When the net profits of a corporation out of which a dividend
might have been declared for the preferred stock are justifiably
applied by the directors to capital improvements, the claim of the
stock for that year is gone, if by the terms of the articles of
incorporation and the certificates the preferential dividends are
not to be cumulative. The fact that there were profits in that year
out of which dividends might have been (but were not) declared does
not entitle such stock to a correspondingly greater preference over
other stock when the profits of a later year are to be divided. P.
280 U. S.
203.
30 F.2d 260 reversed.
Page 280 U. S. 198
Certiorari, 279 U.S. 828, to review a decree of the circuit
court of appeals sustaining a bill brought against the railway
company and its directors by holders of preferred shares to control
the apportionment of dividends as between the plaintiffs and
shareholders of other classes. The district court had dismissed the
bill.
Page 280 U. S. 201
MR. JUSTICE HOLMES delivered the opinion of the Court.
This is a bill by holders of first preferred stock (called Class
A) of the Wabash Railway Company, to have it declared that holders
of such stock are entitled to receive preferential dividends up to
five percent for each fiscal year from 1915 to 1926, inclusive, to
the extent that such dividends were earned in such fiscal years but
were unpaid, before any dividends are paid upon other stock, and
that the Company may be enjoined from paying dividends upon
preferred stock B or common stock unless it shall first have paid
such preferential dividends of five percent to the extent that the
Company has had net earnings available for the payment and that
such dividends remain unpaid. The case was heard upon bill and
answer. The bill was dismissed by the district court, but the
decree
Page 280 U. S. 202
was reversed by the circuit court of appeals, one of the Judges
dissenting, 30 F.2d 260, and a writ of certiorari was granted by
this Court. 279 U.S. 828.
The railway company was organized in 1915 under the laws of
Indiana with three classes of capital stock: shares of the par
value of $100, of Five Per Cent. Profit Sharing Preferred Stock A;
shares of the same par value of Five Per Cent. Convertible
Preferred Stock B, and shares of the same par value of Common
Stock. At the date of the bill, there were 693,330.50 shares of A,
24,211.42 B and 666,977.75 common. From 1915 to 1926, there were
net earnings on most of the years, but for a number of years, no
dividend, or less than five percent, was paid on Class A, while
$16,000,000 net earnings that could have been used for the payment
were expended upon improvements and additions to the property and
equipment of the road. It is not denied that the latter
expenditures were proper and were made in good faith, or that the
money could not have been applied to dividends consistently with
the duties of the Road. The Company now is more prosperous, and
proposes to pay dividends not only upon A, but also on B and the
common stock, but the plaintiffs say that it is not entitled to do
so until it has paid to them unpaid preferential dividends for
prior fiscal years in which it had net earnings that might have
been applied to them but were not.
The obligations assumed by the Company appear in its instrument
of incorporation and in the certificates of Preferred Stock A in
substantially the same words:
"The holders of the Five Per Cent. Profit Sharing Preferred
Stock A of the Company shall be entitled to receive preferential
dividends in each fiscal year up to the amount of five percent
before any dividends shall be paid upon any other stock of the
Company, but such preferential dividends shall be
noncumulative."
In the event of a liquidation, the holders
"shall be entitled to be paid in full out
Page 280 U. S. 203
of the assets of the Company the par amount of their stock and
all dividends thereon declared and unpaid before any amount shall
be paid out of said assets to the holders of any other stock of the
Company."
By the plain meaning of the words, the holders
"are not entitled, of right, to dividends, payable out of the
net profits accruing in any particular year, unless the directors
of the Company formally declare, or ought to declare, a dividend
payable out of such profits,"
in the first instance, at least, a matter for the directors to
determine.
New York, Lake Erie & Western R. Co. v.
Nickals, 119 U. S. 296,
119 U. S.
307.
We believe that it has been the common understanding of lawyers
and businessmen that, in the case of noncumulative stock entitled
only to a dividend if declared out of annual profits, if those
profits are justifiably applied by the directors to capital
improvements and no dividend is declared within the year, the claim
for that year is gone, and cannot be asserted at a later date. But
recently doubts have been raised that seem to have affected the
minds of the majority below. We suppose the ground for the doubts
is the probability that the directors will be tempted to abuse
their power in the usual case of a corporation controlled by the
holders of the common stock. Their interest would lead them to
apply earnings to improvement of the capital, rather than to make
avoidable payments of dividends which they do not share. But
whether the remedies available in case of such a breach of duty are
adequate or not, and apart from the fact that the control of the
Wabash seems to have been in Class A, the class to which the
plaintiffs belong, the law, as remarked by the dissenting Judge
below, "has long advised them that their rights depend upon the
judgment of men subject to just that possible bias."
When a man buys stock instead of bonds, he takes a greater risk
in the business. No one suggests that he has a right to dividends
if there are no net earnings. But the
Page 280 U. S. 204
investment presupposes that the business is to go on, and
therefore, even if there are net earnings, the holder of stock,
preferred as well as common, is entitled to have a dividend
declared only out of such part of them as can be applied to
dividends consistently with a wise administration of a going
concern. When, as was the case here, the dividends in each fiscal
year were declared to be noncumulative, and no net income could be
so applied within the fiscal year referred to in the certificate,
the right for that year was gone. If the right is extended further
upon some conception of policy, it is enlarged beyond the meaning
of the contract and the common and reasonable understanding of
men.
Decree reversed.