Case Name: Adams & Westlake Co. v. Deyette et al.
Court: South Dakota Supreme Court
Jurisdiction: South Dakota
Decision Date: 1895-12-28
Citations: 8 S.D. 119
Docket Number: 
Parties: Adams & Westlake Co. v. Deyette et al.
Judges: 
Reporter: South Dakota Reports
Volume: 8
Pages: 119–148

Head Matter:
Adams & Westlake Co. v. Deyette et al.
The assets of a corporation for profit being a trust fund for its creditors, and its officers, in anticipation of insolvency, being unauthorized to diminish its capital, and release its stockholders from liability, in a manner that will inevitably defeat the rights of bona fide creditors, a judgment confessed in favor of persons who loaned to its directors money for the purpose of, and with actual knowledge that the funds advanced were to be used in, the purchase of shares in itself, is void as to such creditors because, (a) When insolvency occurs, a corporation has no authority to prefer creditors, (b) A corporation, as such, has no power to create a debt by borrowing money with which to purchase its own stock. Kellam, J., dissenting.
(Syllabus by the Court.
Opinion filed Dec. 28, 1895.)
Appeal from circuit court, Brown county. Hon. E. G. Smith, Judge.
This case was first decided by this court in an opinion reported in 5. S. D. 418, 59 N. W. 214, in which opinion the judgment of the court below in favor of plaintiff was affirmed. Thereafter a rehearing was ordered in the case. This opinion is upon the rehearing. The former decision adhered to.
Frank A. Luce, for appellant.
There being no finding that defendant knew that the consent of the stockholders had not been obtained, it must be presumed in favor of the legality of his judgment and claim that he did not know it. G-reenhood on public policy, Rule 130; Garden v. Pleasants, 54 N. W. 832; Bank v.-, 12 Wheat. 70; School v. Collins, 6 Dak. 145; Railroad v. McCleary, .96 U. S. 258; Swam v. Swam, 21 Fed. 299; Curtiss v. Gakey, 68 N. Y. 304; Waite Fraud. Convey. 433; Campbell v. Gold, 51 Fed. 1; Henry v. Ins. Co., 169; Comp. Laws, § 3558. National banks are forbidden to loan money on real estate securities, but if they do so loan they can enforce the contract. Nat’l Bank v. Mathus, 98 U. S. 621; Id. v. Whitney, 103, Id. 621; Snope v. Leffurgwell, 105, Id. 3; Reynolds v. Crawford, 112, Id. 405; Bond v. Terrell, 37 Corp. Cases, 112.
John II. Perry, for respondent.
A decision which is right will not be reversed because based on a wrong or an insufficient reason. Hayne New Trial & App., § 284. The capital of a corporation cannot be used to purchase shares of its own stock. Morawitz Corp. §793; Green Brice’s Ultra Vires, 769.

Opinion:
Fuller, J.
This case, now before us on rehearing, is reported in 5 S. D. 418, 59 N. W. 214, where the unassailed substantive facts are stated as follows: "On the 9th day of May, 1888, the Hicks-Trask Hardware Co., a corporation, being insolvent, confessed judgment against itself in favor of each of the defendants C. E. Deyette and W. W. Lewis, amounting to 11,469.26; the Deyette judgment being for $649.84, and the Lewis judgment for $819.42. After entry of the above judg ments, and on the 12th day of the same month, said defendant confessed numerous other judgments, among which there was one in plaintiff's favor for $1,819.47. Executions issued in succession, and the property of the defendant corporation was levied upon in the order above indicated, and in the order in which the respective judgments were entered and docketed; and the property of the corporation was found to be insufficient to satisfy the judgments which preceded that of the plaintiff. The referee made, among others, the following findings of fact: '(14) That the consideration of the confession of judgment in favor of Charles E. Deyette was as follows: $514.60, money loaned to the Hicks-Trask Hardware Company on January 20, 1888, was borrowed by said company for the purpose of using the same to purchase the stock of said company held by Trask, andón account of the indebtedness of $184.22, owing to said Deyette by said corporation for work and labor done by said Deyette for said corporation. (15) That the defendant Dey-ette had actual knowledge of the purpose and intent of the said corporation to use the same in the purchase of stock. (16) That the consideration of the judgment of the defendant Lewis was $514.60, money loaned to the said corporation by him about January 20, 1888, and borrowed by said company for the purpose of using the same in the purchase of stock of said corporation held by Trask; and the sum of $304.07, due Lewis from said corporation on account of services rendered by Lewis to said corporation. (17) That defendant knew of the purpose and intent for which said money was borrowed by said corporation. (18) That the defendant Lewis, at the time of and prior to the making of said confession of judgment to himself, was a director of said corporation, and secretary thereof, and signed said confessions as- secretary on behalf of said corporation. (19) That the defendant Deyette, at the