annual contribution out of the net earnings for that purpose would be reasonable.

The law does not require that a corporation shall be entirely out of debt, even as to floating debts, before it declares a dividend; but a reasonable provision for eventual payment of its

44 Since debts often represent investments in machinery or other property, the fact that the debts may be greater than the net earnings does not prove that the corporation has made no net profits out of which a dividend may properly be declared. O'Shields v. Union Iron Foundry (1913) 93 S. C. 393, 76 S. E. 1098.

In Belfast & M. L. R. Co. v. Belfast (Me.) supra, the court said, that it did not necessarily follow that debts should be first wholly paid before a declaration of dividends, merely because they are of a floating character; that it might be that it would be reasonable and proper to convert such liabilities into a funded debt; that all depends upon the financial resources and abilities of the corporation and the prospects of the same.

And in Hazeltine v. Belfast & M. L. R. Co. (1887) 79 Me. 411, 1 Am. St. Rep. 330, 10 Atl. 328, the court observed that, while the definitions of net profits in the case of railroad corporations, which are generally more heavily in debt than other kinds of business corporations, call for the payment of company's debts, they do not necessarily require payment of any portion of the principal; and that, while the authorities make a distinction between the payment of the floating debt and the payment of the permanent or bonded debts, it is not indispensable that the company should be free from the pressure of floating debts before it may lawfully pay dividends even to holders of nonpreferred stock. The case was one involving the right of preferred stockholders to dividends.

As to whether directors of a mining corporation may be held liable for declaring dividends before discharge in full of debts which the company has incurred by acquiring property encumbered with a debt, or by making permanent improvements for the working of the mine, see Excelsior Water & Min. Co. v. Pierce (Cal.) under note 218, infra.

45 All the net earnings of an indebt

debts is a proper deduction from earnings.45

Of course, accrued interest on debts owing by the corporation is deductible from the earnings before the net profits are ascertained from which dividends may be paid.46

The directors, acting in good faith,

ed corporation should not always be devoted to dividends; the company has a right to base its calculations in this regard upon a final payment of its debts at some time; steps, however, in that direction should not be untimely or oppressive to other interests, and should be such as not unreasonably to interfere with the expectation or interests of stockholders. Hazeltine v. Belfast & M. L. R. Co. (Me.) supra.

Not only interest on a sum borrowed by a railway company on the credit of the state under legislative authority, in order to relieve stockholders of hasty and heavy calls on their stock for the construction of a new line of railroad, should be deducted from the profits before a division thereof is made among the stockholders, but an additional sum should be set apart from year to year as a sinking fund for the ultimate payment of the principal. Gratz v. Redd (1843) 4 B. Mon. (Ky.) 178, where a division of the profits was not authorized by the charter until "all the necessary current and probable contingent expenses" were paid. The decision is approved and followed in Lexington & O. R. Co. v. Bridges (1847) 7 B. Mon. (Ky.) 556, 46 Am. Dec. 528.

46 Union P. R. Co. v. United States (1879) 99 U. S. 402, 25 L. ed. 274; Mobile & O. R. Co. V. Tennessee (1894) 153 U. S. 486, 38 L. ed. 793, 14 Sup. Ct. Rep. 968; St. John v. Erie R. Co. (1872) 10 Blatchf. 271, Fed. Cas. No. 12,226, affirmed in (1875) 22 Wall. (U. S.) 136, 22 L. ed. 743; Excelsior Water & Min. Co. v. Pierce (1891) 90 Cal. 131, 27 Pac. 44; Hubbard v. Weare (1890) 79 Iowa, 678, 44 N. W. 915; Gratz v. Redd (1843) 4 B. Mon. (Ky.) 178, approved and followed in (1847) 7 B. Mon. 556, 46 Am. Dec. 528; Belfast & M. L. R. Co. v. Belfast (1885) 77 Me. 445, 1 Atl. 362; Hazeltine v. Belfast & M. L. R. Co. (1887) 79 Me. 411, 1 Am. St. Rep. 330, 10 Atl. 328; Bankers Trust Co. v. R. E. Dietz Co. (1913) 157 App. Div.

have a large measure of discretion in determining whether net profits shall be divided among the stockholders as dividends or devoted, through the operation of a sinking fund, to the gradual retirement of its debts.47

c. Taxes; insurance; rent. Taxes are to be deducted in determining net profits for dividend purposes. 48 And the assets account of a corporation for dividend purposes cannot be increased even by the amount of prepaid taxes, since these are not available for a refund, and are paid for past expenses of the government as well as future.49 But prepaid insurance should be listed as an asset, in making up the balance sheet of a corporation for dividend purposes, it being proper to increase the assets

594, 142 N. Y. Supp. 847 (sustaining right to issue scrip dividends bearing interest.)

