Lich v. United States Rubber Co.

• Decision Date: 03 July 1941
• Parties: LICH v. UNITED STATES RUBBER CO.
• Court: U.S. District Court — District of New Jersey

39 F. Supp. 675

LICH v. UNITED STATES RUBBER CO.

District Court, D. New Jersey.

July 3, 1941.

COPYRIGHT MATERIAL OMITTED

Besson & Applegate, of Hoboken, N. J. (John B. Applegate, of Hoboken, N. J., and Charles A. Lich, of St. Louis, Mo., of counsel), for plaintiff.

Pitney, Hardin & Skinner, of Newark, N.J. (Waldron M. Ward and Mahlon Pitney, both of Newark, N. J., of counsel), for defendant.

SMITH, District Judge.

The plaintiff, Sophia G. Lich, a holder of non-cumulative preferred stock of the defendant, United States Rubber Company, a corporation, seeks to enjoin the payment of a dividend on the common stock declared on March 5, 1941. The facts, which are undisputed, are fully set forth in the findings of fact, separately filed. The essential facts are restated herein for the purpose of discussion.

The defendant is a corporation organized and existing under the laws of the State of New Jersey, having been originally incorporated in 1892 under an act entitled "An Act concerning corporations," approved April 7, 1875, Revision 1877, p. 175, and, acts amendatory thereof and supplementary thereto. The plaintiff is, and was during the years in question, the holder of three hundred shares of non-cumulative preferred stock of the defendant.

In each of the fiscal years (the fiscal year conforming to the calendar year) of 1935, 1936, and 1937, the annual net earnings of the defendant were $2,231,377.69, $10,172,484.46, and $8,607,902.92, respectively; in each of the said years, however, there was a deficit of $25,870,402.67, $17,204,158.52, and $10,471,626.89, respectively, and a corresponding impairment of capital. The deficit, representing the accrued losses of prior years, existed in 1934 and was carried over into the succeeding years, varying in each year only as to amount. It definitely appears that in each of the said years the annual net earnings were applied to the deficit, thereby effecting substantial reductions. There were no dividends declared on either the preferred or the common stock during the said fiscal years.

The defendant, in 1938, pursuant to and in accordance with the statute,¹ reconstructed its capital structure. There was issued, in lieu of the outstanding common stock of no par value, common stock of the par value of $10. This reconstruction reduced the capital liability and created a capital surplus, which was applied to the then existing deficit, resulting in its cancellation. Thereafter, in the years 1938, 1939, and 1940, the deficit having been cancelled, the annual net earnings for each of the said years were productive of net profits and were available for the declaration and lawful payment of dividends; in each of the said years dividends on the non-cumulative preferred stock were declared and paid in full. No dividends, however, were declared on the common stock.

On March 5, 1941, the defendant declared a dividend, payable on April 30, 1941, on both the preferred and common stock. This declaration of dividends, which is herein questioned, specifically contemplates payment from the net profits of the current year and from no other fund.

It is to be noted that in the years in question, to wit, 1935, 1936, and 1937, the defendant, despite the deficit, maintained adequate reserves. These reserves were maintained both prior and subsequent to the said period. It is to be further noted, however, that the present declaration of dividends does not direct invasion of the reserves for payment; the reserves are maintained intact.

The preferential rights of all preferred stockholders, including the plaintiff, as stated in the certificate of incorporation and embodied in the certificate of stock issued thereunder, are as follows: "The holders of First Preferred Stock shall be entitled to receive semi-annually or quarterly all net earnings of the Company determined and declared as dividends in each fiscal year up to but not exceeding eight per centum per annum on all outstanding First Preferred Stock before any dividend shall be set apart or paid upon any other stock of the Company. Such dividends upon the First Preferred Stock shall not be cumulative and the First Preferred Stock shall not be entitled to participate in or to receive any profits or earnings other than, or additional to, such non-cumulative eight per cent, dividends. * * *."

The preferences are in conformity with the statute and, as therein permitted, the dividends are declared non-cumulative.

