Kleinberg v. Schwartz

• Decision Date: 05 April 1965
• Docket Number: No. A--211,A--211
• Citation: 87 N.J.Super. 216,208 A.2d 803
• Parties: Paul R. KLEINBERG, etc., Plaintiff-Respondent, v. Arthur SCHWARTZ et al., Defendants-Appellants.
• Court: New Jersey Superior Court — Appellate Division

Page 216

87 N.J.Super. 216

208 A.2d 803

Paul R. KLEINBERG, etc., Plaintiff-Respondent, v. Arthur SCHWARTZ et al., Defendants-Appellants.

No. A--211.

Superior Court of New Jersey, Appellate Division.

Argued Feb. 1, 1965.

Decided April 5, 1965.

Howard T. Rosen, Newark, for appellant (Clapp & Eisenberg, Newark, attorneys, Jerome C. Eisenberg, Newark, of counsel, Arnold K. Mytelka, Newark, on the brief).

Jack L. Cohen, Newark, for respondent.

Before Judges CONFORD, KILKENNY and LEWIS.

The opinion of the court was delivered by

KILKENNY, J.A.D.

After a plenary trial in the Chancery Division, a final judgment was entered against defendant Charles Schwartz (hereinafter 'Charles') alone for the sum of $46,127.21 and in favor of plaintiff, as assignee for the benefit of creditors of Roger's Outfitters, a New Jersey corporation (hereinafter 'Outfitters'). The other defendants were not served in the action. Charles appeals from the judgment.

The trial court found that Outfitters had purchased its own shares of stock from Charles, one of its stockholders and a former director, and in paying therefor had invaded the capital of the corporation to the extent of $46,127.21, without having complied with the requirements of R.S. 14:11--5, N.J.S.A.

R.S. 14:11--5, N.J.S.A. provides that if a corporation buys its own shares of stock and uses the capital of the corporation, as distinguished from its surplus, to pay for those shares, it must retire the purchased shares and publicize the fact that its capital has been thus reduced by filing a written certificate of reduction of capital in the office of the Secretary of State and publishing the same for three weeks successively, at least once in each week, in a newspaper published in the county in which the principal officer of the corporation is located. 'In default of such publication when so required the directors of the corporation shall be jointly and severally liable for all debts of the corporation contracted before the filing of the certificate, and the stockholders shall also be liable for such sums as they may respectively receive of the amount so reduced.'

A corporation may purchase its own shares of stock and pay therefor out of surplus. The purchased shares then become treasury stock and may be reissued. When payment is made out of surplus, it is not necessary to file and publish a certificate of reduction of capital as in the case where capital is used by a corporation to purchase its own shares.

It is conceded that a certificate, such as that required by R.S. 14:11--5, N.J.S.A., was not filed or published by Outfitters. If, therefore, Outfitters purchased its own shares of stock from Charles by the use of capital, then Charles would be subject to the legal consequences, as defined in this statute.

In seeking a reversal Charles contends: (1) Outfitters was not the purchaser of his shares in that corporation, but his brother Arthur was; and (2) payments for his shares were not made out of the capital of Outfitters but out of surplus, or out of loans made by Outfitters to Arthur's corporate nominee and offset by loans made by Arthur to Outfitters.

I

The evidence supports the finding by the trial court that Outfitters was the actual purchaser of Charles' shares, regardless of the form used to screen the real transaction.

Arthur, Charles and their father, Nathan, each owned a one-third stock interest in Outfitters, a family corporation operated by them and organized in 1953. A lack of family harmony resulted in a decision that Charles and Nathan would leave the firm and Arthur alone would remain. Charles and Nathan were each to be paid $152,532 for their respective stock interests in the corporation. The payments were to be made at the rate of $500 weekly (without interest). This was the same amount as had previously been drawn weekly as salary by both Charles and Nathan from this family corporation. There was ample evidence to justify the trial court's finding that the parties anticipated that the payments for the shares would come from the funds of Outfitters.

The parties consulted their respective attorneys and accountants. Arthur's attorney drew an agreement for the purchase of the shares of Charles and Nathan. Outfitters was named therein as the purchaser. Counsel for Charles and Nathan disapproved the form of the agreement because no audit had been made of the financial affairs of Outfitters and fear was expressed as to the possible consequences of a corporation's buying its own shares. Arthur's financial advisers did not want Arthur named as the purchaser because of the income tax consequences of his drawing $1000 weekly from Outfitters to pay his brother and father, besides his own salary.

