed pro rata among the subscribers to the above bonds;"
that several of the defendants subscribed to this contract, and agreed to take bonds in different amounts; that said subscribers paid the coal company for the bonds, and that with the money thus received, to the extent of $30,000, the company paid its debts to certain of its officers and managers, who had become liable by endorsement for the company, and that nothing was or ever has been paid for or upon any of the shares of capital stock thus subscribed for, and to be distributed among them; that is to say, $50,000 of said capital stock, equivalent to 500 shares thereof, was in fact subscribed for and distributed among certain of the defendants, to whom, in May, 1887, there were issued and received by them, respectively, certificates for shares.
The bill further averred that the plaintiffs were judgment creditors of the company by judgments obtained in the courts of Kentucky; that their debts were created before all of the capital stock of said company was paid in, and that all of said $80,000 increase of the capital stock, and each and all of the amounts due to the company for any part of its capital stock, constituted a trust fund for their benefit, which they were entitled to have administered in a court of equity to the satisfaction of their said debts, the company being insolvent.
up" stock, the receipts reciting that it "was issued with bonds for same amount, as per agreement." The certificates on their face recited that the shares of stock were fully paid up "and were nonassessable," or language to that effect. Five thousand dollars of the bonds were left in one of the national banks at Nashville as collateral security for a loan to the company, no one having subscribed for them. The remaining $30,000 shares of increased stock, which were not needed to secure the subscribers to the bonds, appeared to have been distributed pro rata among the old stock holders. In the latter part of 1887 and in the early part of the following year, plaintiffs obtained judgments against the company, which were unsatisfied, and in September, 1887, by an order of the Circuit Court of Hopkins County, Kentucky, the entire property of the company was placed in the hands of a receiver and its operations stopped.
On February 8, 1889, this bill was filed against the coal company and the holders of this increased stock to compel payment therefor and to recover the amounts of the judgments against the company. The court dismissed the bill as to three of the defendants not served with process, and as to the rest held them liable to all the creditors of the company whose debts originated after the alleged increase of stock, and fixed May, 1886, as the date of such increase. As to debts contracted prior to that date, they were excluded, because as between the company and the stockholders, the latter held such stock properly, and without liability to the company, and all creditors who dealt with the company prior to such increase, and not upon the faith of such stock, had no equity to demand more than the company itself could. Five of the defendants against whom decrees were rendered in excess of $5,000 appealed to this Court, and the circuit court suspended the execution of the decree as to those who could not appeal until this Court should determine the rights of the appellants.
The opinion of the circuit court is reported in 41 F. 531.
"unanimously resolved that the capital stock of the company be increased to $200,000, as authorized by the charter, the purposes for which said stock is issued being the betterment of the present plant and the construction of a new plant for coking purposes."
This resolution was subsequently, and in 1888, when the omission to record the same appears to have been first discovered, formally entered upon the minute book of the corporation. The failure to enter this resolution at the time it was adopted did not affect its validity, as most corporate acts can be proved as well by parol as by written entries. Moss v. Averell, 10 N.Y. 449.
meetings, be binding upon all those participating in it as well as upon those acting upon the faith of its validity or receiving stock authorized to be issued at such meeting. It is true there are cases holding that stockholders' meetings cannot be legally held outside of the home state of the corporation, but the question has generally arisen where a majority present at such meeting had attempted by their action to a dissenting minority, or had taken action prejudicial to the rights of third persons. Ormsby v. Vermont Copper Mining Co., 56 N.Y. 623; Hilles v. Parrish, 14 N.J.Eq. 380. Indeed, so far as we know, the authorities are uniform to the effect that the action taken at such meetings is binding upon those who participate in or take the benefit of them. Heath v. Silverhorn Lead Mining Co., 39 Wis. 146. In this case, the meeting was attended by all the stockholders but two, who were represented by proxy, the vote increasing the stock was unanimous, and it does not lie in the mouth of those who participated in this act or received the stock voted at this meeting to question its validity.
be, nor shall any change be made at any time or in any manner which would be inconsistent with the provisions of this act."
Reliance is placed upon the final clause of this section for the position assumed by the defendants, that the increase in the capital stock, never having been recorded or published as required by this clause, was void, and the case of Scoville v. Thayer, 105 U. S. 143, is cited in support of this contention. That was also an action to recover unpaid assessments upon stock. The statutes of Kansas provided that any corporation might increase its capital stock to any amount not exceeding double the amount of its authorized capital. The corporation in question had increased its capital stock, as it was authorized to do, by doubling it, and it subsequently increased it by doubling it again, thus quadrupling the original amount, the defendant in the case having attended by proxy the meeting at which such illegal increase was voted, and received a quantity of the stock thus issued. It was held that such increase was ultra vires and void, and that the defendant was not estopped from denying the validity of the overissue or his obligation to pay for it.
