The First National Bank of Chanute v. Northup

• Decision Date: 11 June 1910
• Docket Number: 16,553
• Citation: 109 P. 672,82 Kan. 638
• Parties: THE FIRST NATIONAL BANK OF CHANUTE, Appellee, v. G. L. NORTHUP et al., Appellants
• Court: Kansas Supreme Court

109 P. 672

82 Kan. 638

THE FIRST NATIONAL BANK OF CHANUTE, Appellee, v. G. L. NORTHUP et al., Appellants

No. 16,553

Supreme Court of Kansas

June 11, 1910

Decided January, 1910.

Appeal from Neosho district court; OSCAR FOUST, judge pro tem.

Judgment affirmed.

SYLLABUS

SYLLABUS BY THE COURT.

1. CORPORATIONS -- Liability of Stockholders -- Shares Nominally Paid Up -- Notice to Creditors. Where at the time of the organization of a corporation stock is issued at a discount, less than par being received for shares that are nominally paid up, the company agreeing that no further payment shall be demanded, the ordinary rule is that the stockholder assumes a liability, so far as is necessary for the protection of creditors who have become such without notice of such arrangement, up to the point where his total contribution to the corporate funds equals the face value of his stock.

2. CORPORATIONS -- Liability of Holders of Shares Issued for Property Worth Less than Face Value of Stock. Where stock purporting to be fully paid up is issued in exchange for property that the parties to the transaction agree is worth a fixed amount, which is less than the face of the stock, creditors of the corporation have a right to look to the stockholder to the same extent as though he had obtained his stock by the payment in cash of the amount so agreed upon.

3. CORPORATIONS -- Same. Where the stockholders of a corporation agree that a new corporation shall be formed, to which shall be transferred a part of its property, in return for a division of the capital stock of the new company among the members of the old one, in proportion to their interest therein, and further agree that the property is worth a stated amount and that anyone not caring to receive stock shall be paid in cash on that basis, and this arrangement is carried out, the holders of stock so acquired are liable to corporate creditors to the same extent as though they had paid cash therefor on the basis of such valuation.

4. CORPORATIONS -- Notice to Corporation -- Knowledge of Officer Having a Personal Interest. Where a bank has lent money to a corporation the stock of which is nominally but not actually paid in full, its right to look to the stockholders for repayment to the extent to which they have not paid the face value of their stock is not defeated by the fact that the president of the corporation, having a substantial pecuniary interest therein, was also the cashier of the bank, and acted for both parties in the negotiation of the loan, without communicating to any other officer of the bank his knowledge that the stock had been issued at a discount.

H. P Farrelly, and T. R. Evans, for the appellants.

James W. Reid, and John J. Jones, for the appellee.

OPINION

MASON, J.:

The First National Bank of Chanute obtained a judgment against the West Plant Oil Company, a corporation organized under the laws of Arizona. Not being able to realize upon the judgment otherwise, it sued a number of stockholders, basing its claim against them upon the ground that they had not paid to the corporation the face value of their shares. It obtained judgment against the defendants and they appeal.

The facts material to the questions presented, as found by the court, were these: The Kansas Vitrified Brick Company, a corporation capitalized at $ 50,000, had among its assets a number of oil-and-gas leases. Its members concluded that this property could be handled to better advantage by a separate company. They therefore organized the Arizona corporation for this purpose, taking out a charter fixing the capital stock at $ 1,000,000. The brick company transferred to the oil company the property referred to, by an instrument reciting a consideration of $ 25,000, and the oil company in payment therefor issued all its stock to the shareholders in the brick company, in proportion to their respective holdings therein. The certificates for the stock thus issued recited that it was fully paid and nonassessable. The stockholders of the brick company agreed among themselves that the property so transferred was worth $ 25,000, and that any who did not care to accept stock in the new company should receive cash in lieu thereof on that basis. The oil company never received any other payments from its stockholders. Its actual invested capital was the property for which its stock was issued. It borrowed $ 10,000 from a bank which was afterward merged in the plaintiff bank, a new note being taken for the amount, which was the basis of the judgment sought to be collected in this action. The president of the oil company, being the owner of a substantial amount of its stock, was the cashier of the bank that lent the money and the president of the plaintiff bank when the renewal note was taken. In each capacity he engaged daily in the conduct of the banking business. He acted for each bank in these transactions, as well as for the oil company. He knew that the corporation's stock had not been paid for at its face value, but no other officer of either bank had knowledge of that fact.

