Fera's Estate, In re

• Decision Date: 17 February 1958
• Docket Number: No. A--60,A--60
• Citation: 139 A.2d 23,26 N.J. 131,76 A.L.R.2d 152
• Parties: , 76 A.L.R.2d 152 In the Matter of the ESTATE OF Henry FERA, Deceased.
• Court: New Jersey Supreme Court

Page 131

26 N.J. 131

139 A.2d 23, 76 A.L.R.2d 152

In the Matter of the ESTATE OF Henry FERA, Deceased.

No. A--60.

Supreme Court of New Jersey.

Argued Jan. 6, 1958.

Decided Feb. 17, 1958.

Charles J. Milton, Jersey City, for appellant (Milton, McNulty & Augelli, Jersey City, attorneys).

Everett M. Scherer, Newark, for respondent (Riker, Emery & Danzig, Newark, attorneys).

George Warren, Trenton, for guardian ad litem.

The opinion of the court was delivered by

PROCTOR, J.

This is an appeal by Theodora Fera Hargrett, the life beneficiary of a trust created by the will of her father, Henry Fera, from the dismissal of her counterclaim in an action instituted by the trustee wherein court approval of the sale of certain trust stock was obtained. In her counterclaim she sought to have that portion of the proceeds of the sale of the stock, constituting the major asset of the trust, which represented undistributed earnings of the corporation accumulated since the inception of the trust, paid to her as income under the terms of her father's will. Both the trustee and the remainderman opposed the counterclaim, maintaining that the entire proceeds of the sale constituted Corpus. There is no substantial controversy as to the facts.

Henry Fera died testate in New Jersey in 1932. He was survived by his only child, Theodora Fera Hargrett, the appellant herein, and four brothers and five sisters. Except for articles of a personal nature the entire estate was left in trust. The Fidelity Union Trust Company and Walter Fera were named executors and trustees. In 1943 Walter Fera died and the Fidelity Union Trust Company continued as the sole surviving trustee. The relevant provisions of the will are as follows:

'Third: All the rest, residue and remainder of my estate, both real and personal, wheresoever situate, and of whatsoever constituted, I give, devise and bequeath to my executors hereinafter named, as trustees, in trust, nevertheless for the following uses and purposes; viz.:

'(a) To invest and reinvest, the same from time to time and collect the income therefrom.

'(b) During the lifetime of my sister, Ella Fera, and so long as she shall be unmarried, to pay to her the sum of Six hundred dollars ($600.00) annually in equal monthly installments.

'(c) During the lifetime of my sister, Ada Jones, and so long as she shall remain unmarried, to pay to her the sum of Six hundred dollars ($600.00) annually in equal monthly installments.

'(d) During the minority of my daughter, Theodora C. Fera, to pay to her legally appointed guardian, the sum of Three thousand dollars (3,000.00) per annum, in equal monthly installments, which amount shall be used by said guardian for the education and comfortable support of my said daughter.

'(e) Upon my said daughter attaining the age of twenty-one years, to pay to her during her lifetime in equal quarterly payments, the whole of the net income of my estate, subject only to the annuities, provided for my two sisters in sub-divisions (b) and (c) hereof.'

The will was executed in 1928 when the appellant was seventeen years of age. When the will was probated in 1932 she was of age and thus entitled to the 'whole of the net income' of the estate, subject to the annuities given the testator's two sisters. The rights of the sisters are not involved on this appeal. Appellant now is married and has one son, age 16, who is the remainderman under the will. As remainderman he is a defendant herein and is represented by a guardian Ad litem.

Among the assets of the estate were 1,199 shares of the capital stock of A. W. Faber, Inc., whose corporate name is now A. W. Faber-Castell Pencil Company Incorporated (hereinafter referred to as Faber). These shares constituted one share less than 30% Of the total outstanding capital stock of the company, which consisted of 4,000 shares having a par value of $100 per share. At the inception of the trust, these shares were carried by the trustee at the value of $126,350.62, or $105.38 per share. The balance of the trust assets were valued at $131,546.91.

Since the creation of the trust, the appellant has received all of the dividends declared by Faber on the stock. From 1932 to 1956 the total net earnings of the company amounted to $1,239,416, of which $771,000 was distributed by way of dividends. Thus, while distributing approximately 62% Of its earnings, the corporation has withheld and accumulated approximately 38% Of its earnings.