In the case under consideration, however, the articles of incorporation did provide that the capital stock should be $120,000, with power to increase to $200,000 by a majority vote of the stockholders, and there was no statutory inhibition, as in Kansas, against any such increase as it might be thought advisable to make. Here, then, was the power to increase the capital stock to the precise amount fixed by the stockholders at their meeting at Nashville, and the defect was merely in the failure to record and publish such change, as required by section six of the statute in question.
"as in the present case, the abstract power did exist, and there was a way in which the increase could lawfully be made, and the creditors acted without fault, believing that the increase had been lawfully effected, and the necessary steps had been taken, there the doctrine of estoppel may apply, and the increased stock be deemed valid as against the creditors who have acted upon the faith of such increase."
"No persons acting as a corporation under the provisions of this act shall be permitted to set up or rely upon the want of a legal organization as a defense to an action brought against them as a corporation; nor shall any person who may be sued on a contract made with such corporation, or sued for an injury done to its property, or for a wrong done to its interests, be permitted to rely upon such want of legal organization in his defense."
It is true that this section seems to apply rather to a want of an original legal organization of the company, but we think it should be regarded as applying as well to amendments to such organization, and that no defense connected with the original organization which a party contracting with the corporation would be disqualified to set up can be made available in connection with an amendment to the original articles.
So far as the question of liability to the proposed assessments is concerned, these defendants, with respect to their relations to this corporation, are divisible into two distinct classes: first, those of the original stockholders who received the $30,000 increased stock as a gift; second, those who subscribed to the $50,000 bonds and received an equal amount of stock as a bonus or inducement to make the subscription.
which they offered to do. There is no reason to suppose that these stockholders did not act in good faith and in the belief that they were entitled to this stock. The fact that they did not subscribe for it or agree to take it until the receipt of the certificates is immaterial, as the acceptance of the certificates is sufficient evidence of an agreement to pay their par value. Sanger v. Upton, 91 U. S. 56, 91 U. S. 64; Chubb v. Upton, 95 U. S. 665; Brigham v. Mead, 10 Allen 245.
Ever since the case of Sawyer v. Hoag, 17 Wall. 610, it has been the settled doctrine of this Court that the capital stock of an insolvent corporation is a trust fund for the payment of its debts; that the law implies a promise by the original subscribers of stock, who did not pay for it in money or other property, to pay for the same when called upon by creditors, and that a contract between themselves and the corporation that the stock shall be treated as fully paid and nonassessable, or otherwise limiting their liability therefor, is void as against creditors. The decisions of this Court upon this subject have been frequent and uniform, and no relaxation of the general principle has been admitted. Upton v. Tribilcock, 91 U. S. 45; Sanger v. Upton, 91 U. S. 56; Webster v. Upton, 91 U. S. 65; Chubb v. Upton, 95 U. S. 665; Pullman v. Upton, 96 U. S. 328; County of Morgan v. Allen, 103 U. S. 498; Hawkins v. Glenn, 131 U. S. 319; Graham v. Railroad Co., 102 U. S. 148, 102 U. S. 161; Richardson v. Green, 133 U. S. 30.
It is simply in affirmance of this general principle that section 14, c. 56, of the General Statutes of Kentucky declares that nothing in the act conferring corporate franchises or permitting the organization of corporations "shall exempt the stockholders of any corporation from individual liability to the amount of the unpaid installments on stock owned by them." If the corporation has no right as against creditors to sell or dispose of this stock with an agreement that no further assessment shall be made upon it, much less has it the right to give it away or distribute it among shareholders without receiving a fair equivalent therefor, and thereby induce the public to deal with it upon the credit of such shares, as representing the assets of the corporation. Union Mut.
