an excess in value of the assets over the par value of the stock issued and outstanding, because of the issuance of stock for property taken at a gross overvaluation, a declaration of a dividend is not forbidden by the statute

15 Goodnow v. American Writing Paper Co. (1907) 73 N. J. Eq. 692, 69 Atl. 1014, affirming (1907) 72 N. J. Eq. 645, 66 Atl. 607. The court said that, although a distinction was indicated by the statute between surplus and net profits, it did not necessarily follow that the latter meant the difference between the gross earnings and what might be called operating expenses; that such profits might be called annual profits, and it might be that by net profits the legislature meant the net profits upon the whole of the company's business from its organization; but that, if either of these meanings were adopted, the declaration of the dividend in this instance was justified. The court further observed that it might not infrequently happen that stock is issued on which only a partial payment is made of the amount subscribed, which is therefore subject to further call; and that in such a case, where the company prospers, it did not think that there were no net profits available for dividends until the earnings accumulated to an amount equal to the par value of the shares.

Citing the Goodnow Case (N. J.) supra, the court in Borg v. International Silver Co. (1925) 11 F. (2d) 147 (circuit court of appeals in New York), said that it is not unlawful in New Jersey to pay dividends out of profits though the capital is in fact impaired. And it was held that dividends so paid by a New Jersey corporation, which were lawful under the laws of that state, did not become unlawful under the laws of New York, where the company did a part of its business.

A statute declaring that dividends must not be made except from surplus profits, and forbidding the withdrawal of the "capital stock" of a company by, or payment thereof to, the stockholders, was held in Martin v. Zellerback (1869) 38 Cal. 300, 99 Am. Dec. 365, to refer to the capital of the corporation or assets with which it transacts business, whether the same consists of money, property, or other valuable commodities. 55 A.L.R.-2.

if there is an excess of gross earnings over operating expenses for the current year, and the value of the assets exceeds the value of the actual assets with which the company began business.15 But the provision of the Com

And in Kohl v. Lilienthal (1889) 81 Cal. 378, 6 L.R.A. 520, 20 Pac. 401, 22 Pac. 689, the court takes the same view, stating that the term "capital stock" as used in the statute before it had a very different meaning from that of shares of the capital stock, as representing the interest which the holders thereof had in the business and property of the corporation whose shares they hold; that the words "capital stock" as used in the statute had the meaning of "capital," and meant the money and property with which the company carried on its corporate business. And to the effect, also, that the term "capital stock" as used in such a statute means actual capital, that is, property used in the conduct of the business, as distinguished from the shares of nominal capital of the corporation, see Excelsior Water & Min. Co. v. Pierce (1891) 90 Cal. 131, 27 Pac. 44; Tapscott v. Mexican Colorado River Land Co. (1908) 153 Cal. 664, 96 Pac. 271; Burne v. Lee (1909) 156 Cal. 221, 104 Pac. 438; Schulte v. Boulevard Gardens Land Co. (1913) 164 Cal. 464, 44 L.R.A. (N.S.) 156, 129 Pac. 582, Ann. Cas. 1914B, 1013; Merchants' & Insurers' Reporting Co. v. Schroeder (1918) 39 Cal. App. 226, 178 Pac. 540.

However, the provision of the California Code above referred to, which unconditionally prohibited the making of dividends except from surplus profits, was amended in 1917, so as to provide in effect that the directors of a corporation might make dividends otherwise than from surplus profits upon receiving permission from the commissioner of corporations. And in Dominguez Land Corp. v. Daugherty (1925) 196 Cal. 468, 238 Pac. 703, it was held to be a reasonable inference from the provisions of the corporate securities act in that state, that the legislature intended that the commissioner should give his permission to make dividends from other than surplus profits only when be found that, if the dividends were made, the corporation would still be left in a sound financial condition,that is, a condition which would be

panies Causes Consolidation Act of England, that companies "shall not make any dividends whereby their capital stock will be in any way reduced," has been construed to refer to paid-up capital, and not to capital assets generally.16

In ascertaining whether there is a surplus fund available for dividends, capital must be set down at its paidin, and not at its par, value, where the statute provides that directors shall have power, after reserving "over and above its capital stock paid in" such sum as shall have been fixed by stockholders, to declare a dividend of the whole of its accumulated profits in excess of the amount reserved.17

safe for the interests of creditors as well as of stockholders.