Annually accruing interest on the bonded debt of a railroad company is a proper charge against the net earnings, to be paid before dividends can be declared therefrom. Mobile & 0. R. Co. v. Tennessee (1894) 153 U. S. 486, 38 L. ed. 793, 14 Sup. Ct. Rep. 968; Union P. R. Co. v. United States (1879) 99 U. S. 402, 25 L. ed. 274 (recognizing rule).

It was held in Gratz v. Redd (1843) 4 B. Mon. (Ky.) 178, that interest on a sum borrowed by a railroad company on the credit of the state, pursuant to legislative authority, in order to relieve stockholders from hasty and heavy calls on their stock for construction of a new railroad, was chargeable against profits before a division of earnings in the form of dividends was paid, and should not be charged to capital construction account, where a division of the profits was not authorized by the charter until all "necessary current and probable contingent expenses" had been deducted.

47 See cases supra this subdivision; and generally, as to discretion of directors, see VI. infra.

48 Burk v. Ottawa Gas & E. Co. (1912) 87 Kan. 6, 123 Pac. 857, Ann. Cas. 1913D, 772; People ex rel. Jamaica Water Supply Co. v. Tax Comrs. (1908) 128 App. Div. 13, 112 N. Y. Supp. 392, modified on other grounds in (1909) 196 N. Y. 39, 89 N. E. 581,

account by the amount of the unearned premiums.50

It has been held that an amusement company which is a lessee is not obliged, before it can lawfully pay dividends, to set aside against the future sufficient money or assets over and above its capital to pay all of its future running expenses, such as liability for future instalments of rent and future accruing taxes; and that the lessor has no right to complainthat dividends were declared and paid without setting aside such a fund.51 d. Depreciation; maintenance; repairs.

It has been held that, in determining net profits from which a dividend may properly be declared, directors must make proper provision for depreciation, 52 alreargument denied in (1909) 197 N. Y. 33, 90 N. E. 112.

49 Cox v. Leahy (1924) 209 App. Div. 313, 204 N. Y. Supp. 741. 50 Ibid.

51 Majestic Co. v. Orpheum Circuit (1927; C. C. A. 8th) 21 F. (2d) 720.

52 Lever V. Land Securities Co. (1891) 8 Times L. R. (Eng.) 94; Davison v. Gillies (1879) L. R. 16 Ch. Div. (Eng.) 347, note. See also Glasier v. Rolls (1889) L. R. 42 Ch. Div. (Eng.) 453, C. A. (opinion of Kekewich), an action for deceit for representing that the net profits were a certain per cent. See also cases in note 56, infra.

It is the duty of a board of directors in declaring dividends to set aside sufficient funds for depreciation and for contingencies which may be reasonably expected to arise. Hastings v. International Paper Co. (1919) 187 App. Div. 404, 175 N. Y. Supp. 815.

That a charge should be made against earnings for depreciation of plant, before profits available for dividends can be ascertained, at least in the case of a mining company whose plant is located at a remote mine and can be of little or no value after the mine is exhausted, is supported by Wittenberg v. Federal Min. & Smelting Co. (1926) — Del. Ch. —, 133 Atl. 48, which is affirmed in the reported case (FEDERAL MIN. & SMELTING CO. v. WITTENBERG, ante, 1).

Where a company's assets consisted principally of leasehold property which was subject to risk through depreciation, the court in Lever v. Land

though they have a reasonable discretion in the matter. 53

But while ordinarily directors of a corporation are not only justified in setting aside from the profits a sum for depreciation, before declaring a dividend, but are in duty bound to do so, this course may be precluded by the articles of the company constituting the contract among its sharehold

Securities' Co. (1891) 8 Times L. R. (Eng.) 94, while taking the position that directors should make due allowance for such depreciation in computing the net profits out of which only dividends could be declared, held that this risk did not come under the head of "claims and contingent liabilities,' to meet which the articles required the directors to maintain a reserve fund; that the latter referred to such matters as outstanding debts and possible adverse verdicts against the company in pending actions.

Findings of fact as to the amount to be paid as a dividend-under a statute making compulsory dividend to the amount of the surplus accumulated over and above the capital stock, and the amount of a working capital fixed by the stockholders-should not be based upon the statement of the financial condition of the corporation, without taking into account as a liability of the corporation the amount reserved by that statement for depreciation on machinery, buildings, etc. Cannon v. Wiscassett Mills Co. (1928) N. C. 141 S. E. 344.

53 Where rolling stock of a railway company has become worn out, or there is need of repairs to stations or other property, it has been held that directors cannot be compelled by a shareholder to replace or repair all of the same before declaring dividends out of revenue, no rights of the public being violated. Kehoe v. Waterford & L. R. Co. (1888) Ir. L. R. 21 Eq. 221. As to discretion of directors generally, see VI. infra.

