In re Fechheimer Fishel Co.

• Decision Date: 26 February 1914
• Docket Number: 195.
• Parties: In re FECHHEIMER FISHEL CO.
• Court: U.S. Court of Appeals — Second Circuit

212 F. 357

In re FECHHEIMER FISHEL CO.

No. 195.

United States Court of Appeals, Second Circuit.

February 26, 1914

[Copyrighted Material Omitted]

The Fechheimer Fishel Company is a corporation organized under the laws of the state of New York and doing business in the city of New York. Its capital stock was fixed at $550,000 divided into 5,500 shares of the par value of $100 per share and of this amount all but $20,000 was issued. In addition debenture bonds aggregating $550,000 were authorized, all of which were issued except $20,000 retained in the treasury of the corporation for future use. The bonds and stocks were issued to the organizers of the corporation, each of whom held, dollar for dollar, equal amounts of bonds and of stock.

By agreement, made part of the bonds, it was provided that 'bonds' and stock should be inseparable and that on any sale of 'bonds' an equal amount of stock should go with them. The right to sell or dispose of the bonds and stock held by any member of the corporation was limited to a sale to the other members in the manner provided by the agreement, and it was required that on the retirement of any member, for any reason, his bonds and stock should be sold to the other members at the book value of the bonds or else that the corporation should be dissolved and liquidated.

On November 1, 1909, Bernard Rothenberg was the holder of a 'bond' of the Fechheimer Fishel Company for $50,000 and a like amount of its stock and was also treasurer of the company. On that date he indorsed in blank and delivered to the company the 'bond' and the certificate for the stock and received from the company a note for $50,000, dated November 1, 1909, payable two years after date, with interest at 6 per cent. per annum, payable semiannually. He also received an agreement by the company to pay him an additional 2 per cent. per annum so as to make the interest on the note equal to the interest on the bond. This agreement was not actually dated or delivered until January, 1910, but was apparently part of the same transaction in which the note was given. This note was entered by Rothenberg himself in the company's bills payable book, but on the last page, and not where such an entry would naturally appear. The bond and stock were put, in an envelope marked with Rothenberg's name, in the company's safe. The bond was never canceled in the manner customary when bonds were surrendered. On August 9, 1911, this note was renewed by a new note for the same amount, payable November 1, 1912, accompanied by a similar agreement for the payment of additional interest. This is the note on which the claim is made. The Fechheimer Fishel Company was adjudicated bankrupt.

It was contended by the trustees in bankruptcy and held by the referee and by the court below:

First, that the so-called 'bonds' were in reality merely a form of preferred stock and as such subject to the general rules of law applicable to a corporation's purchase of its own stock.

Second, that the corporation had no right to buy its own stock unless it was possessed of net profits sufficient to pay therefor without diminishing the fund upon which creditors had a right to rely.

Third, that the claimant was bound by the terms of the 'bond' or stock and could not receive any payment in advance of general creditors.

Colby & Goldbeck, of New York City (Edward D. Brown, of New York City, of counsel), for appellant.

Louis F. Doyle and Joseph M. Proskauer, both of New York City, for trustees in bankruptcy.

Before LACOMBE, WARD, and ROGERS, Circuit Judges.

ROGERS Circuit Judge (after stating the facts as above).

It is necessary in the first place to determine the real nature of the so-called 'debenture bonds' which this corporation issued. The courts have determined that the fact that an instrument is called a 'bond' is not conclusive as to its character. It is necessary to disregard nomenclature and look to the substance of the thing itself. The distinguishing feature of a bond is that it is an obligation to pay a fixed sum of money with stated interest. The distinguishing feature of stock is that it confers upon its holder a part ownership of the assets of the corporation and gives him a right to participate in the management of the corporation and to share in the surplus profits and on dissolution to share in the assets which remain after the debts are paid.

The 'debenture bonds' involved in this case provide on their face as follows:

'This bond is issued subject to and with the benefit of the terms and conditions endorsed thereon, which are deemed part of it.'

