Ellsworth v. Lyons

• Decision Date: 13 July 1910
• Docket Number: 2,017.
• Parties: ELLSWORTH v. LYONS.
• Court: U.S. Court of Appeals — Sixth Circuit

181 F. 55

ELLSWORTH v. LYONS.

No. 2,017.

United States Court of Appeals, Sixth Circuit.

July 13, 1910

B. B Selling, for appellant.

W. C Brown, for appellee.

Before WARRINGTON and KNAPPEN, Circuit Judges, and SANFORD, District judge.

KNAPPEN Circuit Judge.

The appellant, on behalf of himself and other holders of preferred stock of the Lansing Veneered Door Company (hereafter referred to as the 'Door Company ') petitioned the referee for an order directing the payment to him and such other stockholders of the proceeds of a certain policy of insurance upon the life of Charles Broas, taken out by the bankrupt company for the purpose of securing the payment of the dividends upon said preferred stock and the ultimate redemption of the same at par. The referee granted the petition. The District Court, upon review of the referee's order, reversed the same and dismissed the petition. The important facts are these:

The Door Company was originally incorporated in 1896. It had then no preferred stock. In 1902 its capital stock was increased to $50,000; $30,000 being common and $20,000 preferred. This action was taken under the provisions of section 7073 of the Compiled Laws of Michigan hereafter referred to. The full $20,000 of preferred stock was subscribed by Charles Broas secretary of the company, who had charge of the floating of the same. Section 1 of article 4 of the company's by-laws provides that:

'Three thousand shares shall be known as common stock, fully paid and non-assessable, with power of voting at stockholders' meeting, one vote for each share. Two thousand shares shall be known as preferred stock, drawing six per cent. interest, payable semiannually, and redeemable in nineteen hundred and twelve.'

Sections 2 and 3 are as follows:

'Sec. 2. The preferred stock shall be retired in full at par on the first day of June, 1912. For the purpose of providing a fund for the redemption and retirement of said preferred stock there has been placed upon the life of Charles Broas, secretary, treasurer and general manager, twenty thousand dollars ($20,000) of life insurance in the Mutual Benefit Insurance Company of Newark, N.J. Said insurance is taken on the ten year endowment plan and the full amount is payable directly to this company on the death of the insured, or at the expiration of ten years should the insured be then living.

'Sec. 3. After providing for the payment of dividends on the preferred stock and before any dividends shall be declared or paid upon the common stock there shall be set aside from the net earnings of the business of the company each year and paid to the Mutual Benefit Insurance Company of Newark, N.J., at the time when such premium becomes due a sum sufficient to pay such premiums, less the dividend paid on such policy. The moneys received ($20,000) by this company at the expiration of the endowment period, or by the death of the insured, shall be used for no other purpose whatsoever than the retirement of the preferred stock. It being specially provided that in case of the death of the insured the moneys due ($20,000) shall be used only for the purchase of preferred stock at par.'

Section 4 provides that whenever the surplus in the hands of the company exceeds the amount necessary to pay the next year's premium on the insurance policy, together with the amount required to meet interest on the preferred stock for the next two years, 'such surplus and such surplus only may be used in the payment of dividends on the common stock, or may, by a two-thirds vote of the owners of the common stock, be used in the purchase of preferred stock.'

Section 5 requires the by-laws referred to, together with section 7073 of the Michigan statutes above mentioned, conferring authority for the issue of preferred stock, to be printed upon the certificates thereof, and forbids amendment or repeal of the by-laws without the consent of all the holders of preferred stock and of two-thirds of the holders of common stock. The by-laws, together with the statute referred to, were in fact printed upon the certificates of stock when issued, to which were attached semiannual coupons representing dividends for the 10-year period commencing October 1, 1902, each coupon containing this recital: 'The same being six months' dividends on $500.00 preferred stock. ' The 10-year endowment policy was in fact taken out as contemplated, and the holders of preferred stock purchased the same in reliance thereon as security for such preferred holdings. Previous to February 18, 1904, the company paid in cash, out of its assets, premiums amounting to $4,408.89. After that date it paid only the sum of $22.49, which was interest due on a deferred payment maturing February 18, 1904. Later premiums were met through loans upon the policy. Proceedings in bankruptcy were begun against the company August 18, 1906. On November 23, 1906, the trustee in bankruptcy surrendered the policy to the insurance company, receiving therefor $2,310.71, as its surrender value. The referee concluded, apparently with considerable difficulty, that the company was solvent upon February 18, 1904, without taking into account the insurance policy. He also found that the Door Company had no creditors at the time of the adjudication in bankruptcy or at the time of the filing of the petition therein, who were such upon February 18, 1904, and that there was no evidence that any credit was extended by any creditor of the company 'upon the basis or supposition that the said life insurance policy was an asset of said corporation for the payment of its debts. ' It also appeared that a further issue of preferred stock was made in 1906. This fact, however, does not become material in the view we take of the case.

