With regard to the first problem, law and practice are pretty well established and are in accord. The decision in the case of Lee v. Neuchatel Asphalte Co., L. R. 41, Ch. D. 1 (1889), has been followed quite generally. There it is held that “if the objects of the company include the sinking of capital in the acquisition of wasting property, even depreciation by waste is not necessarily a revenue charge, but may by the regulations be thrown upon capital.” And again, if a company is formed “to acquire and work a property of a wasting nature, for example, a mine, a quarry, or a patent, the capital expended in acquiring the property may be regarded as sunk and gone, and if the company retains assets sufficient to pay its debts, it appears to me that there is nothing whatever in the Act to prevent any excess of money obtained by working the property over the cost of working it from being divided amongst the shareholders.”
The inclusion in the periodic dividend of the return of a portion of the capital thus legalized is approved from a business standpoint on the ground that from its very nature the enterprise is speculative in greater or less degree and creditors are therefore sufficiently warned in their dealings with such a concern. Of course, if any such company expects to be permanently engaged in such enterprises it may be the part of wisdom to reserve from distribution all the capital or whatever portion of it may be necessary to finance each new undertaking. This is solely a matter of business policy, however. “It is for the shareholders to say whether or not they will put by a sinking fund to meet the waste.... They may if they like, but they are not bound so to provide.”[66]
As to the second question raised above, the general rule and practice in this country requires the making good of such losses first and the payment of dividends only from a resulting surplus. Shields v. Hobart, 172 Mo. 491, 517 (1902), states the prevailing law in the matter as follows: “Dividends can properly be declared only from the profits over and above the capital stock and the debts of the company.”
There may be circumstances in which this rule may work a very real hardship, and there is some support both in law and in a sense of justice under given conditions for the view that each period stands by itself so far as dividends are concerned, and that there is no need to use the profits of one period to make good the encroachments on capital of a previous period before paying a dividend. In such cases, the remedy is provided by a reduction of capital stock by the amount of the encroachment upon it. The payment of dividends on the remainder is then above question of law or the best business policy. In this connection the student is referred to [page 395, Chapter XXII], for an often-quoted decision of the English courts.
Liquidating Dividends
Any dividend which represents a return of any portion of the capital is to the extent of the portion returned a liquidating dividend. In other words, a payment to a stockholder on account of capital invested is a liquidating dividend. Such a dividend is met when the affairs of a corporation are being wound up. The liquidation of a corporation is discussed in a later chapter. Here the term is only defined because of its relationship to the dividend paid by a corporation which is operating a wasting asset of some sort. Usually the dividends paid by such a concern are not separated as to content, showing how much is profits and how much is a return of capital. A commendable exception to this is seen in the recent dividend notice of the Shattuck Arizona Copper Co., reading as follows:
The Board of Directors of Shattuck Arizona Copper Company has this day declared a dividend of Twenty-Five (25c.) cents per share, and a capital distribution of Twenty-Five (25c.) cents per share, payable January 19, 1918, to stockholders of record at the close of business December 31, 1917. Stock Transfer Books do not close.
November 30, 1917.
If a reserve for depletion of the property is set up, the offsetting charge to Profit and Loss results in that account’s balance showing the true profit. Dividends declared in excess of this represent the part of the capital being returned. In booking these liquidating dividends, the charge must, in strict theory, be made directly against Capital Stock account. A charge to an account called “Capital Liquidated as Dividends,” “Capital Returned to Stockholders in Dividends,” “Capital Payments,” or other self-explanatory title, may be made instead of the direct charge to Capital Stock. If so, such an account should be carried as a valuation account for Capital Stock and shown on the balance sheet as a deduction from Capital Stock.
Where, as has been allowed in connection with income tax returns, there has been a revaluation of properties operating wasting assets, and values in excess of the capital stock are established, such excess may be brought onto the books as a charge to Property or Plant and a credit to an account called “Property Surplus” or other similar title. Dividends thereafter declared, provided the depletion charge is made periodically, will be charged as to their profits against Surplus and, as to their return of capital portion, against Property Surplus until that is exhausted, after which the charge should be made as indicated above.