Court Opinion

ID: 5450647
Source: CourtListenerOpinion
Date Created: 2022-01-08 18:36:52.452297+00
Date Added: 2024-06-11T08:32:22.162226
License: Public Domain

SHENK, J.
This is a,n appeal from an order of the superior court instructing petitioner and respondent, Building and Loan Commissioner of this state, as to the manner of payment of claims against Pacific Coast Building-Loan Association, in liquidation.
On January 11, 1932, the association being insolvent, the commissioner took possession of its business and assets, for the purpose of liquidation. On July 11, 1932, the Superior Court of Los Angeles County, the principal place of business of the association, upheld the action of the commissioner. He thereupon began to liquidate the assets and pay claims.
On March 25, 1937, the commissioner petitioned the superior court for instructions with reference to the payment of claims. It appeared that all general creditors had been paid in full; that holders of investment certificates had been paid *138principal and interest up to the time the business was taken over; that holders of membership shares had not been paid anything as yet, and that a substantial surplus remained in the hands of the liquidator. The holders of investment certificates demanded payment of interest on their claims for the period of liquidation. The holders of membership shares demanded that the principal of their claims be paid before any such interest was given to the investment certificate holders. In response to the commissioner’s request for advice, the court ruled that the membership shareholders were creditors of the association; that no interest was payable to general creditors or investment certificate holders for any period since the commencement of liquidation until the principal sums of the claims of membership shareholders should be paid.
This appeal was taken by representatives of the investment certificate holders.
In figures, the facts are as follows: The membership shares, held by 4,400 owners, amounted to $3,420,563.07, $1,113,809.92 being pledged for loans, and $2,306,693.15 being “free” or unpledged. The investment certificates had claims in the sum of $3,556,897.35. General outside creditors had claims amounting to $5,950.90. It is estimated that only about $1,800,000 of additional assets will be recovered, with the certainty, therefore, that even without payment of interest to the investment certificates, the funds will be insufficient to pay membership shares in full.
The theory of appellants may be summarized as follows:
(1) Investment certificate holders are creditors of the association, entitled to the same preferential treatment as general creditors.
(2) Membership shareholders are stockholders, much like those of an ordinary business corporation; hence they are’ not creditors.
(3) Creditors of a corporation in liquidation are entitled to be paid in full on their claims before stockholders receive any payment on account of their shares.
(4) Payment in full includes interest during the period of liquidation and up to the time of payment. Whether such interest is claimed at the legal rate, or at the rates specified in the individual certificates (5 per cent, 6 per cent and 7 per cent) is not entirely clear.
*139It is conceded that the investment certificate holders are creditors; the nature of their investment, as will hereinafter appear, is plain. It may be further granted that membership shareholders have some voice in the affairs of the corporation which the holders of investment certificates do not have. Yet these concessions do not solve the problem, for they do not positively define the nature of the relationship of the membership shares to the corporation.  One may, with assurance, declare that a common stockholder of an ordinary business corporation is not a creditor of the corporation, and his claim would be subordinated to those of creditors. (Greva v. Rainey, 2 Cal. (2d) 338 [41 Pac. (2d) 328].) But to conclude from this fact that a membership shareholder of a building and loan association cannot be a creditor in any sense is to ignore the peculiar character of such shares. Building and loan associations have grown rapidly in the past few decades, and have developed widely differing types of organization and stock structure. Membership, management, methods of raising capital, indeed, all their operations are so diverse that it is impossible to speak with precision of the relationships unless discussion is confined to a particular association formed under the laws of a single state. (See, Sundheim, Building and Loan Association, p. 12 et seq.; Fidelity Savings & Loan Assn. v. Burnet, 65 Fed. (2d) 477, 479 [62 App. D. C. 131].) Even in our own state, as will appear, we must avoid hasty conclusions drawn from eases dealing with associations formed under old laws different from those in force today. Accordingly it is necessary to examine the organization and structure of this particular association in the light of the governing statutes, articles of incorporation, and by-laws. When we do we find that the membership share is a hybrid affair, the member having some of the characteristics of a stockholder and others of a creditor. Whether those elements which make him a creditor are of sufficient substance to warrant the procedure adopted by the lower court in this case is the question to be answered by our examination.