Life Ins. Co. v. Frear Stone Mfg. Co., 97 Ill. 537. The stock of a corporation is supposed to stand in the place of actual property of substantial value, and as being a convenient method of representing the interest of each stockholder in such property, and to the extent to which it fails to represent such value, it is either a deception and fraud upon the public or an evidence that the original value of the corporate property has become depreciated. The market value of such shares rises with an increase in the value of the corporate assets and falls in case of loss or misfortune whereby the value of such assets is impaired, and the increase of value of such stock is taken to represent either an appreciation in value of the company's property beyond the par value of the original shares or so much money paid to the corporation as is represented by such shares. If it be once admitted that a corporation may issue stock without receiving a consideration therefor, and where it does not represent actual or substituted value in corporate assets, there is apparently no limit to the extent to which the original stock may be "watered" except the caprice of the stockholders. While an agreement that the subscribers or holders of stock shall never be called upon to pay for the same may be good as against the corporation itself, it has been uniformly held by this Court not to be binding upon its creditors.
the stock of the company was not worth more than fifty cents on the dollar, it was evident this could not be effected simply by the issue of new stock. It was proposed at the meeting in March that money should be raised by the issue of $50,000 of bonds, with which to add the requisite structures to the plant. But it was soon evident that the bonds could not be negotiated without the stock, and, acting upon the suggestion of a Nashville banker, it was resolved at the meeting in May that the stock should be increased 800 shares, 500 of which should be turned over to the subscribers to the bonds as a bonus or an additional consideration. The evidence is uncontradicted that the bonds could not have been negotiated without the stock, that they were both sold as a whole, that the transaction was in good faith, and, considering the risk that was taken by the subscribers, the price paid for the stock and bonds was fair and reasonable. The directors appear to have done all in their power to obtain the best possible terms, and there is no imputation of unfair dealing on the part of anyone connected with the transaction. At that time, the mines and property of the company were in good condition and the prospects of success were fair.
in order to carry on a larger business, and the stock thus issued was treated as if it formed a part of the original capital. In County of Morgan v. Allen, 103 U. S. 498, the same principle was applied to a subscription by a county to the capital stock of a railroad company, for which it had issued its bonds, although such bonds had been surrendered to the county with the consent of certain of its creditors.
value is subject to exceptions where the transaction is not a mere cover for an illegal increase.
creditors of the latter; that it was at the time considered advantageous to the company, and it is not proved that all was not paid for the bonds issued and to be issued that they could have been sold for in the market."
"That trust [in favor of creditors] does not arise absolutely in every case where capital stock has been issued, and where it has been settled for by arrangement with the company. It is not as if the stockholders had given their promissory notes for the amount, these notes being in the treasury of the company; but there are often equities to which the stockholders are entitled -- on which they are to stand."
"It is not true that it is in the power of a creditor in every case and in all cases, as a mere matter of right, to institute an inquiry as to the valuation of the amount of the consideration given for the stock, and disturb fair arrangements for its payment in other ways than by cash. If the stock has been fairly created and paid for, there is an end of trusts in favor of anybody, and this does not affect the general proposition that unpaid subscriptions of stock are a trust fund to be administered for the benefit of creditors after a corporation becomes insolvent."
"everyone having claims against the railway company -- even laborers and employees -- who could get nothing except stock in payment of their demands, became bound, by accepting stock at its market value in payment, to account to unsatisfied judgment creditors for its full face value, although at the time it was sought to make them liable the corporation had ceased to exist, and its stock had remained as it was when taken, absolutely worthless . . . To say that a public corporation, charged with public duties, may not relieve itself from embarrassment by paying its debt in stock at its real value -- there being no statute forbidding such a transaction -- without subjecting the creditor, surrendering his debt, to the liability attaching to stockholders who have agreed, expressly or impliedly, to pay the face value of stock subscribed by them, is in effect to compel them either to suspend operations the moment they become unable to pay their current debts, or to borrow money secured by mortgage upon the corporate property."
"What was such an equivalent depends primarily upon the actual value of the stock at the time it was contracted to be issued, and upon the compensation which, under all the circumstances, the contractors were equitably entitled to receive for the particular work undertaken or done by them."
"If, when disposed of by the railroad company, it was without value, no wrong was done to creditors by the contract made with Blair and Taylor. If the plaintiff expected to recover in this suit on the ground that the stock was of substantial value, it was incumbent upon him to distinctly allege facts that would enable the court -- assuming such facts to be true -- to say that the contract between the railroad company and the contractors was one which, in the interest of creditors, ought to be closely scrutinized."
It would seem to follow from this that if the stock had been of some value, that value, however much less than par, would have been the limit of the holder's liability.
liable only for his contract price. So a case might arise where the stock of a going concern was much depreciated, and where its bonds were likewise below par, and there was lawful authority to issue additional stock and bonds. Now in such case the real market value of an equal amount of stock and bonds might not exceed or even equal, the par value of either. In such cases, the question of fraud aside, the purchaser would only be held for his contract price."
This case from Tennessee puts as an illustration the exact case with which we are now dealing.
