Court Opinion

ID: 3565800
Source: CourtListenerOpinion
Date Created: 2016-07-05 23:15:36.74772+00
Date Added: 2024-06-11T13:43:04.127814
License: Public Domain

Complainants own cumulative seven per cent. preferred stock in defendant corporation, upon which there has been default in payment of dividends to the extent of one hundred and forty per cent. The corporation now has a surplus of $5,000,000. It has outstanding, approximately, $12,500,000 preferred stock and $11,500,000 common stock (par value), both of which have voting power without distinction as to whether common or preferred, and there remains unissued of its total authorized capital (which is $35,000,000) $5,000,000 of preferred stock and $6,000,000 of common stock. The board of directors and more than two-thirds of each class of stockholders have adopted a resolution to — *Page 333 
1. Change and reclassify thirty-five thousand shares ($3,500,000 at par) of the unissued preferred stock into thirty-five thousand shares of eight per cent. cumulative prior preference stock having priority, both as to dividends and principal, over the remaining preferred stock, and over the common stock.
2. Besides reducing the authorized capital stock of the corporation by $10,000,000, reduce the outstanding capital stock so that it will be approximately —
First preference eight per cent. cumulative (new) ..............  $3,500,000
Cumulative seven per cent. preferred (remainder of old stock) ..   6,500,000
Common stock (approximately) ...................................  11,500,000

this to be accomplished —
(a) By the purchase with $2,100,000 of cash out of the company's capital assets and retirement and cancellation of $3,000,000 (par value) of the outstanding cumulative seven per cent. preferred stock (thereby cancelling also the dividends in arrear thereon amounting to $4,200,000).
(b) The substitution (with proper pro rata subscription rights to outstanding stockholders preserved) of the $3,500,000 of first preference eight per cent. stock above mentioned for a like amount, share for share of the then remaining (that is after the purchase and retirement of the thirty thousand shares thereof above mentioned) outstanding cumulative seven per cent. preferred stock, thereby retiring the latter and cancelling $3,500,000 of additional present capital obligation and $4,900,000 of additional unpaid accrued dividend obligation thereon, such substitution to be brought about by sale of the new eight per cent. prior preference stock (at not below par) and purchase of a corresponding amount (at not above par) of the said remaining old seven per cent. preferred, or by direct exchange, share for share, as shall be deemed most satisfactory by the board of directors; it being expressly provided in said resolution that at no time shall there be outstanding more in the aggregate of prior preference stock and preferred stock than one hundred thousand shares, that would be upon the completion of this plan thirty-five thousand shares of prior preference stock and sixty-five thousand shares of preferred stock.
3. Amending article 4 of the certificate of incorporation accordingly, whereby, inter alia, "the holders of the eight per cent. cumulative prior preference stock shall be entitled to receive, when and as declared by the board of directors, dividends from the surplus of the corporation or from the net profits arising from its business, at the rate of eight per cent. per annum and no more, accruing from the date of issue of such stock, payable quarterly on dates to be fixed by the by-laws of the corporation, or by resolution of the board of directors. Such dividends shall be payable before any dividends shall be paid upon or set apart for the preferred stock or the common stock of the corporation, and shall be cumulative," c., c. *Page 334 
Complainants are the holders of preferred stock who voted against the adoption of the resolution, and they now ask that the corporation be enjoined from carrying out the provisions of the resolution so adopted, for substantially the following reasons:
1. The proposed amendment of the certificate of incorporation, by interposing a new class of prior preference stock ahead of preferred stock already issued in accordance with the original certificate of incorporation, is claimed to have no legislative authority.
2. The prior preference stock cannot be issued because it is claimed to invade the vested rights of the present preferred stockholders to have their cumulative unpaid dividends up to the present time discharged out of present or future earnings of the company before any prior charge can be placed thereon.
3. The proposed retirement of the $3,000,000 (par value) of preferred stock by the purchase thereof at a cost of $2,100,000 in cash, is claimed to be violative of the rights of the other preferred stockholders, because it is said the $2,100,000 purchase-money will be taken from the $5,000,000 surplus of the corporation, which, it is claimed, equitably belongs to the preferred stockholders on account of their arrears of unpaid dividends. The difficulty with this proposition, as it seems to me, is that it is founded on a false premise. The surplus of the corporation will not be decreased by this transaction, but, on the contrary, will be increased by the difference between the par value of this stock, $3,000,000, and the price, $2,100,000, which is to be paid for it. The $2,100,000 will therefore be paid out of capital assets (as the resolution says) and not out of surplus. So that without passing upon the question of whether or not the board of directors, particularly with the assent of two-thirds of the stockholders of each class, in reducing the amount of its outstanding capital stock, have the right to use money in the surplus for that purpose, it is sufficient now to say that such condition does not here arise. *Page 335 
4. The plan, if consummated, will, by ultimately leaving the number of common stock shares outstanding greater than the number of preferred stock shares, reverse the present condition and transfer the controlling weight of the voting power from the preferred stock as at present to the common stock.