And it was held in Dominguez Land Corp. v. Daugherty (Cal.) supra, that the amendment in conferring upon the commissioner of corporations power to permit the making of dividends otherwise than from surplus profits did not conflict with the provision of the state Constitution, declaring that no corporation should issue stock or bonds except for money paid, labor done, or property actually received, and that all fictitious increase of stock or indebtedness should be void, on the theory that the handing back of assets to stockholders would be tantamount to issuing stock wholly or partly as a bonus, and be an indirect violation of the statute,-this conclusion being reached, at least so as to permit dividends to be declared from so much of the surplus capital as arose from assessments levied and collected upon stock which was fully paid for at its par value, even though the same did not represent surplus profits arising from the business as a corporation.

It was held, also, in Dominguez Land Corp. v. Daugherty, (Cal.) supra, that the power which the statute conferred on the commissioner of corporations to permit payment of dividends otherwise than from surplus profits, while involving in some degree the exercise of judgment and discretion, was a ministerial or administrative function, and not an unconstitutional delegation of judicial or legislative power.

In Williams v. Western U. Teleg. Co. (1883) 93 N. Y. 162, the term

And it has been held that a statutory provision, that a board of directors of a bank when it declares a dividend "shall first set apart" to the surplus fund 10 per cent of the net profits for the period covered by the dividend, until the same amounts to 20 per cent of the capital stock, is mandatory, and not merely directory; and that, before there can be a dividend which the law will recognize in a suit to recover it, there must not only be a net profit, but the dividend can only be declared on that portion of the profit remaining after 10 per cent has been set aside to the surplus fund.18

It is not necessary apparently that there should be net earnings of the "capital stock" in the statute of that state, forbidding directors to make dividends except from the surplus profits arising from the business of the corporation, or to divide, withdraw, or pay to the stockholders any part of the capital stock, and declaring that they should be liable for violation of the act to the amount of the capital stock so divided or paid out, was held not to mean share stock or nominal capital, but property of the corporation contributed by the stockholders or otherwise obtained by it, the purpose of the statute being to create a property capital for the corporation, and to keep the same intact, so as to secure its solvency and its responsibility to creditors.

It is held, also, in Cox v. Leahy (1924) 209 App. Div. 313, 204 N. Y. Supp. 741, that the words "capital of the corporation" in the New York statute, providing that directors shall not make dividends except from surplus, or divide, withdraw, or pay to the stockholders any part of the capital of the corporation, means property capital, and that property accumulated by the corporation in excess of its capital stock at par constitutes the surplus profits, and may be so regarded in the declaration of dividends.

16 Cross v. Imperial Continental Gas Asso. [1923] 2 Ch. (Eng.) 553.

17 Peters v. United States Mortg. Co. (1921) 13 Del. Ch. 11, 114 Atl. 598.

Bank

18 Lapsley V. Merchants (1904) 105 Mo. App. 98, 78 S. W. 1095. The court said in effect that it was manifestly the aim of the statute to compel the accumulation of a sur

particular year during which the dividends are declared, available for their payment, but dividends may properly be declared and paid out of surplus of previous years.19

Without attempting to treat the question of the right of a corporation

plus fund out of net profits for the protection of depositors and others. doing business with the bank, which result could not be secured if dividends were permitted to be declared out of profits in preference to surplus; and that, whenever third persons or the public have an interest in having done that which is prescribed by the legislature, then the act is mandatory even though words permissive in form are used. The decision was followed on similar facts in Edwards v. Merchants' Bank (1904) Mo. App. 78 S. W. 1132.

19 That dividends may properly be declared out of surplus earnings of a corporation from previous years is supported by Council v. Brown (1921) 151 Ga. 564, 107 S. E. 867, holding that an allegation that, in a certain year, dividends have been paid in excess of the earnings for that year, showed no liability on the part of the directors, in the absence of allegations that dividends were improperly paid, or were not paid, out of earnings of the corporation during prior Fears.

And in Mente v. Groff (1910) 10 Ohio N. P. N. S. 148, the court approved the doctrine that directors of a corporation are not prohibited from declaring dividends out of accumulated and undivided profits of previous years, even when there has been no surplus profits for the particular year in which the dividend is declared; and took the view that the statute of that state, providing that it should be unlawful for directors to make dividends except from surplus profits, and providing the method for ascertaining such profits, did not prevent the application of this rule.

In Fricke v. Angemeier (1913) 53 Ind. App. 140, 101 N. E. 329, the court says that a dividend cannot be rightly declared until there is a showing that a profit has been really earned for the year such dividend was declared. But in this case there had been a net deficit for several years, and the corporation at the time was insolvent.

to reduce its capital stock, 19a it may be noted that surplus arising from a lawful reduction of the capital stock of a corporation may be available for dividend purposes and distributed as such.20

As to obligation to take into consideration, in declaring dividends, losses of prior years, see II. b, infra; and see V. infra, as to "wasting assets corporations."