The association was incorporated in May, 1925, under the provisions of sections 634 and 648a of the Civil Code. These and other sections of the code dealing with building and loan associations were superseded in 1931 by the Building and Loan Association Act. (Stats. 1931, p. 483; DBering’s Gen. Laws, Act 986.) Except as noted herein no ma*140terial changes were made in the prior law by the new act which would affect this case; and the parties concede that the act governs these liquidation proceedings.
The said sections 634 and 648a of the Civil Code, as amended in 1907 and 1909, established a new type of permissible capital structure for building and loan associations. The principal characteristic of the new plan was the provision for a .guarantee capital stock, set apart as a fixed, non-withdrawable capital, to ‘ ‘ protect and guarantee all other stockholders and creditors against any loss”. (Civ. Code, old sec. 634 [d] ; see, also, Building and Loan Association Act, see. 4.01.) Such guarantee stock, or as an alternative, a certain fixed reserve fund, must be issued in certain percentages of the amount of outstanding investment certificates. (Civ. Code, old see. 634 [e]; Building and Loan Association Act, sec. 5.03.)  The theory behind this plan is that the other shares and certificates will receive a more or less fixed reasonable rate of return, with the guarantee stock (or reserve fund) as a protection, and that those who supply the capital for the guarantee stock will receive the entire surplus over the amount necessary to pay the fixed return to the other investors, and will also control the business. In brief, the guarantee stockholders take the risks, manage the affairs, and receive the profits in excess of the fixed charges. Only a few jurisdictions permit this type of association to be formed. (Sundheim, Building and Loan Associations, p. 18.)
Guarantee stock was authorized by our statutes in the following manner: Under section 634 of the Civil Code, an existing association could issue the new form of stock. Under section 648a, enacted in 1909, the corporation could, if desired, be formed with guarantee stock alone, thereafter obtaining working capital by issuance of membership shares, units or certificates. Pursuant to the statutory authority of section 648a, the present association was incorporated with guarantee capital' stock only, and it then raised its working capital by issuance of membership shares and investment certificates. These will now be analyzed, as their nature appears in the statutes, articles and by-laws.
First, guarantee capital stock was authorized at $100 per share, the total authorized amount being 5,000 shares. The said stock is non-withdrawable, and no loans can be made upon it. (Civ. Code, old sec. 637.) It must be kept *141unimpaired, guarantees losses, and is assessable and liable for debts. (Civ. Code, old sec. 634 [d] ; see, Act, secs. 4.01, 7.01.) A majority of the board of directors of the association (5 out of 9 members) must be selected from the holders of guarantee stock, and officers are chosen by this board. No action concerning financial matters can be taken except by affirmative vote of a majority of the whole board. In liquidation, after all claims and expenses are paid, a majority of the holders of such stock may have the surplus delivered to the association and obtain title again, free from the commissioner’s claim. (Act, sec. 13.16.)
Second, membership shares were authorized. These are either full paid shares, prepaid shares, or instalment shares, all with a par value of '$100. The instalment shares pay dues of 50 cents per month on each share until the payments and accrued dividends amount to $100. Dividends are paid or credited to the shareholders at rates fixed by the board of directors, there being no guaranteed rate. They have no further right to participate in profits, if such a dividend is specified. They have the right to borrow from the association and pledge their shares as security. The shares aie nonassessable. (Act, sec. 7.07.) They are withdrawable (Act, sec. 3.02), and are subject to forced retirement in the discretion of the directors. (Civ. Code, old see. 635; Act, see. 3.04.) They (the members) are permitted to participate in meetings and vote their shares. The by-laws declare that membership shareholders “are members of the corporation, with all the rights, power and privileges incident thereto, including a right to vote at all meetings of the shareholders and members—one vote for each share—and are subject to the same restrictions and liabilities”. However, it appears to have been the practice for these members at the time of application for membership shares to execute proxies in favor of the secretary.
