Long v. Rike

• Decision Date: 11 June 1931
• Docket Number: No. 4375.,4375.
• Parties: LONG v. RIKE et al.
• Court: U.S. Court of Appeals — Seventh Circuit

50 F.2d 124 (1931)

LONG v. RIKE et al.

No. 4375.

Circuit Court of Appeals, Seventh Circuit.

May 5, 1931.

Rehearing Denied June 11, 1931.

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C. R. Latham, W. T. Alden, H. P. Young, Chas. Martin, and H. C. Lutkin, all of Chicago, Ill., for appellant.

Horace Kent Tenney, of Chicago, Ill., Lee Warren James, of Dayton, Ohio, and Charles F. Harding and S. Ashley Guthrie, both of Chicago, Ill., for appellee Frederick H. Rike.

Frank H. Scott, Leland K. Neeves, Harold D. Burgess, and John E. MacLeish, all of Chicago, Ill., for appellee Ethel L. Rike and others.

Tappan Gregory, of Chicago, Ill., for appellee Susanne Rike.

Before ALSCHULER, EVANS, and SPARKS, Circuit Judges.

SPARKS, Circuit Judge (after stating the facts as above).

The present appeal is from the decree last mentioned, and the questions involved are: (1) Upon the liquidation of the trust stock, did all of the proceeds constitute corpus of the trust estate, or did the portion of such proceeds which represented the accumulated and undistributed earnings and the intangible value or earning power that accrued to the trust stock because of the retention of the earnings of the company in its business constitute income to the estate distributable as such under the will? (2) If, under the facts, corporate action was necessary to preserve the interest of appellant as life tenant in the accumulated and undistributed earnings of the company, the trustee having wrongfully refused and neglected to take adequate measures to protect her interest, will a court of equity grant relief by decreeing an equitable division of the proceeds of the sale of stock?

In discussing this subject it is well to bear in mind that the testator did not by his will attempt to dispose of any of the assets of the Long Manufacturing Company. This he could not have done had he so desired, for he owned no part of them. Gibbons v. Mahon, 136 U. S. 549, 10 S. Ct. 1057, 34 L. Ed. 525. His interest in that company consisted merely of shares of stock. The will operated upon testator's estate and its income, and not upon the assets or the earnings of the company as such. It is quite true that the assets of the estate consisted almost entirely of stock in the company, and the income of the estate came almost entirely, if not wholly, from the earnings of the company; yet the terms "earnings of the company" and "income of the estate" should not be used interchangeably, for the earnings of the company are not to be classified as income of the estate, nor do they come under the operation of the will until they come into the estate.

It is not controverted that the directors of a corporation, so long as they act honestly and in good faith, have the sole power to determine what dividends shall be declared and what part of its earnings shall be retained and used in the maintenance and development of its business. Gibbons v. Mahon, 136 U. S. 549, 10 S. Ct. 1057, 34 L. Ed. 525; De Koven v. Alsop, 205 Ill. 309, 68 N. E. 930, 63 L. R. A. 587; Minot v. Paine, 99 Mass. 101, 96 Am. Dec. 705; Wilberding v. Miller, 88 Ohio St. 609, 106 N. E. 665, L. R. A. 1916A, 718; Id., 90 Ohio St. 28, 106 N. E. 665, L. R. A. 1916A, 722. In the instant case it was found, as a matter of fact, by the trial court that the directors were not guilty of fraud or bad faith in the management of the company's affairs, but, on the other hand, that their management was most excellent, and that their actions were fully warranted by the existing conditions and abundantly justified by the results. The company was in a precarious situation when Rike, as president, undertook its management, and paid small dividends during the first few years, some of which were not wholly earned. The company had no money with which to enlarge its plant and increase its facilities, which was indeed necessary not only for the success but for the existence of the company. By conserving its earnings it was possible to accomplish the necessary expansion, meet the vigorous competition which existed, and enable the company to prosper. In order to make its progress permanent it was deemed wise by the directors to accumulate a substantial surplus out of the earnings, and this surplus was used for plant expansion, improvement of equipment, and as working capital, but in no greater degree than was necessary. Enormously increased dividends were paid as the company prospered, in which appellant, as life tenant, shared pursuant to the provisions of the will. Her income was not only increased, but the investment itself, as time went on, was made more secure.