19a Generally as to reduction of capital and distribution of capital assets upon reduction, see annotation in 44 A.L.R. 11.

20 In Benas v. Title Guaranty T. Co. (1924) 216 Mo. App. 53, 267 S. W. 28, the court recognized this rule, which, however, was not questioned in that

case.

It has been held in New York that, when a corporation under statutory authority reduces its capital stock, the surplus, if any, which it is authorized to pay to its stockholders, depends upon the result of an examination into its affairs, and not upon the difference between the original amount of capital and the reduced amount; and that whenever, by sales of property, or by means of earnings, or otherwise, a corporation comes into possession of funds which are in excess of the reduced amount of such capital, it can distribute that excess without violating any law. Strong v. Brooklyn C. T. R. Co. (1883) 93 N. Y. 426.

Where a national bank, pursuant to statute, reduced its capital stock by requiring stockholders to relinquish a certain per cent of their stock, it was held in Seeley v. New York Nat. Exch. Bank (1878) 4 Abb. N. C. (N. Y.) 61, modified on other grounds in (1878) 8 Daly, 400, which is affirmed in (1879) 78 N. Y. 608, that the return of the reduced capital to stockholders was not a subject for the exercise of the directors' discretion; and that the bank could not, after such reduction, retain as a surplus, or for other purposes, the whole or any portion of the money which it had received for the stock that was retired.

Where, on the reduction of the capital stock of a national bank, a trust fund was created, with the approval of the Comptroller of the Currency, for the stockholders, consisting

b. Distinction in England between fixed and floating capital.

In England a distinction has been made between fixed and floating capital. Thus, it is held, on the one hand, of bad or doubtful assets of the bank, it was held in Cogswell v. Second Nat. Bank (1905) 78 Conn. 75, 60 Atl. 1059, affirmed in (1907) 204 U. S. 1, 51 L. ed. 343, 27 Sup. Ct. Rep. 241, that a sum realized from this fund was the equivalent of net profits, within the meaning of the Federal statute forbidding directors of national banks from declaring dividends except from net profits.

As to the right to distribute property instead of money on reduction of the capital stock, see Continental Securities Co. v. Northern Securities Co. (N. J.) in note 162, infra.

21 Bolton v. Natal Land & Colonization Co. [1892] 2 Ch. 124; Verner v. General & C. Invest. Trust [1894] 2 Ch. 239; Wilmer v. McNamara & Co. [1895] 2 Ch. 245; Re Kingston Cotton Mill Co. [1896] 1 Ch. 331-C. A., reversed on other grounds in [1896] 2 Ch. 279; Bosanquet v. St. John D'El Rey Min. Co. (1897) 77 L. T. N. S. 206; Re National Bank [1899] 2 Ch. 629, affirmed on other grounds in [1901] A. C. 477, 6 B. R. C. 179; Re Crichton's Oil Co. [1901] 2 Ch. 184 (affirmed in [1902] 2 Ch. 86-C. A.); Re Hoare [1904] 2 Ch. 208-C. A.; Ammonia Soda Co. v. Chamberlain [1918] 1 Ch. 266, 9 B. R. C. 819 -C. A.; Lawrence v. West Somerset Mineral R. Co. [1918] 2 Ch. 250; Stapley v. Read Bros. [1924] 2 Ch. 1,; Phillips v. Melbourne & C. S. & C. Co. [1890] 16 Vict. L. R. 111.

In Verner v. General & C. Invest. Trust [1894] 2 Ch. 239, where a limited company was formed to invest in securities, and the income so realized was to be paid in dividends, and its fixed capital was diminished by reason of investments shrinking and proving worthless, it was held that a dividend might be declared out of profits realized in a given year, without making up the loss of the fixed capital previously suffered. It was observed that the term "profits" is not free from ambiguity; and that the law is more accurately expressed by raying that dividends cannot be paid out of capital, than by saying that they can only be paid out of profits; that the last expression leads to the inference that the capital must al

that dividends may be declared out of profits of a given year without making good losses of the fixed capital of the company in other years.21 It has been said, for example, that there is ways be kept up and represented by assets which if sold would produce it, and that this is more than the law requires; that perhaps the shortest way of expressing the distinction is to say that fixed capital may be sunk and lost, and yet that the excess of current receipts over current payments may be divided, but that floating or circulating capital must be kept up, as otherwise it would enter into and form part of such excess, in which case, to divide the excess without deducting the capital constituting a part of it, would be contrary to law.