The sole question presented is whether, as against the creditors of an insolvent manufacturing corporation organized under the laws of Michigan, the preference attempted to be given stockholders of the character in question can be sustained as to assets set apart while the company is still solvent for the security of said holdings, but still held by the company under an attempted trust in favor of such holders. We say this because, in the first place, we must accept the conclusion of the referee that the company was solvent when the insurance premiums in question were paid. In the next place, no question of the lawfulness of the payment of the dividends actually paid is here involved, but only of the application of funds now on hand to the ultimate redemption of the preferred holdings. Moreover, the fund representing the proceeds of insurance was actually paid from the assets of the company, thus reducing to that extent the amount available to creditors and rendering it immaterial whether paid from earnings of the company or not. And, finally, the title to the securities representing the fund so paid from the assets of the company was still held by the latter at the time bankruptcy intervened. That the terms of the bylaws and stock certificates are intended to create the preference claimed is clear. The important question is whether the company had power to give such preference. The law is well settled that a corporation may lawfully give security to one class of stockholders over another class. Warren v. King, 108 U.S. 389, 2 Sup.Ct. 789, 27 L.Ed. 769; Hamlin v. Toledo, St. L. & K.C.R. Co. (6th Circuit) 78 F. 6648 670, 24 C.C.A. 271, 36 L.R.A. 826; Continental Trust Co. v. Toledo, St. L. & K.C.R. Co. (C.C., N.D. Ohio) 86 F. 929, 949; Toledo, St. L. & K.C.R. Co. v. Continental Trust Co. (6th Circuit) 95 F. 497, 531, 36 C.C.A. 155. It is equally well settled that a contract between a corporation and a stockholder by which the latter is to receive the par value or any part of his stock before all corporate debts are paid is contrary to public policy, and void. Warren v. King, 108 U.S. 389, 396, 2 Sup.Ct. 789, 27 L.Ed. 769; Hamlin v. Toledo, St. L. & K.C.R. Co. (6th Circuit) 78 F. 664, 670, 671-672, 24 C.C.A. 271, 36 L.R.A. 826; Guaranty Trust Co. v. Galveston City R.R. Co. (5th Circuit) 107 F. 311, 46 C.C.A. 305; American Steel & Wire Co. v. Eddy, 130 Mich. 266, 269, 89 N.W. 952; s.c. 138 Mich. 403, 407-410, 101 N.W. 578; Clark v. E. C. Clark Machine Co., 151 Mich. 416, 424, 115 N.W. 416; Cook on Stocks and Stockholders (3d Ed.) Sec. 271.

Appellant contends that the holders of this so-called preferred stock were not in reality stockholders at all, but were essentially creditors, and that the corporation could lawfully secure to them the repayment of loans made as such. It may be conceded that if the preferred holders in question were in reality creditors purely, and not stockholders, it was competent to secure the repayment of the money so advanced. The status of these holders must be determined largely by reference to the statute creating that status.

Section 7073 of the Michigan Compiled Laws of 1897 (which was added in 1893 by way of amendment to the general act providing for the incorporation of manufacturing companies, and under which the amendment of the articles of association of the Door Company and the issue of the preferred interests in question were had) confers power upon such manufacturing company 'to create and issue certificates for two kinds of stock, viz.: General or common stock, and preferred stock, which preferred stock shall at no time exceed two-thirds of the actual capital paid in, and shall be subject to redemption at par at a certain time to be fixed by the by-laws of said corporation, and to be expressed in the certificates therefor. ' It is further provided that:

'The holder of such preferred stock shall be entitled to a fixed dividend, payable quarterly, half-yearly or yearly, which said dividend shall be cumulative,

...