5. The provision which makes the prior preference eight per cent. stock redeemable at the option of the board of directors after three years at 115 is claimed to be unauthorized by legislation, because section 18 of the Corporation act expressly limits the rate of annual dividend to not exceeding eight per cent., whereas, it is claimed this might give an additional, due to what is equivalent to, five per cent. per annum dividend, to the holders of this stock.
I am unable to see arguable merit in either of the two last above-named propositions. There was no provision in the original certificate of incorporation that the preferred stockholders should always have a voting power even with or greater than that of the common stockholders. On the contrary, when it came to voting, each shareholder voted as a shareholder in the whole, and not as a shareholder in any particular class. It was a mere accident that more preferred stock came to be issued and outstanding than common stock. It might have been exactly the other way. So, also, the redemption privilege at 115 of the new prior preference stock is not an obligation on the part of the corporation to retire the stock at that price, and, therefore, does not fall within the provision of section 18 of the Corporation act, which says that the dividend on the preferred stock which the corporation is thereby made bound to pay shall not exceed eight per cent. per annum. The redemption right is a privilege which the corporation may or may not adopt, as its business exigencies in the future may dictate. It is not bound to do so. If the prior preference stock on the market should become worth more than $115 per share, and for any reason the corporation might deem it advisable to retire its preferred stock and borrow the money with which to do so *Page 336 
at five per cent., instead of 8 per cent., in that event the option privilege of retirement at 115 would be quite valuable to the corporation. The only prohibition on the subject is that the corporation cannot make its preferred stock retirable at "less than par." Inferentially, of course, this means that it may make it retirable at more than par as well as at par. As this redemption authority clause is a part of section 18, which fixes the maximum of annual dividend at eight per cent., it seems to me quite obvious that the dividend limitation was not intended to affect the redemption provision.
Turning now to the first point, the question is, Where a corporation which might in the beginning have created the two classes of preferred stock here involved if it had seen fit to do so, but which, in fact, created only one class of preferred stock and one class of common stock, can it now, by amendment to its charter, create and interpose ahead of the preferred stock already created and issued and in the hands of stockholders (and, incidentally, ahead, also, of the common stock likewise so outstanding and held) a new class of preferred stock having preference, both in dividends and upon dissolution, in principal over both the existing preferred and common stocks? This right is challenged — first, on the ground that the amending power of this corporation has been exhausted by an amendment to its charter, which took place some years ago, the assertion being that there is no legislation authorizing an amendment to an amendment. This seems to me trivial. The charter as it now exists in its original state or as the result of an amendment, is the charter of the corporation to which the existing legislation applies at the present time, and legislative authority to amend, it would seem to me, would apply to this charter as it now exists; second, it is urged that the amendment legislation does not provide for the creation of a class of preferred stock where such a class already existed before the amendment. I cannot unite with this view. The language of section 27 is: "Every corporation organized under this act may change the nature of its business, change its *Page 337 
name, increase its capital stock, decrease its capital stock, change the par value of the shares of its capital stock, change the location of its principal office in this state, extend its corporate existence, create one or more classes of preferredstock, and make such other amendment, change or alteration as may be desired, in the manner following," c. No one, it seems to me, can deny that what is now proposed to be done is, in fact, the creation of a class of preferred stock. There is nothing in the legislation which limits the power to do this thing to corporations which have not, in fact, already created one or more classes of preferred stock. The legislation seems to apply to all corporations, because it says, "every corporation organized under this act." The objection, if sound, would apply quite as logically in favor of the existing common stockholders where no class of preferred stock had originally been provided for in the certificate of incorporation; but that would, in effect, nullify the amendment power given by the twenty-seventh section. A mere statement of this proposition seems to me to indicate the unsoundness of the contention here urged. I think, therefore, that valid objection to the creation of this prior preference stock cannot be found in the alleged absence of legislation authorizing its creation by amendment as here proposed. If there is such valid objection it must lie rather in the contract rights of the holders of the existing preferred stock, and in the fact, if it is a fact, that those rights would be successfully invaded by the rights given the prior preference stockholders; and that, after all, is the big question in this case.
It is said that this question has never been decided in this court, and no case has been called to my attention in direct conflict with this assertion. The same contention, however (namely, that where preferred stock is issued with the usual preference provisions for its dividend and its principal on dissolution over dividends and principal of the common stock, it carries with it, in itself, a contractual obligation on the part of the corporation that there will not, in the future, *Page 338 
be created by the corporation any other class of obligation holders having a superior priority, or even an equality, to or with that thus secured to the already existing preferred stock), was urged in the case of Berger v. United States SteelCorporation, 63 N.J. Eq. 809, where the attempt was to prevent a bond issue of a somewhat complicated nature which would take precedence over the preferred stock already in existence, and this court there held that there was no contractual right in the preferred stockholder which would be invaded by such an issue.
