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Sanders v. Cuba Railroad Co.

Decided: February 20, 1956.

JOSEPH P. SANDERS, EMIL SCHUMACHER, ERIKA R. DANA, IRENE SIEGEL AND KATHERINE F. SHADEK, ON BEHALF OF THEMSELVES AND ALL OTHER HOLDERS OF 6% NON-CUMULATIVE PREFERRED STOCK OF DEFENDANT, THE CUBA RAILROAD COMPANY, SIMILARLY SITUATED, PLAINTIFFS-APPELLANTS,
v.
THE CUBA RAILROAD COMPANY, DEFENDANT-RESPONDENT



For affirmance -- Chief Justice Vanderbilt, and Justices Heher, Oliphant, Wachenfeld, Burling and Jacobs. For reversal -- None. The opinion of the court was delivered by Jacobs, J. Heher, J., concurring in result.

Jacobs

In the Chancery Division the parties made cross-motions for summary judgment; the defendant's motion was granted and the plaintiffs' motion was denied. The plaintiffs appealed to the Appellate Division and we certified under R.R. 1:10-1(a).

The plaintiffs (excluding Joseph P. Sanders who has disposed of his stockholdings) are the holders of 750 shares of the 6% non-cumulative preferred stock of the defendant The Cuba Railroad Company, a New Jersey corporation. The company has outstanding 100,000 shares of the preferred stock and 700,000 shares of common stock with no par value. All of the common stock is held by Consolidated Railroads of Cuba, a Cuban corporation; the New Jersey

corporation and the Cuban corporation have the same directors. Since 1933 no dividends have been paid on the preferred stock although annual earnings were in excess of $600,000 in each year from 1941 through 1948 and in 1951 and 1952. The net income for the aforementioned years was reserved by the defendant's board of directors as working capital and was apparently used in the business of the corporation. At the end of the fiscal year 1953 the defendant's earned surplus was in excess of $15,000,000; since then it has declined and its published annual report for 1955 indicates its earned surplus to be $12,225,000.

In 1951 the defendant addressed a communication to its preferred stockholders which embodied a plan for the exchange of preferred stock for cumulative income debentures and accrual certificates; the plan never became effective and was abandoned by the defendant for want of approval by the required percentage of preferred stock. However, in its communication the defendant had stated that, because of the unsettled legal questions involved, it did not admit that the holders of the preferred stock had "any equity with respect to the Company's past earnings"; subject to the foregoing, it then presented a computation showing the equity per share of outstanding preferred stock in the earned surplus of the company "if such equity were to be computed on the basis of the difference between the dividends actually paid in any year and the amount of net profits realized in such year limited by the maximum of $600,000 but without regard to debits and credits to surplus and without regard to the amount reserved by the Board of Directors for working capital." In their complaint the plaintiffs set forth the foregoing and sought judgment: (a) determining and declaring the rights of the plaintiffs and the other preferred stockholders, and the extent of such rights to accumulated dividends and their equity in earned surplus in preference to the common stock, and (b) fixing the amount now due to the preferred stockholders for accumulated dividends and ordering the defendant to pay such amount into court for distribution to the plaintiffs and other preferred stockholders. [21 NJ Page 82] In its answer the defendant denied that the plaintiffs were entitled to any dividends not declared by the board of directors. It set forth Article IV of its amended certificate of incorporation which provides, in part, that the holders of preferred stock "shall be entitled to receive from the net profits arising from the business of said corporation in each fiscal year, after reservation of such sum, if any, as shall have been fixed as a working capital, as provided in the Certificate of Incorporation of said corporation, a non-cumulative dividend up to, but not exceeding, six per cent." It also set forth Article VII of the original certificate of incorporation which provides, in part, that the directors are given the power to fix the amount to be reserved from time to time as a working capital before declaring a dividend among its stockholders and that "all amounts so reserved may be applied from time to time to the acquisition of property, as the directors shall from time to time determine, and neither the property of any description so acquired, nor any of its capital stock taken for any debt due the corporation, shall be regarded as accumulated profits, for the purpose of declaration or payment of dividends, unless otherwise determined by the directors." In paragraph 18 of its answer the defendant stated that pursuant to approval obtained at a 1940 stockholders' meeting and in accordance with Articles IV and VII, the defendant's board of directors has "annually reserved its entire net profits as a working capital and has employed the same in the retirement of outstanding mortgage and pledge indebtedness, in maintaining and repairing rolling stock and equipment and in purchasing new rolling stock and equipment." In paragraph 19 it stated that commencing with the fiscal year ending June 30, 1941 and thereafter up to and including the fiscal year 1953 the plaintiffs or their predecessors in interest had received notice that the board of directors had reserved the annual net profits as a working capital and were employing such net profits as aforesaid; that during that period the defendant had realized "aggregate net profits of $16,908,690.16 before debits or credits to earned surplus, and an aggregate of $15,014,639.57

