Lehigh Structural S. Co. v. Commissioner of Int. Rev.

• Decision Date: 27 March 1942
• Docket Number: No. 7852.,7852.
• Citation: 127 F.2d 67
• Parties: LEHIGH STRUCTURAL STEEL CO. v. COMMISSIONER OF INTERNAL REVENUE.
• Court: U.S. Court of Appeals — Third Circuit

127 F.2d 67 (1942)

LEHIGH STRUCTURAL STEEL CO. v. COMMISSIONER OF INTERNAL REVENUE.

No. 7852.

Circuit Court of Appeals, Third Circuit.

Argued January 9, 1942.

Decided March 27, 1942.

Floyd F. Toomey, of Washington, D. C. (Ellsworth C. Alvord, of Washington, D. C., on the brief), for petitioner.

Newton K. Fox, Sp. Asst. to Atty. Gen. (Samuel O. Clark, Jr., Asst. Atty. Gen., and J. Louis Monarch, Sp. Asst. to Atty. Gen., on the brief), for respondent.

Before BIGGS, MARIS, and JONES, Circuit Judges.

MARIS, Circuit Judge.

Lehigh Structural Steel Company, the petitioner, is a Delaware corporation, having its principal office in Pennsylvania. In 1920 the petitioner's certificate of incorporation was amended to authorize the issuance of 5,000 shares of preferred stock bearing an 8% dividend rate. The amended certificate of incorporation and the share certificates contained the following provision:

"A sinking fund for the retirement by purchase of the preferred stock shall be created out of the net profits that shall remain after deducting therefrom any accrued dividends on the preferred stock, and for this purpose there shall be credited to an account to be called the preferred stock sinking fund account on January 1, 1922, and at the beginning of each calendar year thereafter out of the remaining net profits of the previous calendar year after providing for the payment of the full dividend for such year and unpaid dividends for previous years or year on the preferred stock until the whole of the preferred stock issued and outstanding shall have been purchased or retired, the sum equivalent to 5% of the outstanding preferred stock at the beginning of the preceding calendar year before any dividends shall be paid upon any other stock. * * *"

In 1933 a plan was proposed to the preferred shareholders by the petitioner's Board of Directors to reduce the fixed capital charges by redeeming 20 percent of the outstanding preferred stock and by reducing the dividend rate on the balance from 8% to 6%. This plan was approved by the preferred shareholders. In the same year the charter was amended authorizing the new preferred stock. The shares were issued in accordance with the plan and the amended charter. The charter as amended and the new 6% preferred stock certificates contained a provision concerning the sinking fund identical with the one which we have quoted. In 1936 and 1937 the petitioner transferred to the preferred stock sinking fund out of its annual earnings amounts equal to 5% of the preferred stock outstanding in those years. The petitioner's accumulated surplus on December 31, 1935, exceeded its adjusted net income for 1936 and its accumulated surplus on December 31, 1936, exceeded its adjusted net income for 1937. In its income tax returns for the taxable years 1936 and 1937 the petitioner determined the surtax due upon its undistributed net profits by taking credit for so much of its profits for those years as it had paid into the sinking fund for the retirement of its preferred stock. The Commissioner ruled that the petitioner was not entitled to take the claimed credits and assessed a deficiency. The Board sustained the assessment. 44 B.T.A. 422.

Section 14 of the Revenue Act of 1936 imposes a surtax upon corporate undistributed profits, 26 U.S.C.A. Int.Rev.Acts, page 823. Section 26(c)(1) of the Revenue Act of 1936, 26 U.S.C.A. Int.Rev.Acts, page 836,¹ permits the corporation to compute its undistributed net income by taking credit for so much of the income as it is prohibited from paying its stockholders in the form of dividends by "a provision of a written contract executed by the corporation prior to May 1, 1936, which provision expressly deals with the payment of dividends."

The petitioner claims the credit by virtue of the provision for the payment into the sinking fund of income which would otherwise be paid out as dividends to the owners of the common stock. It is undisputed that the certificates are in writing, that they were executed by the petitioner prior to May 1, 1936, and that they expressly prohibit the payment of dividends to the holders of the common stock until a certain portion of the petitioner's net income has been paid into the preferred sinking fund. The sole question is whether the certificates are "contracts" within the meaning of Section 26(c)(1) of the Revenue Act of 1936.

A certificate of stock is primarily the evidence of the stockholder's ownership of an interest in the corporation. Baker v. Bankers Mortgage Co., 15 Del.Ch. 209, 135 A. 486; Smith v. Universal Service Motors Co., 17 Del.Ch. 58, 147 A. 247. Where the terms of the respective rights and obligations of the corporation and the stockholders are set forth in the certificate of stock it becomes also a contract between corporation and stockholder. Thus in Warren v. King, 108 U.S. 389, 396, 2 S.Ct. 789, 795, 27 L.Ed. 769, Mr. Justice Blatchford said "The rights of the holders of preferred stock in this case must be determined by the language of the stock certificate." It was squarely ruled in Geiger v. American Seeding Mach. Co., 124 Ohio St. 222, 177 N.E. 594, 599, 79 A.L.R. 614,...