CHAPTER XIII

CAPITAL STOCK

§ 105. Definition and Nature. The capital stock of a corporation is the amount fixed by the corporate charter as the sum paid in or to be paid in by the stockholders for the prosecution of the business of the corporation and for the benefit of corporate creditors. The capital stock of a corporation is to be clearly distinguished from its capital. Capital is wealth in use. It is that part of a man's stock which he expects to afford him a revenue, as defined by Adam Smith. The capital of a corporation consists of the sums paid in by the stockholders, increased by profits of the corporate business, and diminished by its losses. The capital stock of a corporation does not vary but remains fixed, although its capital may fluctuate widely in value, diminished by losses or increased by gains.

§ 106. Shares of Stock: Stockholder. The term stockholder indicates one who owns stock in a corporation and has been accepted as a member by it. He is one who owns one or more of the aliquot parts of the shares of stock into which the capital stock of the corporation is divided. He is an individual distinct and separate from the corporation in all its contracts and the transaction of its business. The corporation is the legal entity; its business is transacted in the name of the corporation and the title to its property is vested in the corporation. All rights resulting from the existence of a corporate capacity and the transaction of corporate business exclusively belong to it and are vested in the corporation as a legal person. A certificate of stock is the written acknowledgement by the corporation, under its seal, of the ownership by the person designated of one or more of the aliquot parts into which its capital stock is divided. Its possession is not necessary to constitute a

person a stockholder. It is the legal fact of ownership which establishes the relation.

Nature of Shares of Stock. Shares of stock are universally regarded as personal property, and this is true although all the property of the corporation may consist of real estate. A share of capital stock, though personal property, is not a chattel. It is, as some authorities declare, property in the nature of a chose in action. Its character is such that it ordinarily cannot, either by act of law or of its owner, be taken into tangible possession by its owner. It is representative merely. The certificate of stock, as evidence of that ownership, may, however, be taken into tangible possession. The certificate of stock is prima facie evidence of the ownership of the particular property designated. It transfers nothing from the corporation to the stockholder, but merely affords the latter evidence of his rights. A certificate of stock, further, it should be clearly understood, is not the stock, but merely evidence of the ownership of shares. Certificates of stock are not, in the true meaning of the words, negotiable instruments, though they are commonly regarded as quasi-negotiable.

The Statute of Frauds controls sales of capital stock since it is regarded as personal property, and its provisions must be complied with. On the death of the stockholder shares are distributed as personal property and divided according to statutory provisions relative to the distribution of property of that character. Statutory provisions declaring the nature of shares of stock as personal property are common in all the States.

§ 107. Classification of Capital Stock. In the absence of statutory prohibitions, a corporation upon its organization may divide its capital stock into as many classes as the organizers may elect, which are known by names usually indicating their peculiar rights and characteristics. The usual classification, if different kinds are provided for, is that into common and preferred. By common stock is meant that which entitles the owners to an equal pro rata division of the profits, if any there be, one stockholder, or

class of stockholders, having no advantage, priority or preference over other stockholders in the division. By preferred stock is understood that which entitles its owners to some special right or priority over the holders of the common stock. The priority, preference, or advantage may consist in the right to receive dividends from the corporate profits before the holders of the common stock are entitled to any. The dividend rate may be a maximum one fixed by the articles of incorporation, or the rate to be paid may be left to the discretion of the board of directors or managing officers. It may be either cumulative or non-cumulative. If of the former class, all arrears of dividends on the preferred stock must be paid from the profits of subsequent years before the holders of common stock are entitled to receive dividends. If non-cumulative, the dividends paid to holders of preferred and common stock are determined and paid from the profits of corporate business of each fiscal year. The priority, preference, or advantage again may consist in other rights granted to the holders of the preferred stock. They may be entitled, for illustration, to elect a majority or a prescribed number of the board of directors, irrespective of the proportion which it bears to the total capital stock. Or the advantage may consist in rights granted to the holders of preferred stock to receive, upon a dissolution of the company, from the sales of the corporate property, after the payment of corporate debts, a reimbursement of the sums paid by them for their stock before anything can be paid to the holders of the common stock. To summarize, the rights usually granted to holders of preferred stock consist of a priority or a preference in respect to dividends, voting, or a division of corporate property upon dissolution. The preferences in respect to dividends and division of property are those commonly given.