The liability of a subscriber for the par value of increased stock taken by him may depend somewhat upon the circumstances under which, and the purposes for which, such increase was made. If it be merely for the purpose of adding to the original capital stock of the corporation, and enabling it to do a larger and more profitable business, such subscriber would stand practically upon the same basis as a subscriber to the original capital. But we think that an active corporation may, for the purpose of paying its debts and obtaining money for the successful prosecution of its business, issue its stock and dispose of it for the best price that can be obtained. Stein v. Howard, 65 Cal. 616. As the company in this case found it impossible to negotiate its bonds at par without the stock, and as the stock was issued for the purpose of enhancing the value of the bonds, and was taken by the subscribers to the bonds at a price fairly representing the value of both stock and bonds, we think the transaction should be sustained, and that the defendants cannot be called upon to respond for the par value of such stock, as if they had subscribed to the original stock of the company. Our conclusion upon this branch of the case disposes of it as to those who were held liable by virtue of their subscription to the bonds.
"complainants had no knowledge or notice of the subscription paper of December 30, 1886, under which $45,000 of the new stock was distributed to those who subscribed for bonds, nor of the distribution among the old stockholders of $30,000 of said increased stock, nor does it affirmatively appear that they, or either of them, dealt with and trusted the company upon the faith of that increased stock; but the fact that the capital stock had been increased to $200,000 was made public, and was generally known."
The real question in this connection is when may it be presumed creditors trusted the corporation upon the faith of the increased stock? Obviously when such increase was ordered. That is a fact to which publicity would naturally be given. The creditors could not be expected to know when and by whom such stock would be taken. It is true, they assume the risk of the stock not being taken at all, but the moment shares are taken, they are supposed to represent so much money put into the treasury as they are worth, which becomes available for the payment not only of future, but of existing, creditors. It is manifest that any attempt to gauge the liability of stockholders by the exact time they took their stock with reference to the dates when the several claims of the creditors accrued, and by the further fact whether the creditors actually knew of and relied upon such stock, would, in a case like this, where the creditors and stockholders are both numerous, lead to inextricable confusion. Even the flexibility of a court of equity would be inadequate to adjust the rights of the parties.
Sandford to represent him at stockholders' meetings. He knew of the arrangement to issue an amount of the stock equal to the bonds and to distribute $30,000 of the increased stock ordered by the resolution of May, 1886, and on April 5, 1887, he gave a power of attorney to Sandford authorizing the latter, for him, and in his name and stead, to "receipt to the Clifton Coal Company for stock in my name, and transfer, bargain, and sell the same as if I were there present." Under this power of attorney, Sandford surrendered Neely's certificate for 300 shares, and receipted for 375 shares, the certificates for which were delivered to him as agent of Neely, and which Sandford subsequently voted at stockholders' meetings under the general proxy from Neely to represent his stock. Knowing of the contemplated action in issuing the new stock, and having authorized Sandford to represent him in all matters connected therewith, we think it too late for him to repudiate Sandford's act in receiving the additional 75 shares, which were distributed to him as the owner of 300 original shares. Indeed, the circuit judge finds it to be established by the proof that all of the old stockholders knew of and acquiesced in the disposition of the new stock as made, and that such increased stock was represented and voted at subsequent meetings of stockholders, and was recognized and held out to the public as part of the capital stock of the company. Under the case of Sawyer v. Hoag, 17 Wall. 610, Neely was clearly not entitled to set off against the claim of the creditors his own claim against the corporation. Cook on Stock and Stockholders §§ 193 and 194.
There are several minor points made in the briefs of counsel with regard to the claims of certain creditors which we do not find it necessary to discuss at length. We think there was no error in the rulings of the court in these particulars.
MR. CHIEF JUSTICE FULLER, with whom concurred MR. JUSTICE LAMAR, dissenting.
I dissent from the conclusion of the Court in respect of the stock received by the subscribers to the bonds. That stock was not paid for in money or money's worth, or issued in payment of debts due from the company, or purchased at sale upon the market. It was a mere bonus, thrown in with the bonds as furnishing the inducement to the bond subscription, of larger control over the corporation, and of possible gain without expenditure. Becoming secured creditors through the bonds, the subscribers increased their power through the stock. In my view, there was no actual payment for the stock, and to treat it as paid up is to sanction an arrangement to relieve those who would reap the benefit derived from the possession of the stock in the event of the success from liability for the consequences in the event of the failure of the enterprise.
When the capital stock of a corporation has become impaired, or the business in which it has engaged has proven so unremunerative as to call for a change, creditors at large may well demand that experiments at rehabilitation should not be conducted at their risk.
My Brother LAMAR concurs with me in this dissent.

References: v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v. 
 v.