Thus, up to the time the stock was sold and the interest of the estate in the proceeds was paid to the trustee, it cannot be and is not contended that either the executor of the will, or the trustee, or the beneficiaries under the will, had any authority over or direct interest in the undivided earnings of the company; nor, up to that time, could the undivided earnings be considered as income of the estate. The stock having been sold, however, and the estate's interest in the proceeds having been paid to the trustee, it is appellant's contention that, as between her and the remaindermen, the court should now take an account of all the earnings of the company and of the increased value of the estate, and determine the separate amounts of corpus and income with relation to the estate. The controversy is entirely as to how, if at all, the proceeds of the sale of the stock shall be distributed to the life tenant and the remaindermen.

Appellant divides these proceeds into three classes: First, that representing the capital stock at par, to which she makes no claim; second, the difference between the capital stock at par and the book value of the 1,960 shares held by the trustee at the time of the sale, which she contends should be divided between her and Mrs. Rike on the ground that it represents accumulated and undistributed earnings; third, the intangible value or earning power of the corporation allocated to income upon the basis of the earnings accumulated and retained in the business, which she claims should be divided equally between her and Mrs. Rike.

The matter of the division of dividends, both cash and stock, between life tenants and remaindermen, has been before the courts of this country many times, and as a result three different rules have been enunciated, and, broadly stated, they are as follows: The Kentucky rule makes no distinction between cash and stock dividends, and considers the time of the declaration of the dividend as the basis of the rule. If declared out of surplus earnings during the existence of the trust, it is income; but, if prior to the trust, it is corpus. This rule is followed by Delaware, and was followed in New York prior to 1913. The Pennsylvania rule, considering the source of the dividend as its basis, holds that extraordinary dividends from corporate earnings, whether paid in cash or stock, should be apportioned between the life tenant and the remainderman in accordance with the amount thereof accumulated before and after the creation of the life estate. This rule has been followed in California, Iowa, Maryland, Minnesota, Mississippi, New Hampshire, New Jersey, South Carolina, Tennessee, Vermont, and Wisconsin. It was also followed in New York from 1913 to 1926. The Massachusetts rule considers the character of the dividend as its basis, and regards all cash dividends, however large, as income, and all stock dividends as corpus. This rule has been followed by the Supreme Court of the United States, Connecticut, Georgia, Illinois, Maine, Missouri, North Carolina, Ohio, Virginia, and West Virginia; and in 1926 New York adopted it by statutory enactment (N. Y. Laws 1926, c. 843).

It is true that the cases decided under these rules by the various courts named dealt with the distribution of dividends, and with that particular form of assets we are not concerned in the instant case, for neither cash nor stock dividends are here involved. For this reason appellant contends that the cases cited by appellees are not decisive of the questions presented here, and are applicable only in cases where dividends have been declared. On the other hand, appellees urge that the Massachusetts rule and the cases supporting it, which the trial court followed, not only hold that stock dividends are corpus, but that undivided earnings are likewise to be considered as corpus when invested in good faith in capital.

If the Supreme Court of Illinois has adjudicated the question now before us, it is our duty to follow that construction, inasmuch as we are dealing with the assets of an Illinois estate, under the provisions of a will of a citizen of that state, by virtue of a trust which is being administered in that state.

The Massachusetts rule was first enunciated in 1868, in the case of Minot v. Paine, 99 Mass. 101, 96 Am. Dec. 705. In that case shares of stock in a railroad corporation were held by the trustee under a will to pay over the net income to the life tenant, with remainder in fee to others. In addition to cash dividends which had been declared, a stock dividend of 20 per cent. was declared, and the trustee received the shares of stock representing it, which he sold at a profit above par. The question presented was whether the stock dividend was to be treated by the trustee as income belonging to the life tenant, or as capital to be kept for the legatees of the stock in remainder and of which the life tenant would be entitled to receive the income during her life. The court said:

"The net earnings of a railroad corporation remain the property of the company as fully as its other property, till the directors declare a dividend. A shareholder has no title to them prior to the dividend being declared. In most of our prosperous railroad corporations, the directors apply a considerable...