Of course, the point is a particularly important one, for while it is quite desirable that corporations organized under the laws of New Jersey should have ample proper latitude in making readjustments to meet new and unexpected business conditions, it is even more important that the contractual rights of stockholders of all classes of stock shall be upheld by the courts under all circumstances. If, therefore, the preferred stock of this corporation, when originally created, had had affixed to it by the certificate of incorporation, as one of the terms of its preference (as expressly authorized by the Corporation act) a provision to the effect that no class of stock should ever be issued having a preference over or equality with it, without the unanimous consent of all of the holders of this class of stock, I should, without hesitation, say that the present proposed issue of prior preference stock could not be upheld, and that, even though every cent of past dividends has been, in fact, paid: but there was no such provision, although it is a very common one in preferred stock issues. In its absence, therefore, I incline to the view that as to future dividends on the old preferred stock, and also as to priority of payment of principal upon dissolution, the proposed prior preference stock does not invade any contract rights of the old preferred stockholders. It was a part of their contract with the corporation and with the other stockholders, both common and preferred, that the corporation should have all the powers given it by the legislation in existence when the corporation was organized, unless those *Page 339 
powers were expressly surrendered in some particular respect by the articles of incorporation themselves.
This brings me to the only question in the case which has given me trouble, and that relates to the earned but unpaid dividends up to the present time upon the old preferred stock. These unpaid dividends, amounting in all to one hundred and forty per cent., seem to be partially covered by present surplus (to the extent of about forty per cent.), but as to the rest of them seemingly, although cumulative, the company has not, up to the present time, had sufficient earnings to meet them if the board of directors saw fit to apply them to dividends. As a matter of fact, none of the present surplus, amounting to about $5,000,000, has been voted by the board of directors to be distributed as dividends. In the absence of circumstances strongly indicating fraud, and there seem to be no circumstances of this nature urged here, surplus can only be ascertained to be available for the payment of dividends by action of the board of directors. I incline to the view, therefore, that from a dividend standpoint all of this one hundred and forty per cent. of arrears of dividends must be theoretically taken not to have been availably earned up to the present time. But the question in my mind is, is that sufficient to authorize the corporation to destroy the cumulative portion of the contract held by preferred stockholders in a retroactive way, so that not only is that cumulative provision modified as to the future (which is a risk which all investors in preferred stock not secured by express contractual provision undertake when they buy such preferred stock), but as to the past also? Can the rights of the preferred stockholders to receive compensation according to their contract, even though at some future time, for the period during which their money has already remained invested on the faith of that contract, be absolutely wiped out and destroyed? I find myself unable to adopt this view. In Morris
v. American Public Utilities Co., 122 Atl. Rep. 696, the court of chancery of the State of Delaware, in an opinion by the chancellor (citing as authority for the proposition *Page 340 
opinions by Vice-Chancellor Emery in our court of chancery inPronick v. Spirits Distributing Co., 58 N.J. Eq. 97, andColgate v. United States Leather Co., 73 N.J. Eq. 72, as well as several New York cases), held: "While it is true that a holder of cumulative preferred stock is not a creditor of the corporation, so as to entitle him to bring suit at law against the corporation for dividends in arrear, but not declared [American Steel Foundries Co. v. Lazear, 204 Fed. Rep. 204], yet, considering the relations of the stockholders inter sese
in such a case as the instant one, there is every reason to hold that, as soon as the accrued dividend which the preferred stockholder is to receive is matured by time, a right to its ultimate payment as against those who have agreed to its payment becomes a vested right. It is a present property interest. The period of its enjoyment may be deferred by the directors of the corporation in the legitimate exercise of their discretion in the management of the corporate affairs, and thereby the privilege of asserting the right to the dividend in a suit or action may be postponed. This, however, does not in anywise impair the status of the preferred stockholder as the owner of a present right against the corporation, assertable upon the arising of the proper contingency, namely, when the earnings are such as to justify the declaration of a dividend. Nor is the fact that the preferred stockholder may be required to await the contingency of adequate earnings sufficient to deprive him of the right to be recorded in substance as a creditor as against the common stockholders."
It seems to me, therefore, that as to the accrued unpaid dividends upon the preferred stock up to the present time, complainants cannot be deprived of their vested present property right to have those dividends paid to them at some future time out of earnings of the corporation before the payment of any dividends which did not have priority over them at the time they from time to time matured.
But does this view invalidate the proposed action of this corporation to which complainants are now objecting? I am *Page 341 
inclined to think that it does not. As to future accruing dividends, the dividends of the prior preference stock about to be issued will, of course, have preference, but, as above stated, I think there is nothing illegal in that. As to dividends already accrued, however, my view is that the dividends on the new prior preference stock will not have preference over them, and that, therefore, the carrying out of the plan does not, in itself, overturn the vested rights to these back dividends of the complainants. Those vested rights will not be invaded until, as it seems to me, there shall be an attempt to pay dividends either to these prior preference stockholders or to the common stockholders before the present matured and unpaid dividends on the preferred stock of complainants shall have been paid. When that occurs, if it ever does occur, I shall be inclined to think that, as in Day v. United States Pipe Co., 95 N.J. Eq. 389;96 N.J. Eq. 736, such action could be enjoined.
I am requested by Mr. Justice Katzenbach to say that he concurs in the views herein expressed.