Putnam's Handy Law Book for the Layman

by Albert Sidney Bolles

What acts are fraudulent are sometimes difficult to determine. Different courts interpret the same act sometimes in different ways. They do not differ so much on the application of the principle—for all acts of fraud, whether of omission or commission, directors are liable.

There is another series of acts for which they are liable, those of gross negligence. How gross must the act be? If it is so gross as to amount to a fraud, they are liable; if not so gross, if no fraud is found of any kind, nothing but negligence pure and simple, they are not liable at all. Most courts though go further and declare that if they are guilty of gross negligence, even though the smell or taint of fraud is not perceptible, they are liable. What, then, is the nature of the acts that constitute gross negligence? These cannot be easily defined, they differ in each case; so each case stands by itself. This is the conclusion of the highest court in the land and which is followed by many others. The same case therefore may be regarded differently by different tribunals. Thus some directors were tried not long since for wrecking a national bank. The lower court decided that all the directors were guilty of gross negligence, on appeal the reviewing court decided that the president only was guilty of fraud and acquitted the others.

DIVIDENDS.

One of the most cheerful things a corporation can do is to declare a dividend, especially if it be a large one. Until a dividend is declared the profits of a corporation are simply its assets, do not belong to the stockholders, and should it become insolvent must be used to pay creditors. But if a dividend has been declared and the corporation afterwards becomes insolvent before paying it, the stockholders may insist on its payment to them instead of paying it to the creditors.

Dividends must be paid from net profits. They can never be taken from the capital, for this would impair it and, if continued, result in the insolvency of the corporation. The laws everywhere forbid this, and, if violated, the directors are usually penalized. It is not an infrequent thing to declare a dividend that has not been earned in order to keep up the value of the stock, and enable the directors and their friends to sell out before the true condition of things has become public. Such action is a palpable fraud which the law recognizes and for which the guilty ones must answer.

Nor can dividends be declared out of borrowed money, for this is no profit, though money may be temporarily borrowed for this purpose. A profit may have been actually made, which may not have been reduced to money, that will justify a corporation in borrowing to pay a dividend, assured that the loan will soon be repaid. But the rule or practice is hedged about with limitations. Thus the premiums received by an insurance company and interest on its capital stock constitute the fund from which dividends are paid. Unearned premiums that have been paid do not form a part of that fund, for, while the risk is still running, the company may be obliged to pay them out in settling losses.

The profits of coal and other mining corporations may be divided without making any deduction for decrease in the value of the mine from extracting minerals. The same principle applies to all corporations organized to operate wasting property like a mine or patent, though in thus dividing all its net profits and accumulating no surplus the value of the property is lessened. Except such cases, before a corporation can lawfully set apart its profit as a dividend, a sufficient sum must be set aside to represent the wear and tear for the purpose of creating a fund to renew and improve the property of the corporation.

Dividends illegally declared and paid, not based on profits may be recovered either by the corporation or by its representative for the benefit of creditors. The fact, says Clark, that the directors acted in good faith under a misconception of the amount of profits possessed by the company or that were available for that purpose is immaterial. And if the capital stock of a company has been wrongfully paid away by the directors as dividends, it may be recovered by the creditors from anyone who is not an innocent receiver.

Whether a dividend shall be declared, and also the amount, are questions lying largely within the discretion of the directors. A company may earn a large net profit, yet the directors may think it should be used for improvements or kept for a future contingency in business, perhaps a time of business depression. Courts will not interfere in such cases. Corporations are sometimes organized with the well understood intention that the earnings shall be kept until a large surplus has been accumulated. On the other hand directors are not permitted to abuse their power; they must act in good faith. They cannot withhold dividends in order to depress the value of the property and buy its stock at a lower price.

Dividends must be distributed among the stockholders without unjust discrimination. "The dividends," said a court, "must be general on all the stock so that each stockholder will receive his proportionate share. The directors have no right to declare a dividend on any other principle. They cannot exclude any portion of the stockholders from an equal participation of the profits of the company." A stockholder cannot be deprived of his dividend because he purchased his stock a very short time before the action of the directors in declaring a dividend. On one occasion a person held bonds convertible into stock. Shortly after the conversion a dividend was declared. He was as much entitled to his dividend as any other stockholder.