1. Capital stock or shares of a corporation -- especially the
unpaid subscriptions to such stock or shares -- constitute a trust
fund for the benefit of the general creditors of the
corporation.
2. This trust cannot be defeated by a simulated payment of the
stock subscription, nor by any device short of an actual payment in
good faith.
3. An arrangement by which the stock is nominally paid, and the
money immediately taken back as a loan to the stockholder, is a
device to change the debt from a stock debt to a loan, and is not a
valid payment its against creditors of the corporation, though it
may be good as between the Company and the stockholder.
4. The twentieth section of the Bankrupt Act was not intended to
enlarge the doctrine of setoff beyond what the principles of legal
or equitable setoff previously authorized.
5. A stockholder indebted to an insolvent corporation for unpaid
shares cannot set off against this trust fund for creditors a debt
due him by the corporation. The fund arising from such
unpaid-shares must be equally divided among all the creditors.
6. The relations of a stockholder to the corporation, and to the
public who deal with the latter, are such as to require good faith
and fair dealing in every transaction between him and the
corporation, of which he is part owner and controller, which may
injuriously affect the rights of creditors or of the general
public, and a rigid scrutiny will be made into all such
transactions in the interest of creditors.
About the 1st of April, 1865, and prior, therefore, to the
passage of the Bankrupt Act of 1867, the directors of the
Lumberman's Insurance Company of Chicago -- a company then recently
incorporated and authorized to begin business on a capital of
$100,000, of which not less than one-tenth should be paid in, the
residue to be secured -- invited subscriptions to the capital stock
of the company; stating, in most instances, to those whom they
invited to subscribe, that only 15 percent would be required to be
paid down in cash, and that the remaining 85 percent would be lent
back to the subscriber, and a note taken therefor, payable in five
years, with 7 percent interest, payable semiannually, secured
Page 84 U. S. 611
by collateral security satisfactory to the directors of the
company.
In this state of things one Sawyer about the said 1st of April,
1865, at the solicitation of one of the directors, subscribed for
fifty shares of stock. When called upon to close his subscription,
he was informed, as indeed all the subscribers were, that the
matter would be closed on the plan above mentioned.
Sawyer accordingly complied with the requirements, and gave his
check to the company for $5,000, the full amount of his stock, and
his note payable to it in five years from date, for $4,250, that is
to say, for 85 percent of the par value of the stock, with
interest, payable as aforesaid, and delivered to the company as
collateral security for the payment of his note satisfactory
securities, and received from the company a check for $4,250 or 85
percent of the par value of the stock, by way of, and as for a loan
thereof from the company. At the same time, Sawyer gave a written
authority to the company to sell the securities at public auction,
for cash, in case default should be made in the payment of the note
and the interest thereon.
Sawyer subsequently took up this note and gave in substitution
therefor another note, and new securities as collateral, with
power, as in the case of the former ones, to sell them on default
of payment of the note or interest.
At the time when the said original and substituted notes were
made, money was worth and could have been lent in Chicago at from 8
to 10 percent interest per annum, payable semiannually, on good
security.
The original transaction was regarded and treated by the company
and by Sawyer as a loan by the company to him, and his stock was
treated as fully paid for. At various times after the giving of the
original note, the company reported to the authorities of the state
of Illinois and of other states that its capital stock was fully
paid.
On the 8th and 9th day of October, A.D. 1871, a great fire
devastated the city of Chicago and rendered the Lumberman's
Insurance Company insolvent; and on the 25th of
Page 84 U. S. 612
January, 1872 -- it being at that time a notorious fact, one
well understood by the public, and one which Sawyer had good reason
to believe, that the said company was insolvent and unable to pay
its liabilities -- Sawyer purchased of a certain Hayes a
certificate of an adjusted loss for $5,000 against the company for
33 percent of its par value.
In June, 1872, after Sawyer had purchased this certificate of
adjusted loss, a petition in bankruptcy was filed against the
company, and it having been adjudicated a bankrupt, one Hoag was
appointed its assignee.