The third classification was the investment certificate, a type of unsecured note or debenture, used by the association in raising funds from time to time, as needed. (See, Act, sec. 5.01.) The purchasers pay a certain sum and receive a certificate in a form similar to a promissory note, with attached interest coupons. The terms of the notes vary from one to three years. No dividends are paid, but a fixed sum as interest as specified, ranging in different instances from 5 per cent to 7 per cent. The certificates may' be *142pledged for loans and are subject to enforced retirement or redemption. (Act, sec. 5.06.) The holders have no voice in management, do not participate in the business affairs, and the by-laws provide: “Holders of either form of these Investment Certificates are not members of the corporation and have none of the rights, powers and liabilities incident thereto.” They are immune from liability for assessments or debts. (Act, see. 5.01.) They have a special priority in the event of liquidation; they are “entitled upon liquidation of an association to receive payment in full before any payment or distribution shall be made to shareholders or stockholders”. (Act, sec. 5.01.)
It is apparent from the most cursory examination of the above that a sharp distinction exists between guarantee stock and membership shares. The definitions in the statute make this distinction at the outset. “Shareholder” is synonymous with “member” and means the holder of “shares”. “Stockholder” means the holder of “stock”. “Shares” refers to “withdrawable shares” which constitute “membership shares”. “Stock” means “guarantee stock”. (Act, sec. 1.01; see, also, Civ. Code, old sec. 648a.) The guarantee stock, as already pointed out, is permanent, non-withdraw-able, assessable, and liable to claims of creditors. None of these things is true of membership shares. The guarantee stockholders take the major risk, and in return have the controlling voice in management (since a majority of the board must be selected from their group). They receive all the profits over the moderate return by way of interest or dividends going to others. The very name of the guarantee stock discloses a primary purpose, the creation of a fund for the protection of others who invest in the association, including membership shareholders and investment certificate holders. In liquidation, their rights are expressly subordinated, not only to investment certificate holders, but also to membership shareholders. (Act, see. 13.16.)  These guarantee stockholders closely resemble the common stockholders of an ordinary business corporation, in both powers and liabilities, and bear no resemblance at all to the traditional members of a building and loan society or association. The membership shares, however, have none of these characteristics, but instead are of the familiar type found in the typical building and loan association. The power of the *143member to withdraw, and the power of the association to compel retirement, are significant indications of the difference between ordinary common stock and guarantee stock on the one hand, and membership shares no the other.
Further study discloses a marked similarity between membership shares and investment certificates. The declared purpose of each type is to secure working capital, which means, it would seem, operating funds rather than an original stated capital or capital stock. Neither is assessable, neither is liable for debts. Both are withdrawable, and both are subject to forced retirement. Both may be pledged for loans. Both are protected by the guarantee stock, and such stock is subordinated to both in the payment of claims on liquidation. There is an obvious legislative purpose to treat these two forms of investment in most eases as substantially similar in so far as the rights of the investors are concerned.
What then are the differences between membership shares and investment certificates, upon which appellants rely? There are only three of consequence. First, the return on the investment differs. Investment certificate holders receive a fixed rate of interest. Membership shareholders are entitled only to dividends as determined by the board of directors. But such a dividend must be specified, or they share in the profits. In practice, dividends are specified. The result is some more or less fixed return, in both types of investment, varying not more than a few per cent. Second, the investment certificate holders have no voice in the management of the association. The membership shareholders may attend meetings and vote. This distinction is less impressive when we consider the fact that the majority of the board, with full control over financial matters, must be guarantee stockholders, so that in truth the membership shareholders only help select the management, but have no genuine power of management themselves. Third, the investment certificate holders have a liquidation preference. They are entitled to have their claims paid in full before any payments are made to other kinds of shares (except in the case of exchangeable shares under late legislation).