after reflecting the net of such debits and credits"; and that "during the same period $11,808,724.41 was spent to retire $12,775,000 of indebtedness, and $19,567,738.45 was spent on additions to capital, less borrowings."

In the Chancery Division, Judge Grimshaw found that since the plaintiffs merely questioned the business judgment of the board of directors but did not make any charges of "dishonesty or fraud" he would not be justified in ordering a dividend payment as sought in paragraph (b) of the plaintiffs' prayer for relief. See Casson v. Bosman, 137 N.J. Eq. 532, 535 (E. & A. 1946); Murray v. Beattie Manufacturing Co., 79 N.J. Eq. 604, 610 (E. & A. 1911). This holding is not now questioned by the plaintiffs and is not encompassed in their appeal. With respect to paragraph (b) of the prayer for relief Judge Grimshaw stated that he was "somewhat at a loss" as to what the plaintiffs desired; he then said:

"If, as I think, they want this court to determine by way of a declaratory judgment the value of their equity in the present surplus of the defendant company, they are seeking something which they cannot get. The earned surplus is not a fixed amount. It may grow larger or smaller, depending on the needs of the business. A calculation of plaintiffs' interest in that surplus at this time would be simply an idle arithmetical exercise in which the court will not indulge.

On the other hand, it may be that the plaintiffs seek a declaratory judgment as to their rights in the event that the directors move to declare a dividend on the common stock. So far as the record shows, no such action is contemplated. But should it be, the rights of the preferred stockholders are not open to question. They have had consideration in a number of cases and a rule of conduct for the guidance of directors has been announced. Moran v. [United States] Cast Iron Pipe, [& Foundry] Co., 95 N.J. Eq. 389 (Ch. 1924), affirmed 96 N.J. Eq. 698 (E. & A. 1924); Agnew v. American Ice Co., supra [2 N.J. 291]. Further comment by me is unnecessary."

The rights of the holders of the non-cumulative preferred stock rest generally (apart from statutory restrictions) upon the terms of the defendant's certificate of incorporation. [21 NJ Page 84] See Ballantine, Corporations, 516, 517 (1946). Those terms conferred priority rights over common stockholders when there were annual net profits from which dividends could properly be declared. Agnew v. American Ice Co., 2 N.J. 291, 298 (1949). If there were no such profits in a given year, then no dividends could be paid to the preferred stockholders with respect to that year, then or thereafter. If, however, there were such profits the board of directors still had broad discretionary power to withhold any declaration of dividends and retain the profits as part of the corporation's working capital. If during a later year the corporation earned net profits and its board of directors wished to declare dividends to both the non-cumulative preferred stockholders and the common stockholders, the question would then be presented as to whether the preferred stockholders were entitled to receive the earlier dividends (which were passed though they could have been paid from the annual net profits) before the common stockholders received any dividends. This question finds neither a clear nor a specific answer in the defendant's certificate of incorporation, and its determination, in an appropriate case, will involve full consideration of the precise language of the certificate and the present scope and effect of New Jersey's so-called "Cast Iron Pipe Doctrine" or dividend credit rule. See Bassett v. United States Cast Iron Pipe & Foundry Co., 74 N.J. Eq. 668 (Ch. 1908), affirmed 75 N.J. Eq. 539 (E. & A. 1909); Moran v. United States Cast Iron Pipe & Foundry Co., 95 N.J. Eq. 389 (Ch. 1924), affirmed 96 N.J. Eq. 698 (E. & A. 1924); Day v. United States Cast Iron Pipe & Foundry Co., 95 N.J. Eq. 389 (Ch. ...


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