The thirteenth section of the Bankrupt Act enacts "that after
the adjudication in bankruptcy the creditors shall choose one or
more assignees of the debtor." And the fourteenth section, under
the marginal head of, "What is to be vested in the assignee by the
adjudication of bankruptcy," &c., enacts that:
"All the property conveyed by the bankrupt in fraud of his
creditors, all rights in equity, choses in action . . . all debts
due him or any person for his use, and all liens and securities
therefor, and all his rights of action for property or estate . . .
and for any cause of action which the bankrupt had against any
person . . . with the like right, title, power, and authority to
sell, manage, dispose of, sue for and recover the same, as the
bankrupt might or could have had if no assignment had been made,
shall, in virtue of the adjudication of bankruptcy and the
appointment of his assignee, be at once vested in such assignee:
and he may sue for and recover the said estate, debts and effects,
and may prosecute and defend all suits at law and equity, . . .
in the same manner and with the like effect as they might have
been prosecuted or defended by such bankrupt."
The fifteenth section of the act enacts:
"That the assignee shall demand and receive from any and all
persons holding the same all the estate assigned or intended to be
assigned under the provisions of this act."
The sixteenth section enacts:
"That the assignee shall have the like remedy to recover all
said estate, debts and effects, in his own name, as the debtor
Page 84 U. S. 613
might have had if the decree in bankruptcy had not been rendered
and no assignment had been made."
Among the effects of the company, which came into Hoag's hands
as assignee, was the already-mentioned note of Sawyer for $4,250,
with the securities assigned as collateral. Hoag demanding of
Sawyer payment of this note, Sawyer produced his certificate of
adjusted loss for $5,000 and insisted on setting it off against the
demand; asserting a right to do this under the twentieth section of
the Bankrupt Act, a section in these words:
"In all cases of mutual debts or mutual credits between the
parties, the account between them shall be stated, and one debt set
off against the other, and the balance only shall be allowed or
paid, but no setoff shall be allowed of a claim in its nature not
provable against the estate:"
"
Provided, that no setoff shall be allowed in favor of
any debtor to the bankrupt of a claim purchased by or transferred
to him after the filing of the petition."
Hoag refused to allow the setoff, and was about to sell the
collateral securities in accordance with the power given to him.
Hereupon Sawyer filed a bill in the court below to enforce the
setoff, in which he alleged, among other things, that the note
given by him to the insurance company was for money lent to
him.
The assignee, in his answer, denied that the note was for money
lent, and averred that it was in fact for a balance due by Sawyer
for his stock subscription, which had never been paid, and insisted
that such balances constituted a trust fund for the benefit of all
creditors of the insolvent corporation, which could not be made the
subject of a setoff against an ordinary debt due by the company to
one of its creditors. After the general replication, the case was
submitted to the court below on an agreed statement of facts. That
court decreed against the complainant, and from that decree the
case was brought by the present appeal to this Court.
Page 84 U. S. 618
MR. JUSTICE MILLER delivered the opinion of the Court.
The first and most important question to be decided in this case
is whether the indebtedness of the appellant to the insurance
company is to be treated, for the purposes of this suit, as really
based on a loan of money by the company to him, or as representing
his unpaid stock subscription.
The charter under which the company was organized authorized it
to commence business upon a capital stock of $100,000, with ten
thousand paid in, and the remainder secured by notes with mortgages
on real estate or otherwise. The transaction by which the appellant
professes to have paid up his stock subscription is, shortly, this:
he gave to
Page 84 U. S. 619
the company his check for the full amount of his subscription,
namely, $5,000. He took the check of the company for $4,250, being
the amount of his subscription less the 15 percent required of each
stockholder to be paid in cash, and he gave his note for the amount
of the latter check, with good collateral security for its payment,
with interest at 7 percent per annum. The appellant and the
company, by its officers, agreed to call this latter transaction a
loan, and the check of the appellant payment in full of his stock;
and on the books of the company, and in all other respects as
between themselves it was treated as payment of the subscription
and a loan of money. It is agreed that at this time the current
rate of interest in Chicago was greater than 7 percent, and it is
not stated as a fact whether these checks were ever presented and
paid at any bank, or that any money was actually paid or received
by either party in the transaction. It must therefore be treated as
an agreement between the corporation, by its officers, on the one
part, and the appellant, as a subscriber to the stock of the
company, on the other part, to convert the debt which the latter
owed to the company for his stock into a debt for the loan of
money, thereby extinguishing the stock debt.
