It will be noted that payment by cash or other asset has the effect of decreasing the assets in order to decrease the liability for dividends; that payment by the issue of bonds or scrip cancels one kind of liability by the issue of another kind; whereas payment by the issue of the company’s own shares liquidates the liability by increasing proprietorship through the issue of stock, thus reinvesting in the business the portion of profits distributed as dividends.
Borrowing to Pay Dividends
The answer to the question as to the legality of borrowing funds to pay dividends may be inferred from the discussion above as to the status of a declared dividend. Where the question of legality is not involved in the declaration of dividends, i.e., where a declared dividend is legal in all respects, the legality of borrowing to pay the dividend is no more open to question than the legality of borrowing to pay any other legally contracted debt. Though there may be ample profits, the affairs of a corporation may be in such shape financially that the payment of a dividend would result disastrously to the shareholders and even to the creditors. Here it is possible to enjoin the directors from making payment. Action cannot be based on the illegality of making payment but on the abuse of discretion amounting to illegality in the declaration of the dividend.
If by so doing the finances of a corporation are not crippled, there is no more legal objection to borrowing to pay a dividend debt than to borrow to pay other debts. The courts have not always held so, however, but the weight of authority seems to be that where profits have been earned but become tied up in the enterprise the corporation may “borrow money on the faith of it and divide that,” may sell the property in which the profits are tied up and distribute the proceeds, or may borrow funds on the general credit of the corporation sufficient to meet the dividend payments.
It has even been held that where the income has been applied to the extension and betterment of the plant but the expenditure has been wrongly booked as an expense charge instead of being capitalized, the income so used may be recreated on the books by proper correcting entries and dividends declared and paid therefrom. To the accountant such a procedure seems perfectly correct, though the courts usually look askance at anything savoring of a payment of dividends out of capital.
The chief question involved, therefore, in borrowing funds for the payment of dividends is purely a financial one and the wisdom of such a procedure must be based on financial considerations. If from that standpoint, it is deemed feasible to borrow, the further question as to the form of the loan must be considered. Is it for the best financial interest of the company to borrow on short or long time, to create a floating or a funded debt, etc.—these points require consideration and can, of course, be answered only in the light of the conditions prevailing in each case as to the status of the working capital requirements.
Dividends Paid in Property, or by Borrowing on Property
Payment of dividends by means of property is unusual. It is seldom that the property held can be so divided as to serve this purpose without loss of value. Exception is found in the case of liquidating dividends, discussed on page 445, for which purpose often the shares of stock and bonds of the vendee may be distributed as payment to the vendor’s stockholders. More often, the stocks and bonds will be used as collateral for a loan with which to pay the dividend, or the real estate will be mortgaged for the same purpose, thus effecting a borrowing of funds, a discussion of which has just been given. Plots of land may sometimes be so divided as to be acceptable as equitable shares of a dividend, where the stock of a corporation is held in comparatively large blocks.
Bond and Scrip Dividends
Reference also has been made to the issue of the company’s own obligations for payment of the dividend. If financial policy dictates a long-term obligation, payment may be made out of any unissued bonds which the company may possess or by means of a bond issue for this specific purpose.