54 Thus, in Paterson v. Paterson [1917] S. C. (Scot.) 13-H. L., it was held that a provision that directors might, before recommending any dividend, set aside out of the profits of the company such sums as they thought proper as a reserve, was inconsistent with a provision of the articles of the company that, after allowing for all charges, including the payment of directors' salaries, the profits

ers.54 And if the amount set apart for depreciation is larger than is reasonably necessary, it seems that the excess may still be available for dividend purposes.55

Likewise, in ascertaining the net profits out of which dividends may be declared, provision should be made for expenditures for maintenance, upkeep, and repairs.56

of the company should be applied in a prescribed manner, and that the latter precluded the creation of a reserve, the former provision being among those incorporated in the articles only so far as not excluded or modified thereby.

55 It has been held that if a limited company retains the item of good will in its balance sheet, and carries profits to a good will depreciation reserve fund, it may distribute such profits, at least to the extent that the amount of the reserve fund exceeds the amount of the actual depreciation, if there is nothing in its constitution to prevent it from doing so; and if, instead of keeping its accounts in this way, it purports to apply profits to the writing off of good will as an asset, it does not so capitalize the profits as to preclude its subsequently restoring them to reserve and dealing with them as profits; but it may restore to the profits account, and distribute as dividends, so much of the depreciation written off good will as has proved to have been in excess of the proper requirements. Stapley v. Read Bros. [1924] 2 Ch. (Eng.) 1. The court said that no doubt the account as showing the methods adopted were approved from year to year by the shareholders, but it was not satisfied that they thereby intended to bind themselves for all time and in all circumstances to give up their claim to those profits and to treat them as capital only.

56 As to discretion of directors in this regard, see VI. infra.

The net income of a corporation for dividend purposes cannot be determined until all depreciation, maintenance, and upkeep expenditures have been deducted; otherwise the dividend is not paid from the earnings, but by a depreciation of capital account. People ex rel. Jamaica Water Supply Co. v. Tax Comrs. (1908) 128 App. Div. 13, 112 N. Y. Supp. 392 (dictum) modified on other grounds in (1909)

e. Accretions to capital; excess of assets over par value of stock.

It has been held that a realized accretion to the value of capital assets

196 N. Y. 39, 89 N. E. 581, reargument denied in (1909) 197 N. Y. 33, 90 N. E. 112. And this view is quoted with implied approval in People ex rel. Binghamton, Light, Heat & P. Co. v. Stevens (1911) 203 N. Y. 7, 96 N. E. 114.

The question whether or not semiannual dividends declared by directors of a corporation were paid out of surplus or net earnings of the company must be determined by ascertaining the actual value of all the live assets of the company at the termination of the semiannual period during which it was claimed that the supposed surplus or net earnings accrued; and this can only be done by taking into account the cost of repairs, and also a reasonable allowance for depreciation for wear and tear, giving credit for all actual permanent improvements. Whittaker v. Amwell Nat. Bank (1894) 52 N. J. Eq. 400, 29 Atl. 203.

The cost of operation of the plant of a gas and electric company, including necessary repairs, extensions, and fixed charges, are to be deducted from the entire receipts from the business, in determining net profits for the purpose of declaring a dividend. Burk v. Ottawa Gas & E. Co. (1912) 87 Kan. 6, 123 Pac. 857, Ann. Cas. 1913D, 772. Where for several years no allowance was made by a tramway company for expense of repairs and maintenance, and the road had deteriorated until a sum more than the amount of the proposed dividend would be required to put it in proper state of repair, it was held in Davison v. Gillies (1879) L. R. 16 Ch. Div. (Eng.) 347, note, that an injunction should be granted restraining the payment of a dividend. The articles of the company provided that no dividend should be declared except out of the profits of the company, that the directors should, with the sanction of the company in general meeting, declare annual dividends, payable to the members out of the profits of the company, and that, before recommending any dividends, the directors should set aside out of the profits such sum as they thought proper as a reserve for maintenance, repairs. depreciation,

may be carried into the profit and loss account, and taken into consideration in determining the funds available for payment of dividends.57 And the exand renewals. It was held that the term "profits" in these articles meant net profits, to ascertain which a reasonable sum should be allowed for the items last above indicated.

57 Where a company, having purchased certain property and assets, including promissory notes not apparently considered of any particular value, later received full payment for the notes and interest, it was held in Foster v. New Trinidad Lake Asphalt Co. [1901] 1 Ch. (Eng.) 208, 1 B. R. C. 959, that the company would not be allowed to declare a dividend of all of this stock as a windfall pending the result of the whole account of the company for the year; but the court observed that it should not be understood as determining that this sum, or a portion of it, might not properly be brought into profit and loss account to be taken into consideration in ascertaining the amount available for dividends; and that appreciation in total value of capital assets, if duly realized by sale or getting in of some portion of such assets, may, in a proper case, be treated as available for purposes of dividends.