It is the contention of the plaintiff that the established preference as to dividends, to wit, priority of payment, extends not only to the current year, but to the prior years of 1935, 1936, and 1937, to the extent of the annual net earnings of the said years; and, that dividends may not be paid on the common stock at this time until the dividends are paid on the preferred stock for the years in question, either in full or in proportion to the annual net earnings of those years. It is urged that an inchoate right to dividends attached to the annual net earnings of the said years and that the arrearages must be paid in full to the holders of the non-cumulative preferred stock before there can be any payment of dividends on the common stock even out of current net profits.

It is conceded that the rights of stockholders, both common and preferred, are dependent upon, and must be determined under, the law of the corporate domicile. The plaintiff relies upon the doctrine enunciated in the following cases: Bassett v. United States Cast Iron Pipe & Foundry Co., 75 N.J.Eq. 539, 73 A. 514; Day v. United States Cast Iron Pipe & Foundry Co., 95 N.J.Eq. 389, 123 A. 546, affirmed 96 N.J.Eq. 736, 126 A. 302. The doctrine is not disputed. The principal question presented for determination is its applicability to the instant case. The question requires a full discussion of the cited cases.

In the Bassett case the corporation accumulated from the net profits for the years 1900 to 1904, inclusive, a fund which was designated as "reserve for additional working capital." A substantial portion of the fund thus accumulated represented net profits withheld from non-cumulative preferred stockholders and retained in the business, but otherwise available for the payment of dividends. Thereafter, in a succeeding year, there was a declaration of dividends on the preferred stock; the said declaration of dividends contemplated payment out of the accrued net profits. A common stockholder sought to enjoin the payment of the dividends. He argued that the right of the holders of non-cumulative preferred stock to share in the undistributed net profits was lost on the passing of the fiscal year in which the net profits were earned.

The court in determining the relative rights of preferred and common stockholders stated: "It seems to us that neither the contention of the complainant nor that of the defendant is altogether sound. On the one hand, the corporation has no right to accumulate a reserve fund from earnings which would otherwise be paid out as dividends to the holders of common stock, and afterward use it to pay dividends to the preferred stockholders, when the net profits of the year for which the dividend is declared are not sufficient for that purpose. On the other hand, when the reserve fund is accumulated, in whole or in part, by the cutting down of dividends which would otherwise have been paid to preferred stockholders, that fund, so far as it represents moneys so retained, is available for the payment of subsequent dividends upon the preferred stock. To yield to the contention of the complainant would be to permit the directors of the corporation to defraud the preferred for the benefit of the common stockholders; while to sanction the claim of the defendant would be to put it in the power of the directors to defraud the common for the benefit of the preferred stockholders. * * * So far as that fund is made up from monies which would otherwise have been paid to the preferred stockholders, we concur in the conclusion of the vice chancellor that it is available for the purpose of paying the dividend which is the subject-matter of this controversy."

In the Day case, 95 N.J.Eq. 389, 123 A. 546, the facts were substantially the same as in the Bassett case. The net profits of prosperous years were withheld from both the common and preferred stockholders and were transferred to a fund designated as "Working Capital Reserve." Thereafter, in a succeeding year, dividends were declared on both the common and preferred stock; the said declaration of dividends contemplated payment out of the fund thus accumulated. Day, a non-cumulative preferred stockholder, sought to enjoin the payment of the dividends on the common stock; he contended that dividends could not be paid on the common stock until all of the "withheld profits" applicable to the dividends on the non-cumulative preferred stock had been paid. Moran, a common stockholder, in the same suit, sought to enjoin the payment of dividends on the non-cumulative preferred stock.

The Court of Chancery, in passing on the specific question thus presented, restated the doctrine as follows: "It will be observed that section 18 provides not only that preferred stockholders shall be entitled to receive, and the corporation shall be bound to pay, a fixed yearly dividend, but also declares that such dividend shall be paid `before any dividend shall be set apart or paid to the common stock.' The quoted language is unmistakable and the reason for it is aptly demonstrated in the present effort of the board of directors to favor the common stock at the expense of the preferred stockholders. While the statute says that the preferred stockholders shall be entitled to receive and the company shall be bound to pay a fixed yearly dividend out of the profits, when that obligation is to be performed is largely a matter of discretion with the directors. They are at liberty to pass dividends year after year and pile up...