We should not be led astray, when observing these differences, and come to the hasty conclusion that they determine a point which, upon further consideration, has nothing to do with them. The difference in voting rights, for example, is *144not conclusive. Suppose the certificate holders were themselves given a vote. Would this outweigh all the other factors which make them creditors and itself turn them into stockholders? Obviously it would not. Nor does the liquidation preference of investment certificates have the effect claimed by appellants. The investment certificate holder is without doubt a preferred creditor, but this does not make the membership shareholder any less a creditor, though an inferior one. In short, it appears that the membership shares are fundamentally similar to the investment certificates, and the differences noted are not of such significance as to overcome this similarity, in respect of the rights of the investor against the association. We conclude that the membership shareholders are creditors of the association.
The cases relied upon by appellants to deny the status of creditors to holders of such shares are all distinguishable.
Groover v. Pacific Coast Sav. Soc., 164 Cal. 67 [127 Pac. 495, Ann. Cas. 1914B, 1261, 43 L. R. A. (N. S.) 874], was an old form of association, incorporated prior to the statutes of 1891 governing building and loan associations, and whether its structure bore any substantial resemblance to that of the association here involved does not appear. But aside from this, the issue in the case was whether upon insolvency borrowing instalment shareholders should be given a credit on their debts in the amount of payments made on their stock. It was held that to permit this would be to discriminate against nonborrowing members and outside creditors, and to violate the equitable principle of equality. In the course of its opinion the court referred to the distinction between a stockholder and a borrower, and held that the dual position 'of the borrowing stockholder could not be ignored. In the present case many of the borrowing shareholders were credited with their share payments, and no complaint was made as to this action. The problem before us here, as to the respective rights of membership shareholders and investment certificate holders, is one upon which the Groover case throws no light. Not only was the controversy there over a different issue, but it does not appear that there were any investors in a- position comparable to that of the investment certificate holders.
Pacific Coast Sav. Soc. v. Sturdevant, 165 Cal. 687 [133 Pac. 485, 49 L. R. A. (N. S.) 1142], a case involving the *145same association' as the Groover ease, was concerned solely with the question whether stockholders whose stock had matured and who had given notice of withdrawal and demand for payment prior to insolvency, were entitled to priority over other stockholders, in liquidation. The court held that the principle of equality among members applied; that all should be treated alike, without preference; and that the notice of withdrawal and demand did not change them into general creditors with a right to preferential treatment. Again it must be emphasized that the conflict there was between members or stockholders, and no class of investment certificate holders existed. As for the general language of this and the preceding case, far from supporting the position of appellants, it is actually contrary thereto, for it stresses the principle of equality among those similarly situated. As we have already shown, the marked similarity between membership shares and investment certificates would, under the language of both these cases, suggest the denial of preferences rather than the giving of them.
Equally distinguishable are several federal cases cited by appellants. In Fidelity Savings & Loan Assn. v. Burnet, 65 Fed. (2d) 477 [62 App. D. C. 131], an association with both guaranty stock and membership shares, the only question was whether the normal return paid to the membership shares was “interest”, deductible under the Revenue Act of 1921, or “dividends” which would be nondeductible. The court concluded that the shareholders were not creditors receiving interest, but stockholders receiving dividends, and that these were not deductible payments. There is no reason to dispute the soundness of this conclusion, for the court was dealing with a solvent association, and the question of rights in liquidation was not at all involved. As will hereinafter be seen, the court expressly recognized that an entirely different view is properly taken upon insolvency. In Harry E. Jones, Inc., v. Kemp, 74 Fed. (2d) 623, and Barrymore v. Kemp, 69 Fed. (2d) 335, the sole question was whether investment certificate holders were entitled to parity with general creditors in payments on liquidation. There was no consideration given to the status of membership shareholders in either case.
On the other hand, there are several decisions which have, in various situations, recognized that members or sharehold*146ers of an insolvent association in liquidation may be treated as creditors.