time of said confessions of judgment by said corporation to himself, was not a director. (20) That no written consent of the stockholders of the Hicks-Trask Hardware Company was ever had to the pur chase of stock from Trask by said corporation. (21) That on May 12, 1888, executions were issued from the district court upon the said judgment of said plaintiff to the sheriff of Brown county, in which said defendant the Hicks-Trask Hardware Company had its place of business. (22) That executions issued from the clerk of the district court of Brown county on each of the judgments of the defendants Foster, Deyette and Lewis, and were by him levied on the personal property of the Hicks-Trask Hardware Company, and all thereof; and the said sheriff sold the same, and holds the money realized from said sale, to be applied on said executions according to the decree of this court. (23) That the proceeds arising from said sale are not sufficient to pay the judgments against the Hicks-Trask Hardware Company prior to the judgment of plaintiff.' Upon these findings of fact the following conclusions of law were based: '(2) That the judgment of the defendant Deyette, as to the sum of $514.60, money loaned to the said corporation for the purpose of purchasing stock, is invalid, for the reason the Hicks-Trask Hardware Company, and the officers thereof had no power to borrow money for the purchase of its stock; and the defendant having loaned said money knowing of the illegal purpose for which it was to be used, cannot recover the same from said corporation. (3) That as to the sum of $134.25, included in the judgment of said Deyette, the same is valid, and should stand, and be enforced for said sum of $134.25. (4) That judgment of'the defendant Lewis is invalid for the reason that the confession of the same, made by him and obtained by him when he was a director of said corporation, was an illegal preference as against the creditors of said corporation, and that the relief prayed by plaintiff should be granted as against said Lewis. (5) I further find as to the judgment of the defendant Lewis that as to the sum of $514.60 it is invalid for the reason that, as to said amount, the consideration was for money loaned to said corporation by Lewis for the illegal purpose of purchasing stock of said corporation.' Judgment by the court was accordingly entered on motion of plaintiff's counsel, and defendants Deyette and Lewis appeal therefrom. "
In order to affirm the contention of appellant's counsel and disaffirm our former conclusion, we must adopt and proclaim a rule by which a corporation without surplus profits or unemployed capital may, in contemplation of insolvency, borrow money with which to purchase shares in itself, and, when insolvency occurs, give a preference to the persons from whom the loan was made, by confessing judgments in their favor for an amount equal to the corporate assets, at a time, for the purpose .of, and in such a manner that the rights and claims of l)ona fide creditors are entirely defeated. In determining the rights of these parties, rules of law and statutory provisions bearing upon the questions presented must be viewed in the relation that each bears to the other; and all must be considered with reference to an enlightened public policy, upon which is based a strong and wholesome rule of law, prohibiting a corporation from distributing its capital among shareholders by the purchase of stock in itself to the inevitable detriment of creditors. As observed by Mr. Thompson in the second volume of his recent commentaries on the Law of Corporations, at page 155: 'Stringent precautions to prevent the reduction of the capital of a limited company without due notice and judicial sanction would be idle if the company might purchase its own shares wholesale; and, if it were otherwise, the result would be that the shareholders would receive back the money subscribed, and there would thus pass into their pockets what before existed in the form of cash in the coffers of the company, or of buildings, machinery, or stock, available to meet the demands of their creditors. The purchaser of the stock must be one who succeeds to a liability, distinct from and in addition to that of the corporation. " Mr. Spelling, after conceding that the foregoing rule is supported by the irresistible weight of authority, and in 'connection with a suggestion that he can see-no valid reason why shares in itself might not be purchased by a corporation, provided always that by so doing its capital stock is not diminished and its creditors are not injured, states the rule as follows: "A purchase of shares in itself by a corporation would be ultra vires wherever and whenever the effect would be to diminish its capital and lessen the security of its creditors. ' 1 Spell. Priv. Corp. 168. Mr. Morawitz says that: "No verbiage can disguise the fact that a purchase by a corporation of shares in itself really amounts to a reduction of the company's assets. The fact that such a transaction may not necessarily