Status of Preferred Stockholder. It must be understood, however, that because the holders of preferred stock are entitled to priority in the payment of dividends that they are legally entitled to them if the corporation has

not earned profits which can be properly applied to their payment. Dividends, both on preferred and common, or other classes of stock, must be earned, otherwise the corporate creditors have the legal right to enjoin the payment of dividends where, by so doing, they can prove that a portion of the sum representing the capital stock of the corporation will be illegally distributed and their security, therefore, impaired or diminished. If the dividends upon the preferred stock are cumulative, a holder of that stock has the right to prevent payments to common stock before the arrears are made up. A preferred stockholder, where his priority consists of a preference in respect to the payment of dividends, is not considered a creditor of the property or the assets of the corporation upon its insolvency, and he is not entitled to any arrears of dividends upon his preferred stock in case of insolvency as a creditor of the corporation. On the question of the right to cumulative dividends, a New York court1 said:

"The reasonable and fair interpretation of the contract (referring to the priority in dividends on preferred stock) is that the dividends were not only to be preferred, but being guaranteed, were cumulative and a specific charge upon the accruing profits, to be paid as arrears, before any other dividends were divided upon the common stock. The doctrine that preference shares are entitled to be first paid the amount of dividends guaranteed and of all arrears of dividends and interest before the other shareholders are entitled to receive anything, and although they can receive no profits where none are earned, yet, as soon as there are any profits to divide, they are entitled to the same, is fully supported by authority."

§ 108. Declaration of Dividends within Discretion of Managing Officers. As already stated, no dividends can be paid to any class of stockholders except from the net earnings or profits of the corporation, and the declaration of dividends is left, in all cases, to the discretion of the board of directors or managing officers. They may apply 1 Boardman v. Lake Shore, etc., Ry. Co., 84 N. Y. 157.

the net profits or earnings of corporate business toward the payment of debts, the enlargement of the corporate plant, the accumulation of a cash surplus or reserve, if, in the exercise of their best and honest business judgment and discretion such a course is advisable, rather than in its distribution in the form of dividends to the stockholders of the corporation.

§ 109. Trust Fund Theory. In an early case,2 Justice Story declared that the capital stock of a corporation is a trust fund in the hands of the corporation for the payment of its debts, and that the corporation stands in the relation of a trustee to the creditors and the shareholders of the corporation. This doctrine was attempted to be applied in many subsequent decisions in its technical meaning, but it is quite evident that Justice Story did not so intend, but used the language in its general sense and under the limitations which have since been stated by the Supreme Court of the United States and in many other jurisdictions. The true basis upon which the property of a corporation is held, both for its creditors and for its stockholders, is well stated in a recent case in the Supreme Court of the United States,3 where the court, after referring to various decisions in which the phrase trust fund was used, and the trust fund doctrine applied, said:

"While it is true language has been frequently used to the effect that the assets of a corporation are a trust fund held by a corporation for the benefit of creditors, this has not been to convey the idea that there is a direct and express trust attached to the property. A corporation is a distinct entity. Its affairs are necessarily managed by officers and agents, it is true; but, in law, it is as distinct a being as an individual is, and is entitled to hold property (if not contrary to its charter) as absolutely as an individual can hold it. Its estate is the same, its interest is the same, its possession is the same. Its stockholders may call the officers to account, and may prevent any malversation of funds, or fraudulent disposal of property on their

2 Wood v. Dummer, 3 Mason, C. C. 308.

3 Hollins v. Brierfield Coal & Iron Co., 150 U. S. 371,