Crane-Johnson Co. v. Commissioner of Internal Rev.

• Decision Date: 15 September 1939
• Docket Number: No. 11446.,11446.
• Citation: 105 F.2d 740
• Parties: CRANE-JOHNSON CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Eighth Circuit

105 F.2d 740 (1939)

CRANE-JOHNSON CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 11446.

Circuit Court of Appeals, Eighth Circuit.

August 3, 1939.

Rehearing Denied September 15, 1939.

COPYRIGHT MATERIAL OMITTED

John E. Hughes, of Chicago, Ill., for petitioner.

Helen R. Carloss, Sp. Asst. to Atty. Gen. (Sewall Key, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Thomas H. Remington, of Rochester, N. Y., Philip F. Biggins and Claude W. Dudley, both of Washington, D. C., and Carter & Jones, of St. Louis, Mo., amici curiæ.

Before GARDNER, SANBORN, and WOODROUGH, Circuit Judges.

GARDNER, Circuit Judge.

This is a petition to review a decision of the United States Board of Tax Appeals. The facts were stipulated and hence are not in dispute. Petitioner, a corporation, was organized under the laws of the State of North Dakota in 1903. As of January 1, 1936, it had a deficit of $21,251.40. The records, prior to January 1, 1929, do not show whether the deficit occurred from operating losses or capital distributions in excess of earnings, or other adjustments. No dividend distribution had been made by the petitioner since March, 1930, when $9,672 was distributed from its surplus balance. In its income tax return for the calendar year 1936, it claimed a credit under Section 26(c) of the Revenue Act of 1936, 49 Stat. 1664, against the imposition of surtax on undistributed profits under Section 14(a), 49 Stat. 1655, which the commissioner disallowed. The net income computed for 1936 was $13,450.76. The commissioner found a deficiency of $1,707.36 on an undistributed net income which he found to exist in the amount of $12,032.72. The Board of Tax Appeals having sustained this determination, the petitioner seeks a review of that decision.

It is the contention of the petitioner that it was not subject to the undistributed profits surtax because it did not have any surplus or undivided profits from which, under the laws of North Dakota, any dividends could lawfully have been paid or distributed.

Section 4543 of the North Dakota Compiled Laws of 1913 provides that: "The directors of corporations must not make dividends except from the surplus profits arising from the business thereof; nor must they divide, withdraw or pay to the stockholders, or any of them, any part of the capital stock, nor must they create debts beyond the subscribed capital stock * * *."

Section 4544 provides as a penalty for a violation of Section 4543 that the directors under whose administration a violation shall have occurred, except those who have caused their dissent therefrom to be entered at large on the minutes or were not present, shall in their individual and private capacity be jointly and severally liable to the corporation and to the creditors thereof, in the event of its dissolution, to the full amount of the capital stock so divided, withdrawn, paid out, or reduced, or the debt contracted.

The Revenue Act of 1936 imposed a special surtax on that part of the profits of the corporation not distributed as dividends. Section 26(c) allowed a credit against the income on which this tax was imposed in the event a corporation was expressly restricted from payment of dividends by "a written contract executed by the corporation prior to May 1, 1936." It is the contention of petitioner that the North Dakota law became a part of the contract between the corporation and the state, and hence, by the provisions of Section 26(c) (1) of the Revenue Act of 1936, it was entitled to credit for dividends which could not be paid without violation of a written contract executed by the corporation, and that if the Revenue Act should be construed to tax the corporation because its directors refused to violate the state law, the Act violated the Fifth Amendment to the Constitution.

The Supreme Court of North Dakota has held that a dividend can not rightfully be declared by a corporation except out of the profits earned by it, and that this principle is embodied in the North Dakota statutes above referred to. Ulness v. Dunnell, 61 N.D. 95, 237 N.W. 208. Similar statutory provisions were in existence when petitioner was incorporated.

The question for determination is whether, within the purview of Section 26 (c) (1) of the Revenue Act of 1936, petitioner's charter, including as it doubtless does the North Dakota statutes, constituted a "written contract executed by the corporation." For some purposes, the charter of a corporation may be said to be a contract with the state, and the laws, constitutional or statutory, of the state where the corporation is organized become a part of its articles of incorporation, so that the charter of a corporation organized under general law consists of its articles of incorporation and the laws applicable thereto. Here, the articles of incorporation and such certificate as may have issued on the organization of the corporation contain no provision restricting dividend payments. It is necessary, therefore, to look to the statutes of North Dakota for the restriction, and to determine whether the state law of North Dakota is a written contract executed by the corporation.

As has been observed, Section 4543 of the North Dakota Compiled Laws contains a prohibition against improper declaration of dividends by directors, and Section 4544 penalizes such consenting directors by making them jointly and severally liable to the corporation and to the creditors in the event of dissolution, to the full amount of the capital stock reduced. These statutes, we think, do not establish a contract executed by the corporation expressly dealing with the payment of dividends. If there is such a contract, it is not an express one, but is implied. Under these statutes, the directors assume a liability as to creditors akin to that of suretyship, and the corporation may itself hold its directors liable for improper distribution of its assets. The obligation is that of the directors, and in the event of the improper exercise of their power to declare dividends, they, as distinguished from the corporation, may be held liable for the consequences of a violation of the statute. Under the North Dakota statutes the liability is statutory and is purely one between the directors and the creditors....