In re Western States Building-Loan Assn., 50 Fed. (2d) 632, was a bankruptcy proceeding, and the question was whether certificate holders or shareholders were creditors with provable claims. Emphasizing the right of withdrawal, the court said: “It is to be noted that the contract relationship established does make the association the debtor of its shareholder”, and wrent on later to explain: ‘1 When an association is forced into liquidation, and as a consequence is in a position no longer to fulfill its obligations, it must be that the debt matures, and that, in whatever fund is realized upon a sale of the assets, the debtor or shareholder is entitled to participate.” In Fidelity Savings & Loan Assn. v. Burnet, supra, strongly relied upon by appellants, the Western States case is considered and distinguished, the court conceding that upon insolvency, the shareholder gains the rights of a creditor. Likewise, the ease of In re Guaranty Building & Loan Assn., 49 Fed. (2d) 776, while denying shareholders the right to institute bankruptcy proceedings, recognizes that “they become invested with the character of creditors upon the adjudication in bankruptcy”. (See, also, Sundheim, supra, see. 193; Rummens v. Home Savings & Loan Assn., 182 Wash. 539 [47 Pac. (2d) 845, 100 A. L. R. 570] ; Mott v. Guardian Bldg. & Loan Assn., 140 Or. 489 [14 Pac. (2d) 447].)
From the foregoing discussion, it must be concluded that the membership shareholders herein are to be treated as creditors of the insolvent association in liquidation. With this established, the determination of the precise point at issue becomes a relatively simple matter. We are not concerned with the rights of general outside creditors, which are universally conceded to be prior to those of members.  Our only problem is to determine the rank of the claims of shareholders and investment certificate holders. The statute expressly places the investment certificate holders in a more favorable position than the membership shareholders; but this does not wmrrant the courts in still further extending the preferential position established by statute. The law gives preference in the matter of payment of the claim, which, reasonably interpreted, means the principal sum due; and this claim has already been satisfied in full. As to interest the statute is silent. And, in view of that silence, the statu*147tory preference should logically end at that point, and the problem must then be solved in accordance with the usual equitable principle governing liquidation, namely, the principle of equality among creditors.  Stated broadly, the rule is that one creditor is not entitled to payment of interest on his claim in receivership, bankruptcy, or other form of liquidation, after the commencement thereof, where the assets are not sufficient to pay the principal of all claims in full. (See, Greva v. Rainey, 2 Cal. (2d) 338 [41 Pac. (2d) 328] ; Glenn on Liquidation, secs. 488, 510.)
The above rule was announced by this court recently, upon a full review of the authorities, in Greva v. Rainey, supra. A bank was in liquidation and the respective rights of stockholders and various depositors were involved. This court held first that the depositors, as creditors, were entitled to payment of not only the principal of their claims but interest during liquidation, before any payments should be made to stockholders. This distinction between the rights of creditors and stockholders is well settled, and as applied to the present case, would mean that any of the various kinds of creditors of the association would be entitled to interest as against the guarantee stockholders. The second holding in the Greva case was that as to the different classes of depositors, that is, those in the commercial and those in the savings departments, neither should receive interest until payment of the entire principal sum to all. We said (p. 346): “The decisions . . . are uniform to the effect that in so far as is possible the creditors of an insolvent debtor must be treated on a basis of equality . . . That, indeed, is the premise from which springs the rule that interest ordinarily will not be computed nor paid from the date of the suspension of business, or commencement of the receivership or other liquidation procedure. Therefore, there being but one debtor involved, all creditors are entitled to equal consideration except where the statute expressly provides otherwise, and then only to the extent provided.” And quoting from People v. American Loan & Trust Co., 172 N. Y. 371 [65 N. E. 200], we said further (p. 347) : “As the statute does not say that preferred claims shall be paid with interest to the date of payment, the courts should not, because the claims of substantially all the creditors, both preferred and unpreferred, were alike in origin, for they /were created by the deposit of money; and preference in derogation of the common law should not be *148extended by construction beyond the express command of the statute. ’ ’
It follows that the lower court, correctly instructed the respondent Building and Loan Commissioner as to the apportionment of funds in payment of claims against the association.
The order is affirmed.
Edmonds, J., Gibson, J., Carter, J., and Waste, C. J., concurred.