Donohue v. Heuser

• Decision Date: 01 May 1951
• Citation: 239 S.W.2d 238
• Parties: DONOHUE et al. v. HEUSER et al.
• Court: United States State Supreme Court — District of Kentucky

Page 238

239 S.W.2d 238

DONOHUE et al. v. HEUSER et al.

Court of Appeals of Kentucky.

May 1, 1951.

Henry J. Tilford, Lucian L. Johnson, Louisville, for appellants.

John E. Tarrant, Earl S. Wilson, Thomas S. Dawson, and Bullitt, Dawson & Tarrant, all of Louisville, for appellees.

MILLIKEN, Justice.

Appellants, minority preferred stockholders, seek in this action to enjoin the consolidation of the Louisville Railway Company (hereinafter referred to as 'Railway') with the Capital Transit Company of Frankfort (hereinafter referred to as 'Capital'). The Chancellor dismissed appellants' petition.

In August, 1949, all the directors of both Railway and Capital voted in favor of consolidation. Thereafter all of Capital's stockholders, all of the holders of Railway's common stock, and the holders of roughly 91 percent of Railway's preferred stock, consented to it. Appellants are the owners of the 9 percent of preferred stock voting against consolidation. The basis of their objection is that the plan of consolidation destroys valuable rights of the preferred stockholders and at their expense greatly favors the common stock. Their contentions are substantially as follows: I. The proposed terms for exchange of stock violate the Federal and State Constitutions because the contractual rights of the preferred stockholders are impaired; II. The proposed terms for exchange of stock are not authorized by statute; III. The plan is unfair and inequitable; and IV. The plan is otherwise illegal.

The consolidation of corporations is specifically authorized by statute. KRS 271.470 through 271.490. The formal requirements of this statute have been complied with. We direct our attention to the plan proposed.

The name of the new company is to be the 'Louisville Transit Co.' As in all consolidations, it is necessary that stock in the new company be issued in place of the old stock of the constituent corporations. The proposed basis for exchange, insofar as it affects the preferred stock, is that in return for each share of Railway 5 percent $100 par preferred, the shareholder will receive: (1) $2.50 in cash, and (2) one share of Louisville Transit Co. $80 par 5 percent preferred stock, preferred over the common in dividends from earnings and in the distribution of capital assets upon dissolution, and callable at $80 per share plus accrued dividends.

Under the proposal the preferred shareholders will receive something different from what they had before. The preferred stock they now hold has a par value of $100, a preferential cumulative dividend of 5 percent, no preference on dissolution, and is non-callable. Since no dividends have been paid on this stock since 1930, cumulative dividends in the amount of $100 per share have accrued as against the dividend rights of the common shares.

At this point it is proper to consider the history of Railway's operations, its financial condition, and the objectives of the proposed plan of consolidation. Railway was incorporated in 1867. Its first preferred stock was authorized by amendment and issued in 1890. Preferred dividends were paid from 1892 to 1930, and for most of that period dividends were paid on the common stock. Due to many factors (some of which were common to similar transit companies), Railway has been unable to pay any dividends since 1930, even though its operations prospered from 1941 to 1947. By the end of 1949, its books showed a capital deficit of something over $5,000,000.

In 1948, after an abortive attempt to sell Railway's properties to the City of Louisville, its directors decided upon a program of expansion, and subsequently acquired interests in other transit companies in other Kentucky cities. The consolidation with Capital was deemed advisable for several practical reasons. It is obvious that such consolidation presented an admirable opportunity, if authorized, for Railway to adjust its capital structure and wipe out the $5,000,000 capital deficit.

It appears Railway has had substantial financial difficulties over the past twenty years. The future outlook is not bright. It, of course, could not pay dividends in the future until the $5,000,000 capital deficit was extinguished. KRS 271.265. Assuming that it would earn an allowed return of 7 percent on its estimated rate base of $4,000,000, it would take 17 years to liquidate this deficit from earnings. (On the basis of its 1950 earnings if would take 39 years.)

There was thus little prospect of the payment of any dividends for a great many years. For many reasons Railway's directors could reasonably conclude, as a matter of sound business judgment, that it was expedient to eliminate the capital deficit by changing the capital structure. The plan seemed a realistic approach to a serious corporate problem.