Faced with this concern as to the legal and tax consequences of using Outfitters' funds to purchase its shares of stock held by Charles and Nathan, the parties adopted the following form of agreement. They designated as purchaser of the shares of Charles and Nathan an inactive corporation, which the three of them had formed in 1953, named Rogers Credit Department Stores (hereinafter 'Credit'). This was a mere paper corporation, without any assets, bank account or business activity. Its corporate franchise tax returns always listed it as 'inactive.' All parties knew that Credit had no financial means to pay for the shares of stock. Yet, an agreement of purchase was executed on November 17, 1955 between Charles and Nathan as sellers and Credit as purchaser. Arthur and his wife signed as guarantors of performance by Credit. The agreement provided for deposit of the shares with the attorneys to be held in escrow, with delivery on performance, or a right to retake the shares and resell in the event of default.

All payments on account of the purchase of the shares came thereafter from the funds of Outfitters. From November 1, 1955 to about July 1956 the payments of $500 weekly to Charles and Nathan were in the form of checks drawn by Outfitters directly to the order of Charles and Nathan, respectively. From July 1956 to the time of the last payment on February 12, 1959 Outfitters' checks for this purpose were made payable to the order of Credit and were then deposited in a checking account which had been opened in June 1956 in Credit's name solely for the purpose of acting as a conduit for transmittal of checks of equal amount issued in the name of Credit as drawer to the order of Charles, in payment for his shares. This new setup was contemporaneous with the death of Nathan and a change of accountants by Outfitters.

This new procedure included the last payment to Charles in 1959, when Outfitters issued its check to Credit for $39,000, which Credit deposited in its account, after which Credit issued its check to Charles for $39,000. This payment represented the full balance of the purchase price receivable by Charles and was made under a prepayment discount provision in the agreement. Credit closed its checking account on March 4, 1959, after this last check cleared. The remaining balance of $121.92 in the account was transferred to Outfitters.

The expenditures of Outfitters' funds in satisfaction of the purchase price of the shares were reflected in different forms on the books and in the records of the company, depending upon who acted as accountant at the particular time. In the beginning, the bookkeeper for Outfitters entered the $500 weekly payments in Outfitters' books with the notations 'stock purchase' or 're-purchase of stock.' An existing account payable to Arthur on the books of the company was, during that period, reduced by the amount of these $500 payments. From July 1956 on, the book entries reflected the checks payable to Credit as an account receivable from Credit, without any diminution bookwise in the account payable to Arthur. There was some testimony that Credit was also charged bookwise with the payments originally made directly by Outfitters to Charles and Nathan, and this sum was added back to the amount 'due to stockholders' (Arthur), which had previously been reduced.

There were testimony and notations in the records that Outfitters held an informal option to purchase the shares of Charles and Nathan, and the trial court found that to be a fact.

Despite the forms in which the parties cast the transaction, the bald fact remains that Outfitters' money was the sole means actually employed to buy back its own shares from Charles and Nathan. Charles and the others knew that Outfitters was the contemplated source of payment. This knowledge was confirmed when Charles accepted Outfitters' checks directly for several months after the agreement. He was also aware that Credit was only an empty shell, a mere conduit for disbursement of Outfitters' funds. Charles conceded on appeal that Credit was not the real purchaser but he argues that Arthur was the purchaser. However, as Charles knew, Arthur strenuously opposed casting himself in any such role, after it was suggested that he, rather than Outfitters, be named as purchaser.

Equity looks to the substance rather than the form. Fortugno v. Hudson Manure Co., 51 N.J.Super. 482, 144 A.2d 207 (App.Div.1958); Adolph Gottscho, Inc. v. American Marking Corp., 26 N.J. 229, 139 A.2d 281; 67 A.L.R.2d 816 (1958). The same approach should be taken to effectuate the underlying policy of the statute, which is regulatory in nature. In substance, Outfitters purchased the shares. Even the attorney who represented Charles and Nathan at the time the agreement was made frankly admitted in his testimony that he was 'worried' about the final form of the transaction, but he and his clients 'took the calculated risk and went along on that basis.' He explained that the calculated risk was that Outfitters would continue to flourish and 'there would be sufficient surplus.'

The persuasive factor herein is that Outfitters' money was used without any reasonable expectation that Outfitters would ever get anything in...