Morrow v. Nashville Iron & Steel Co.

• Decision Date: 05 February 1889
• Citation: 10 S.W. 495,87 Tenn. 262
• Parties: MORROW v. NASHVILLE IRON & STEEL CO. et al.
• Court: Tennessee Supreme Court

10 S.W. 495

87 Tenn. 262

MORROW v. NASHVILLE IRON & STEEL CO. et al.

Supreme Court of Tennessee.

February 5, 1889

Appeal from chancery court, Davidson county; ANDREW ALLISON Chancellor.

LURTON J.

The Nashville Iron, Steel & Charcoal Company is a manufacturing corporation, organized in 1887, under the general incorporation law of this state. Complainant's bill charges that it was organized upon the following scheme or basis, namely: "The capital stock was fixed at $350,000 in shares of $100 each. The company was also to issue $350,000 of $1,000 negotiable interest-bearing coupon bonds to run twenty years, secured, principal and interest, by first mortgage, in the usual form, upon the company's plant. Every subscriber was to have bonds and also stock of the company, each to the amount of the subscription. That is to say, a subscriber to the amount, say of $1,000, was to pay $1,000, and therefor was entitled to and was to receive $1,000 of said bonds and $1,000 of said stock of the company." Complainant alleges that "upon this basis and plan of operations, as the defendant company well knew your orator subscribed for $10,000 of said stock and bonds each; that is, he took an interest to the extent of and subscribed $10,000, and he was to pay the said $10,000 upon calls to be made." Upon this subscription he afterwards paid $1,000, and executed his three negotiable notes, each for $3,000, and payable in March, April, and May, 1888. Subsequently the corporation refused to carry out the scheme by which subscribers were to receive bonds to an amount equal to their stock, and instead resolved to mortgage their property only to the extent of $100,000, and these bonds they resolved to sell upon the market, applying the proceeds to corporate purposes strictly. This change in the plan of operations seems to have been assented to by all of the subscribers save complainant, who caused his protest to be entered. The bill alleges that the notes executed by complainant have been transferred to the Commercial National Bank, in payment of a pre-existing debt, with notice of the considerations upon which they were executed. This charge, the case being heard upon demurrer, together with the fact that the insolvency of the iron company does not appear, justifies us, for the pur poses of this case, in treating the bank, as the holder of these stock notes, as standing upon no higher ground than the assignor. The complainant seeks to be relieved from his subscriptions upon the ground that the company has refused to carry out its agreement concerning its bonds; that his notes be canceled; and that he have a decree for the money paid in on his subscriptions. He further prays that in the event he be held liable upon his subscriptions that the contract by which he was to receive bonds be specifically performed The bank and the iron company join in a demurrer which questions the validity and legality of the contract by which the complainant was to receive the bonds of the company. This demurrer was sustained by the learned chancellor, and the bill of complainant dismissed.

In considering the meaning and legal effect of the contract set up by the complainant, it is important at the outset to observe that this is not the case of a purchase of stock and bonds, or either, in an organized and going corporation. Upon the contrary, the bill states that the contract into which complainant entered was that upon which all shares were to be issued, and that the contract between himself and the corporation constituted what the pleader properly designates the "basis of organization."

Whether this "basis of organization" be construed to be a contract whereby each subscriber to the stock was to be given a bond as a bonus, or each subscriber to the bonds was to be given paid-up stock as a bonus, or as an agreement by which each contributor to the capital stock was to receive the obligation of the company, secured by a primary mortgage, that he should be repaid the amount of his subscription, with interest, such an agreement would clearly be illegal and ineffective as to existing or subsequent creditors of the corporation, upon the ground that the payment for the stock was unreal and simulated, or that the bond had been issued upon no consideration. 2 Mor. Priv. Corp. § 824; Sawyer v. Hoag, 17 Wall. 610; Scovill v. Thayer, 105 U.S. 143.

The learned counsel for complainant has very ably and earnestly presented the well-understood distinction between contracts which are invalid as to creditors, and yet are legal and binding upon the corporation,--a distinction well illustrated by the cases just cited from the supreme court of the United States; and he insists upon the doctrine of these cases, that, however invalid such an agreement may be as against creditors, inasmuch as all the subscribers to shares were parties to the same agreement with the corporation, the arrangement and contract cannot be questioned by such stockholders or by the corporation, and that as between the subscriber and the company the agreement is legal and binding.

This presents a question of great importance, and one which is entitled to receive grave consideration at our hands. There are undoubtedly a class of cases where subscriptions to initiatory stock upon special terms, not prohibited by the charter, and not in contravention of any clearly-defined public policy, have been upon sound principles held valid as between the subscribers and the corporation, and yet invalid in so far as the rights of creditors were affected upon a condition of corporate insolvency ensuing. To this class of cases belong the cases of Sawyer v. Hoag and Scovill v. Thayer. The invalidity of the special terms upon which the contract of subscription rested in these two cases arose from the well-settled doctrine that unpaid stock subscriptions constitute a trust fund for the benefit of general creditors, and that any arrangement or device by which a payment of a stock subscription is simulated or released, is void, in so far as it operates to discharge a liability in favor of creditors by a subscriber to capital stock. In the first of these cases there was a contract whereby the stock was nominally paid in full, but immediately taken back as a loan to the subscriber. Now, the only effect of this arrangement was to work a change in the character of the debt, whereby a debt due, as for unpaid stock, was to become a debt due as for a loan. The debt in the latter case was one which was subject to offsets in the hands of the borrower, while so long as it was a stock debt it was a trust fund, and the debtor could not apply it exclusively upon his own claim against the insolvent corporation.

Concerning the validity of such an arrangement as between the subscriber and the corporation, Mr. Justice MILLER said: "Undoubtedly this transaction, if nothing unfair was intended, was one which the parties could do effectually, so far as they alone were concerned. Two private persons could thus change the nature of the indebtedness of one to the other, if it was found to be mutually convenient to do so; and in any controversy which might or could grow out of the matter between the insurance company and the appellant we are not prepared to say that the company, as a corporate body, could deny that the stock was paid in full." The court, however, held that, upon a suit by the assignee in bankruptcy of the corporation, the stock had not in fact been paid in such manner as to prevent a recovery for benefit of creditors, and the defendant was not allowed to offset his liability upon his notes given for the alleged loan to him by the company by a claim he held against the corporation.

Concerning this case, it is enough to say that the validity of the arrangement as against the company could very well be rested upon the fact that such a lending of money to the share subscriber was not prohibited by the charter of the corporation; and no public policy was violated, in that the corporation had only taken the secured notes of the subscriber in place and stead of his unsecured liability as a shareholder; or these notes stood for and represented an investment of the capital of the company, and, being an insurance company expressly permitted to lend out or otherwise invest its funds, no reason occurs why the company should not be regarded as bound by such a change in the character of the debt. The case, however, would be different if such loans, or any other, had been made by a manufacturing corporation under the general incorporation laws of this state; the lending of money to stockholders being expressly prohibited by such corporations.

In the case of Scovill v. Thayer the stock was subscribed upon an agreement that, upon the payment of 20 per cent., paid-up non-assessable certificates of stock should be issued to the nominal amount of the subscription. Mr. Justice WOODS, speaking for the court, said, concerning this contract, "that as between them and the company this was a perfectly valid agreement. It was not forbidden by the charter, or by any law or public policy, and as between the company and the stockholders was just as binding as if it had been expressly authorized by the charter."

When he came to consider the matter as it affected creditors, he said: "But the...