Following an application by the trustee, the Chancery Division, on March 8, 1957, entered a judgment approving an agreement by the trustee to sell 599 shares of the Faber stock for $153,793.25, or $256.75 per share. Both the appellant and the guardian Ad litem for the remainderman approved the sale. However, in that proceeding, the appellant interposed a counterclaim seeking judgment that the trustee be directed to pay her, as income beneficiary, to quote from her brief, 'so much of the profit of the shares of stock sold as would represent a proper proportion of the net earnings of Faber during the life tenancy withheld from distribution and accumulated as earned surplus, including that portion of the surplus account which was transferred to a general reserve for bad debts and contingencies.' She also demanded judgment 'for such portion of the purchase price as was generated by the retention and investment of the said surplus.'

The trial court dismissed the counterclaim, after concluding that the term 'net income,' as it is ordinarily understood in dealing with corporate stockholdings, means declared dividends and not 'net corporate earnings'; that corporate earnings which are not paid out as dividends are additions to principal, and that proceeds from the sale of stock held in trust constitute Corpus. An appeal was taken to the Appellate Division and while pending there we certified the cause on our own motion.

The single issue presented is whether the income beneficiary, upon the sale of trust stock, is entitled to that portion of the profit realized from the sale which allegedly represents the net earnings of the corporation that were withheld from distribution and accumulated as earned surplus.

The appellant contends that since the New Jersey courts have consistently applied the doctrine of equitable apportionment, also known as the 'Pennsylvania rule,' as between the life tenant and the remainderman, in cases involving declared dividends, the same doctrine should be applied to the profit realized from a sale of stock to the extent that any portion of such profit may be attributable to the existence of surplus and undistributed earnings which have accrued during the life tenancy. The appellant further asserts that when the testator specified that 'the whole of the net income' should go to the life tenant he intended the life beneficiary to receive the entire 'net earnings' of the company, including any which were retained and accumulated by the corporation.

The question of how to properly distribute, between Corpus and income, the various benefits received by a trustee through the trust's ownership of corporate stock, where the trust instrument is silent, has indeed proved a vexatious problem to the courts. In attempting to resolve the trustee's dilemma as to whether a particular dividend or benefit should be allotted to income or Corpus, or apportioned between the two, where the testator has not manifested any specific intention, the courts have divided into three groups, each announcing a different theory. For a discussion of these theories see 4 Bogert, Trusts and Trustees, § 843 (1948); 3 Scott, Trusts (2d ed. 1956), § 236.3.

The 'Pennsylvania rule' is based on the theory that the source of every stock benefit, regardless of its form, should be determined and that it should go to the person equitably entitled to ownership of the source from which it was declared. It is a rule designed to achieve as nearly as possible exact justice between the successive interests, irrespective of the difficulty of its application. The 'Massachusetts rule' treats all cash dividends as income and all other dividends or benefits as principal. It is a simple, convenient rule based largely upon form. There is no attempt to go behind the declaration of the dividend to ascertain its source and determine the equities in each case. The 'Kentucky rule' ignores both form and source. It allocates all corporate benefits to income as of the date they are declared irrespective of the time they were earned.

New Jersey has consistently applied the 'Pennsylvania rule' of equitable apportionment to declared dividends. Lang v. Lang's Executors, 57 N.J.Eq. 325, 41 A. 705 (E. & A.1898), extraordinary dividends; Day v. Faulks, 79 N.J.Eq. 66, 81 A. 354 (Ch.1911), affirmed 81 N.J.Eq. 173, 88 A. 384 (E. & A.1912), stock dividends; Ballantine v. Young, 79 N.J.Eq. 70, 81 A. 119 (Ch.1911), extraordinary and stock dividend; McCracken v. Gulick, 92 N.J.Eq. 214, 112 A. 317 (E. & A.1920), extraordinary dividend; Beattie v. Gedney, 99 N.J.Eq. 207, 132 A. 652 (Ch.1926), extraordinary dividend; Hagedorn v. Arens, 106 N.J.Eq. 377, 150 A. 4 (Ch.1930), ordinary cash dividend.

The appellant urges that since we have applied the 'Pennsylvania rule' of equitable apportionment in determining the allocation of declared dividends, we should follow the leading Pennsylvania case of In re Nirdlinger's Estate, 290 Pa. 457, 139 A. 200, 56 A.L.R. 1303 (Sup.Ct.1927), which extended the rule of equitable apportionment to the proceeds of a sale of corporate stock. In that case the court held that where a trustee sells corporate stock and receives a price greater than the value of the stock at the inception of the trust, and the increase in value is due in part to an accumulated surplus from the earnings of the corporation, accruing during the period of the trust, the life tenant is entitled to an apportionment of the proceeds. But if the profit realized from the sale was due to...