So, where a bank sold a part of its business for a sum which, after deducting its paid-up capital and incidental expenses, showed a large net balance, it was held that this balance might be treated as profit and carried to the profit and loss account, and distributed accordingly. Lubbock v. British Bank [1892] 2 Ch. (Eng.) 198.

And in Cross v. Imperial Continental Gas Asso. [1923] 2 Ch. (Eng.) 553, it was held that an English company operating in Germany, which during the late World War was compelled to liquidate its holdings in that country, and realized on such liquidation a sum in excess of the book value of the property, might treat the excess as profits available for dividends. It was recognized in earlier decisions that companies registered under the Joint Stock Companies Act might distribute a realized profit on their capital assets, but a distinction was claimed in that the company in question was governed by the Companies Causes Consolidation Act, which specified that companies should not make

cess over par which a newly organized insurance company has received for a part of its stock has been regarded as profits, which it may distribute as dividends.58 It has been held, also, that collections made on a judgment

any dividend whereby their capital stock would be in any way reduced. But the court held that the latter provision referred to paid-up capital, and not to capital assets generally.

That, on the sale of part of a company's property, an amount representing accretions to capital, and not needed for the payment of debts or the carrying on of the part of the business retained, may be distributed to shareholders as dividends, is supported also by Holt v. Croker (1922) 91 L. J. Ch. N. S. (Eng.) 346, a' case involving the respective rights of the life tenant and remainderman.

And, in determining whether or not there are profits available for dividends, it has been held that a company may set off an appreciation in the value of its capital assets, as ascertained by a bona fide valuation, against losses on revenue account. Ammonia Soda Co. v. Chamberlain [1918] 1 Ch. (Eng.) 266, 9 B. R. C. 819-C. A.

In Bishop v. Smyrna & C. R. Co. [1895] 2 Ch. (Eng.) 596, where a company had invested in its own debentures, and, they having fallen, had charged a certain amount to depreciation, on later liquidation of the company the foregoing amount of depreciation was treated as appreciation in investment, the debentures having risen in value, and the court held that this amount, having been taken from profits, must go back into profits.

As to what may be treated as profits and what as capital for dividend purposes may, according to the views expressed in an English case, depend considerably upon the mode and manner in which the company is carried on, and can scarcely be treated as an abstract question. Dovey v. Cory [1901] A. C. (Eng.) 477, 6 B. R. Č. 179-H. L.

That the capital and revenue accounts are distinct and separate, and that both depreciation and appreciation of the former are to be disregarded for the purpose of determining profit, is the view expressed in Lee v. Neuchatel Asphalte Co. (1889) L. R. 41 Ch. Div. (Eng.) 1 (opinion of Lo

against a person, on claims arising out of his abstractions of capital of the company, are properly declared as dividends when the company already has funds largely in excess of its capital stock.59

pes, L. J.), where, however, the property was of a wasting nature (mines), so that the rule applicable in case of accretion to capital was not directly involved.

In Equitable Life Assur. Soc. v. Union P. R. Co. (1914) 212 N. Y. 360, L.R.A.1915D, 1052, 106 N. E. 92, it was held that profits made by a railroad company by investments in stock of other corporations, and by converting its bonds into stock, need not be dealt with as an accretion to capital, to be distributed among all stockholders, but may be treated as earnings, and distributed as dividends, within the application of a clause in its articles of incorporation by which the dividends to preferred stock should not exceed a specific sum per annum; and therefore, when that per cent has been paid to preferred stockholders, the remainder may be distributed among the common stockholders.

The

58 Union Pacific L. Ins. Co. v. Ferguson (1913) 64 Or. 395, 43 L.R.A. (N.S.) 958, 129 Pac. 529, 130 Pac. 978. question in this case was whether the company had paid-up unimpaired cash capital sufficient under the statute to entitle it to a certificate authorizing it to carry on the insurance business. Only a part of the capital stock of $100,000 (the amount required by the statute) had been subscribed, but it was alleged that more than this sum had been received from the stock actually sold. It was held that the company was not entitled to a certificate, because the fund required by the statute did not include profits or surplus until they had been made capital in some legal way, but referred to a trust fund which could not be diverted, and the profits accumulated in the sale of stock were subject to withdrawal at any time in dividends.

59 Hyams v. Old Dominion Copper Min. & Smelting Co. (1913) 82 N. J. Eq. 507, 89 Atl. 37, affirmed on opinion of lower court in (1914) - N. J. Eq. 91 Atl. 1069, rehearing denied in (1914) 83 N. J. Eq. 705, 92 Atl. 588.

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