As we have seen, the proposed plan provides for the exchange of stock which will effectuate a substitution of rights. The preferred stockholders will lose their dividend arrearages, their return will be reduced, and their stock will be callable. In substitution for these rights, they will receive an immediate cash payment of $2.50 per share and will be given a preference upon dissolution in the assets of Railway. In addition, the statute gave them, at their election, the right to receive the fair cash value of their shares. KRS 271.490(1).

Fundamentally this substitution of rights presents the first two serious questions raised by appellants: I. If the consolidation statute authorized the cancellation of dividend arrearages and the other changes effected by the plan, would the obligations of the preferred shareholders' contract be unconstitutionally impaired?; and II. If not, may we construe the consolidation statute, in providing for the conversion of stock, as authorizing the proposed extinguishment of rights in return for the new incidents of stock ownership? This requires us to consider briefly the statutory background and the nature of the rights held by the preferred stockholders.

I. The first preferred stock of Railway was issued in 1890. At that time there was in effect a statute enacted in 1856, Acts 1856, Ch. 48, p. 15, declaring that the charters of corporations should be subject to amendment at the will of the Legislature, provided that no amendment should impair other rights previously vested. Effective in 1893, Acts 1891-2, Ch. 171, the Kentucky Legislature enacted a general corporation law, and specifically repealed all charters theretofore granted or obtained insofar as inconsistent with the new law. This statute authorized consolidation. It also required corporations subject thereto to accept the provisions of the Kentucky Constitution.

In 1904, pursuant to the provisions of the 1893 general corporation law, Railway accepted the Kentucky Constitution, Section 3 of which provided that every grant of franchise, privilege or exception should be subject to revocation, alteration or amendment. In 1946 a new general corporation law was enacted, which included provisions for consolidation originally established in 1893 and maintained on our statute books since the latter date. From 1904 until 1946 Railway had amended its charter many times under the provisions of the 1893 general corporation law, and in 1948 it amended its charter to provide that it should have all powers conferred by the 1946 general corporation law.

We think it evident that the foregoing constitutional and statutory provisions and the series of acts by Railway in accordance therewith effectively made the power to consolidate a part of Railway's charter, and the rights of the preferred stockholders were subject to this corporate prerogative. See Central University v. Walters' Ex'rs, 122 Ky. 65, 90 S.W. 1066. This additional power of the corporation, though it may have affected the original rights of the preferred stockholders, cannot be said to have impaired ipso facto their contract with the corporation. This is especially true when we consider the fact that all of appellants purchased their stock after 1917. See Senn v. Levy, 111 Ky. 318, 63 S.W. 776; Haggard v. Lexington Utilities Co., 260 Ky. 261, 84 S.W.2d 84; Francke v. Axton-Fisher Tobacco Co., 289 Ky. 687, 160 S.W.2d 23; and Colgate v. U. S. Leather Co., 73 N.J.Eq. 72, 67 A. 657. As stated in the Haggard case, 260 Ky. 261, at page 268, 84 S.W.2d 84, at page 88: 'These statutory provisions become a part of the charter of every corporation organized under the laws of Kentucky, and are consented to by the stockholders when they purchase the stock, and consequently an exercise of this power by the corporation in accordance with the provisions of the statute does not impair the obligation of a contract.' (Our italics.)

Having determined that the statute does not impair the obligation of appellants' contracts simply because it authorizes some sort of consolidation, the next phase of our question is whether or not, if the statute specifically authorized the terms of the proposed plan, it would violate the constitutional prohibitions found in Article 1, Section 10, of the Federal Constitution, and Section 19 of the Kentucky Constitution (which of course are limitations upon legislative power). The parties apparently agree, and we take the same view, that the most significant impairment of appellants' contract rights, if it is an impairment in the constitutional sense, is the extinguishment of dividend arrearages.

A significant case is McNulty v. W. & J. Sloane, 1945, 184 Misc. 835, 54 N.Y.S.2d 253. It involved the validity of a 1943 act of the New York Legislature, Laws 1943, c. 600, Stock Corporation Law, McKinney's Consol.Laws, c. 59, § 36, which specifically authorized corporations by amendment to reclassify their shares and eliminate accrued but underclared cumulative preferred dividends. The New York Supreme Court held this act did not unconstitutionally impair the obligation of contract even when applied to dividends which had accrued prior to the date the law...