Among the conditions so indorsed on the bonds was the following:

'All the bonds of said series A are to be subordinate to the claims of the general business creditors of said company, and upon liquidation or dissolution of said company or upon the final distribution of its assets, such creditors shall be entitled to priority of payment in full over said bonds.'

Another condition indorsed on the bonds provides that the said debenture bond shall be entitled to receive out of the earnings interest at the rate of 8 per cent. per annum before any dividend shall be set apart or paid on the stock of the company, and that such interest shall be cumulative. It is also provided that, upon the liquidation or dissolution of the company's business or the final distribution of its assets, the said debenture bonds shall after payment of the debts of the company be entitled to the whole residue of the company's assets. All these features are quite characteristic of stock. They are not at all characteristic of bonds. And we are satisfied that no error was committed by the court below in holding that these so-called 'bonds' were in effect preferred stock. Burt v. Rattle, 31 Ohio St. 116; Hilson Co. v. State Board of Assessors, 82 N.J.Law, 2, 80 A. 929; Cass v. Realty Securities Co., 148 A.D. 96, 132 N.Y.Supp. 1074, affirmed 206 N.Y. 649, 99 N.E. 1105.

The bond for $50,000 which Rothenberg surrendered to the company on November 1, 1909, being in effect preferred stock of the company, the transaction was therefore a purchase by the company of its own stock and payment therefor by the issue of its own note, which, after renewal, matured when the company was insolvent. We are thus led to inquire whether the company had the right to purchase the stock and, if so, under what conditions.

The courts are not at all agreed concerning the right of a corporation to purchase its own stock.

The view that a corporation cannot buy its own stock without an express grant is based on the following grounds:

1. That corporations cannot increase or diminish their capital stock without the sanction of the Legislature.

2. That such a transaction is a fraud upon creditors.

3. That it is foreign to the purposes for which the corporation was created.

In England the courts, in a long and unbroken line of decisions, have held that a corporation, unless expressly authorized to do so, cannot purchase its own stock. The leading case in that country upon the subject was decided in the House of Lords in 1887, Trevor v. Whitworth, L.R. 12 App.Cas. 409.

In the United States the courts of some of the states have followed the English rule. But the clear weight of authority upholds the right of a corporation to buy its own stock if the purchase is made in good faith and does not prejudice the rights of creditors. Cook on Corporations, vol. 1 (7th Ed.) Sec. 311.

The text-writers have arrayed themselves generally on the side of the English rule. Thompson on Corporations says, in volume 2, Sec. 2054:

'The rule which forbids a corporation thus to employ its funds rises to the grade of a rule of public policy; and is so strong that although power is conferred upon the company to deal in the shares of joint-stock companies generally, this does not authorize it to deal in its own shares.'

Machen on Modern Law of Corporations says, in volume 1, Sec. 628:

'In America, many courts uphold the same sound and wholesome doctrine as the English cases. But it must be conceded that a somewhat larger number of the American courts have taken the view that a corporation may without express statutory authority purchase its own shares, provided the purchase is entered into bona fide and does not endanger the claims of creditors. It should be observed that the American cases which agree with the English doctrine are often well considered and fully reasoned, whereas those which uphold the contrary view generally lack any extended examination of the subject.'

Mr. Morawetz, in his work, says in volume 1, Sec. 112:

'No verbiage can disguise the fact that a purchase by a corporation of shares in itself really amounts to a reduction of the company's assets, and that the shares purchased do in fact remain extinguished, at least until the reissue has taken place. The fact that such a transaction may not necessarily be injurious to any person is not a sufficient reason for supporting it. It is contrary to the fundamental agreement of the shareholders, and is condemned by the plainest dictates of sound policy. To allow the directors to exercise such a power would be a frightful source of unfairness, mismanagement, and corruption. It is for these reasons that a shareholder cannot be allowed to withdraw from a corporation with his proportionate amount of capital, either by a release and cancellation before the shares have been paid up, or by a purchase of the shares with the company's funds.'

We have referred to the opinions of these writers because we think that, in recognizing the right of a corporation to buy its own stock, they indicate the necessity of confining the right to purchase within strict limits. Indeed, the dangers incident to...