be injurious to any person is not a sufficient reason for supporting it. It is contrary to the fundamental agreement of the shareholders, and is condemned by the plainest dictates of sound policy. To allow the directors to exercise such a power would be a fruitful source of unfairness, mismanagement and corruption. It is for these reasons that a shareholder cannot be allowed to withdraw from the corporation with his proportionate amount of capital, either by a release and cancellation before the shares have been paid up, or by a purchase of the shares with the company's funds." Cases almost innumerable are cited by each author in support of the foregoing rule, based upon the equitable principle that the assets of a corporation are a trust fund for its creditors— a doctrine that so completely pervades and enters into the warp and woof of the law of corporations that no literary effort, by whatever degree of legislative sanction or judicial sagacity aided, can destroy the immutable principles of justice and considerations of public policy from which the doctrine emanates, and upon which the rule is based. For the reason that creditors of a corporation cannot, as in case of a partnership, ultimately look to those who constitute the membership for the payment of their claim, the law requires corporations for profit, as a condition precedent to the commencement of business and for the protection and security of creditors, to have capital stock and shareholders, and to hold that they may, upon the strength of their capital, incur debts in the prosecu tion of legitimate corporate business, and then destroy their assets and the credit of the corporation by borrowing money with which to purchase shares in themselves, and defeat their creditors by confessing preferred judgments in favor of those who loaned the money with a knowledge of the purpose for which it was to be used, would be to sanction a fraud and judicially approve a vicious species of legerdemain.
Commencing at page 5115 of the fifth volume of his Commentaries, Judge Thompson approves in a vigorous manner the rule adopted by all recent text writers, which asserts and emphasizes the proposition that the assets of a corporation are a trust fund for its creditors; and, after stating that it is the only doctrine worthy of any respect, proceeds to discuss at length the fallacy by which courts have been led to hold that a corporation anticipating insolvency has the power of a private individual to deal with its assets, and under like circumstances to prefer creditors; and at page 5121 he concludes his observations in part as follows: "It is thus perceived that the courts which have adopted the doctrine that an insolvent corporation may prefer its creditors have jumped at the conclusion by reasoning that, in the absence of statutory prohibitions, a corporation has the same power in disposing of its property that an individual has. But in adopting this hasty conclusion they have overlooked the fact that the anology between an insolvent individual and an insolvent corporation wholly fails in this: that, although an insolvent individual may turn over his property to certain of his creditors whom he desires to prefer, and may, by so doing, hinder and delay the others, yet he merely hinders and delays them; he does not, by that act, destroy himself; he still lives; and he may, and often does, get on his feet again, and acquire property, and discharge his previous obligations. But when a corporation becomes insolvent, and ceases to have the means of carrying out the objects of its creation, and disposesses itself of all its property, it destroys Itself and, becomes ipso facto dissolved, and, in fact, is regarded as a dissolved corporation for many purposes having reference to the rights of creditors. An assignment for the benefit of creditors is, in point of fact and experience, an end of the corporation; and to this statement there is not one exception in a thousand cases, as every lawyer and judge knows. The corporation, after such a catastrophe, not only has nothing more for its unprefered creditors, but it will never have anything more for them. Its act of exhausting its assets in preferring particular creditors deprives the others of all remedy, unless in those cases where the law has left them the remedy of proceeding against its stockholders." In determining whether a corporation, organized for the purpose of dealing in hardware at wholesale, has power to borrow money with which to traffic in its own shares, and thereby relieve its stockholders from liability, the question of intent is of no importance, when the inevitable result must bring disaster to honest creditors. As between them and the money loaner, in case of insolvency, a knowledge of the purpose for which the funds were borrowed is sufficient to at least postpone his claim until they have been paid in full; otherwise it would be a popular scheme for a corporation to incur debts, limited in extent only by its ability to engender confidence, and then, in contemplation