The above case was followed in Wilmer v. McNamara & Co. [1895] 2 Ch. 245, where the articles of a company formed to conduct a carrier's business merely provided that no dividends should be payable except from profits arising out of the business; and it was held that dividends could be declared out of profits realized in a particular year, although because of depreciation in good will, leases, etc., the assets were insufficient to make good the fixed capital.

And, relying on the Verner and Wilmer Cases, supra, the court in Bosanquet v. St. John D'El Rey Min. Co. (1897) 77 L. T. N. S. 206, held that a mining company might declare a dividend without applying profits realized in a certain year to the payment of capital paid out in previous years for interest on debentures during a period when the mine, which had fallen in, was being reopened and no profits were made.

And in Bolton v. Natal Land & Colonization Co. [1892] 2 Ch. 124, where a limited company was organized to deal in land, and its articles provided for the payment of dividends out of net profits, and it appeared that profits were actually earned in a particular year, the court refused to restrain the paying of a dividend on the ground that in a previous year the value of the property was less than that put on the balance sheet, and that this difference ought to be treated as a loss, in which case there would be no profits realized for the payment of dividends.

It has been held, also, in England.

no law which prevents a company from sinking its capital in the purchase or production of a money-making

that while the paid-up capital of a limited company cannot be lawfully returned to the stockholders, under the guise of dividends, yet that in the case of such a company, even though it is a banking concern, if the accounts are made up annually, losses of one year need not be made good before dividends are declared out of profits of a subsequent year, although the effect is to throw upon the capital bad debts or other losses written out in one year, and not provided for in the reserve fund, and the paid-up capital may thus be diminished from year to year, while dividends are paid out of excess of the annual receipts over the current expenses. Re National Bank [1899] 2 Ch. 629, affirmed on other grounds in [1901] A. C. 477, 6 B. R. Č. 179. Romer L. J., says: "I agree that when a company has made a profit in one year they may be entitled to divide it as a profit, without regard to capital lost in a previous year. There is no hard and fast rule that you cannot divide profits until capital lost in a previous year has been made good." In the opinion of the court by Lindley, M. R., it is said: "It is obvious that this method of procedure, if long continued, would ultimately exhaust the paid-up capital of the company, and the first disastrous year in which the current outgoings exceeded the current incomings would produce great embarrassment. Such a mode of dealing with the company's assets, however reprehensible, must nevertheless not be confounded with paying dividends out of the paid-up capital of the company. It is not possible for the court to say that the law prohibits a limited company, even a limited banking company, from paying dividends unless its paid-up capital is intact. Suppose a heavy unexpected loss is sustained, which must be met if there are assets with which to meet it. The capital, even. uncalled capital, must, if necessary, be applied to meet it. Such an application of capital is a perfectly legitimate use of it. There is no law which, in the case supposed, prevents the payment of all future dividends until all the capital so expended is made good. Many honest and prudent men of business would replace a large loss of capital

property or undertaking, and in dividing the money annually yielded by it, without preserving the capital sunk by degrees, and would reduce the dividends, but not stop them entirely, until the whole loss was made good. No law compels them to pay none at all. There are cases in which no honest, competent man of business would think of charging particular debts or expenses to capital. We are certainly not prepared to sanction the notion that all debts incurred in carrying on a business can be properly permanently charged to capital, and that the excess of receipts over other outgoings can be afterwards properly divided as profit as if there had been no previous loss. No honest, competent man engaged in trade or commerce would carry on business on such a principle. But, excluding cases in which everyone can see that a particular debt or outlay cannot be reasonably charged to capital, it may be safely said that what losses can be properly charged to capital, and what to income, is a matter for business men to determine, and it is often a matter on which the opinions of honest and competent men will differ. There is no hard and fast legal rule on the subject."

It is said in Re Hoare & Co. [1904] 2 Ch. 208, (opinion of Vaughan Williams, L. J., that however much capital has been lost at any given date, if the profit and loss account of the company shows a profit balance, to the extent of that profit the company is entitled to distribute the money as dividends, notwithstanding the fact that the lost capital has not been replaced.

And it is held in Ammonia Soda Co. v. Chamberlain [1918] ↑ Ch. 266, 9 B. R. C. 819-C. A., that a corporation may pay dividends out of clear net profits of its business in any year without first making good losses incurred in previous years, since the payment does not involve a reduction of capital, but merely a failure to make good capital which has been already lost. It may be noted, however, that the question is not apparently an abstract one, but depends somewhat upon the particular circumstances, it being observed by one of the judges in this case that he was far from saying that in all cases dividends could properly be paid without making good the previous losses; that