Undoubtedly this transaction, if nothing unfair was intended,
was one which the parties could do effectually as far as they alone
were concerned. Two private persons could thus change the nature of
the indebtedness of one to the other if it was found to be mutually
convenient to do so. And in any controversy which might or could
grow out of the matter between the insurance company and the
appellant we are not prepared to say that the company, as a
corporate body, could deny that the stock was paid in full.
And on this consideration, one of the main arguments on which
the appellant seeks to reverse the decree stands. He assumes that
the assignee in bankruptcy is the representative alone of the
corporation, and can assert no right which it could not have
asserted. The weakness of the argument is in this assumption. The
assignee is the representative of the creditors as well as the
bankrupt. He is appointed
Page 84 U. S. 620
by the creditors. The statute is full of authority to him to sue
for and recover property, rights, and credits, where the bankrupt
could not have sustained the action, and to set aside as void
transactions by which the bankrupt himself would be bound. All
this, of course, is in the interest of the creditors of the
bankrupt.
Had the creditors of this insolvent corporation any right to
look into and assail the transaction by which the appellant claims
to have paid his stock subscription?
Though it be a doctrine of modern date, we think it now well
established that the capital stock of a corporation, especially its
unpaid subscriptions, is a trust fund for the benefit of the
general creditors of the corporation. And when we consider the
rapid development of corporations as instrumentalities of the
commercial and business world in the last few years, with the
corresponding necessity of adapting legal principles to the new and
varying exigencies of this business, it is no solid objection to
such a principle that it is modern, for the occasion for it could
not sooner have arisen.
The principle is fully asserted in two recent cases in this
Court, namely,
Burke v. Smith, [
Footnote 1] and in
New Albany v. Burke.
[
Footnote 2] Both these cases
turned upon the doctrine we have stated, and upon the necessary
inference from that doctrine, that the governing officers of a
corporation cannot, by agreement or other transaction with the
stockholder, release the latter from his obligation to pay, to the
prejudice of its creditors, except by fair and honest dealing and
for a valuable consideration.
In the latter case, a judgment creditor of an insolvent railroad
company, having exhausted his remedy at law, sought to enforce this
principle by a bill in chancery against the stockholders. The
court, by affirming the right of the corporation to deal with the
debt due it for stock as with any other debt, would have ended the
case without further inquiry. But asserting, on the contrary, to
its full extent,
Page 84 U. S. 621
that such stock debts were trust funds in their hands for the
benefit of the corporate creditors, and must in all cases be dealt
with as trust funds are dealt with, it was found necessary to go
into an elaborate inquiry to ascertain whether a violation of the
trust had been committed. And though the court find that the
transaction by which the stockholders had been released was a fair
and valid one, as founded on the conditions of the original
subscription, the assertion of the general rule on the subject is
nonetheless authoritative and emphatic. [
Footnote 3]
In the case before us, the assignee of the bankrupt, in the
interest of the creditors, has a right to inquire into this
conventional payment of his stock by one of the shareholders of the
company; and on that inquiry we are of opinion that, as to these
creditors, there was no valid payment of his stock by the
appellant. We do not base this upon the ground that no money
actually passed between the parties. It would have been just the
same if, agreeing beforehand to turn the stock debt into a loan,
the appellant had brought the money with him, paid it, taken a
receipt for it, and carried it away with him. This would be
precisely the equivalent of the exchange of checks between the
parties. It is the intent and purpose of the transaction which
forbids it to be treated as valid payment. It is the change of the
character of the debt from one of a stock subscription unpaid to
that of a loan of money. The debt ceases by this operation, if
effectual, to be the trust fund to which creditors can look, and
becomes ordinary assets, with which the directors may deal as they
choose.
And this was precisely what was designed by the parties. It
divested the claim against the stockholder of its character of a
trust fund, and enabled both him and the directors to deal with it
freed from that charge. There are three or four of these cases now
before us in which precisely the same thing was done by other
insurance companies organized
Page 84 U. S. 622
in Chicago, and we have no doubt it was done by this company in
regard to all their stockholders.
It was therefore a regular system of operations to the injury of
the creditor, beneficial alone to the stockholder and the
corporation.