of suicidal dissolution, borrow money from some trusted friend with which to purchase its entire stock, upon the assurance that by its last official act, and by a judgment timely confessed, the proceeds of the entire assets of the company shall be turned into the pockets of the man who loans the money with a knowledge of such fraudulent purpose, and to the exclusion of honest persons who extended credit, believing that the assets of a corporation are a trust fund for the benefit of creditors. A corporation, as such, has no power, under the statute, to enter into any obligation or contract except such as are necessary and essential to'the transaction of the ordinary business for the prosecution of which it was organized; and in recognition of the trust-fund doctrine the directors are expressly prohibited from diverting, withdrawing, or paying to stockholders any part of the capital stock, and are in their individual and private capacity made jointly and severally liable to the creditors of the corporation, to the full amount so "divided, withdrawn, paid out, or reduced, or debt contracted." Comp. Laws, § 2917, 2928. Section 2917 is as follows: "Unless otherwise provided, a corporation may purchase, hold and transfer shares of its own stock, from its surplus profits, or as provided in the article on the assessment of stocks, or by the unanimous consent in writing of all its stockholders, in such manner and for such price or consideration as the said stockholders may unanimously decide upon." Although, by enabling a corporation to purchase shares of its own stock from its surplus profits, our legislature has to that extent encroached upon the otherwise invariable rule by which all such traffic is prohibited, the foregoing section, construed, as it must be, with other statutory provisions relating to the same subject, is not sufficient to empower a corporation, through the agency of its directors, to ' 'divide, withdraw, or pay to stockholders, or any of them, any part of the capital stock, " or to increase its liability by borrowing money with which to purchase shares in itself. This is obvious, because it is "otherwise provided," and because the power is, by the law of corporations, expressly withheld from directors and officers as such, as well as by that portion of Sec. 2917 which authorizes no purchase of stock in any manner, except from surplus profits, or by virtue of the law of assessment, unless the purchase be made by and through the unanimous consent and united individual action of all the stockholders, evidenced by a stipulation in writing, signed by every member, and specifying the consideration to be paid, and the manner of and the means by which the purchase is to be effected. Without such written consent, the corporation cannot be bound; and in the total absence of express or implied power to borrow money with which to purchase shares in itself, and in the face of the fact that the loaners thereof had actual knowledge of the extraordinary use to which the funds were to be applied, their claims are ultra vires, and must not be asserted to the detriment of creditors. Lime Works v. Dismukes (Ala.) 6 South. 122. Actual notice on the part of one who loans money to a mercantile corporation that the funds so loaned are to be used for the purchase of stock in itself is sufficient to charge him with knowledge that such an unauthorized act works an immediate fraud upon creditors, and is, therefore, against public policy, and prohibited by the law of the land. These promissory notes upon which the Deyette and Lewis judgments were confessed, being ultra vires because the corporation was, under the circumstances, powerless to make them, it follows, of course, that the judgments were void to the extent of the money loaned for a purpose beyond the scope and object for which the corporation was created. Currier v. Slate Co., 56 N. H. 262; Richardson v. Sibley, 87 Am. Dec. 700; Pearce v. Railroad Co., 21 How. 441; Pennsylvania R. Co. v. Keokuk & H. Bridge Co., 131 U. S. 371, 9 Sup. Ct. 770.
We are fully aware that numerous cases may be found in which judges, though standing upon an eminence, have been unable to observe or unwilling to concede that the assets of an insolvent corporation are a trust fund for the benefit of all Tjonafide creditors, none of whom, at the hands of a corporation are entitled to a preference; but a careful research discloses no case which goes to the extent of holding that a corporation apparently in failing circumstances can borrow money with which to purchase shares in itself, and give to the persons from whom the money is borrowed a preference over all other creditors. Manifestly, a transaction so inconsistent with every consideration of common honesty and public policy, and so disastrous to the credit of corporations, as well as to the rights of those with whom they. transact business, cannot receive the stamp of judicial approval. Adhering substantially to the views expressed in our former opinion, the judgment f>f the trig! court ig afhoiecl,,