The defendants claim that since their stock was issued as fully paid they owed the oil company nothing, and hence were not liable to its creditors for the payment of its debts; that if any such liability existed it could only be with respect to credit extended on the faith of the capitalization stated in the charter, and that the plaintiff's loan was not of that character, since the bank's officer, who was active in making it, knew all about the facts in the case.

Where at the time of the organization of a corporation stock is issued at a discount, less than par being received for shares that are nominally paid up, the company agreeing that no further payment shall be demanded, the general rule is that so far as is necessary for the protection of creditors the stockholder assumes a further liability up to the point where his total contribution to the corporate fund equals the face value of his stock. (10 Cyc. 460, 461; 4 Thomp. Corp., 2d ed., §§ 3902, 3911; 1 Cook, Corp., 6th ed., §§ 42, 45; 8 L.R.A. N.S. 263, note.) Where the stock is issued for property, the authorities differ; some follow what has been called the "true value" rule--that is, that the creditors' rights are the same as though the corporation had received, instead of the property, its actual value in money; others adopt the "good faith" rule--that is, that in the absence of fraud the stockholder can not be held liable for any further payment, however greatly the property may have been overvalued. (10 Cyc. 473; 4 Thomp. Corp., 2d ed., §§ 3975, 3976.) The overvaluation, if gross, has been held to be evidence of fraud; if intentional, to be proof of it. (4 Thomp. Corp., 2d ed., §§ 3978, 3979. See, also, 42 L.R.A. 593, note; 23 C. C. A. 315, 326, 332-334, note; 1 Cook, Corp., 6th ed., §§ 46, and note 2, p. 165.) In the work last cited the modern tendency is represented as being against holding the stockholder liable, the author saying:

"During the past thirty years there has been a vast amount of litigation on this subject. The courts still disagree in their conclusions, but a careful study of the cases will show that upon authority as well as principle the stockholders can not be held liable in such a case. . . . This principle of law, that there is no liability on stock issued for property the value of which is less than the par value of the stock, seems a self-evident principle of law. Moreover, this principle is based on business usage and is sound practice. There is no more harm in the issue of stock below par than there is in the issue of a note or bond below par. The extent to which the courts have gone in sustaining such issues of stock for property is shown by the fact that even constitutional and statutory prohibitions against watered stock have been practically construed away by the courts. Moreover, the laws of trade are more powerful than the laws of men, and in business circles it has become customary to capitalize property at a reasonably high figure. This is due to the fact that it is easier to sell stock at less than par than at par, and also to the fact that, by a large capitalization, dividends are kept low enough to avoid the cupidity of possible competitors and the interference of legislatures. To such an extent is this practice carried of issuing stock for property at an overvaluation that the investing public and persons who give credit to corporations rather expect it, and they no longer rely upon the nominal capitalization of the company. Experience has taught them that they must investigate the real financial condition of the company, and invest or give credit upon that alone." (1 Cook, Corp., 6th ed., § 46.)

In the present case, if we were required to apply the "good faith" rule, there would seem to be little difficulty in saying that the exchange of the property for a stock issue of $ 1,000,000 involved an overvaluation that was both gross and intentional. But the case is hardly one of overvaluation. The amount recited as the consideration for the transfer ($ 25,000) appears to have been the valuation fixed by the persons concerned. This is shown by the fact that the stockholders of the old company who preferred not to become members of the new one were to be paid out on that basis. The real transaction amounted to an agreement to issue stock at 2 1/2 cents on the dollar, and the acceptance of the property in lieu of cash on those terms, at a valuation of $ 25,000. The contention of the. defendants that their stock was in fact fully paid for must therefore fail.

Inasmuch as the holder of stock which is issued as fully paid owes nothing to the corporation (19 L.R.A. N.S. 115, note) any liability to creditors must be founded...