We do not believe we characterize it too strongly when we say
that it was a fraud upon the public who were expected to deal with
them.
The result of it was that the capital stock of the company was
neither paid up in actual money, nor did it exist in the form of
deferred installments properly secured.
It is said by the appellant's counsel that, conceding this, it
is still a debt due by him to the corporation at the time that he
became the owner of the debt due by the corporation to Hayes, and
therefore the proper subject of setoff under the twentieth section
of the Bankrupt Act. That section is as follows:
"In all cases of mutual debts or mutual credits between the
parties, the account between them shall be stated, and one debt set
off against the other, and the balance only shall be allowed or
paid, but no setoff shall be allowed of a claim in its nature not
provable against the estate,
provided that no setoff shall
be allowed in favor of any debtor to the bankrupt of a claim
purchased by or transferred to him after the filing of the
petition."
This section was not intended to enlarge the doctrine of setoff,
or to enable a party to make a setoff in cases where the principles
of legal or equitable setoff did not previously authorize it.
The debts must be mutual; must be in the same right.
The case before us is not of that character. The debt which the
appellant owed for his stock was a trust fund devoted to the
payment of all the creditors of the company. As soon as the company
became insolvent, and this fact became known to the appellant, the
right of setoff for an ordinary debt to its full amount ceased. It
became a fund belonging equally in equity to all the creditors, and
could not be appropriated by the debtor to the exclusive payment of
his own claim.
Page 84 U. S. 623
It is unnecessary to go into the inquiry whether this claim was
acquired before the commission of an act of bankruptcy by the
company, or the effect of the bankruptcy proceeding. The result
would be the same if the corporation was in the process of
liquidation in the hands of a trustee or under other legal
proceedings. It would still remain true that the unpaid stock was a
trust fund for all the creditors, which could not be applied
exclusively to the payment of one claim, though held by the
stockholder who owed that amount on his subscription.
Nor do we think the relation of the appellant in this case to
the corporation is without weight in the solution of the question
before us. It is very true, that by the power of the legislature
there is created in all acts of incorporation a legal entity which
can contract with its shareholders in the ordinary transactions of
business as with other persons. It can buy of them, sell to them,
make loans to them, and in insurance companies, make contracts of
insurance with them, in all of which both parties are bound by the
ordinary laws of contract. The stockholder is also relieved from
personal liability for the debts of the company. But after all,
this artificial body is but the representative of its stockholders,
and exists mainly for their benefit, and is governed and controlled
by them through the officers whom they elect. And the interest and
power of legal control of each shareholder is in exact proportion
to the amount of his stock. It is therefore but just that when the
interest of the public, or of strangers dealing with this
corporation is to be affected by any transaction between the
stockholders who own the corporation and the corporation itself,
such transaction should be subject to a rigid scrutiny, and if
found to be infected with anything unfair towards such third
person, calculated to injure him, or designed intentionally and
inequitably to screen the stockholder from loss at the expense of
the general creditor, it should be disregarded or annulled so far
as it may inequitably affect him. [
Footnote 4]
Page 84 U. S. 624
These principles require the affirmation of the decree in the
present case, and it is accordingly
Affirmed.
MR. JUSTICE HUNT dissented, holding that the transaction was a
loan by the company to the appellant.
NOTE
At the same time with the preceding case were submitted and
adjudged two other cases,
Meyer v. Vocke, and
Jaeger
v. Same, both from the same court as the preceding case, which
though differing, both, in some respects -- the latter case
especially, which was a suit at law -- from the one just above
reported, were declared by the court to fall within the same
governing principles. In both cases, the decision below had been in
favor of the assignee in bankruptcy, and in both it was accordingly
affirmed in this Court.
[
Footnote 1]
83 U. S. 16 Wall.
390.
[
Footnote 2]
78 U. S. 11 Wall.
96.
[
Footnote 3]
See also Curran v. State of
Arkansas, 15 How. 304;
Wood v. Dummer, 3
Mason 305;
Slee v. Bloom, 19 Johnson 456, and numerous
other cases cited by the counsel for the appellees.
[
Footnote 4]
Lawrence v. Nelson, 21 N.Y. 158.
